Contents

CMBS

Positives seen in Euro CMBS

The secondary European CMBS market has remained fairly active over the last week, albeit with a slight drop in selling from earlier in the month. Recent developments in respect of the GRAND restructuring proposal and the latest flurry of loan maturities (see SCI's loan events database for more) are being seen as positive for the sector.

"Fewer BWICs have been circulating lately than we were used to earlier in the month, but there is still fairly good activity occurring. Demand for senior paper is as strong as ever and we are also seeing a little more appetite for mezz," reports one trader.

That said, he notes that investors are still largely sticking to "the safer stuff" and there is not much traction on more distressed, lower cash price mezz. He is, however, encouraged by the fact that investors have begun paying more attention to second- and third-pays as well as the senior paper.

"Client activity is good. It still feels like there could be more trading going on if there was more paper available for sale, but buyers are being very selective and they know what they will buy and what they will not buy," the trader adds.

Meanwhile, early indications are positive for the proposed GRAND CMBS refinancing (SCI passim). "Heads of terms have been agreed with 44% of noteholders, so the restructuring appears to be moving ahead, which is good for the market," says the trader.

He continues: "There have also been a lot of loan maturities recently and they have been a slight positive too. While it is mixed news because there were a lot of extensions, some loans did also pay off. Generally, the outcomes were as expected, but there were some positives as well."

Finally, spreads remain largely unchanged - although they vary so greatly from deal to deal that the trader notes it is difficult to generalise. "The tightest seniors could be 100bp over and higher quality stuff is in the high-100s or low-200s. But the old conduit stuff is probably averaging somewhere in the low-400s, with second-pays in the 600s."

JL

RMBS

Non-agency RMBS holding steady

Activity in US RMBS has been slightly subdued over the last few days, given the focus on IMN's ABS East conference. Yesterday saw fixed-rate bonds in vogue in the non-agency secondary market, with SCI's PriceABS BWIC data indicating that prices were largely stable.

Interactive Data figures put non-agency BWIC volume at just a little over US$200m for the session. The firm notes: "Overall BWIC volume remains light, as market players slowly return to their seats from the ABS conference. Fixed-rate bonds contribute the majority of supply, a change from the prior session in which subprime paper dominated."

Prime fixed tranches, such as SASC 2005-16 1A2 and BOAMS 2005-10 1A3, were out for the bid. The former was talked at 100, up from the high-90s it was talked at on 22 August, while the latter was being talked in the mid/high-90s.

Hybrid names, such as INDA 2005-AR1 1A1 and WAMU 2005-AR10 1A2, were also offered and show a slight divergence in their price talk. INDA was talked in the low-80s, up from the 80 area talk from the prior session, but price talk of low/mid-90s for WAMU was slightly down from the mid-90s talk of the day before.

Subprime paper was also circulating yesterday. ACE 2007-WM1 A2A was up slightly as it was talked yesterday in the low/mid-30s and low-30s, having been talked solely in the low-30s in the prior two sessions. Talk was in the mid/high-20s and between the high-20s and low-30s on 5 September. CWL 2006-7 2A3 was talked in the mid-80s yesterday and at the same level in the two prior sessions as well.

JL

Structured Finance

SCI Start the Week - 29 October

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

Pipeline
Last week was fairly busy for the pipeline, although ABS was in the minority, with only one new deal announced. An RMBS, two CMBS and four CLOs also hit the market.

The ABS deal was Silverleaf Finance XV series 2012-D, a US$191.258m timeshare securitisation. The RMBS was the Russian RUB2.4bn Mortgage Agent ITB 1.

The CMBS deals entering the pipeline comprised US$835m BB-UBS Trust 2012-SHOW and US$1.111bn COMM 2012-CCRE4. Finally, the CLOs consisted of US$189m Gallatin CLO IV 2012-1, US$412m ING IM CLO 2012-4, US$400m KKR Financial CLO 2012-1 and US$350m Vibrant CLO.

Pricings
Considerably more ABS deals printed last week. Along with four new ABS, two RMBS, one CMBS and six CLOs were issued.

One of the ABS pricings was an auto securitisation (€809m Cars Alliance Auto Loans France V 2012-I), while the others were a student loan deal (US$471m Edsouth Indenture No.3 Series 2012-2), a timeshare deal (US$275m Sierra Timeshare 2012-3 Receivables Funding) and a credit card deal (US$777.78m Master Credit Card Trust II Series 2012-2). The RMBS comprised A$300m RESIMAC Bastille Trust Series 2012-1NC and US$1.16bn Springleaf Mortgage Loan Trust Series 2012-3, while the CMBS was US$351.4m NorthStar 2012-1 Mortgage Trust.

Finally, the CLO new issues consisted of: US$308m Golub Capital Partners CLO 14, US$461.2m Jamestown CLO I, US$374m Oaktree Enhanced Income Funding Series I, US$770m OHA Credit Partners VII, €721.9m Promise Neo 2012-1 and £1.51bn Sandown Gold 2012-2.

Markets
The US CLO market began last week slowly as IMN's ABS East conference took centre stage. Bank of America Merrill Lynch securitised products strategists note that the tone of the conference was particularly positive for CLOs. Over US$2bn in new deals priced during the week and secondary spreads remained flat.

The US ABS market saw supply really take off towards the end of the week, as SCI reported on Friday (SCI 26 October). Credit card paper was covered at very tight levels, with SCI's PriceABS BWIC data showing tranches such as BOIT 2003-A4 A4 covered at 2bp over Libor.

US CMBS was pretty stable over the week. Barclays Capital CMBS analysts report that tiering based on collateral quality has declined at the top of the capital structure, but "bond selection remains of paramount importance in the AJ and mezzanine space". Generic 2007 vintage LCF and AMs widened about 5bp to finish at swaps plus 140bp.

The US RMBS market also started slowly, although activity did pick up as the week went on, as SCI reported on Thursday (SCI 25 October). Prices were largely steady, with fixed-rate bonds particularly popular. Price talk for subprime paper was also up slightly.

However, fortunes were mixed for the European RMBS market, as SCI reported on Tuesday (SCI 23 October). JPMorgan RMBS analysts note that peripheral spreads tightened over the week, with core spreads largely unchanged.

They observe: "Italian and Spanish RMBS seniors are now 100bp tighter than at the beginning of September, at 350bp and 450bp respectively. Amongst the more plain vanilla asset classes, UK prime RMBS triple-As and Granite seniors also closed the week marginally tighter, while Dutch RMBS seniors were unchanged." 

Deal news
• Ocwen Loan Servicing and Walter Investment Management Corp were jointly awarded the highest and best bid for the mortgage servicing and origination platform assets of Residential Capital in last week's bankruptcy court-sponsored auction (SCI passim). The bid, with a purchase price of US$3bn, is subject to definitive documentation and bankruptcy court approval. Nationstar was the only other bidder for the assets.
• The Peter Cooper Village/Stuyvesant Town Tenants Association has confirmed its intention to bypass the special servicer and buy the property. Such a move would be a considerable positive for CMBS bondholders, but the fact that any resolution would have to be negotiated with the servicer provides a sticking point.
• Confirmation that an interest rate swap remains in place for the Mapeley loan, securitised in the European Loan Conduit No. 22 CMBS, has surprised the market. The news has prompted questions about the loan's recent restructuring.
• Two auctions were concluded on Auction.com last week for 12 of 16 properties collateralising the US$180.9m DRA-CRT Portfolio I loan, securitised in JPMCC 2005-CB13 (see also SCI's loan events database). The outcome indicates that the trust will see heavy losses as a result.
• Finance documents for the £114.61m Government Income Portfolio loan, securitised in the Windermere XI CMBS, have been amended to reflect an extension of the final repayment date for up to three additional periods (SCI 10 August). The restructure is subject to the satisfaction of various conditions.
• Ramius Structured Credit Group has replaced NIBC Credit Management as collateral manager for Belle Haven ABS CDO 2005-1. Moody's has determined that the move will not result in the withdrawal, reduction or other adverse action with respect to the deal's ratings.
• MJX Asset Management has been retained to act as liquidation agent for Independence III CDO. The collateral will be sold in two auctions, to be held in New York on 30 October.

