Contents

Structured Finance

Compare and contrast

Cross-sector relative value key for yield

With QE3 driving down interest rates and spreads rallying to near-term tights, investors are being forced to work harder to find yield. The right portfolio composition is vital in this process, which is driving more investors to look at cross-sector relative value.

"Investors are being forced to look at asset classes where they may not have traditionally invested. That is creating a cross-sector bid between various asset classes. Our view is that the world is getting smaller very quickly, so cross-sector relative value is something which all investors need to start looking at, if they are not already," says Richard Hill, director of CMBS and CLO strategy at RBS.

Interest in US CMBS and CLOs has been particularly noteworthy. Hill notes that the asset classes are rarely compared to each other, despite each regularly being compared to corporate bonds, with investors perhaps missing a trick.

Investing in CMBS and CLOs enables investors to increase assets under management, while diversifying their portfolio and producing strong risk-adjusted returns. There was a noticeable cross-over bid from corporates into CMBS earlier in the year, mainly as a result of the MAX and WAVE CDO liquidations (SCI 2 May), which created demand for CMBS from non-traditional buyers.

"As CMBS spreads have tightened in both the new issue and legacy space, we are receiving increased inquiry from mortgage buyers about CLOs. That is what everybody is now interested in and looking at," Hill says.

He continues: "CLOs offer attractive relative value compared to other asset classes. If you are comfortable with the reduced liquidity, then we believe they provide a compelling opportunity across the capital structure."

However, while cross-sector relative value between CLOs and CMBS makes sense, such a comparison is more difficult with ABS or RMBS. It is generally much simpler for ABS and RMBS investors to look at CLOs and CMBS than the other way round, not least because ABS has such tighter spreads and shorter durations.

"With CLOs you have a full capital structure from triple-A to double-B and syndicated equity. Typically in ABS only senior tranches are distributed," says Kenneth Kroszner, RBS CLO analyst.

He continues: "Consumer ABS is certainly one benchmark for measuring the relative value of CLOs, but current ABS spreads are so tight that it makes a comparison more difficult. Consumer ABS also has different types of credit enhancement, coming from more than just subordination, which further complicates the analysis."

As the characteristics of CLOs and CMBS complement each other nicely, investors would be well served by holding both asset types in their portfolio rather than focusing exclusively on one or the other. "CMBS is a longer duration, fixed-rate asset, so it provides a significant opportunity for carry in a low interest rate environment. The CMBS market is also much larger than the CLO market, so it provides more liquidity as well," notes Hill.

He continues: "But CLOs are a smaller market and offer more spread on an absolute basis. If you are a traditional corporate or ABS investor, then you would really want to look at both CMBS and CLOs to grow your AUM and also diversify your holdings."

Investors looking to add these assets to their portfolio but who wish to stay towards the top of the capital stack will find greater spread pick-up in the CLO market. The CLO market offers spreads of around 140bp-145bp over Libor, while CMBS new issue A4 tranches are closer to 85bp over swaps.

Hill concludes: "From a risk-adjusted basis, CLOs appear cheap relative to new issue CMBS. But that is to be expected to some degree because the market is relatively smaller and less liquid. For investors, we think this provides an opportunity to add alpha and a way to complement their existing core portfolios."

JL

CLOs

Great expectations

Shifting CLO assumptions amid strong performance

US CLO tranches tightened across the board in the third quarter, with primary issuance and secondary activity both exceeding expectations. Positive sentiment is prompting more aggressive assumptions from investors, based on expectations of continued strong performance.

Third-quarter issuance surpassed post-crisis highs, and issuance for 2012 as a whole is expected to be the highest since 2007. One of the contributing factors to this strong issuance is how quickly the market restarted after its summer lull.

"It was a strong quarter and August was particularly good. The expectation was that the holiday period would be quite slow. There was a rush of deals in advance of 4 July, where the tone was weak and prices widened, but the market came back very quickly from the beginning of August," says Matt Natcharian, md and head of structured credit at Babson Capital.

A series of issues from strong managers also sparked a rally in the secondary market. The rallying in both primary and secondary has prompted many investors to move into the CLO space, attracted by the strong performance and attractive yields.

"Compared to other asset classes out there, CLOs were looking pretty wide, so I think people saw tightening in other asset classes and started to come into CLOs. The volume of new issuance has been very strong, deals have been upsized and a lot of tranches are well over-subscribed, so it has been a very healthy period for the market," Natcharian adds.

