Contents

CDO

CRE, Trups CDOs creep higher

SCI's PriceABS data recorded over 100 CDO line items yesterday, with a significant number of CRE and Trups transactions represented. Prices were flat to slightly higher against Monday's session.

In the CRE CDO space, a US$15m piece of CRELT 2006-1A A2B was talked in the low-80s and 80 area, which is also where it was talked in the prior session and on 30 November. Talk in October was regularly in the mid- and high-70s.

A US$30.73m piece of GKKRE 2006-1A A1, meanwhile, was talked in the high-80s and covered at 90. Previous talk from 6 September was also in the high-80s and 90 area.

A few LNR tranches were also circulating yesterday. A US$15m piece of LNR 2007-1A A was talked in the low-single digits, as was a US$28.9m piece of LNR 2007-1A B. Additionally, a US$9.5m slice of LNR 2006-1A BFL was talked in the low/mid-single digits. When it traded on 18 October it was being talked at less than 1, the level at which a US$6.4m piece of LNR 2006-1A CFL was being shown yesterday.

Trups CDOs were also circulating during the session, not least with seven different PRETSL and I-PRETSL tranches. The I-PRETSL 4 A1 tranche was covered in the low-90s, up from the high-80s and 90 area talk of the session before. Meanwhile, I-PRETSL 3 A1 was covered in the low/mid-90s, in line with talk from the previous session, which had been between the low- and mid-90s.

PRETSL 1 SNR was covered in the low/mid-100s, after talk the day before had been as low as the high-80s, while PRETSL 21 A2 was covered in the mid/high-40s - at the lower end of talk, which in the previous session was up to the low-60s. Its previous cover back in July was in the 40 area.

REIT Trups CDO tranches were also out for the bid yesterday. TBRNA 2006-6A A2 was covered at 11.75, with talk from the low/mid-teens down to less-than-1. Previous talk towards the end of September had ranged from the low/mid-singles to high-singles.

TBRNA 2006-7A A2LB and TBRNA 2006-7A A1LB were also covered: the former at 0.75, with talk between the low-singles and less-than-1; and the latter at 10.0625, with talk as low as less-than-1 but also ranging up to the low-double figures.

JL

CLOs

Bumper session for CLO secondary

Supply stepped up in the US CLO and CDO secondary space yesterday. SCI's PriceABS data shows 162 CLO line items and 84 CDO line items for the session, with CLO sub and Trups paper out in force.

The number of CLO BWIC line items displayed by PriceABS for yesterday's session is only one fewer than for the two previous sessions combined and the number of CDO line items is actually greater than for those sessions. US names account for around 90% of tranches captured for the session.

Liquidity appears strong at both ends of the CLO capital structure. Senior paper - such as the US$1.35m KKR 2006-1A A1 tranche, which was covered at 98 - and subordinated tranches both proved popular.

The US$3.5m ARES 2007-3RA SUB tranche was covered at 89, at the higher end of talk, which had also ranged down to the low/mid-80s. Talk in each of the previous two sessions had been in the very high-80s.

The US$6.5m MSIM 2005-1A SUB and US$14m MSIM 2005-1X SUB were also out for the bid. While neither traded, talk for each ranged from the mid-60s to the low-70s.

A surprising number of Trups CDOs were also represented. No fewer than 20 unique PRETSL tranches circulated during the session, including PRETSL 11 A1 (which was covered in the mid-70s) and PRETSL 26 C-1 (which was talked at around the 10 area).

Beyond PRETSL, TBRNA 2005-2A A1B was talked in the mid-40s and 40 area, which is in line with talk from both Monday and Wednesday. TRAPEZA 4 A1A was covered in the low/mid-90s, with talk going down to the high-80s (talk in the three prior sessions had all suggested a price between the high-80s and low-90s). The TROPC 2004-1A A1 tranche was also out for the bid, talked in the mid-60s and mid/high-60s.

JL

CMBS

Slight widening seen in US CMBS

US CMBS secondary spreads were quoted yesterday at swaps plus 175bp/174bp, just a little wider than the previous close of swaps plus 173bp, according to Interactive Data. SCI's PriceABS data shows a healthy amount of BWIC activity for the session, with little change in price levels over the last few weeks.

A variety of BACM paper was out for the bid on Wednesday. The BACM 2007-2 A2 tranche, for example, was talked at mid-102 - having been covered at 103.14 on 18 October.

BACM 2006-1 AJ was also covered, having been talked yesterday at between 330bp and 335bp. BACM 2008-1 B was covered at 76.8 and BACM 2008-1 C was covered at 65.18.

In addition, four JPMCC tranches - including JPMCC 2007-CB20 AJ and JPMCC 2011-C5 D - were being shown. The former was covered at 94.14 (slightly higher than on 8 November when it was covered at 93.2), while the latter was talked at swaps plus 490bp, wider than the low/mid-400s talk of 5 October but a lot tighter than the mid-600s talk from 29 June.

A trio of FREMF tranches also circulated during the session. FREMF 2012-K501 B was covered at 190bp (in from swaps plus 232bp on 22 August), while FREMF 2012-K709 B was covered at 220bp (tighter than its previous talk of 290bp on 18 July) and FREMF 2012-K707 B was covered at 210bp (just 1bp wider than the cover it attracted two months earlier on 27 September).

Other noteworthy names seen in secondary yesterday include GECMC 2005-C1 B and WFRBS 2011-C5 F. The GECMC tranche was talked in the mid-200s.

While WFRBS 2011-C5 has appeared several times in the PriceABS archive, yesterday was the first time the F tranche has been out for the bid. It was talked at swaps plus 675bp.

JL

RMBS

No winter slow-down for US RMBS

December kicked off with steady supply for the secondary US RMBS market. The non-agency sector continues to be dominated by subprime paper, with a CDO liquidation boosting the number of senior and mezz classes out for the bid.

"The subprime sector continues to see the majority of activity, as it accounts for the most volume and positions out for bid. Alt-A collateral dominates the fixed space, while an option ARM block is in focus in ARMs. The market has a stable tone, with dealer indications in the context of recent levels and dealer offerings mostly unchanged," Interactive Data notes. The firm puts total non-agency volume for the session at US$435m.

SCI's PriceABS data displays a number of subprime tranches that were circulating yesterday. For example, FFML 2006-FF13 A2C was talked in the mid/high-60s and high-60s, after previous talk on 24 September had been in the low/mid-60s. The JPMAC 2007-CH1 MV4 tranche did not trade, but was talked from as low as the high-20s up to the low/mid-50s.

Countrywide paper was also well represented during the session. The CWL 2004-2 M3 tranche was talked in the mid-40s, while CWL 2005-14 M6 and CWL 2005-14 M7 were each talked in the low single-digits. CWL 2007-3 2A1, on the other hand, was talked in the high-90s.