Regulatory update
• SIFMA has submitted comments to the OCC, the Federal Reserve and the FDIC regarding the agencies' proposals to implement new capital standards under Basel 3. The letter was co-signed by the American Bankers Association and the Financial Services Roundtable.
• The Reserve Bank of Australia is introducing new eligibility criteria for RMBS in its operations. Issuers of RMBS will be required to provide more detailed information than is currently the case, covering both transaction-related data as well as information on the underlying assets.
• The US SEC has adopted a rule that establishes standards for how registered clearing agencies should manage their risks and run their operations, in accordance with the Dodd-Frank Act. The new rule requires registered clearing agencies that provide central counterparty services to maintain certain standards with respect to risk management and operations.
• The US government has filed suit against Bank of America, Countrywide Financial Corporation and Countrywide Home Loans. The government alleges Fannie Mae and Freddie Mac were sold fraudulent and defective mortgage loans by Bank of America and Countrywide that later defaulted, causing over US$1bn in losses.
• A group of Alabama homeowners has filed a putative antitrust class action in federal court in New York against a number of financial institutions for allegedly conspiring to manipulate Libor. According to the complaint, the alleged manipulation increased the interest rates on plaintiffs' mortgages, which were securitised in RMBS that the defendants backed or purchased.
• The Consumer Financial Protection Bureau (CFPB) has released its first annual report on private credit student loans. The agency's proposals are largely benign for the student loan ABS market, although there are some areas of concern.
• RBS Financial Products has settled with Nevada Attorney General Catherine Cortez Masto to resolve an investigation into the purchase and securitisation of subprime and option ARM mortgages in the state. RBS will pay US$42m and neither admits nor denies any wrongdoing.
• ISDA has announced its support of the Clearing Connectivity Standard (CCS) by working with Sapient Global Markets to provide programme management, governance and industry oversight. Sapient developed the standard to help improve OTC derivatives reporting and communication for asset managers, futures commission merchants (FCMs), central counterparties (CCPs) and custodians (SCI 15 August).
• The effects of a short-term White House plan intended to relieve some pressure on student borrowers are starting to surface in the student loan ABS sector. Fitch believes an up-tick in consolidation prepayments in some recent FFELP transactions is largely the result of students taking advantage of the Direct Loan Consolidation Program that President Obama invoked by executive authority in 2011.
• FINRA has ordered David Lerner Associates (DLA) to pay approximately US$12m in restitution to affected customers who purchased shares in Apple REIT Ten and who were charged excessive mark-ups. The agency alleges that DLA sold the illiquid REIT without performing adequate due diligence to determine whether it was suitable for investors and used misleading marketing materials that presented performance results without disclosing to customers that income from the REIT was insufficient to support the distributions to unit owners.

Deals added to the SCI database last week:
Ally Auto Receivables Trust 2012-5; ARI Fleet Lease Trust 2012-B; Chesapeake Funding series 2012-2; CIFC Funding 2012-II; COMM 2012-FL2; COMM 2012-LTRT; FREMF 2012-K21; Galaxy XIV CLO; GE Equipment Transportation Series 2012-2; Macquarie Equipment Funding Trust 2012-A; MSBAM 2012-CKSV; MultiCat Mexico series 2012-1; Nissan Auto Lease Trust 2012-B; NorthStar Student Loan Trust I series 2012-1; Paragon Mortgages 17; Svensk Autofinans 1; SVO 2012-A VOI Mortgage; West CLO 2012-1; WFRBS 2012-C9; World Omni Auto Receivables Owner Trust 2012-B.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-4; BSCMS 2006-PW14; CSMC 2006-3; DBUBS 2011-LC2; DECO 2005-UK1; DECO 2006-C3; DECO 2007-C4; DECO 8-C2; DECO 9-E3; EPICP BROD; EURO 19; EURO 24; EURO 25; EURO 27; FLTST 3; GCCFC 2007-GG9; GRF 2006-1; GRND 1; INFIN CLAS; INFIN SOPR; JPMCC 06-LDP7 & 06-CB16; JPMCC 2005-CB13; JPMCC 2006-CB15; JPMCC 2006-LDP7; JPMCC 2007-CIBC18; JPMCC 2007-LD11; JPMCC 2007-LDPX; LBCMT 2007-C3; MSC 2007-IQ14; PROMI 2; TITN 2005-CT1; TITN 2005-CT2; TITN 2006-1; TITN 2007-2; TITN 2007-CT1; WBCMT 03-C8 & WBCMT 03-C7; WBCMT 2007-WHL8; WINDM VII; WINDM X; WINDM XI; WINDM XIV; WTOW 2006-3.

Top stories to come in SCI:
Opportunities in CLO equity
Cross-sector relative value analysis
Focus on Australian RMBS

CLOs

Euro CLO resiliency underlined

European CLO tranches have lagged the strong rally in the broader credit markets over the past few months, due to perceived heightened asset default risks. However, a recent RBS study finds that legacy deals appear adequately structured to withstand severe default scenarios.

The RBS analysis subjects 188 different mainstream European CLO transactions, with a total balance of €70bn, to a range of stress scenarios. Under an extreme scenario, where defaults on loans with maturities before 2015 spike beyond normal ranges to 50% of all rated and unrated assets within CLO portfolios, only 3% of the European CLO universe (or 33 bonds) are shown to be principal-impaired. Moreover, the impact under this scenario is limited to junior bonds (originally triple-B and double-B rated), with no bonds in the belly of the capital structure and higher (original A-rated or better) affected.

Moody's estimates that 25% of unrated leveraged loans with debt maturing through 2015 could default, as a result of their refinancing burden - a figure that could double if external market factors shut the refinancing outlet around the same time. In contrast, rated borrower loans have pushed out their maturity profile, with 76% of debt in such companies maturing after 2016.

One significant reason for the limited impact of Moody's default forecast on CLOs is that the maturity distribution of underlying CLO loan portfolios differs quite markedly from the current maturity distribution in the unrated leveraged loan market, according to European asset-backed analysts at RBS. "Only 33% of the underlying collateral in the CLO market has maturities before 2015, compared to 54% of the overall leveraged loan market. This disparity underscores both the widespread manager asset-rotation styles of recent years (into longer-dated assets) and equally the lesser near-term refinancing needs of borrowers in CLO portfolios, relative at least to the broader loan market."

That aside, the current credit support in CLOs - both hard (par subordination) and soft (excess spread diversion) - appears to be sufficient to cushion the effect of a steep rise in default rates in CLO portfolios. The study also demonstrates that the credit resiliency in European CLOs looks poised to continue through any renewed period of leveraged loan market stress, due to adequate credit enhancement and other structural benefits, such as spread diversion triggers.

Moreover, the analysis measured potential impairment risks to CLO par values. With most bonds trading at discounts-to-par anywhere from 5%-10% for seniors to 35%-40% for the more levered parts of the capital structure, the extent of principal resiliency would of course be greater, albeit at the expense of some yield-to-maturity. Yet European CLOs continue to trade cheap versus comparable vanilla or other asset-backed credit.

"If anything, CLO price discounts appear to better reflect immediate portfolio break-up values rather than any reasonable loan default or loss forecast, but such asset liquidation valuations overstate lifetime portfolio values, in our opinion," the analysts conclude. "Within CLO capital structures, we find subordinated original triple-B rated bonds the most underpriced relative to risks - even with the benefit of the recent rally, these bonds still trade in the 1000dm context compared to single-A rated bonds in the 600dm region. Given the non-negligible principal risks in this part of the capital structure, stock selection in our view should focus on better quality portfolios/managers in amortising transactions that offer steadily increasing credit protection to the subordinated bonds."

CS

CLOs

Evolving CLO appetite observed

The CLO investor base continues to evolve, with diversification seen across real money, banks and hedge funds. A recent JPMorgan analysis confirms that investor interest in the asset class is increasing post-QE3 and ECB actions, as tail risks decline and risk premia are squeezed across spread product.