Mezzanine paper tightened the most over the quarter, with triple-B and double-B tranches tightening by 225bp and 300bp respectively. The recent Fed announcement that rates will remain low has also made equity particularly attractive at tighter-than-historical levels, helping contribute to strong demand.

The fact that investors are now making far more aggressive assumptions on future default and recovery rates has been a notable change in the market. While this has certainly helped fuel activity, it does not seem to have impacted underwriting practices at this time.

"The underwriting in terms of creating the structure has been pretty stable. The rating agencies have their methodologies and are not bending those, so the amount of leverage you can get is pretty much settled - although each deal tries to tweak that in its own unique way," notes Natcharian.

He continues: "Where you see more aggressive assumptions is with what you would expect for equity returns. We would model a deal right now around the 12% range; marketing materials at the moment are generally showing higher, more aggressive assumptions for the equity."

Despite rallying a long way, Natcharian does not believe that mezzanine and equity spreads are now at unsustainable levels. In fact, there may even still be room to tighten further before year-end.

"You have got to look at it relative to bank loan spreads. The mezzanine triple-B tranche is much better subordinated on a new deal than the pre-crisis triple-Bs were," says Natcharian.

He continues: "In the tights of the market, those pre-crisis triple-Bs traded at about half the spread of the underlying bank loan portfolio and had a cushion of about 15% net realised losses in the underlying pool before they got hit. The new deals are closer to 17% and are still trading at about the same spread as the underlying bank loans."

It is not quite the same story at the top of the capital stack: while subordinated spreads have rallied strongly, triple-A spreads have barely moved. Triple-As tightened by 15bp over the quarter to around 150bp and now appear comparatively wide. This lack of movement compared to mezzanine and equity is largely due to technical factors.

"On a spread basis triple-As are very wide, but on an absolute yield basis it is still quite a low yield. The natural buyer for that is a bank because it is not enough yield for most insurance companies. It has been a technical problem, where there is a handful of large buyers but a lot of deals in the market," Natcharian explains.

With over 50 managers bringing deals so far this year, there has been plenty of choice for investors. Some distribution appears to be starting to go to regional banks (SCI 31 October), but capital rules and regulations have been keeping European banks at bay. That situation does not appear likely to change and regulation could start to bite harder for US parties too.

"In the US it seems like the story about how well CLOs have performed is now resonating, but you never know until the rules are finalised," notes Natcharian. He believes that corporate credit securitisations are very different to originate-to-securitise products, such as mortgages, and could be seen differently.

Natcharian says: "You have the collateral manager actively managing the pool, loans can be purchased and sold, and those loans come from companies with audited financial statements. It is a very different, more transparent product. It is a proven structure, so even if some of the regulations are onerous, we hope that over time that will be corrected."

In the nearer future, spreads are expected to keep tightening as the rally continues until year-end at the least. How far triple-As can tighten remains to be seen.

Natcharian concludes: "It has been an active market and there will be bumps in the road between now and its next tights. It will not necessarily be smooth through year-end, but if the global recovery continues, then we think CLOs will enjoy the liquidity in the market and the low default rate in corporate credit and should perform well."

JL

CLOs

Euro CLO market on pause

Activity in the secondary European CLO market stalled this week as first the US and later Europe all but shut down. Several lists planned for the end of October could now be hitting the market next week instead.

"It has been a strange week. The beginning of the week was the slowest we have seen because of the US and then yesterday it was a religious holiday for most of Europe, so a lot of BWICs have been delayed and not that much has happened," reports one trader.

He continues: "We had one guy who was going to show us a big slice, but decided to delay to next week. There are a couple of people we have been speaking to who are looking to move some large blocks, but with the US shut at the beginning of the week and Europe shut yesterday it has not been possible."

The limited selling was largely from people in need of end-of-month cash, the trader notes. "I had a guy showing me a large sterling list selling for T+1, who said he just needed cash now. It is only these people who are really looking to shift stuff."

The trader has been working away from BWICs on some double-B paper and some ABS CDOs, although he notes that there are a few more lists out today than there were earlier in the week. SCI's PriceABS BWIC data shows that more CLO tranches were out for the bid yesterday than in the first three days of the week combined.