Beyond subprime, the fixed rate segment saw a US$11.8m piece of the MSM 2006-17XS A6 tranche covered at around 60, with talk in the mid/high-50s and high-50s. Smaller slices of the same bond were talked at around 60 and in the very low-60s in both August and October, with the previous cover on 22 August being in the mid/high-50s.

US$16.5m of the RFMSI 2006-S12 3A9 tranche did not trade, but was talked between mid-90s and low/mid-90s. And US$14.6m of WFALT 2007-PA1 A10 was covered in the mid-80s, with talk ranging down to the low-80s.

Finally, talk was seen in the low/mid-70s for option ARM tranche RALI 2007-QH2 A1. Previous talk back in July had been in the 60 area. Talk for Alt-A hybrid tranche MSM 2007-2AX 2A2 was in the mid-40s, which is also where talk was back on 21 September.

JL

Structured Finance

SCI Start the Week - 3 December

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

Pipeline
Last week saw nine deals join - and remain in - the pipeline. Five of these were ABS, with the remainder comprising three CMBS and a single CLO.

The ABS consisted of: US$215.95m ARL First Series 2012-1, a railcar lease securitisation; US$220m Drug Royalty II 1 series 2012-1, a drug royalties transaction; US$500m Mercedes Benz Master Owner Trust 2012-A and US$250m Mercedes Benz Master Owner Trust 2012-B, both auto deals; and US$1.53bn SLM Student Loan Trust 2012-8, a student loan ABS.

The CMBS were US$175m JPMCC 2012-PHH, US$1.5bn UBSBB 2012-C4 and US$1.3bn WFRBS 2012-C10. The CLO was US$507.25m Ares XXV.

Pricings
The number of new issues was consistent with the week before. Seven ABS, two CMBS and five CLOs priced.

The ABS included: US$205m American Credit Acceptance Receivables Trust 2012-3, €800m Auto ABS 2012-3, €952.5m Private Driver 2012-3 and €282m VCL Master Compartment - which are each auto deals; €840m IM CITI TARJETAS 1 and £400m Invicta Funding 2012, which are both credit card securitisations; and US$1.012bn Nelnet Student Loan Trust 2012-6, a student loan ABS.

The CMBS comprised US$300m BAMLL 2012-PARK and £215m Telereal Securitisation Tap-3. The CLO prints consisted of €2.4bn FonCaixa FTPYME 3, US$612m Magnetite 2012-7, US$326m NewStar Commercial Loan Funding 2012-2, US$626m Northwoods Capital IX and US$514m Wind River 2012-1.

Markets
The European ABS market has not been afflicted with the traditional year-end theme of price softening so far, according to analysts at Deutsche Bank. "We expect to see another week or two of limited activity before seasonal liquidity dries up." For the primary market, they expect minimal issuance - if any - ahead of year-end.

TMAN 7 remains among the most liquid European CMBS, as SCI reported on Tuesday (27 November). BWICs continue to circulate without prices moving very much, as the market appears to be winding down for year-end. "Most people have had a fairly good year and just want to now ride out the last few weeks without adding too much risk," notes one trader.

He adds: "General credit indices widened out a lot and then tightened in again, so it has also been a bit more volatile recently and maybe people are looking for some direction. TMAN 6 and 7 have both traded up a little bit, but only by 10 or 20 cents, and other paper has not moved much."

The US CMBS market, meanwhile, saw secondary spreads widen mid-week before tightening again. Price levels were largely unchanged, as SCI reported on Thursday (29 November).

Wednesday's session saw a variety of tranches circulating, although BACM and JPMCC tranches were particularly prevalent. BACM 2007-2 A2 was talked at mid-102, while JPMCC 2007-CB20 AJ was covered at 94.14.

US RMBS activity picked up from a slow start to the week. Non-agency BWIC volume on Tuesday was up by 40% on Monday's levels, as SCI reported on Wednesday (28 November).

SCI's PriceABS data showed subprime talk edging higher. Names such as CARR 2005-NC1 M2 were being talked higher than levels in the previous session, with Alt-A fixed paper such as RAST 2006-A8 3A4 also moving higher.

The US CLO market grew increasingly busy as the week progressed, as SCI reported on Friday (SCI 30 November). Thursday's session was busier than most, with CLO subordinated paper proving popular. There were also several Trups CDOs out for the bid, with no fewer than 20 unique PRETSL tranches captured by PriceABS.

Deal news
• MBIA has successfully completed a consent solicitation resulting in the amendments to indentures governing its 6.4% Senior Notes due 2022, 7% Debentures due 2025, 7.15% Debentures due 2027, 6.625% Debentures due 2028 and 5.7% Senior Notes due 2034. Bank of America had previously tried to obstruct the move with a tender offer to purchase at par the monoline's outstanding senior notes due 2034 (SCI 20 November).
• New York Mortgage Trust has entered, through a wholly-owned subsidiary, into a master repurchase agreement with a three-year term for the purpose of financing certain K-Series multifamily CMBS. The REIT received gross cash proceeds of approximately US$52m before deducting expenses associated with the transaction.
• The EIB's project bond credit enhancement (PBCE) instrument (SCI 14 November) - whether in the form of funded subordination or an unfunded letter of credit - could improve a project's credit metrics to a level in line with ratings in the single-A category, according to Fitch. However, to achieve this, projects would also need to display a reasonably strong standalone credit profile.
• Bocage Mortgages No.1 has been restructured to include the appointment of a back-up servicer, increased issuance of the unrated variable funding note (VFN) and a termination of the basis swap. In Fitch's view, the appointment of a back-up servicer and the increase in the VFN are both positive for the transaction.
• Moody's has downgraded 20 notes previously rated at the country ceiling and confirmed one note from 18 Portuguese RMBS, further to its reassessment of the entire Portuguese RMBS market. The reassessment takes into consideration the agency's updated European RMBS rating methodology, as well as ongoing deterioration in the credit quality of the Portuguese sovereign and transactions' counterparties.
• Moody's has downgraded three senior notes and 10 junior notes across seven Italian RMBS, further to its reassessment of all rated Italian RMBS. The rating agency's reassessment takes into consideration: its updated European RMBS rating methodology; ongoing collateral performance deterioration; and the deterioration of the ratings of the Italian sovereign and the transactions' counterparties over the last 12 months.
• Moody's has taken rating actions on 156 Spanish RMBS, affecting approximately €62.5bn of debt securities, further to its reassessment of the entire Spanish RMBS market. The rating agency's reassessment takes into consideration continued collateral performance deterioration, its updated European RMBS rating methodology and ongoing deterioration in the credit quality of the Spanish sovereign and transactions' counterparties.