In terms of investor type observed in secondary US CLO BWIC activity, real money accounts for 52% of buying volume year-to-date, according to the analysis. Hedge funds and banks account for 24% and 23% respectively - albeit, as banks tend to buy triple-As, the larger notionals relative to other tranches may overstate their volume.

In contrast, hedge funds focus on CLO equity and double-B rated tranches for yield. Some hedge funds have undertaken more active trading strategies this year, taking advantage of the rally to sell out of certain bonds and reinvest the proceeds in others.

With respect to the primary market, medium to large banks have generally been the largest buyer of triple-A rated tranches so far in 2012. But some regional banks have also entered the market, given tightening in ABS spreads. For other investment grade tranches, real money appetite is emerging.

From an insurance company perspective, triple-A to single-A CLO bonds receive the same NAIC risk weight, but they're more likely to invest in triple-As or double-As to maintain liquidity. Meanwhile, as the new SSFA model entails high risk weights for anything with a subordination roughly below new issue CLO double-A paper, it seems unlikely that US banks will buy lower rated bonds in the future.

New issue BBB/BB to equity bonds remain the province of hedge funds, but CLO analysts at JPMorgan note interest from non-traditional clients (some pension funds, endowment funds and family offices) too. "CLO equity provides a high current income, which may be important to some of these investors - though many hedge funds are still interested in the convexity/price upside potential of discounted bonds."

Finally, the analysis highlights that the emergence of new investors is being echoed by CLO managers. Year-to-date issuance stands at roughly US$38bn, with 52 managers tapping the market, including 25 that issued their first post-crisis transaction.

CS

CMBS

CMBS prepay potential examined

With continued improvements in US commercial real estate liquidity and price transparency, not only will many more problem CMBS loans begin to be resolved, but several other dynamics could also be set in motion. AM and cuspier AJ tranches are expected to outperform in such a scenario.

One dynamic that could be set in motion is that because fewer loans are becoming newly delinquent, as loans are liquidated and delinquency pipelines are flushed, some of the uncertainty regarding what a deal's cumulative losses may be will diminish. MBS analysts at Bank of America Merrill Lynch believe that this will result in greater liquidity and increased trading, particularly among legacy AJ bonds.

Another dynamic is that as the pace of voluntary and involuntary prepayments increases, investors that own legacy front-pay or high-dollar price A4s could experience instances in which a bond's average life shortens considerably. Transactions with large foreclosure/REO buckets, a significant amount of A/B modified loans or those issued in 2004-2005 are particularly vulnerable to faster-than-expected prepays, according to the BAML analysts.

To determine how much of the outstanding conduit universe could voluntarily or involuntarily prepay more quickly than anticipated, they grouped outstanding fixed-rate conduit loans by year of maturity and categorised each loan as: locked out from prepaying or would incur a prepayment penalty; open and able to prepay freely; and in foreclosure or REO. Assuming that the US$24bn of loans currently in foreclosure or REO are liquidated over the next two years as a result of greater liquidity and price transparency, the analysts found that the maturity profile shifts forward to roughly US$21bn of loans that will effectively prepay ahead of schedule.

The severity at which the specific loans are liquidated will determine how much is allocated to losses and how much will prepay a deal's current-pay bond, while the extent to which borrowers prepay their loans to lock in low coupons will also increase the rate at which current-pay bonds factor down. Nevertheless, the better convexity profile of legacy AMs should result in continued outperformance by these bonds, with the basis between AMs and A4s likely to continue to narrow.

Further, wider-spread AMs should outperform tighter-spread ones as investors become increasingly comfortable with the risk profile of these bonds. In addition to AMs, the analysts recommend that investors consider lower dollar price AJs, many of which offer attractive yields given their risk profile across a range of scenarios.

"We believe that many of the cuspier AJ bonds that currently trade between US$70 and US$90 will continue to see their prices increase. This will not only be driven by strong market technicals, but also by the ongoing recovery in commercial real estate fundamentals," they conclude.

CS

CMBS

Auction results spell losses for CB13

Two auctions were concluded on Auction.com yesterday for 12 of 16 properties collateralising the US$180.9m DRA-CRT Portfolio I loan, securitised in JPMCC 2005-CB13 (see also SCI's loan events database). The outcome indicates that the trust will see heavy losses as a result.

According to MBS analysts at Barclays Capital, the auctions listed two packages: one consisting of seven office properties in Jacksonville, Florida (at 45% occupancy); the other comprising five office properties in Orlando, Florida (70% occupancy). The Jacksonville offices received a final bid for US$26.5m out of an allocated loan balance of US$85.6m, which met the reserve price and indicates that the transaction is likely to close. The Orlando offices were bid to US$33m out of US$51.7m of allocated balance, but whether this met the reserve wasn't disclosed.

Two properties each in Charlotte, North Carolina, and Rockville, Maryland were not listed. It remains unclear when they may be sold, as special servicer LNR has indicated that the Maryland properties are in 'value-add mode' and not ready for sale at present.

The auctioned assets could net proceeds of about US$53m, of which US$27m should account for the reimbursement of outstanding ASERs and advances. Based on the allocated balance of the 12 assets that were sold, the Barcap analysts estimate that losses could touch US$110m - although final losses could head higher, depending on where the remaining four assets liquidate.

The ASER reimbursements could flow into the deal in the coming remittance period, leading to full repayment of interest shortfalls on the B to F tranches and partial repayment to the G tranche. However, losses are unlikely to be applied to the loan until all properties are liquidated, which could lead to higher severities when the loan is finally extinguished as advances and ASER accrue. Eventual losses could write off the E to H tranches and may even reach into the D tranche, the analysts conclude.

CS

CMBS

Special servicing trends underlined

LNR Partners remains the largest US CMBS special servicer by outstanding balance, but its impact in terms of year-to-date loan liquidations has been even greater than is suggested by its market share. LNR also accounts for the largest average liquidated loan size so far in 2012.

According to FTN Financial figures, LNR Partners accounts for 37% of CMBS loan liquidations this year, even though its market share is only 27%. Similarly, C-III Asset Management has accounted for 30% of loan liquidations, more than would be suggested by its 23% market share. In contrast, CWCapital accounts for only 15% of the loan liquidations so far in 2012 - a lower percentage than indicated by its 24% market share.

Servicing timelines also appear to be remarkably similar this year, with the average recovery time being 16-17 months - regardless of loan size - for each of the 'big three' special servicers. The average recovery time for Midland and Torchlight has been only slightly longer than the overall average for all special servicers in 2012.

Meanwhile, although the average size for all loans liquidated with losses has been volatile from month to month over the past two years, it now seems to be trending upwards - indicating larger liquidated loans on average. "This makes sense, as special servicers have been more likely to liquidate smaller loans up to this point - delaying the more time-intensive resolutions of some of the larger troubled loans," FTN Financial CMBS strategists point out.

The average size of all loans liquidated with losses across all special servicers is approximately US$8.8m year-to-date. LNR has the largest average liquidated loan size at US$11.2m, while C-III has the smallest average at only US$5.8m.

Finally, California has accounted for the largest share of liquidated loans in 2012 at over 12%. However, California's share of all outstanding CMBS loans is almost 15%.

New York has also outperformed, given its overall market share of over 13%, by accounting for less than 5% of all liquidated loans so far this year. In contrast, Arizona, Nevada and Michigan all account for larger shares of total liquidated loans than is suggested by their respective overall market shares.

CS

RMBS

Servicing performance compared

In light of yesterday's ResCap MSR auction, MBS analysts at Bank of America Merrill Lynch have analysed the collateral performance of the securitised portfolio, as well as other non-agency servicing pools that have been transferred previously. Non-bank entities - such as Ocwen and Nationstar - have emerged as the biggest beneficiaries of these sales.

BAML's findings show little differentiation in servicing practices in the prime sector, which is marked by a higher use of short sales, lower severities and limited REO inventory. Jumbo loans serviced by ResCap have slightly shorter timelines and lower severities compared to the other servicers in the sector, with short sales accounting for 80% of all distressed sales (compared to a sector average of 67%). Loans serviced by ResCap also have shorter distressed timelines across all sectors.