"It looks like it is busier again today than it was yesterday. There is one list for this lunchtime with a dozen or so names on it. It is a bunch of smaller pieces - the biggest looks like a €9m piece - so we will see how that goes," the trader says.

He continues: "Yesterday the focus was more on mezz stuff. There were a few covers, but it was mainly all talk. Appetite is still strong and there is a decent bid from the US as well, so I think the market will be coming back to life next week."

JL

CLOs

Secondary CLO activity rises

The secondary markets were very active yesterday, with noticeably more CLO paper circulating than normal. SCI's PriceABS BWIC data shows 115 CLO line items, with notes from the bottom of the capital structure showing more liquidity.

Tuesday's session saw a mix of US and European paper. One of the highest covers, at 89.09, was for CENT9 2005-9X D1. The tranche was also talked between the mid/high-80s and low-90s. It was being talked on Monday between mid-80s and 92.

At the other extreme, GSHAM 2006-3X S EQ was covered at just 5, with talk ranging from single digits up to low-teens. Another tranche - ELEXA 2006-1X SUB EQ - was covered in the low/mid-20s and covered again in the low-30s during the same session.

Other names of interest from the session include: CLAV 2007-1X SUB, which was covered at 53.08, up slightly from last week when talk was regularly in the low-50s; HARBM 10X SUB, which was covered at 48.31, higher than the talk which had ranged between the low-40s and mid-40s, after talk on Monday had been in the high-30s; and GROSV I-X F, which was covered at 44.03, after talk last week had ranged from the low-20s to mid/high-50s.

CMBS

CMBS drives bid-list volume

US BWIC activity remained muted yesterday in the aftermath of Superstorm Sandy, with only CMBS supply exceeding expectations. Bid-list volume for the sector totalled almost US$150m, according to Trepp - about a third higher than that for the ABS and RMBS sectors combined.

Spreads on legacy CMBS super-senior tranches edged 2bp-3bp wider during the session, while AM and AJ spreads were wider by 10bp-15bp. The bellwether GSMS 2007-GG10 A4 bond ended the day at 160bp over swaps, or 2bp wider than last Friday's close.

SCI's PriceABS data suggests that a preponderance of AM and A4 bonds circulated yesterday. For example, the BSCMS 2007-PW16 AM tranche was covered at 220 over, having been talked at plus 250 area on 15 October.

CGCMT 2007-C6, JPMCC 2006-LDP9 and GCCFC 2005-GG5 AMs were talked at plus 250 area, plus 335 and plus 200 respectively during the session. The latter bond was talked at plus 225 area on 10 October, according to SCI's PriceABS archive.

With respect to A4 tranches, the LBUBS 2003-C5 and MSC 2003-IQ6 bonds were covered at plus 65 and plus 60 respectively. The latter was covered at plus 59 on 17 September.

Finally, the LBUBS 2004-C1 A3 trance was also covered at plus 65 yesterday.

RMBS

US RMBS starts back up

The US RMBS market began the week on a positive note with non-agency supply elevated across the board. Interactive Data figures put total non-agency volume at US$525m, with ARMs comprising the bulk.

Valuations appear to have held fairly stable, with SCI's PriceABS BWIC data showing prices have moved just slightly higher over the last few weeks. The BSARM 2007-1 2A1 tranche exemplifies this trend nicely, with talk yesterday in the low/mid-70s, after the tranche was covered in the low-70s on 10 October.

Prices have been creeping up since the summer. Yesterday's session saw MSM 2007-15AR 2A1 talked in the high-60s, having been talked in the mid-50s on 19 July, while SAST 2006-3 A3 was talked in the mid/high-60s, having been talking in the low/mid-50s to mid/high-50s on 16 July.

There was also a considerable amount of price variation by vintage during the session. MALT 2004-4 8A1 was talked as high as 106, while GSAMP 2007-FM1 A2D was talked in the mid-40s.

JL

ABS

SLABS pool benchmarking recommended

Private student loan ABS has seen demand increase during 2012, with spreads tightening commensurately, with spreads for new issue five-year average life bonds almost halving between January and October. Wells Fargo ABS analysts report that relative value is still likely to depend on security selection and structural protections and advocate benchmarking deals based on their pool factor when making relative value comparisons.

The complication with student loan ABS is that credit analysis is often displayed as a percentage of loans in repayment, but a student loan can be current while not making payments of interest or principal. This can contribute to a lag in the timing of default rates, with a larger proportion of losses later in a deal's life.