Regulatory update
• The CFTC has issued new rules to require certain credit default swaps and interest rate swaps to be cleared by registered derivatives clearing organisations (DCOs), as promulgated under the Dodd-Frank Act. Under the rules, market participants are required to submit a swap for clearing by a DCO as soon as technologically practicable and no later than the end of the day of execution.
• The ECB has adjusted its timeline for the start of loan-level data reporting requirements as part of the Eurosystem's collateral framework, to allow for the smooth implementation of what it deems as necessary amendments to Guideline ECB/2011/14 at the national level.
• ISDA has published an analysis of initial margin (IM) requirements for non-centrally cleared OTC derivatives under current regulatory proposals. The analysis is based upon data submitted by member firms to the Basel Committee and IOSCO joint Working Group on Margining Requirements (WGMR), as part of its Quantitative Impact Study.
• The US SEC has charged three executives at KCAP Financial for overstating its assets during the financial crisis. KCAP, a publically traded fund regulated as a BDC, had an asset portfolio consisting mainly of corporate debt securities and CLO investments.
• IOSCO has published its final 'Principles for Ongoing Disclosure for Asset Backed Securities' report, which is designed to provide guidance to securities regulators that are developing or reviewing their regulatory regimes for ongoing disclosure for ABS. The eleven principles were developed as a complement to IOSCO's 'Disclosure Principles for Public Offerings and Listings of Asset-Backed Securities', which was issued in 2010.

Deals added to the SCI database last week:
Anchorage Capital CLO 2012-1; Auto ABS 2012-2; BB-UBS Trust 2012-SHOW; Bilkreditt 3; Carlyle Global Market Strategies CLO 2012-4; Centre Point Funding Series 2012-2; Cerberus Offshore Levered I; Driver UK Master Compartment 1; FTA Santander Consumer Spain Auto 2012-1 ; Globaldrive Auto Receivables 2012-A; GSMS 2012-GCJ9; Kramer Van Kirk CLO 2012-2; Oaktree Enhanced Income Funding Series I; Pepper Prime 2012-1 Trust; RCMC 2012-CREL1; Tidewater Auto Receivables Trust 2012-A; Vermont Student Assistance Corp series 2012-1; VNDO 2012-6AVE.

Deals added to the SCI CMBS Loan Events database last week:
BRUNT 2007-1; BSCMS 2007-PW16; DECO 2006-C3; DECO 2006-E4; DECO 7-E2; ECLIP 2007-1A; EMC VI; FLTST 3; GECMC 2007-C1; GRND 1; JPMCC 2007-LD12; LBUBS 2007-C1; MSC 2007-IQ15; RIVOL 2006-1; TAURS 2006-2; TITN 2005-CT2; TMAN 6; WBCMT 2007-C30; WINDM XII.

Top stories to come in SCI:
Year-end outlooks

CMBS

Stuy Town court case settled

The Roberts vs. Tishman Speyer Properties court case has been settled. The settlement removes the last significant obstacle to a sale of the Stuyvesant Town-Peter Cooper Village apartment complex and reduces the likelihood of CMBS losses.

The settlement has been agreed to by both sides, as well as the New York State Division of Housing and Community Renewal and the Chief Justice of the Appellate Term. However, Deutsche Bank CMBS analysts note that it is still subject to final state court approval and could be subject to challenges from tenants.

Of the settlement, US$68.75m will be set aside to compensate tenants for rent overcharges between 2003 and 2011, with US$58.25m coming from special servicer CWCapital and US$10.5m from Metlife. The additional advance will increase the total outstanding on the loan to approximately US$350m, or 12% of the unpaid principal balance. The Deutsche Bank analysts note that the allocation between the five related CMBS deals will be 50% for WBCMT 2007-C30, 27% for MLCFC 2007-5, 8% for CWCI 2007-2, 8% for WBCMT 2007-C31 and 7% for MLCFC 2007-6.

"Not much should happen in the immediate future and, if all goes according to plan, by April the servicer advance total will increase by US$58m. Around 20% of the total has already been escrowed and we expect the servicer will continue to escrow money during the next four months, so the interest distributions for the related deals will have as little disruption as possible," the analysts observe.

Despite the large outstanding advance total, they do not expect it to be declared non-recoverable. Once the agreement is finalised and the settlement disbursed, the negotiations between CWCapital and the potential owners of the asset should intensify.

A hearing has been scheduled for 9 April 2013 to finalise the settlement, with a sale not expected to be announced until 2014 at the earliest. "This is the beginning of the end. It is a positive event and we expect a meaningful reaction in the levered bonds from the five deals," the analysts note.

The senior loan is still expected to be repaid through payments made by tenants purchasing units. As the property could be sold before the loan's maturity date in 2016, the repayment of principal could begin before the open period begins in September of that year.

"Another possibility is a potential buyer could defease the existing loan sometime in 2014 (it is eligible now) and refinance the debt at a lower rate. We estimate the annual savings from a refinanced senior loan would be approximately US$60m a year, so the incentive is there, but obtaining the financing could be tough."

As the GSEs effectively already own the Stuy Town risk through their ownership of the A1A classes, it may be that having that risk defeased with an opportunity to originate a very large new loan could be interesting for them. "In sum, the settlement should significantly reduce the market's expectation of losses and narrow the work-out period, resulting in higher bond prices for related AM classes through senior mezzanine classes," the analysts conclude.

JL

Risk Management

Basel 3 liquidity challenges examined

Basel 3 is introducing significant challenges to the traditional ALM product set in the way that liquidity risk is managed and reported. Such considerations are, in turn, forcing firms to approach risk management on an enterprise-wide basis.

The Basel 3 liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) require banks to project forward - for 30 days and a year respectively - scenario analyses to better understand what would happen to their liquidity under severe stresses. Once they've calculated the appropriate net cash outflow, banks are required to set aside that amount as a liquidity asset buffer.

To calculate these scenario analyses, banks need to model cashflows in ways that traditional analytics don't provide for, according to Calypso strategy and business development director David Little. "The emphasis should be on the optionality of complex derivative instruments. It is necessary to understand what would happen in the event of the trade population varying; for example, to adjust for interest rate movements or the inability to roll over a given position."

Intraday liquidity monitoring is another Basel 3 requirement that the industry is trying to get to grips with. The intention is for banks to better understand how their liquidity behaves during the day, as well as the sources or sinkers of that liquidity. By gathering and reporting this information, it is hoped that the industry can defend against liquidity shocks.

Little says that the concept of sequential duty is already coming under fire as a result. "UK banks, for instance, are no longer allowed to push the float offshore. Other central banks are likely to restrict the ability of banks to undertake sequential duty too."

He adds: "This is impacting liquidity on a global scale: it's a fine balance between safety and maximum utilisation of liquidity. Ultimately, banks will have to hold more high quality collateral against a number of different liquidity requirements."

Equally, as banks gain a better understanding of the sources of their liquidity, funds transfer pricing will gain in importance. "Funds transfer pricing ensures that desks are charged for all the costs of doing business, including increased liquidity costs," Little explains. "It is a mechanism whereby different business lines are charged or credited a liquidity premium, depending on whether and by how much they are using or providing liquidity to the bank as a whole."