For alt-A portfolios, Nationstar has employed significantly less short sales on the legacy Aurora loans (accounting for 28% of liquidations) compared to the rest of the sector (57%). However, the severity impact has been partially negated by the shorter time distressed loans spend in delinquency relative to other servicers.

Meanwhile, legacy option ARM loans serviced by Chase, as well as the ones acquired from Washington Mutual, have shown twice the voluntary prepay speeds (8% and 9% respectively) compared to the legacy EMC portfolio Chase acquired (4%). The higher rate of delinquency and higher severities of the legacy EMC loans suggest that the bonds are likely backed by weaker collateral, the analysts note.

The subprime sector shows the highest level of variation between servicers, according to the study. Nationstar and Ocwen have notably lower delinquency levels compared to bank servicers, as they tend to employ more aggressive modification practices.

The two specialty servicers also push distressed loans that do not qualify for modifications into foreclosure at a faster pace than the sector average. They are shown to have employed similar servicing practices with each of the portfolios they have acquired.

A number of servicing transfers have taken place over the last several years (SCI passim), driven by regulatory capital considerations, bankruptcy sales or companies looking to exit the mortgage industry. The trend is expected to accelerate with the advent of Basel 3, under which the value of MSRs will only account for up to 10% of common equity when determining a bank's Tier 1 capital requirements.

CS

Structured Finance

Multi-disciplinary approach

Hansol Kim, md in FTI Consulting's structured finance practice, answers SCI's questions

Q: How and when did FTI Consulting become involved in the securitisation market?
A: FTI is a multi-disciplinary consulting firm that is well known in the restructuring world, which falls under our corporate finance group. But we also have robust and established practices in forensic and litigation, economic, strategic communications and technology consulting. I run the structured finance group within the corporate finance practice.

You might be surprised, but FTI has been involved in the securitisation market for quite a while. We've acted as back-up servicer in many of the whole business transactions. The interim-management service FTI offers is a natural fit for this role. Our transaction advisory services group has also been active in collateral due diligence for a wide range of securitisations.

FTI may not be a household name in the structured finance world yet, but is a good fit for the comprehensive services I want to offer. It made sense to me as a way to get involved in the post-financial crisis environment in not only tackling the legacy asset overhang, but also facilitating the re-emergence of the securitisation market.

The multi-disciplinary nature of the firm means we can pull together, from 3700-plus professionals, the right resources for all the different complexities involved in dealing with today's volatile market conditions as well as evolving regulatory environment.

Q: What are your key areas of focus today?
A: What we offer can be broadly divided into risk management and valuation. On the risk management side, we've provided analytical support to prop desks and funds acquiring portfolios of secured and unsecured receivables, M&A advisory to major institutions in acquiring asset management platforms and oversight in various liquidating trust situations - just to name a few. But I'm really excited about some of the newer opportunities in which FTI is playing a control party role in new deals and funding structures.

The control party is essentially a risk management entity built into the transaction structure. The range of our responsibilities can be as wide as investors are willing to have us take on.

Looking back at the financial crisis, especially in the securitisation or structured transaction context, I think we all felt the need to have an independent entity either directly make credit decisions or cause decisions to be made in a timely manner. Monolines played this role in certain sectors, but they are now gone from the non-muni market. There's definitely a void that needs to be filled.

In this role, FTI can deal with different aspects of the securitisation - ranging from fairly benign events, such as additional note issuance, to more serious events such as defaults and servicer replacement. We also formulate strategies and recommendations to investors in those areas outside our purview.

Obviously, in these areas, investors have the ultimate say, but half the battle is letting them know what their options are and what the related consequences might be. I think FTI can add most value in more complicated transactions, which contain flexible or complicated structures and/or asset substitutions.

On the valuation front, we're doing work on both legacy and new deals. On the legacy side, we do periodic valuation work for government entities, trustees overseeing bankrupt REITs, investors looking to make hard decisions on their exit strategy and others with exposure to legacy assets.

Work on new deals is mainly in relation to banks disposing of non-core assets. With all the forthcoming regulatory changes and increased capital requirements, banks recognise that the cost of holding certain assets will rise, which makes them a fairly motivated seller.

There's plenty of private equity and hedge fund money chasing these assets and, once acquired, they need to be marked properly. CFOs and others signing off on their valuations are more than ever concerned about making sure that there's a proper valuation protocol in place and there are logical and market-based assumptions behind these assets.

Q: How do you differentiate yourself from your competitors?
A: FTI is unique in that it combines the flexibility of a small firm with the breadth and depth of a larger one. We have such a diverse group of professionals, including turnaround specialists, forensic accountants, former SEC and FTC professionals, Nobel laureates, economists and former chief executives.

We can quickly bring the right combination of these specialists together to focus on a particular project at hand, yet we have the corporate heft to provide long-term stability, having been around for 30 years. It would be difficult for smaller shops to take on the control party role, for instance, because rating agencies and investors need to know that the adviser will be there for the long haul.

Q: What major development do you need/expect from the market in the future?
A: I think we'll continue to see more banks de-leveraging, resulting in more assets trading hands. Sellers, in my opinion, are more reasonable in terms of price expectations these days and there are plenty of buyers waiting in the wings.

So far, US banks have generally done a better job at this than their European counterparts. I'd say we're not even close to half way through tackling the overhang on banks' balance sheets.

Ultimately, assets trading hands can be viewed as a precursor to the broader securitisation market rebooting, even though the US RMBS market continues to lag. In order for this important sector to gain traction, we need clarity and actual implementation of Dodd-Frank, which does not appear imminent.

But, at some point, securitisation take-outs should become more common in order for buyers to refinance the assets or monetise them. Securitisation is the next logical step - it certainly seems like a good source of permanent financing, doesn't it?

CS

Structured Finance

UBS launches balance sheet overhaul

UBS has announced plans to become "less capital and balance-sheet intensive", by cutting an estimated 10,000 jobs and winding down certain fixed income business lines. Among the aims outlined in the plan is a reduction of Basel 3 risk-weighted assets (RWAs) in the bank's legacy portfolio to approximately Sfr25bn by end-2017.

"By concentrating on its traditional strengths in advisory, research, equities, FX and precious metals and by exiting business lines - predominantly those in fixed income that have been rendered uneconomical by changes in regulation and market developments - UBS will reduce costs significantly while driving further efficiencies across the group more rapidly. By 2015, UBS is likely to have a headcount of around 54,000," the bank states.

The investment bank will consist of two core client segments under the plan: corporate client solutions and investor client services. Corporate client solutions includes all advisory and solutions businesses, plus execution that involves corporate, financial institutions and sponsor clients. This segment is expected to generate around one-third of the investment bank's revenues and utilise around 15% of its Basel 3 RWAs.

Investor client services includes execution, distribution and trading for institutional investors, and will provide support to UBS's wealth management businesses. In flow rates and credit, risk facilitation capabilities aligned to the bank's debt capital market and wealth management franchises will be maintained. This segment is expected to generate the remainder of the investment bank's revenues and utilise around 85% of its Basel 3 RWAs.

The lines of business to be exited will include many that do not meet their cost of capital sustainably or are in areas with high operational complexity or long tail risks that are likely to weigh on future returns. Exited businesses and positions will be transferred to, and reported in, the corporate centre from 1Q13.

An experienced team, led by Carsten Kengeter, has been appointed to manage the exited businesses and positions to optimise risk and returns over time. This team will manage the sale or exit of these positions within the robust oversight structure that has successfully supported UBS' risk-weighted asset reduction in its legacy portfolio.

CDO

ABS CDO manager replaced

Ramius Structured Credit Group has replaced NIBC Credit Management as collateral manager for Belle Haven ABS CDO 2005-1. Moody's has determined that the move will not result in the withdrawal, reduction or other adverse action with respect to the deal's ratings. In reaching its conclusion, the agency considered the experience and capacity of the replacement manager.