"We believe it is important to have an analytical framework to gauge credit risk to determine if the incremental yield is indeed providing adequate compensation for the risk taken. We recommend benchmarking deals based on their pool factor to compare deals with differing collateral characteristics and issued under differing economic circumstances," say the analysts.

Wells Fargo has found that 2010 and 2011 post-crisis SLMA private student loans ABS have higher early-stage default rates than the 2006 and 2007 vintage deals, although latter stage default rates for post-crisis deals are expected to be lower than for pre-crisis ones. While it is too early to draw definitive conclusions, the 2012 vintage deals seem to be performing better than the 2011 ones. An improving jobs market should see post-crisis private student loan ABS outperform pre-crisis deals based on cumulative default rates.

JL

Structured Finance

Solvency II proposals critiqued

The European Insurance and Occupational Pensions Authority (EIOPA) has published its proposed capital rules for Solvency II, albeit it is labelled as a working document to allow insurance companies to carry out quantitative impact studies. European asset-backed analysts at RBS note that in the aggregate the requirements are now fairly well-specified, with a few issues remaining open.

"Important among these are the acceptability of internal models, the approach to transition from the current capital regime and the level of flexibility local regulatory authorities will have to interpret or override the EU requirements," they explain.

Tranching appears to be the primary aspect of what defines a structured product. But the RBS analysts say that the new definition raises more questions for than it answers and are hopeful that this will be clarified in future drafts. For example, even an A-B note structure in a commercial real estate loan could be called an asset-backed security, since it is clearly tranched.

Rated ABS are still subject to high capital charges, starting with 7% per year of duration for triple-A rated ABS and quickly increasing for longer duration and lower rated ABS. "We continue to view this as excessive and driven by confusion about what comprises ABS," the analysts observe.

Meanwhile, residential whole loans are favourably treated, with virtually zero capital charges for loans of up to about 70% LTV and modest capital charges at higher LTVs. Commercial real estate will fall in the category of specialised lending, which is treated like a corporate bond just below investment grade.

The analysts believe that the implementation date is becoming more uncertain as the months go by. A plenary vote on the proposals in the European Parliament has been rescheduled to March 2013, after which member states will have to adopt them as law by June 2013, leaving little time until the official 1 January 2014 implementation date.

Indeed, recognition that this is looking increasingly unlikely is gaining traction. For instance, the UK FSA only plans to approve internal models by December 2015, with RBS now projecting January 2016 as the most likely implementation date.

CS

Structured Finance

SCI Start the Week - 5 November

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

Pipeline
The pipeline was joined last week by two auto ABS, two RMBS and one CLO. The ABS were Bumper 6 France and €560m FCT Autonoria Compartment 2012-2, the RMBS were Gosforth Funding 2012-2 and A$400m Light Trust No.4 and the CLO was US$624.5m Race Point VII.

Pricings
ABS was once more accounting for the bulk of the week's prints. There were seven ABS issued, two RMBS, one CMBS and five CLOs.

The ABS were US$1.122.73bn American Express Credit Account Master Trust Series 2012-4 and US$685.72m American Express Credit Account Master Trust Series 2012-5, US$183m California Republic Auto Receivables Trust 2012-1, US$612.63m GE Dealer Floorplan Master Note Trust 2012-4, €1.03bn Golden Bar 2012-2, €1bn FCT Ginkgo Private Compartment 2012-1 and US$1.25bn SLM Student Loan Trust 2012-7.

The RMBS were €320m Adriatico Finance RMBS 2012-1 and A$300m RESIMAC Trust 2012-1 NC, while the CMBS was US$835m BB-UBS Trust 2012-SHOW. The CLOs were US$315m Gallatin CLO IV 2012-1, US$407m Shackleton II, €889m UBI SPV BBS 2012, €1.017bn UBI SPV BPA 2012 and €852.7m UBI SPV BPCI 2012.

Markets
Even Hurricane Sandy could not derail the US ABS market, say Barclays Capital ABS analysts. Secondary volume was subdued, but the primary market was active. "Despite the first part of the week being effectively washed out by the storm, volume in non-mortgage ABS primary and secondary markets picked up after the winds subsided. Primary issuance, though low relative to this year's average weekly volume, registered US$3.7bn from four transactions."