Front offices are increasingly finding that post-trade costs are impacting the profitability of a trade. This, in turn, is driving executive committees to reassess whether they want to participate in such trades going forward.

Some capital-intensive business lines are already being divested and absorbed by non-bank institutions. But Little notes that LDI pension funds - as well as trading institutions - are being impacted by post-trade cost considerations.

"Derivative hedging costs are rising and OTC trades will become considerably more expensive, given new margin requirements. This is likely to change the structure of the market, as participants look for different mechanisms and/or ways to reduce costs," he says.

Such considerations are also forcing firms to approach risk management on an enterprise-wide basis by bringing together trade data from the investment bank, loan data from the commercial and retail bank, and payments information. Typically banks aggregate this data in clumps and then bring the clumps together, but this diminishes the granularity of individual transaction data.

"Ideally, banks should bring all of the data into one system at the transaction level and aggregate it once to show cashflows on a contractual or future basis. This means that they can still drill back down to the individual transaction and dice and slice the data to understand trends and perform investigations in real time," Little concludes.

These themes and more will be discussed in an SCI-hosted webinar on 12 December at 9am GMT. Click here for complimentary registration to the event.

ABS

Second infrastructure debt fund launched

AMP Capital has appointed Patrick Trears as infrastructure debt director in New York and launched a new debt fund in response to increased infrastructure investment demand. The new fund is AMP Capital Infrastructure Debt Fund II (IDF II).

Trears joins from WestLB and has previously held structured and project finance positions at Hypo Real Estate, Citi Investment Bank and DEPFA Bank (Ireland). He will focus on increasing opportunities for debt investment in infrastructure assets across North America to expand deal flow for AMP's existing and new debt funds.

IDF II will invest in the subordinated debt of infrastructure assets in the essential water, gas, electricity and transportation services in Europe, North America and Australia. It follows the successful IDF I, which was launched two years ago and closed to new investors in the summer.

Structured Finance

Fund closed, new one prepped

Deer Park Road Corp's flagship fund, STS Partners Fund, has closed to new investors. The fund - which focuses on deeply discounted short-duration, high cashflow MBS and other ABS securities - was launched in May 2008 and has since grown to more than US$600m AUM.

Michael Craig-Scheckman, portfolio manager and owner of the firm, comments: "In order to preserve the ample opportunity we continue to see in our market, near and longer term, we decided it was best to limit the size of the portfolio."

However, Deer Park plans to roll out a new fund early in 2Q13 that uses the same strategy and process employed in STS Partners Fund, but with securities that - for the most part - will be slightly higher in the capital structure and with slightly lower return expectations. The new fund will essentially replicate a strategy currently used by Deer Park to manage a US$150m-plus separately managed account.

Structured Finance

KNG grows fixed income team

Alessandro Vargiu and Filippo Gromo have joined the fixed income team at KNG Securities. They follow the appointment of fixed income head Andrea Podesta, who joined as managing partner last month.

Vargiu and Gromo will play a key role in strengthening KNG's offering, particularly for the Italian markets. Vargiu has previously worked at Deutsche Bank and Credit Suisse, working across the credit markets and structured products. Gromo joins from BNP Paribas, where he spent seven years in the credit and structured rates sales team.

Structured Finance

Asset manager returns to credit

Michael Mabbutt is set to join Liontrust in January as head of a newly-formed global credit division. The firm sold its credit hedge fund business to Avoca last year (SCI 13 April 2011).

Concurrent with Mabbutt's appointment, Liontrust will launch a Dublin-based global strategic bond fund, subject to appropriate regulatory approvals. He is currently a consulting partner at Thames River Capital and was previously head of the firm's global credit division, head of emerging market debt at LGT Asset Management and head of emerging market debt at Baring Asset Management.

CDO

Basis CDO complaint filed

Basis Pac-Rim Opportunity Fund and Basis Yield Alpha Fund have filed a lawsuit against TCW Asset Management in New York state court in connection with a transaction that TCW issued in May 2007. According to the complaint, the plaintiffs acquired a total of US$28.1m securities issued by Dutch Hill Funding II, a mezz ABS CDO.

They allege that TCW misrepresented that the securities were safe investments, despite knowing that many of the home loans backing the securities would default. The complaint further alleges that TCW prepared a false investor report that omitted information regarding likely problems with the loans.

The complaint includes claims for fraud, negligence and breach of contract, according to a Lowenstein Sandler client memo. In addition to seeking compensatory damages of US$28m, the complaint seeks punitive damages of US$100m.

CDO

Manager transfers agreed

Halcyon Neptuno II Management has assumed from Bankia investment management responsibilities for Neptuno CLO II. Moody's has confirmed that the move won't cause the current ratings of the notes to be reduced or withdrawn.

Separately, Dock Street Capital Management has added another ABS CDO to its roster. The firm has been named successor collateral manager for Mercury CDO III, which was initially managed by Chotin Fund Management Corp.

For other recent CDO manager transfers, please click here.

CLOs

Alternative investment transition due

Recent investor notices for the Duane Street CLO I to IV transactions provide an insight into how the Volcker Rule is impacting bank investment management arms.

The notices state that certain Citigroup Alternative Investments (CAI) businesses - including the Duane Street CLOs - are being transitioned to a newly formed employee-owned asset management company (dubbed Newco) controlled by the current Citi Capital Advisors senior management team (co-ceos Jonathan Dorfman and James O'Brien). The move is a result of a strategic review related to recently-enacted regulatory reforms, according to the notices.

Newco will own CAI's hedge fund and CLO businesses, as well as portions of certain other businesses. The investment philosophy and risk management processes that are currently provided to these businesses by CAI is expected to remain the same when transitioned to the new entity. The partners of Newco will be the same people who currently manage the businesses, with data and other systems to be transitioned from their current Citi platform to a platform established for the new entity.

Newco is expected to have US$6.4bn of assets under management post-transition, US$2.3bn of which is Citi proprietary capital that will be redeemed by 15 July 2014. Citi will own a passive, non-controlling minority interest in the new entity.

The transition is expected to occur in 1Q13, subject to the satisfaction of certain conditions.

CLOs

Fund settles over fair value charge

The US SEC has charged three executives at KCAP Financial for overstating its assets during the financial crisis. KCAP, a publically traded fund regulated as a BDC, had an asset portfolio consisting mainly of corporate debt securities and CLO investments.

The SEC says KCAP did not account for certain market activity in determining the fair value of its debt securities and CLOs and failed to disclose that it had valued its two largest CLO investments at cost. Primary responsibility for pricing the securities fell to ceo Dayl Pearson, cio Jonathan Corless and cfo Michael Wirth.

The enforcement action is the first of its kind against a public company that failed to properly fair value its assets. Without admitting or denying the SEC's findings, Pearson and Wirth each paid US$50,000 to settle, while Corless agreed to pay US$25,000.