CLOs

TFG makes affiliate acquisition

Tetragon Financial Group has acquired Polygon Management's asset management business and its interests in LCM Asset Management and GreenOak Real Estate. The acquisition is part of Tetragon's ongoing strategy to expand its asset management platform.

The Polygon acquisition includes the London and New York asset management businesses and infrastructure platform as well as Polygon's 25% stake in LCM and 13% stake in GreenOak, taking Tetragon's ownership of the former to 100% and of the latter to 23%. Certain non-core Polygon assets were not included in the transaction.

The transaction is being entirely financed by currently issued and outstanding Tetragon non-voting shares. Tetragon has also announced its intention to repurchase its non-voting shares up to a maximum value of US$150m.

RMBS

RBS settles over Nevada mortgages

RBS Financial Products has settled with Nevada Attorney General Catherine Cortez Masto to resolve an investigation into the purchase and securitisation of subprime and option ARM mortgages in the state. RBS will pay US$42m and neither admits nor denies any wrongdoing.

The settlement ends an investigation into potential misrepresentations by lenders such as Countrywide and Option One to consumers who took out subprime loans and payment option ARMs that were bought and securitised by RBS between 2004 and 2007. Misrepresentations include deceiving customers about the actual interest rate payable and the appraised value of the property as well as using a teaser rate that borrowers could meet for mortgages with an adjusted rate which borrowers could not afford.

Masto notes that RBS played a key role in making the market for payment option ARMs and examined the extent to which it knew about lenders' allegedly deceptive practices through due diligence when it bought the loans. As well as paying the settlement, RBS must also commit to certain changes in how it securitises Nevada mortgages in the future.

RBS has pledged to only finance, purchase, or securitise Nevada subprime mortgage loans if it has engaged in a "reasonable review" of such loans. RBS will not securitise a loan where it has reason to believe that: the lender has not adequately disclosed to the borrower the existence of an initial teaser rate, the potential negative amortisation on the loan, the maximum adjusted interest rate or payments and the potential for payment shock if payments increase after a loan reset or recast; or the borrower's stated income was unreasonable and that the borrower would not have qualified for the loan without the overstatement.

RMBS

US government sues BofA, Countrywide

The US government has filed suit against Bank of America, Countrywide Financial Corporation and Countrywide Home Loans. The government alleges Fannie Mae and Freddie Mac were sold fraudulent and defective mortgage loans by Bank of America and Countrywide that later defaulted, causing over US$1bn in losses.

It is the first civil fraud suit brought by the Department of Justice concerning mortgage loans sold to Fannie Mae or Freddie Mac. Countrywide and Bank of America are alleged to have "systematically removed every check in favour of its own balance" from 2007 to 2009 through a process called the high-speed swim lane (HSSL), also known as 'the hustle'.

Countrywide and Bank of America are accused of casting aside underwriters, eliminating quality controls, incentivising unqualified personnel to cut corners and concealing all resulting defects. Internal Countrywide documents state that the goals of the hustle were high speed and high volume, with the removal of any quality control measure that might slow the origination process down.

The toxic products were then sold to the GSEs as good loans, the government says. Countrywide, both independently and later as part of Bank of America, was the largest provider of residential mortgage loans to the GSEs, which were then pooled into RMBS and sold to investors.

The complaint seeks civil penalties under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 and treble damages and penalties under the False Claims Act, for over US$1bn in losses suffered by the GSEs.

ABS

ILS fund to target Japanese investors

Asuka Asset Management Co has established a Bermuda insurance-linked securities (ILS) investment fund, with an initial seed investment of approximately US$40m. The master-feeder fund structure, dubbed Asuka ILS Opportunities Unit Trust, will feed into a Bermuda master mutual fund company called Asuka ILS Opportunities Fund.

The fund will initially target sophisticated and institutional investors in Japan. It will be sub-managed by investment manager Eastpoint Asset Management, which is headed by ceo Masahide Kitade, who was previously regional director/head of Japan business at Aon Asia.

Peter Ch'ng and Chris Page of Conyers Dill & Pearman's Bermuda office acted for Asuka and Eastpoint, in association with Japanese fund lawyers Anderson Mori & Tomotsune.

ABS

Up-tick for FFELP consolidation prepays

The effects of a short-term White House plan intended to relieve some pressure on student borrowers are starting to surface in the student loan ABS sector. Fitch believes an up-tick in consolidation prepayments in some recent FFELP transactions is largely the result of students taking advantage of the Direct Loan Consolidation Program that President Obama invoked by executive authority in 2011.

"While difficult to quantify the full impact, we estimate the up-tick was limited and may have resulted in a one-time increase in consolidation prepayments to approximately 10% from the current 1%-3%. In our view, a sustained increase at such level for several years would be needed to cause any meaningful negative impact on some of existing FFELP ABS ratings. We believe this scenario is unlikely, as the programme has ended," the agency notes.

Given the political environment and moderate participation in the programme, Fitch also believes that future consolidation programmes will not be forthcoming soon. The US Department of Education initially projected it could consolidate US$38bn in student loans and approximately US$12bn-US$13bn were consolidated under the programme.

"In our view, the programme faltered, in part, because it did not offer an incentive significant enough for borrowers to consolidate their loans. To make consolidations more attractive, taxpayers would likely need to shoulder some of the cost. With potential federal budget cuts and fiscal cliff pressures looming, we believe that this type of programme will not be politically attractive in the near term," the agency adds.

President Obama invoked executive authority in 2011 to create the programme, which was open for the first half of 2012. It allowed borrowers to consolidate most student loans into one direct government loan, reduce the interest rate on their loan by up to 0.5%, access more flexible payments and renew deferment. It was available to 5.8 million borrowers that had both Direct Loans and a Federal Family Education Loans.

ABS

Argentine sub-sovereign deals downgraded

Moody's has downgraded the ratings of five Argentine securitisations linked to sub-sovereign entities. The move follows its downgrade of the ratings of Argentine provinces and municipalities on 17 October.

The rating action affects: Fideicomiso Financiero de Infraestructura Electrica - Serie I and III; Fideicomiso Financiero Programa Federal Plurianual de Construcción de Viviendas - Provincia del Chaco - Serie I and II; and Fideicomiso Financiero Programa Plurianual de Construcción de Viviendas - Provincia de Buenos Aires. Fideicomisos Financieros Municipalidad de Rio Cuarto Serie I and II are unaffected, however.

In terms of Fideicomiso Financiero Programa Federal Plurianual de Construcción de Viviendas - Provincia de Buenos Aires, Moody's considers that the transaction is highly linked to the credit risk of the Province of Buenos Aires, which was downgraded from A3.ar to Baa3.ar. The deal is backed by resources of the Housing Agency of the Province of Buenos Aires (IPVBA) and by federal co-participation taxes, as an additional guarantee.

The agency has not provided credit for the assignment of co-participation revenues, however, as similar assignments have been legally challenged in the past. But it notes that to date collections from the IVPBA have been sufficient to make principal and interest payments on the VRD without resorting to the assigned co-participation cashflows.

With respect to Fideicomiso Financiero Plan Plurianual de Construcción de Viviendas - Provincia de Chaco Serie I and II, Moody's considers that the transactions are highly linked to the credit risk of the Province of Chaco, which was downgraded from B3 (global scale, local currency) and A3.ar (national scale) to Caa3 and Caa2.ar. The deals are backed by resources of the Housing Agency of the Province of Chaco (IPDUV Chaco) and by FONAVI resources, as an additional guarantee.

However, unlike the assignment of co-participation taxes, the assignment of FONAVI resources to a financial trust has never been legally challenged in Argentina. This is reflected in the rating, which is higher than the rating of the province of Chaco by one notch in the global scale and three notches in the national scale.

The ratings of Fideicomiso Financiero Infraestructura Electrica Serie I and III, meanwhile, are now at the same level as the current ratings of the Province of Chaco. Moody's views these transactions as highly linked to the credit risk of the Province of Chaco because the Province creates and establishes the legal framework for the specific tariff that constitutes the underlying asset of the trust, while the seller (Secheep), the collection agent (Nuevo Banco del Chaco) and the trustee (Fiduciaria del Norte) are all entities that have the Government of the Province of Chaco as the main shareholder.