US CMBS was first to recover in the aftermath of Superstorm Sandy, as SCI reported on Thursday (SCI 1 November). SCI's PriceABS BWIC data shows spreads on legacy CMBS super-seniors edging wider during Wednesday's session and shows a number of AM and A4 bonds circulating, spreads for which were wider by 10bp-15bp.

The US CLO market stayed quiet last week. Bank of America Merrill Lynch securitised products strategists report that BWIC volume was US$221m for the week, with equity pieces accounting for around three quarters of that. Spreads remained flat on light volume.

The quiet week in the US translated into a quiet week for European ABS, according to Deutsche Bank ABS analysts. They add: "Indeed, with sector returns year to date looking robust, the investor community could well look to effectively shut their books early this year to protect gains." They note that both the new issue market and secondary market were quiet.

The European CMBS market was fairly active over the week, as SCI reported on Wednesday (SCI 31 October). The GRAND restructuring proposal and rash of loan maturities were both viewed positively. "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," notes one trader.

Finally, the European CLO market also stalled, with several BWICs planned for last week now expected this week, as SCI reported on Friday (SCI 2 November). "It has been a strange week. The beginning of the week was the slowest we have seen because of the US and then yesterday it was a religious holiday for most of Europe, so a lot of BWICs have been delayed and not that much has happened," reports one trader. He adds: "Yesterday the focus was more on mezz stuff. There were a few covers, but it was mainly all talk. Appetite is still strong and there is a decent bid from the US as well, so I think the market will be coming back to life next week."

Deal news
• The early termination of two German SME CLOs has been announced. 2012S-Fix 1 was called last month by LBBW due to a change in transaction economics, following the bank's recent downgrade. Meanwhile, KfW is set to exercise a clean-up call for Promise XXS-2006-1.
• 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.
• 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.
• 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.
• 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.
• 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.

Regulatory update
• The European Insurance and Occupational Pensions Authority (EIOPA) has published its proposed capital rules for Solvency II, albeit it is labelled as a working document to allow insurance companies to carry out quantitative impact studies. European asset-backed analysts at RBS note that in the aggregate the requirements are now fairly well-specified, with a few issues remaining open.
• The New York state supreme court has allowed Basis Yield Alpha Fund, an Australian-based hedge fund, to proceed with fraud claims against Goldman Sachs in connection with Timberwolf 2007-1 and Point Pleasant 2007-1. In its complaint, Basis had alleged that Goldman sold it US$80m of notes issued by the two CDOs that lost all their value almost immediately after closing, according to a recent Lowenstein Sandler client memo.
• 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.
• 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.

Deals added to the SCI database last week:
Arbor Realty Collateralized Loan Obligation 2012-1; BlueMountain CLO 2012-2; Cars Alliance Auto Loans France V 2012-1 ; Fairway Outdoor Funding series 2012-1; FCT Auto ABS Compartiment 2012-1; Golub Capital Partners CLO 14; Jamestown CLO I; Master Credit Card Trust II Series 2012-2; NorthStar 2012-1 Mortgage Trust; OCP CLO 2012-2; OHA Credit Partners VII; Promise Neo 2012-1; Sandown Gold 2012-2; Sequoia Mortgage Trust 2012-5; Sierra Timeshare 2012-3 Receivables Funding; Springleaf Mortgage Loan Trust 2012-3.

Deals added to the SCI CMBS Loan Events database last week:
DECO 11-C3; DECO 2005-E1X; DECO 2006-E4; DECO 8-C2; DECO 9-E3X; ECLIP 2006-1; ECLIP 2006-2; ECLIP 2006-3; EMC VI; EPICP CASP; EPICP DRUM; EURO 19; EURO 21; EURO 22; EURO 24; JPMCC 2006-LDP9; LBCMT 2007-C3; MSC 03-IQ4, GMACC 03-C3 & MSC 04-HQ4; MSC 2007-HQ13; MSC 2007-IQ14; OPERA FR-01; RIVOL 2006-1; TITN 2006-1; TITN 2006-5; TITN 2007-CT1; TMAN 3, 4, 5, 6 & 7; WBCMT 2007-C32; WINDM XI.

Top stories to come in SCI:
Focus on Australian RMBS
CDS short selling regulatory impact
US CMBS note auctions
October EMEA CMBS maturity outcomes

Structured Finance

Aussie SF partner joins

James Mok has joined Minter Ellison in Sydney as partner. He specialises in structured and asset finance, particularly aircraft leasing and financing.