CMBS

CRE vet recruited

United Realty Capital has named Craig Eastmond md. He will be based in New York and report to Barry Funt, president of the firm.

In addition to providing advisory, placement, corporate finance and investment banking services to United Realty and its affiliates, Eastmond will be responsible for originating and executing arbitrage opportunities in the commercial real estate and finance space. He has previously been involved in over US$10bn of commercial real estate and related finance deals in numerous capacities, including executing CDOs.

Prior to joining United Realty Capital, Eastmond was one of the founding principals of Allegiance Investment Advisors, a boutique private equity and structured finance shop that executed over US$750m of commercial real estate and related debt transactions. Before that, he was an svp in charge of the Northeast region of Deutsche Bank's real estate mortgage conduit.

ABS

Improvement seen in Japan consumer credit

Moody's reports that the overall credit quality of all consumer asset classes in Japan's ABS market has improved. The agency expects the sector to remain stable, even in the face of severe unemployment and a decline in income levels.

The Japanese ABS default rate is generally stable. The default rates of card cash advances and consumer finance loans, for instance, have this year touched their lowest level in 10 years.

Moody's notes that this is mainly because credit quality has improved due to: tighter lending policies, in accordance with the revised Money Lending Business Law that came into effect in 2010; originators have agreed to provide more favourable terms for loans and have repurchased these amended receivables from securitised pools; obligors with weak credit profiles have already defaulted and left the pool; and some transactions that were weak are no longer part of the index.

On the other hand, the improvement in credit quality will gradually slow down. Therefore, default rates are unlikely to decline substantially from current levels, according to Moody's.

Credit quality is also improving in other asset classes such as auto loans and instalment sales loans, as new ABS are now backed by loans that were screened more strictly.

Structured Finance

PBCE could reach single-A rating

The EIB's project bond credit enhancement (PBCE) instrument (SCI 14 November) - whether in the form of funded subordination or unfunded letter of credit - could improve a project's credit metrics to a level in line with ratings in the single-A category, according to Fitch. However, to achieve this, projects would also need to display a reasonably strong standalone credit profile.

The unfunded PBCE instrument can improve the construction phase risk profile of a project by providing additional subordinated liquidity to fund cost overruns or to replace a defaulted contractor, Fitch notes. It is also capable of enhancing a project's rating profile during operations as, in the event of material stress, it can be used to partially prepay senior debt to restore cashflow coverage levels.

Following a drawing, the PBCE can be assimilated to subordinate debt, as it is repaid through a cash sweep after senior debt service. Amounts repaid can be redrawn, potentially providing future liquidity support.

The funded subordinated debt option, meanwhile, does not improve a project's risk profile during construction and it provides marginally less liquidity support during operation. Fitch's analysis of debt enhanced by the funded subordinated facility would follow the guidelines of the rating criteria relevant for the asset class, the agency says.

Structured Finance

SCI conference line-up unveiled

Final panellist line-ups have been announced for SCI's 6th Annual Pricing, Trading & Risk Management Seminar, which is taking place on 7 December in London. The event is being held at Reed Smith's offices at 20 Primrose Street, EC2A 2RS.

This conference will focus on risk management and pricing/valuation issues, as well as trading and secondary market strategies. The programme consists of a series of roundtables, panel debates and an RMBS relative value workshop.

Speakers include representatives from: AEGON; AFME; Bishopsfield Capital Partners; BNP Paribas; Brookland Partners; Cadwalader; CBRE; Chenavari; FSA; HSBC; IKB; Knight Capital; Lloyds; PCS Secretariat; Pearl Diver Capital; Prytania; RBS; Santander; SCIO Capital; and TwentyFour Asset Management. The event is sponsored by Reed Smith and Moody's Analytics.

Email SCI for a registration code or click here to register.

CDO

ABS CDO on the block

VCAP Securities has been retained to act as liquidation agent for Knollwood CDO II. The collateral will be auctioned in New York via two public sales on 13 December. Sale No. 1 comprises cash CDO, CMBS and RMBS assets, while Sale No. 2 consists of subprime RMBS collateral.

CDS

Clearing deadlines set

The CFTC has issued new rules to require certain credit default swaps and interest rate swaps to be cleared by registered derivatives clearing organisations (DCOs), as promulgated under the Dodd-Frank Act. Under the rules, market participants are required to submit a swap for clearing by a DCO as soon as technologically practicable and no later than the end of the day of execution.

The clearing requirement determination applies only to swaps currently cleared by four DCOs: CME; ICE Clear Credit; ICE Clear Europe; and LCH.Clearnet. Swaps in four interest rate swap classes and two CDS classes (North American - CDX IG and HY - and European - iTraxx Main, Crossover and HiVol - untranched indices) are required to be cleared.

The Commission also is issuing regulation to prevent evasion of the clearing requirement and related provisions. Finally, pursuant to the clearing requirement determination, a DCO is required to post on its website a list of all swaps that it will accept for clearing and clearly indicate which of those swaps the Commission has determined are required to be cleared.

Swap dealers and private funds active in the swaps market will be required to comply beginning on 11 March 2013. Accounts managed by third-party investment managers, as well as ERISA pension plans, will have until 9 September 2013 to begin clearing swaps. All other financial entities will be required to clear swaps beginning on 10 June 2013.

If no DCO offers iTraxx indices for client clearing by 11 February 2013, the Commission will delay compliance for those swaps until 60 days after an eligible DCO offers iTraxx indices for client clearing.

The requirement does not apply to firms who are eligible to elect an exception from clearing, such as non-financial entities hedging commercial risk. Any swaps entered into prior to the enactment of the Dodd-Frank Act or prior to the application of the clearing requirement are not required to be cleared either.

CDS

Hedging decisions to become more complex

The cost of central clearing of formerly bilateral trade structures will serve as the primary catalyst in the move towards less exotic instruments and outright vanilla products, according to TABB Group. The firm suggests that although many exotic trade structures will remain on the books of market participants until they eventually expire or are terminated, new products aimed at mimicking the economics and potential accounting advantages of an OTC derivative - while simultaneously exhibiting the operational efficiency and regulatory certainty of a listed derivative - will be added to the selection spectrum. In short, the list of available hedging products is set to expand - not contract - due to the onset of central clearing, further complicating hedging decisions.

CLOs

Reg cap concerns underlined

Bond investors remain cautious on taking exposure to European corporate risk via SME CLOs, Fitch reports. This is due partly to regulatory capital treatment, since SME leasing transactions are still being placed with investors, which suggests there is appetite for securitised SME corporate risk but only for deals with short tenors that attract less punitive capital charges.

A handful of corporate leasing CLOs were placed with investors in 2012, according to Fitch. These had weighted average lives of between 16 and 25 months. As well as the relatively high asset spreads on leases that help make deals economically viable, investors may be more willing to buy these deals because the short WAL means that the discrepancy between the capital charges they attract compared with corporate bonds is less pronounced.