The main underlying asset of the trust is a specific tariff paid by most users of the electric service in the Province of Chaco. Electricity is provided by the Provincial company Secheep (Servicios Energeticos del Chaco Empresa del Estado Provincial).

The trust agreement bans the Province from reducing the specific tariff in terms of nominal amount or duration. If the Province interferes with the tariff, investors will have a legal claim against the Province.

The current ratings of Fideicomisos Financieros Municipalidad de Rio Cuarto Serie I and II are not affected because Moody's believes there is a lower probability of interference with the assignment of the assets to the trust. This is due to: the relatively short term to maturity; the high interest debt service coverage ratio; the relative low bond factors; and the amounts available in the liquidity reserve fund.

ABS

Swiss Re preps cat bond first

Swiss Re is in the market with what is being hailed as a catastrophe bond first. The senior tranche of the reinsurer's second Mythen Re transaction is exposed to both a catastrophe peril and mortality risk.

Rated by S&P, the dollar-denominated deal comprises 4.2-year single-B plus class A notes and four-year single-B minus class Cs. The class A notes will provide protection on a per-occurrence basis from US hurricane losses and UK mortality in the covered area on an aggregate basis, while the class C notes cover losses from US hurricane in the covered area on a per-occurrence basis.

Specifically, the notes will be exposed to major North Atlantic hurricane risk in selected US states between November 2012 and November 2016 as modelled by AIR Worldwide Corp. The mortality risk exposure covers England and Wales between January 2012 and December 2016, as modelled by Risk Management Solutions.

The class A notes will cover losses from US hurricanes and UK mortality between the attachment level of 620.2-845.5 and 125%-135% respectively. The class C notes will cover losses from US hurricanes between the attachment level of 372.7 and 511.4 on an annual aggregate basis. The covered area for hurricane is: Alabama, Connecticut, Delaware, District of Columbia, Florida, Georgia, Louisiana, Maine, Maryland, Massachusetts, Mississippi, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Puerto Rico, Rhode Island, South Carolina, Texas, Vermont and Virginia.

S&P points out that the potential for modelling error in respect of the transaction is greater than it would be for a catastrophe bond using a parametric index, as the modelling for an industry loss trigger uses all modules within the catastrophe model, not just those associated with generating the hazard at each location. In addition, it notes that there are differences in the modelled probabilities of attachment between the three main catastrophe modelling agencies - AIR, EQECAT and RMS.

Structured Finance

Korean Covered Bond Act welcomed

The Korean Financial Services Commission (FSC) last week published a draft Covered Bonds Act. The bill is expected to provide strong legal protections for the sector, as well as cover pool registration and an independent party to monitor the management of cover pools.

Similar to the covered bonds laws in other jurisdictions, the bill clearly specifies the dual recourse nature of covered bonds, according to Moody's in its latest Credit Outlook publication. Investors in covered bonds will have priority claims against the cover pool and recourse against the issuer on any shortfall amount.

The bill also enhances legal certainty and avoids legal disputes, by specifying both the issuer's primary obligation to repay the covered bonds and investors' rights to submit a senior unsecured claim against a defaulting issuer, as well as participate in its bankruptcy and rehabilitation proceedings. Additional details that are credit positive with respect to protecting investors' rights and interests include the strong separation of the cover pool from the issuer's bankruptcy assets. In addition, it expands the eligible assets list to include cash acquired through management, operation and disposition of the assets, as well as derivative transactions entered into pursuant to the covered bond issuance plan.

Meanwhile, requirements to register the details of the covered bonds issuance with the FSC and to keep a separate ledger for the cover pool further enhance protection, Moody's notes. The bill provides additional checks and balances for a covered bond transaction by stipulating that a qualified cover pool monitor has to conduct independent monitoring of the cover pool. The duties of the cover pool monitor include cover pool audits, inspections on compliance with the covered bond issuance plan and relevant laws and regulations, a review of the issuer's management, disposition and execution of the cover pool, and preparation and submission of a quarterly report to the regulator.

CDS

EU urged to uphold investor choice

ISDA has welcomed last Friday's European Parliament vote on proposed amendments to MiFID and its accompanying regulation MiFIR. The vote paves the way for negotiations between the Parliament, Council and Commission, which will ultimately lead to the adoption of final MiFID/MiFIR rules.

ISDA believes that many of the changes put forward by the Parliament support the ambitions behind the review of the existing MiFID framework: a safer, sounder, more transparent and more responsible financial system, working for the economy and society; and more integrated, efficient and competitive EU financial markets. In the interests of promoting transparency, MiFIR will for the first time require certain derivatives contracts - those that are both cleared through a central counterparty (CCP) and deemed sufficiently liquid - to trade on a trading venue.

The Parliament has recognised the need to develop further this liquidity test: it acknowledges that block trades are less likely to be liquid, and it has ensured that trading venues will be obliged to provide pre-trade price data only for liquid contracts. "We believe that these changes are vital for OTC derivatives, which are not mass-produced for secondary-market turnover, which can be customised, and which typically trade infrequently," the association says. "This also reflects the spirit of the G20 commitment of September 2009, which stated that derivatives transactions should be brought onto platforms only "where appropriate" - liquidity is very clearly part of this."

ISDA is, however, concerned that the Parliament text simultaneously limits investor choice on how to negotiate such financial contracts. For example, the Parliament is proposing limitations on when derivatives can be executed on an Organised Trading Facility, effectively pushing transactions towards other, more exchange-like categories of venue, and thereby reducing the diversity of available platforms in a manner contrary to the desire to promote systemic resilience. At the same time, the Parliament has defended a ban on the use of proprietary capital by operators of Organised Trading Facilities, crimping their ability to fulfil customers' needs, according to the association.

ISDA believes that maintaining an appropriate degree of investor choice over how and where trades are executed - and allowing dealers to serve their customers by making markets - is vital to ensuring safe and efficient OTC derivatives markets. Policymakers should proceed with caution to ensure that the ambitions of the MiFID project are not undermined by the promotion of the equities exchange-trading model, which is not a suitable template for reform of OTC derivatives markets.

CDS

Ex-EU CDS index in the works

Markit is set to make available for trading on 1 November a new sub-index - Markit iTraxx SovX CEEMEA ex-EU - which was launched as a theoretical index on 20 September. This new sub-index comprises the subset of constituents of the Markit iTraxx SovX CEEMEA index that do not form part of the European Economic area. The weights of the entities removed from the Markit iTraxx SovX CEEMEA index to form the Markit iTraxx SovX CEEMEA ex-EU index have been redistributed on a prorated basis between the remaining entities.

CLOs

A-to-E success highlighted

An estimated US$67bn of CLO amend-to-extends (A-to-Es) were completed by end-3Q12 in the US, compared to US$53bn during all of 2011. Such activity has helped push the bulk of loan maturities out into 2017 and 2018.

Bank of America Merrill Lynch figures put the amount of loans coming due in 2013 and 2014 as US$10bn and US$56bn respectively, down significantly from the US$66bn and US$175bn that was originally scheduled to mature. In August and September alone, US$5.1bn and US$9.1bn of A-to-Es were completed.

A-to-Es remain one of the cheapest ways for issuers to extend their maturities, BAML CLO analysts note. "On average, in 3Q12, companies paid 25bp in fees and saw their spreads increase by 142bp to execute A-to-Es. Despite the fees and additional spread, the average yields paid are still very attractive relative to new refinancings or high yield take-outs. The lower yields are somewhat balanced by shorter terms, where A-to-Es extend maturities by 2.7 years versus 7.6 and 5.5 years for high yield take-outs and refinancings respectively."

However, A-to-E activity has also pushed maturities out closer and in some cases past the maturity of the CLO liabilities. In conjunction with continued reinvestment in some CLOs even after the end of the reinvestment period, A-to-Es have increased the percentage of assets maturing after the liabilities in some deals, according to the analysts.

"The mismatch in funding duration has not only introduced increased extension risk, but also market value risk to the extent assets need to be disposed of when the CLO matures. The impact, if any, would primarily fall on junior mezzanine tranches, as senior tranches should have already amortised down well before the legal finals," they observe.