Mok joins from King & Wood Mallesons. He will work closely with partner John Elias across derivatives, DCM, securitisation, receivables finance and asset finance.

CDS

PM pair reunited for new strategy

Channel Capital Advisors has recruited Peter Bakker and Frits Lieuw-kie-song to establish a new liquid credit strategy for the firm. Bakker was high yield portfolio manager at Lazard while Lieuw-kie-song held the same role at LKS and joins from Britton Hill Capital. The pair previously worked together at SGS Asset Management.

CLOs

Alpstar CLO transfers mooted

Chenavari Investment Managers is set to replace Alpstar Management as collateral manager on the Alpstar CLO 1 and 2 transactions. Consent of controlling noteholders via a written resolution is required by 12 November for this to occur.

If approved, Chenavari will designate Loïc Fery and Mick Vasilache as replacement key persons pursuant to the collateral management agreement. Fery is the founder and managing partner of Chenavari, and has veto rights at the investment committees of the dedicated strategies.

Vasilache is a partner at the firm and is responsible for its leveraged finance and CLOs business. Prior to joining Chenavari, he developed and ran the €1.1bn Cerberus AIM's European leveraged credit fund and was one of the founders of Elgin Capital's CLO business.

In order to ensure continuity and a smooth transition, it is proposed that certain personnel who have been actively involved in providing Alpstar Management collateral management services will join Chenavari as part of the agreement.

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

RMBS

REIT co-founder takes over

Wellington Denahan-Norris has been appointed to Annaly Capital Management's board as chairman. She also becomes ceo, having stepped up to co-ceo last month (SCI 11 October).

Kevin Keyes also joins the board, while Rose-Marie Lyght and Kristopher Konrad each become co-cio. Keyes was appointed president last month and previously served as chief strategy officer and head of capital markets. Lyght was previously cio of Annaly subsidiary Fixed Income Discount Advisory Company and Konrad was previously head portfolio manager.

Structured Finance

Links Finance ratings reviewed

Moody's has placed the Euro and US MTN programmes of Links Finance on review for possible downgrade. The move follows the placement of Bank of Montreal's Aa2 rating under review for possible downgrade on 26 October.

There is a direct linkage between the ratings of the SIV and its sponsor, BMO, due to its commitment to provide liquidity support in the form of a liquidity facility for the repayment of the CP and MTNs as they fall due. The SIV is also generating funds through an orderly unwind of its portfolio.

Moody's notes that the vehicle is subject to a high level of macroeconomic uncertainty, which could negatively impact its ratings. This is evidenced by uncertainties of credit conditions in the general economy and, more specifically, that any uncertainty associated with the underlying credit could have a direct impact on the SIV.

CDO

Basis fraud claims to proceed

The New York state supreme court has allowed Basis Yield Alpha Fund, an Australian-based hedge fund, to proceed with fraud claims against Goldman Sachs in connection with Timberwolf 2007-1 and Point Pleasant 2007-1. In its complaint, Basis had alleged that Goldman sold it US$80m of notes issued by the two CDOs that lost all their value almost immediately after closing, according to a recent Lowenstein Sandler client memo.

The lawsuit further alleged that Goldman was betting against the CDOs via credit default swaps, and that bank executives knew that the notes issued by the CDOs were poor quality, contrary to the representations they made to Basis. Supreme Court Justice Shirley Werner Kornreich dismissed Basis' claims for breach of contract and breach of the implied covenant of good faith and fair dealing. However, the court denied Goldman's motion to dismiss with respect to Basis' claims for fraud, fraudulent inducement and fraudulent concealment.

In allowing the fraud claims to proceed, Justice Kornreich cited not only representations alleged in Basis' complaint, but also to a separate case against Goldman in federal court brought by Dodona I, a hedge fund that invested in another CDO.

CDO

Aussie court issues CPDO fine

The Federal Court of Australia has ruled that S&P misled investors by giving ABN Amro's Rembrandt 2006-3 CPDO a triple-A rating. The rating agency and the bank are both judged to have misled those Australian councils which purchased the Rembrandt notes.

The court found that ABN Amro manipulated the inputs used for Monte Carlo modelling to achieve the best possible rating and pressed S&P to use its inputs. The court also notes that "at least one person within S&P considered that ABN Amro, whether intentionally or not, had effectively 'gamed' the model it knew S&P would apply to rate the CPDO".