The agency believes the proposed capital treatment of securitised debt may significantly dent appetite among banks and insurers. For example, Solvency II's draft rules require a 35% capital charge for a triple-A security with duration of five years, compared with 7% for a single-A rated corporate bond or 12.5% for a triple-B rated corporate bond. Below one year, the capital charge for triple-A securities is 7%.

Meanwhile, banks are more concerned with structured finance's exclusion from the liquidity coverage ratio (LCR).

Capital charges applied to longer-dated structured finance bonds are arguably excessive, given the low actual losses in EMEA structured finance. The historical and expected loss between 2000 and 2011 for EMEA leveraged loans and SME CLOs originally rated triple-A is zero.

Regulatory treatment is one reason why CLO supply in Europe is expected to remain constrained in 2013. Other reasons include the continued availability of central bank liquidity and the high cost of issuing SME CLOs compared with RMBS and unsecured bank debt.

CLOs

Euro A2E activity tracked

Fitch says in its new European leveraged loan CLO tracker report that up to 40% of the CLO portfolio has been subject to amend-and-extend activity in the past two years.

"While refinancing opportunities for highly leveraged borrowers remain scarce, the maturity wall has been extended and smoothed," says Laurent Chane-Kon, director in Fitch's European structured finance team.

The cumulative default rate observed within CLO portfolio stands at 13.4% and is still below expectations, Fitch says. Although the maturity wall has been smoothed, defaults may still pick up when most loans are due for repayment between 2015 and 2017, and if refinancing options continue to be limited and highly selective.

In addition, Fitch expects further write-downs for loan issuers that have previously defaulted on their obligations. The initial debt restructurings - driven by the limited willingness of lenders and CLO manager to accept write-downs - are not sustainable and do not accurately reflect the value of the defaulted debts, the agency notes.

Nonetheless, net losses for European CLOs remain low. Excess spread has enabled transaction to deleverage and reduced losses close to zero. Most CLOs that have passed their reinvestment period are deleveraging surprisingly quickly, up to 20% after one year.

CMBS

Repo resecuritisation closed

New York Mortgage Trust has entered, through a wholly-owned subsidiary, into a master repurchase agreement with a three-year term for the purpose of financing certain K-Series multifamily CMBS. The REIT received gross cash proceeds of approximately US$52m before deducting expenses associated with the transaction.

Pursuant to the terms of the master repurchase agreement, RB Commercial Mortgage transferred approximately US$116m of CMBS assets to New York Mortgage Securitization Trust 2012-1. The notes - issued under a private placement - bear interest of one-month Libor plus 6.5%.

The notes and the financing under the master repurchase agreement are scheduled to mature in November 2015, at which time the issuer will transfer the CMBS assets back to the REIT. All income received on the assets during the term of the agreement will be applied to pay any price differential and to reduce the aggregate repurchase price of the collateral. NYMT agreed to guarantee the due and punctual payment of the seller's obligations under the agreement.

The collateral comprises securities issued from four separate Freddie Mac-sponsored CMBS, including a first-loss floating rate security acquired by the REIT in October, as well as first-loss principal-only securities and interest-only securities it acquired this month.

CMBS

Liquidation volumes move higher

US CMBS loss severity levels remained relatively unchanged in November, according to Trepp, while the volume of loans liquidated during the month moved sharply higher. There were 159 loan liquidations in November, resulting in US$750.3m in losses and an average loss severity of 42.22%.

The November reading was 29bp lower than the October level of 42.51%. November's average loss severity was slightly above the 12-month moving average of 41.03%.

The face amount of the November liquidations was US$1.78bn, which is more than US$400m above the October total. It also surpassed the 12-month moving average of US$1.37bn. Since January 2010, servicers have been liquidating at an average rate of US$1.17bn per month.

The number of loans liquidated was higher than the 12-month moving average of 141. The average size of liquidated loans in November was US$11.18m, up slightly from October's US$10.99m and significantly above the 12-month average of US$9.73m.

CMBS

Loans in special servicing drop

The volume of underperforming US CMBS loans in special servicing registered its sharpest quarterly decline, according to Fitch's latest index results for the sector. After peaking at US$91.7bn in 2010, CMBS loans in special servicing dropped by nearly US$6bn to US$74.8bn at the end of 3Q12.

Other encouraging signs for the sector include declines in both the number of assets per asset manager and the balance of loans transferred into special servicing. "The backlog of underperforming CMBS loans is still formidable, but servicers are gradually seeing fewer loans to work out and increased refinancing opportunities, which bodes well for the next year," says Fitch md Stephanie Petosa.

CMBS

Conflict of interest warning

Fitch believes that the steep reduction in the balance of US CMBS loans in special servicing (SCI 3 December) may intensify some of the conflicts of interest that special servicers have wrestled with. It also may be difficult to maintain over the long run, as the balance remains high and a large number of maturities are due in 2015-2017.

A reduction in the number of assets per special servicer asset manager and the balance of loans transferred into special servicing has allowed these companies to reduce their headcounts and operate at more reasonable levels, according to Fitch. Over the past year, the average number of assets per asset manager has declined from 20 to 12. As recently as 2010, one special servicer had nearly 50 assets per manager.

The agency also believes that the relative scarcity of specially serviced loans is increasing competition between servicers and may make the conflicts of interest that they must manage more important. Investors are concerned that special servicers agree to resolution terms that are in their own best interest, rather than protecting the interests of all bondholders.

Increased competition for troubled assets, either for fee generation or ultimate control of the real estate, will further intensify investor concern as special servicers compete for controlling classholder rights. "In our view, the trend toward a smaller specially serviced loan pool may be difficult to maintain over the longer run. The large volume of maturities that will begin in 2015 and run through late 2017 are difficult to predict amid uncertain interest rate trends and the current delicate recovery in the business cycle," Fitch notes.

CMBS

Mixed outlook for US CMBS

The overall credit quality of loans backing new US CMBS will continue to weaken in 2013, but underwriting will not match the low quality experienced when CMBS volumes peaked in 2007, according to Moody's. Higher DSCRs and greater amortisation are expected to combine to somewhat mitigate the impact of higher leverage in new transactions, which the agency predicts will total US$70bn in 2013.

"Higher DSCR helps reduce default risk during the term of a loan and greater amortisation helps reduce balloon risk when a loan matures," says Tad Philipp, Moody's director of commercial real estate research. "The higher DSCR and faster amortisation on current loans are both due to historically low interest rates."

The agency expects commercial real estate fundamentals to recover unevenly during 2013. The recovery of two major CMBS sectors - office and retail, which account for more than 60% of recent issuance - will not occur until after 2013.