CMBS

CMBS default rates stabilising

The cumulative default rate for fixed-rate US CMBS increased slightly to 13.5% during 3Q12 from 13.2% the previous quarter, according to Fitch. New defaults for 3Q12 totalled US$2.2bn across 119 loans, compared with US$2.1bn across the same number of loans in Q2.

The agency notes that the pace of new issuance - which increased almost three-fold compared to the start of this year (US$6.2bn last quarter, compared to US$2.1bn in 1Q12) - is helping to stabilise CMBS default rates. Office leads new defaults for 2012 at over 50%, with 43 loans totalling US$1.4bn becoming delinquent for the first time this quarter. However, the office cumulative default rate still trails the other main property types.

Three loans with an outstanding balance greater than US$100m defaulted during the quarter: US$678m One Skyline Tower (securitised in BACM 2007-1, JPM 2007-LDP10 and GE 2007-C1); US$171m Colony IV Portfolio B (JPM 2006-LDP9); and US$116m Koger Center (CSMC 2007-C1).

CMBS

Moorestown Mall watchlisted

Morningstar has added the US$53.8m Moorestown Mall loan - securitised in LBUBS 2003-C7 - to its watchlist, due to a decline in the net cashflow debt service coverage ratio (NCF DSCR). The NCF DSCR fell below breakeven through 2Q12.

For the six-month period ended 30 June, the NCF DSCR was 0.82, with net cashflow of US$1.7m. Occupancy was reported at 92%. The NCF DSCR and net cashflow for the 12 months ended 31 December 2011 were 1.14 and US$4.7m respectively, while occupancy was reported at 93%.

The decline in DSCR is attributed to declining rental rates within the market, with tenants successfully negotiating more favourable terms as leases expire. Scheduled rollover for the near term is low, with leases for only 2% of the GLA scheduled to expire through June 2013. Leases for an additional 2% of the GLA are scheduled to expire through June 2014, according to Morningstar.

The loan sponsor is Pennsylvania Real Estate Investment Trust (PREIT), which reportedly plans to replace the current United Artists Theater with a 12-screen Regal Premium Experience theatre and open a series of new restaurants within the mall.

Morningstar considers the decline in NCF DSCR through the first half of 2012 as a low to moderate near-term credit concern, especially given loan maturity is set for 11 June 2013, with an estimated US$52.7m balloon. A preliminary Morningstar analysis of collateral estimates a 111% LTV, suggesting there is value deficiency. A ratio at this level indicates potential refinancing difficulty, although mitigating this concern somewhat is the experience of PREIT as the sponsor.

CMBS

NorthStar CMBS slammed

Fitch has released an unsolicited comment on NorthStar 2012-1 Mortgage Trust, the first US CMBS backed by transitional collateral. The agency says that the US$351m transaction, which priced last week at a weighted average coupon of 163 over Libor, lacks sufficient credit enhancement to achieve triple-A ratings.

While approached to provide feedback on NorthStar 2012-1, Fitch was ultimately not asked to rate the deal due to its more conservative credit stance. The agency says that the class A notes, as structured with 56.5% credit enhancement, would likely achieve a rating no higher than single-A under its approach - two full rating categories below where the class was rated by Moody's and S&P.

Fitch is concerned that a significant portion of the collateral is sub-performing and transitional in nature, with a reliance on borrower pro forma business plans to improve performance. Absent significant growth in cashflows, the agency would be concerned about refinance risk and the high likelihood of default at maturity, especially in a higher interest rate environment.

Fitch's view is that the default probability for the collateral in this pool exceeds any that it has seen to date in CMBS 2.0. Further, in high stress scenarios, the agency concludes that there is potential for very limited recovery prospects upon default.

For example, Buena Park - the largest loan in the pool at 20.8% - is an anchored retail centre with a sub-performing mall component. Fitch is concerned about the below market occupancy, the significant amount of temporary tenants and low reported in-line tenant sales of approximately US$200 per square-foot, including falling per screen sales for the movie theatre. It is also concerned over stiff competition in the sub-market, including healthier malls nearby.

Further, the loan is subject to interest rate risk, given that it does not have an interest rate cap. Fitch says it has recently seen several instances of sub-performing malls experiencing significant loss severities, which in some cases have exceeded 100%. If the borrower's business plan is not successful, the mall component of Buena Park could experience substantial losses or face significant challenges refinancing in a higher interest rate environment.

Concentration risk also subjects the pool to a high potential for adverse selection, according to Fitch. The deal could be heavily dependent on the servicer's ability to work out loans to realise value recovery to pay down the bonds. Additionally, the bonds could be susceptible to interest shortfalls if the servicer experiences significant costs to work out the loans and passes these costs and other work-out fees through to the trust.

Fitch suggests that the rating methodology for this type of pool should track the methodology used for large loan multi-borrower transactions, which puts a heavy weight on the idiosyncratic risks associated with a smaller, more concentrated pool. While the agency says it is not opposed to rating these types of deals, it has a conservative view on transitional properties and properties with less stabilised operating history than those typically securing CMBS loans. It will look at in-place cashflow and in-place value, but give no credit for pro forma income.

Fitch may also consider a rating cap for loans with more than one key risk factor, even if each risk individually may not be considered substantial, to account for the layering of risk.

CMBS

Schron note sale scheduled

An estimated US$500m of CMBS loans will be up for bid on Auction.com in November, spread across four auctions, according to MBS analysts at Barclays Capital. The note sales include five properties from the US$340m Schron Industrial Portfolio, securitised in GCCFC 2005-GG5, which carry an allocated loan balance of about US$45m.

Six of the thirteen properties from the US$127m Trinity Hotel Portfolio in BACM 2006-5 are also scheduled for auction, with an allocated loan balance of approximately US$57m. Other deals with significant exposure to the auction include COMM 2004-LB4 (Metro I building) and WBCMT 2007-C31 (35 Nutmeg Drive).

CMBS

GRAND refi seen as distressed exchange

Moody's has determined that the proposed restructuring of the German Residential Asset Note Distributor (GRAND) CMBS would constitute a distressed exchange for the class D, E and F notes. The move follows the release last week of final heads of terms for the refinancing and the launch of a lock-up solicitation (see SCI's loan events database for more).

Under a distressed exchange, the notes would be downgraded due to the distressed exchange definition, and then upgraded to similar levels as today. The upgraded ratings would be based on several restructuring features that Moody's views as credit positive. Meanwhile, the restructuring of the transaction would not constitute a distressed exchange for the class A, B and C notes.

The main aspect considered in the distressed exchange analysis is the extension of the final legal maturity of the notes by five years, which avoids an ultimate default of the affected classes of notes. Moody's would adjust the ratings for the affected classes of notes if the proposed restructuring was implemented. The downgrade would reflect the expected losses for the respected classes of notes in a scenario without the proposed restructuring.

After the restructuring, Moody's would adjust the ratings to reflect the amended terms and conditions of the notes, including the extended final legal maturity. The adjusted ratings would address the expected loss posed to investors by the amended legal final maturity and incorporate the other features of the restructuring.

To assess the presence of a distressed exchange, the agency assumed a payment default at loan maturity in 2013 absent a restructuring. It says the main risks for the transaction are: a failure to refinance the loans; and the uncertainty around the timely repayment of the notes by the current legal final maturity date, given the size of the issuance and the short time period to the legal final maturity date.

Due to the size of the portfolio, the limited number of investors capable of buying large residential portfolios and the time constraints, Moody's expects the sales price to reflect the distressed work-out. This impacts junior notes more than senior notes, given that senior notes could withstand high discounts on sale prices without suffering a loss. There is also a risk that not all recovery proceeds will be paid to the noteholders by the legal final maturity, considering the limited time for a refinancing or a work-out of the loan.

Overall, the default probability during the loan term due to decreasing rental income will decrease mainly due to the deleveraging of the portfolio as a consequence of equity injection and lower interest rates. Moody's anticipates a low risk of cashflow shortfall, even if the refinancing fell behind the sponsor's business plan and the unhedged amount of debt increased.