The councils have been awarded around A$30m for losses and damages, although S&P has pledged to appeal. It follows another decision a few weeks ago by Australia's Federal Court that Lehman Australia had misled investors in the sale of CDOs (SCI 2 October).

CLOs

SME CLO duo called

The early termination of two German SME CLOs has been announced.

2012S-Fix 1 was called last month by LBBW due to a change in transaction economics, following the bank's recent downgrade. The liquidation became effective on 30 October.

Meanwhile, KfW is set to exercise a clean-up call for Promise XXS-2006-1, which will become effective on 12 November.

CMBS

CMBS delinquencies plummet

The US CMBS delinquency rate fell by 30bp to 9.69% last month - its biggest drop in 14 months, according to Trepp. Loan resolutions remained high during October, however.

Over US$1.5bn in loans were resolved in October with losses. The removal of these loans from the delinquent loan category accounted for 28bp of downward pressure on the delinquency rate.

Loans that were newly delinquent - around US$2.6bn in total - put upward pressure of about 46bp on the rate. This was significantly less than September's US$3.3bn of newly delinquent loans that contributed 59bp of upward pressure. Loans that cured in October put downward pressure of 45bp on the rate, essentially offsetting the amount of loans that became delinquent.

Added together, the impact of the loan resolutions, the effect of loans curing and the effect of newly delinquent loans created a net improvement of 27bp in the rate. The remaining 3bp were a result of the repayment of performing loans, loans becoming defeased, the amortisation of existing loans and the addition of new deals to the pool.

Among the major property types, only the multifamily segment weakened in October, Trepp notes. Office, retail, lodging and industrial loans all saw improvements month-over-month.

CMBS

CMBS loss severity holds steady

US CMBS loss severity levels held steady month-over-month in October, according to Trepp. While cumulative losses remained practically equal to September levels, the cumulative balance before liquidation fell slightly.

This led to a slight up-tick in severity, with October average loss severity ending at 42.51%, up from September's 37.87%. Liquidations hit US$1.36bn during the month, relative to the 12-month moving average of US$1.39bn.

The 124 loan liquidations in October resulted in US$579.4m in losses, with the loss severity reading climbing by 464bp, staying on par with the 12-month moving average of 42.2%. The average size of liquidated loans in October was US$10.99m, well above September's US$9.55m and the 12-month average of US$9.59m.

CMBS

Small-balance CMBS review completed

Fitch has completed a review of US small-balance CMBS. The agency has taken various rating actions on 261 classes in 30 transactions that were issued between 2003 and 2008 and have collateral consisting of fixed- and adjustable-rate mortgage loans secured by senior liens on commercial, multifamily and mixed-use properties.

Of the 261 classes, 172 were affirmed and 89 were downgraded. Most of those downgraded classes already held a non-investment grade or distressed rating prior to the review and, of classes with a rating outlook, close to 100% of the classes downgraded were on outlook negative prior to the review. The majority of the rating revisions were one category.

"Collateral performance deteriorated modestly over the past year with delinquency increasing on average from 22% to 25% and with realised losses to date increasing on average from 9% to 12% as a percentage of the original pool balances. A high percentage of the remaining loans have been modified. For mortgage pools with modification data available, close to 50% of the remaining loans have been modified," Fitch notes.

Insurance-linked securities

Sandy 'credit negative' for cat bond

Details are beginning to emerge on the extent of Superstorm Sandy's impact on catastrophe bonds. Moody's believes the estimated insured property losses of US$7bn-US$20bn are credit negative for Combine Re Series 2012.

The US$200m cat bond was issued by Swiss Re earlier this year (SCI 16 March). The agency says that Combine Re will now have to use up additional protective subordination and in a worst case will result in losses for the cat bond.

Moody's notes: "If property losses turn out to be at the high end of the current estimates, Combine Re cat bond investors will sustain losses. Under the high estimates, the net losses for this event will exceed the first loss layer that absorbs net losses before the rated tranches do."

The hybrid nature of the storm - combining an Atlantic hurricane with a winter storm - means it is not yet clear whether Sandy will qualify as a covered hurricane event or as a covered severe thunderstorm or winter storm. The former would see losses subject to a US$200m hurricane per-event limit, but there is no limit for either of the latter cases.