"Office and retail have an ample supply of excess inventory that the market must absorb before rents can rise," Philipp continues. "Multifamily and hotel, two other important sectors, are further along in their recovery and net operating income for both will grow."

The credit quality generally - and therefore the ratings - of outstanding CMBS transactions will be stable in 2013, with affirmation constituting 80% of rating actions. The remainder are likely to be evenly divided between upgrades and downgrades.

"Credit quality of the collateral supporting seasoned deals varies by sector and location," says Keith Banhazl, a Moody's vp. "Recovery will be uneven across the major US metro areas, and local property market analysis matters more than ever."

The proportion of delinquent and specially serviced CMBS loans is anticipated to decline in 2013 but remain within a few percentage points of current levels. Losses on loans defaulting at maturity will be significantly lower than on loans defaulting during their term.

CMBS

EMEA funding gap underlined

Over 70% of EMEA CMBS loans maturing in 2012 have not been repaid, suggesting that a lack of refinancing options will continue to weigh on the sector in 2013 and 2014, Fitch says. Evidence of new entrants in the European commercial mortgage market is growing, with several senior debt funds in the process of raising equity and large insurance companies also targeting the sector. However, institutional funds are unlikely to fill the funding gap left by banks as long as their focus is on higher-quality properties.

Only 24 out of 122 loans that matured in the first 11 months of 2012 were fully paid at maturity. A further 12 were fully paid after maturity and one was repaid in full following a breach in representations and warranties, which obliged the originator to repurchase it.

Of the remainder, 31 are in workout, 29 are in standstill and 20 have had their maturity extended. Three have already suffered losses.

The 2012 maturities dwarfed the previous peak in 2011, with more than twice the number and almost three times the aggregate loan balance coming due, according to Fitch. With 227 loans accounting for €31.9bn maturing in 2013 and 2014, refinancing and timely repayment will remain challenging.

As in 2012, the key constraint for CMBS servicers handling defaulted loans in the next two years will be the limited amount of debt available to finance non-prime assets that secure the majority of the CMBS portfolio. Furthermore, several loan workouts over the past 12 months suggest that weaker assets are subject to significant obsolescence risk, which - in the most extreme cases - can reduce market values to a mere fraction of the original appraisals.

"This is particularly concerning for single-let properties littering the CMBS portfolio where tenancy risk is the central concern, especially as medium-sized corporates continue optimising their use of sites across Europe. Generally, a strong tenancy profile is increasingly a prerequisite for lenders considering debt financing," Fitch explains.

Even where collateral and loan performance have been stable, other considerations are coming into play, however. One is collateral jurisdiction, with properties in countries seen as vulnerable to the eurozone debt crisis - such as Spain and Italy - enjoying little investor demand and next to none from foreign buyers.

The approach of CMBS legal maturities will intensify the pressure on servicers working out loans, making forced sales more likely and potentially pushing down prices further. Sixty-six loans falling due in 2013 or 2014, with a total outstanding balance of €16.2bn, have to be resolved within three years of loan maturity. For 16 loans, with a balance of €2.7bn, the gap is less than two years.

Risk Management

Pricing analytics offered

Deutsche Bank has made two of its analytic models - Deutsche Bank CMBS Credit Model and Deutsche Bank Mortgage Prepayment Model - available on the Bloomberg Professional service. The former is the first independent CMBS model on the Bloomberg Professional service and enables investors to estimate the overall value of commercial mortgage securities and effectively analyse loan portfolios. The latter is an agency MBS prepayment model, which is designed to allow users to assess an independent prepayment opinion to better analyse bond value and risk.

RMBS

CIM3 clarifies repurchase responsibilities

Credit Suisse has priced its third non-agency RMBS of the year - the US$329.89m CSMC Trust 2012-CIM3. S&P, which rated the transaction, notes that there are significant differences between it and the other two deals in the series (see SCI's pricing database).

One of the differences is that the CIM3 transaction includes time limits (sunset provisions), within which investors may make claims for breaches of two particular representations and warranties (R&Ws) from the relevant originator or R&W back-stop provider. In addition, the offering attempts to clarify what constitutes a breach of an R&W.

"We believe that traditional R&W provisions merit attention to provide greater clarity on repurchase responsibilities, encourage greater due diligence in the origination and securitisation processes, and reduce litigation and related expenses for all market participants in the long term. The CIM3 transaction is the first of what we expect will be many non-agency examples of the effort to provide greater clarity around these impactful issues," S&P observes.

The CIM3 sunset provisions are limited to a three-year period for claims related to fraud and non-compliance with underwriting guidelines only. S&P recognises that there is the possibility that claims for legitimate breaches will be barred following the applicable sunset period. However, the agency considers the likelihood of such claims - based on breaches that have actually been the primary cause of a default or an excessive loss after three years from the sale date - to be remote.

The second major change featured in the CIM3 transaction is the inclusion intended to clarify the 'material and adverse' repurchase standard that has been the subject of significant litigation and consideration. The apparent purpose of the provisions in some of the repurchase agreements in CIM3 is to limit the repurchase obligation to situations when the associated R&W breaches either caused a default or increase a loss as a result of default.

It remains to be seen whether these provisions will have a significant impact on future repurchase disputes, given the difficulties of establishing proximate cause, but S&P believes that the provisions provide greater clarity than traditional language. The agency says it agrees with general market consensus that risk for life events -such as unemployment - should be a risk that investors bear, while deficiencies in loan origination and underwriting should be borne by originators and issuers.

RMBS

CIM3 credit enhancement concern

Fitch has published an unsolicited comment on CSMC Trust Mortgage Corp 2012-CIM3 (see also SCI 3 December), suggesting that the RMBS has insufficient credit enhancement to achieve a triple-A rating. Although asked to provide feedback, the agency was ultimately not selected to rate the transaction.

Fitch believes it has a more conservative credit stance regarding the deal: at 5.85%, the credit enhancement available to the triple-A rated A2 class is more than 15% lower than any Fitch-rated prime RMBS issued since 2008. The agency's estimated credit enhancement for the senior class A1 and A2 notes was 8%.

While the collateral attributes of the CIM3 pool are consistent with those Fitch would consider representative of a high credit quality prime portfolio, the 5.85% CE available to the A2 class is not sufficient in the agency's view to fully address the risks associated with the pool. These include concentrations in geographies whose property prices remain well above what it believes are sustainable values.

A key component of Fitch's analysis is to reduce home prices to their sustainable value prior to applying its market value decline (MVD) stresses. Six of the top-ten MSAs represented in the transaction were applied base MVDs of over 20%, including Washington-Arlington-Alexandria that accounts for 17.3% of the pool.

The portfolio consists of 30-year fully amortising fixed-rate mortgages extended to borrowers with strong credit profiles (weighted average FICO of 774) and fully documented income.

RMBS

Rally seen in ABX

The ABX index has rallied impressively in 2012. Year-to-date price appreciation for the triple-A sub-indices in the 2006-1, 2006-2, 2007-1 and 2007-2 series is 9%, 36.1%, 36.1% and 39.1% respectively.