The restructuring effectively staggers refinancing risk over the new loan term due to the annual amortisation targets and the bullet repayment at the amended loan maturity date. Moody's determined the refinancing default probability in the medium/ high range (25%-50%) based on the expected leverage and the size of the sub portfolios and the total issuance.

NPLs

Sareb framework unveiled

Further details have emerged about Sareb, Spain's bad bank (SCI 18 October). The vehicle will purchase up to €90bn of real estate assets from Group 1 and 2 banks.

Group 1 banks - Bankia, Banco de Valencia, Catalunya Caixa and NovaCaixaGalicia - will transfer around €45bn of assets, with the remainder coming from Group 2 banks in 2013. The assets will mostly be foreclosed real asset assets, non-performing developer loans and equity stakes in real estate companies.

Sareb will apply an average 63.1% discount on foreclosed assets, an average 45.6% discount on loans and nearly an 80% discount on foreclosed land. The bad bank will manage these assets over a period of up to 15 years.

The Spanish government has asked Santander, BBVA and CaixaBank to take a 30% equity stake in Sareb. A portion of the vehicle's capital could come from subordinated bonds, RBS credit analysts suggest, while the rest of the capital structure will be financed through state-guaranteed senior debt.

That these 'good' banks will in part capitalise the bad bank is one of the potential shortfalls of the plan, according to the RBS analysts, with the risk that this will undermine the strength of the good banks. "It is imperative for Spain that the bad bank is able to attract more foreign private capital, in order to reduce the sovereign-bank nexus and to sever the link between good banks and bad assets."

In addition, the size of Sareb may be insufficient to completely remove all bad assets from the Spanish banking system. The Bank of Spain estimates that around €180bn of troubled assets are held on bank balance sheets in the real estate sector alone, for example.

The analysts expect the final capital needs of Spanish banks to exceed Oliver Wyman's €60bn estimate and instead be closer to €80bn.

Risk Management

Liquidity management service offered

Calypso Technology has launched a new liquidity management solution that aims to enable financial institutions to comply with Basel 3 liquidity standards. The treasury system provides intraday, short-term and long-term liquidity management capabilities, in addition to extensive cash management functionality, the firm says.

The Calypso solution is designed to address two key challenges facing treasuries when managing and forecasting liquidity. One is the ability to aggregate cashflows and data from multiple systems and/or business units, as the system can capture trade and cashflow data from various sources through its robust interfaces. Another benefit is the system's ability to model all asset classes or integrate custom pricing models, so that managers can perform market data perturbations or simulate behavioural assumptions into business-as-usual or stressed scenarios.

The platform offers the ability to manage enterprise concerns, such as survival horizon, asset-liability distortion and intra-day liquidity usage. Apart from producing the required metrics - namely liquidity coverage ratio (LCR), net stable funding ratio (NSFR), credit line usage ratio, asset maturity mismatches and funding concentration - the service also allows treasurers to understand the key significant currencies by running balance sheets at a currency level.

Risk Management

CCS expansion plan sealed

ISDA has announced its support of the Clearing Connectivity Standard (CCS) by working with Sapient Global Markets to provide programme management, governance and industry oversight. Sapient developed the standard to help improve OTC derivatives reporting and communication for asset managers, futures commission merchants (FCMs), central counterparties (CCPs) and custodians (SCI 15 August).

CCS currently provides for standardised connectivity and reporting initially for central counterparty-eligible interest rate and credit default swap products in the US through LCH.Clearnet's SwapClear and the CME Group. The initial version of the standard has been adopted by a group of participants representing more than 12 firms and multiple end-users in the buy-side community.

ISDA and Sapient are working on a plan to expand the service to include additional products, participants and geographies over the next year. The intent is to broaden the range of participants to include additional FCMs, custodians, asset managers and CCPs.

Future enhancements to the CCS will also include a conversion of the standard to FpML under the guidance of FpML Working Groups.

Risk Management

CVA engine extended

Pricing Partners has extended its CVA engine to provide regulatory CVA VaR on all derivatives products. The update enables users to aggregate corresponding CVA VaRs at the portfolio level per counterparty, the firm says. The move is in response to the need to account for variation in CVA under recent Basel 3 enhancements.

RMBS

Further credit watches resolved

S&P has lowered its ratings on 406 classes - 238 by more than three notches - from 65 US RMBS, while removing 381 of them from credit watch with negative implications and 16 from credit watch with developing implications. The agency also raised its ratings on 29 classes from 11 transactions, while removing three of them from credit watch with positive implications and 19 of them from credit watch with developing implications. In addition, it affirmed the ratings on 216 classes from 57 of these transactions and removed 25 of them from credit watch with negative implications, one of them from credit watch with positive implications and nine of them from credit watch with developing implications.

S&P subsequently withdrew 41 of the lowered ratings, seven of the raised ratings and 30 of the affirmed ratings because of the increased risk due to the small number of loans (fewer than 20) remaining in the affected deals. The agency also withdrew ratings on 44 additional classes from 16 transactions and removed 41 of them from credit watch with negative implications and two of them from credit watch with developing implications, in accordance with its interest-only criteria and/or they were paid in full.

The transactions in this review were issued between 2001 and 2006 and are backed by adjustable- and fixed-rate prime jumbo, subprime, alternative-A and negatively amortising mortgage loans secured primarily by first liens on one- to four-family residential properties. The actions represent the latest credit watch placements to be resolved as a result of S&P's implementation of revised criteria for surveilling pre-2009 US RMBS (SCI 16 August).

RMBS

Re-REMIC ratings hit

S&P has initiated 2,847 credit watch placements on 205 US RMBS re-REMIC transactions, with a par amount of US$46.65bn. The move follows the implementation of the agency's revised criteria for the surveillance of pre-2009 RMBS and subsequent credit watch actions on pre-2009 US RMBS classes (SCI passim).

In total, S&P has placed its ratings on: 2,775 classes from 203 re-REMICs, totalling approximately US$45.12bn in current par amount, on credit watch with negative implications; and 72 classes from 25 US re-REMICs, totalling approximately US$1.53bn in current par amount, on credit watch developing. The affected classes represent approximately 70.9%, by par amount, and 77.4% by the number of classes of the agency's total universe of US RMBS re-REMIC rated classes.

The credit watch placements only affect classes rated single-B minus and above. S&P's preliminary analysis indicates that most of the collateral types would show a move toward lower ratings under its revised criteria.

RMBS

Joint bid wins ResCap auction

Ocwen Loan Servicing and Walter Investment Management Corp were jointly awarded the highest and best bid for the mortgage servicing and origination platform assets of Residential Capital in yesterday's bankruptcy court-sponsored auction (SCI passim). The bid, with a purchase price of US$3bn, is subject to definitive documentation and bankruptcy court approval. Nationstar was the only other bidder for the assets.

As at 31 March, ResCap serviced over 2.4 million loans, with an aggregate unpaid principal balance (UPB) of approximately US$374bn. Of these, approximately 68% of the loans are owned, insured or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.

"The acquisition of ResCap significantly advances Ocwen's planned growth initiative to add high return servicing assets to our portfolio and to expand our servicing capacity through retention of a significant portion of ResCap's high quality servicing organisation," comments Ocwen's executive chairman William Erbey.

Under the joint bidding arrangement, Walter Investment will acquire the Fannie Mae mortgage servicing rights (MSR) portion of ResCap's servicing portfolio, representing approximately US$50.4bn in UPB, as well as the origination and capital markets platform. Mark O'Brien, chairman and ceo of Walter Investment, says: "We believe our long-established relationships with Fannie Mae and history of driving strong performance from their portfolios makes us ideally suited to acquire the Fannie MSR portfolio from ResCap. Further, the opportunity to acquire the ResCap origination platform will allow us to profitably achieve additional scale in our originations business."

The transaction is subject to completion of definitive acquisition documents that are expected to provide representations, warranties and covenants, as well retained liabilities provisions relating to certain pre-closing liabilities. The sale approval hearing before the bankruptcy court is set for 19 November.