Three other events this year have already amassed losses for Combine Re and eroded the first layer of loss protection. Moody's notes that the attachment level for ultimate net losses has fallen to US$189.7m, down from US$300m.

Risk Management

Enterprise risk solution launched

Misys has launched what it describes as a new generation of collaborative risk management solutions, dubbed Misys Global Risk (MGR). The solution's best-in-class risk, regulatory and workflow modules can collaborate with a client's in-house or third-party systems in a single enterprise risk technology environment for the first time.

With MGR, banks and financial institutions can now obtain a holistic view of the enterprise risk exposure at any point in time, via an interactive dashboard that brings on-demand transparency to limit, market, credit and liquidity risk across trading and banking books. The new solution also enables firms to coordinate, control and manage risk from every part of their organisation, allowing users to make proactive business decisions based on comprehensive risk intelligence.

Risk Management

CVA whitepaper published

Quantifi has released a whitepaper comparing alternate methods for calculating CVA capital charges under Basel 3. It is published jointly with consultant Jon Gregory and covers the difference in capital charges between the simple and more advanced approaches and the capital relief which can be achieved.

Banks can compute CVA VaR through standardised or advanced methods, depending on their regulatory approval. Firms can also reduce the capital charges via eligible hedges. The whitepaper aims to help banks understand the different approaches allowed and the impact that hedging has on regulatory capital charges under Basel 3.

The whitepaper covers: the various methodologies for calculating counterparty credit risk; a comparison between the standardised and advanced methods, showing that simple comparative analysis can be done based on CVA volatilities and correlations; tests to see which method performs better for various maturities; and an analysis of results for a real portfolio, examining the importance in the difference in capital between the simple and advanced approaches when considering hedging.

Dmitry Pugachevsky, director of research at Quantifi, adds: "In the current environment, when different regulatory capital charges are drastically reducing ROE targets, it is extremely important to understand the structure of some of the largest charges, in particular Basel 3 CVA capital charge. This whitepaper demonstrates that using more advanced methodologies and applying optimal hedges can significantly reduce these charges and improve ROE for OTC businesses."

RMBS

Mortgage affordability rules discussed

New rules on affordability announced by the UK FSA following its Mortgage Market Review (MMR) will - over the long term - be credit positive for UK prime RMBS and credit negative for UK non-conforming RMBS, according to Moody's. The agency suggests that the new rules, which are broadly in line with the proposals announced on 19 December 2011, will also be credit neutral for UK RMBS in the short term.

"In the long term, the new rules will be credit positive for UK prime RMBS as they introduce affordability rules, which cover areas such as interest only and proof of income," says Sophia Velissaratou, a Moody's associate analyst. "However, the new rules will be credit negative for UK non-conforming RMBS over the long term, as it will be more difficult for these weaker borrowers to take advantage of proposed waivers on affordability checks." As such, these borrowers will continue to have extremely limited refinancing options.

"In our view, the new rules will have a limited impact on UK RMBS in the short term," says Jonathan Livingstone, a Moody's vp - senior analyst. "The subdued mortgage market and the FSA's longstanding mortgage review mean that lenders have already tightened their underwriting criteria significantly, which has reduced refinancing options for interest-only borrowers."

The setting of a concrete implementation date for the rules also removes further short-term uncertainty, Moody's notes.

RMBS

UK NC RMBS picture improves

Fitch has affirmed 71 tranches and upgraded a further 11 of 13 UK non-conforming RMBS transactions. The agency has also revised its outlook on two tranches from stable to positive.

The reviewed transactions include the Bluestone, Landmark, Alba and Ludgate series as well as EuroMASTR 2007-1. Most of the upgrades are at the junior end of the capital structure and comprised both collateralised notes and excess spread notes.

Ludgate 2007 has the lowest volume of loans in arrears by three months or more with just 3.8%, while Landmark 1 has the most with 22.8%. Most transactions show stable arrears, although Ludgate 2007 and 2008 each exhibit marginally declining arrears.

Good performance allowed the reserve fund for Ludgate 2006 to replenish to its target level on the September IPD and is for EuroMASTR 2007-1 is expected to be fully funded on the December IPD. Principal payment rates are relatively low but credit enhancement has built up over the past year. The outlook on EuroMASTR's class A2 and B notes has been revised to positive from stable.