Serious delinquency rates for the same index series declined by 87bp, 70bp, 67bp and 106bp to 35%, 38.7%, 40.7% and 39.2% respectively. The average serious delinquency rate of all ABX series declined by 82bp from October to 38.4% in November. The year-over-year decline is 3.04%, reflecting improvements in the housing shadow inventory, according to ABS analysts at Deutsche Bank.

They note that the average REO rate has also continued to decline, with monthly REO rates decreasing by 5bp to 2.7% in November. Monthly REO rates for 2006-1, 2006-2 and 2007-1 decreased by 21bp, 2bp and 7bp from October to 2.6%, 3% and 2.7% respectively. The REO rate for 2007-2 increased by 8bp to 2.6%, however.

Voluntary prepayments increased by 92bp to 1.9% in November. Voluntary CPR for 2006-1, 2007-1 and 2007-2 rose by 11bp, 67bp and 325bp to 1.5%, 0.5% and 4.6% respectively. But voluntary prepayments for 2006-2 decreased by 36bp to 0.9%.

Finally, loss severity increased across all the indices, with aggregate loss severity rates rising by 85bp to 81%. Severities for the 2006-1, 2006-2, 2007-1 and 2007-2 indices increased by 2.3%, 0.6%, 0.1% and 0.4% to 77.4%, 81.3%, 84% and 81.2% respectively.

RMBS

Portuguese RMBS restructured

Bocage Mortgages No.1 has been restructured to include the appointment of a back-up servicer, increased issuance of the unrated variable funding note (VFN) and a termination of the basis swap. In Fitch's view, the appointment of a back-up servicer and the increase in the VFN are both positive for the transaction.

The move is believed to have been initiated in order to comply with the new ECB guidelines on ABS collateral eligibility for refinancing purposes. The new guidelines require ABS transactions used as collateral with the ECB to have servicing continuity provisions and prohibit any parties with close links to the transaction to act as interest rate hedge providers.

FinSolutia has been appointed as back-up servicer. The firm will take over servicing activities within six months after a delivery of a servicer event notice.

FinSolutia also performs a similar role in Turbo Finance. In Fitch's opinion, this arrangement reduces servicing continuity risk in the transaction.

Meanwhile, the VFN notional amount has been increased by €20m and the available proceeds will be deposited in a liquidity account maintained with the account bank (Citibank). On any interest payment date that the cash reserve reaches its floor amount of €4.9m, proceeds from the liquidity account will be used to replenish the cash reserve up to its initial target.

Finally, on termination of the basis swap, the swap provider (Barclays Bank) paid a swap termination fee of approximately €295,000 to the issuer. This payment will form part of the available revenue at the next payment date.

Fitch analysed the transaction with no hedging in place and found that the availability of the reserve fund and liquidity account, along with the build-up in credit enhancement since close means that the rating of the class A notes is not affected.

RMBS

Regional differences skewing recovery

Fitch believes that recent national increases in previously-owned home sales and reductions in the inventory of homes indicate the recovery in the residential real estate market is continuing. But the agency notes that regional differences remain important, with meaningful improvement likely to be hampered by the foreclosure process in some states and regional unemployment rates.

Existing homes sold at a seasonally adjusted annual rate of 4.79 million units in October, a 10.9% increase over the previous 12 months. There was also a decline in the number of homes for sale. According to the National Association of Realtors, the inventory of homes has dropped by 22% over the past 12 months.

In Fitch's view, these encouraging statistics reflect important regional distinctions in the foreclosure process that some states employ. The judicial process governing liquidations in states including New Jersey and New York may add more than six months to the timeline. While home prices in those states fell less than in many others during the downturn, both have seen prices erode in the past year.

Nationally, tight residential lending practices must be loosened before a meaningful recovery can take root, the agency adds. Federal Reserve Chairman Ben Bernanke recently said "it seems likely at this point that the pendulum has swung too far the other way, and that overly tight lending standards may now be preventing creditworthy borrowers from buying homes, thereby slowing the revival in housing and impeding the economic recovery".

Fitch also believes that a recovery in residential real estate prices will require many regional unemployment rates to improve more quickly than they are currently. The Bureau of Labor and Statistics' latest unemployment data shows that the Pacific region continued to report the highest jobless rate at 9.5%, while the lowest was the West North Central at 5.6%.

Just two of the regions reported statistically significant unemployment rate changes. The rate in the South fell by 0.2% and the West by 0.1%.

RMBS

Portuguese RMBS hit

Moody's has downgraded 20 notes previously rated at the country ceiling and confirmed one note from 18 Portuguese RMBS, further to its reassessment of the entire Portuguese RMBS market. The reassessment takes into consideration the agency's updated European RMBS rating methodology, as well as ongoing deterioration in the credit quality of the Portuguese sovereign and transactions' counterparties.

Moody's downgraded the affected classes of notes by one to two notches. The downgrades are driven by insufficient levels of credit enhancement required for a rating to reach the country ceiling.

The agency has also concluded its rating review of six Portuguese RMBS transactions placed on review on 8 June 2012, following the release of its updated RMBS methodology. In addition, it has revised key collateral assumptions in a further nine transactions that were not affected by this latest rating action.

All Portuguese RMBS notes rated above Ca and not confirmed remain on review, pending reassessment of required credit enhancement to address country risk exposure. Some tranches are also on review pending Moody's assessment of rating linkage to counterparties.

Key changes to the EMEA RMBS methodology include the introduction of a transaction minimum portfolio credit enhancement level and the Minimum Expected Loss Multiple. The minimum portfolio MILAN CE for Portuguese RMBS ranges between 10%-15% to Baa3 rating (the country ceiling).

RMBS

Japanese RMBS prepays rising

Moody's reports that Japanese RMBS prepayment rates continue to increase significantly, because of falling interest rates and strong competition in the mortgage market. At the same time, default and delinquency rates have remained stable.

The agency says this is due to: the creditworthiness of borrowers in Japanese RMBS asset pools being higher than the average credit quality of employees in Japan, with the former resistant to economic downturns; and the buybacks of modified loans, which have improved the credit quality of the pools. Such loans belong to financially troubled borrowers, who have successfully applied for the modifications under the Loan Payment Moratorium Law.

Although the Loan Payment Moratorium Law expires at the end of March 2013, Moody's expects financial institutions to continue modifying the loans of troubled borrowers. The subsequent buybacks is expected to help maintain the stable performance of Japanese RMBS by curbing the rise in default and delinquency rates.

Prepayment rates have continued to rise, as borrowers switch to lower interest rate mortgages; in particular, from long-term fixed-rate loans to floating-rate loans or short-term fixed-rate loans. Falling interest rates and strong competition among financial institutions have sparked this trend, which Moody's expects to continue.