Contents

Structured Finance

SCI Start the Week - 10 December

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

Pipeline
In what ended up being a busier week than the previous one, three ABS, one ILS, two RMBS, three CMBS and two CLOs entered the pipeline. The ABS comprised: €266.5m Auto ABS French Loans Master, US$600m Chase Issuance Trust 2012-8 Reopen and A$726.5m Crusade Series 2012-1 Trust. The ILS was US$225m Lakeside Re III, while the RMBS were A$300m FirstMac Series 3-2012 and A$272m PUMA Masterfund S-12.

The newly-announced CMBS consisted of: US$1.37bn FREMF 2012-K23, US$300m GSMS 2012-BWTR and JPMCC 2012-LC9. As for the CLOs, they were US$515.4m Finn Square CLO and US$600m Neuberger Berman CLO XIII.

Pricings
Many deals printed last week ahead of the holiday slow-down. Eight ABS, one ILS, two RMBS, five CMBS and six CLOs were issued in the flurry of activity.

Among the ABS were: four auto securitisations (US$160m CPS Auto Receivables Trust 2012-D, US$700m Mercedes-Benz Master Owner Trust 2012-A, US$700m Mercedes-Benz Master Owner Trust 2012-B and US$700m Santander Drive Auto Receivables Trust 2012-A); two student loan deals (US$420m CIT Education Loan Trust 2012-1 and US$239.5m New Hampshire Higher Education Loan Corporation Series 2012-1); a railcar lease deal (US$216m ARL First Series 2012-1); and a factoring receivables ABS (€1.15bn FCT F.A.S.T. 1).

The ILS print was US$250m Residential Reinsurance Series 2012-II, while the RMBS pricings were €711m Arena 2012-1 and A$500m National RMBS Trust 2012-2. CMBS new issues comprised US$1.134bn COMM 2012-CCRE5, US$294.7m COMM 2012-MVP, US$208m GSMS 2012-TMSQ, US$175m JPMCC 2012-PHH and US$1.5bn UBSBB 2012-C4.

Finally, the CLO prints consisted of: US$568m Ares XXV CLO, US$412.4m Battalion CLO III, US$516m CIFC Funding 2012-3, US$311m Doral CLO 2012-3, US$360.1m Great Lakes CLO and US$626m Octagon Investment Partners XIV.

Markets
The US CMBS market remained busy ahead of year-end, as SCI reported on Thursday (SCI 6 December). AM tranches proved particularly popular, with almost US$500m of US CMBS paper available on Wednesday alone. Among the AM bonds was a US$100m piece of the JPMCC 2007-LD11 AM tranche, which SCI's PriceABS data shows was covered at 525bp.

The US RMBS secondary market was also fairly active, as SCI reported on Tuesday (SCI 4 December). Non-agency supply continues to be dominated by subprime paper, which was boosted by a CDO liquidation at the start of the week. CWL, FFML and JPMAC bonds were among those out for the bid.

US ABS saw private student loan spreads tighten by about 10bp over the week, with long-dated FFELP ABS and prime autos also tightening by a few basis points, report Bank of America Merrill Lynch ABS analysts. "The current low-yield environment and favourable supply-demand technicals should benefit higher yielding ABS sectors. Stabilising fundamentals also should benefit the private student loan market. Spreads for auto, card, equipment and short-dated FFELP should be range bound for the balance of the year and into next year," they add.

European CMBS led the way on the other side of the Atlantic, although JPMorgan analysts note that ABS and RMBS were both fairly active. They say: "Flows continue to be relatively healthy, despite the time of the year; spreads tightened in the yieldier asset classes and jurisdictions, with CMBS and Spanish paper once again leading the charge. More plain vanilla asset classes, on the other hand, have seen lighter flows and spreads closed the week unchanged after widening marginally the previous week."

The CDO market was also active, as SCI reported on Wednesday (SCI 5 December). CRE and Trups transactions attracted a lot of attention in Tuesday's session, with a large slice of GKKRE 2006-1A A1 covered at 90 and I-PRETSL 4 A1 covered in the low-90s - slightly higher than it had been talked in the prior session.

Deal news
• S&P has placed on credit watch negative its credit ratings on 240 tranches in 77 European CMBS, following an update to its criteria for the sector that is now in effect (SCI 8 November). The move affects tranches where the agency believes there is at least a one-in-two chance that ratings will be lowered, following the application of the updated criteria.
• Moody's has taken rating actions on eight South African RMBS, following its reassessment of the sector. The review takes into consideration the risks to RMBS ratings following the deterioration of the credit quality of the South African sovereign.
• Fitch has resolved the rating watch status of various classes in the US prime, Alt-A, subprime and re-REMIC RMBS sectors. The classes previously on rating watch negative generally reflected increasing tail risk, as well as rating sensitivity to the agency's updated loan loss model and surveillance criteria (SCI 13 August).
• 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.
• Alpstar Capital has notified Alpstar CLO 1 and 2 investors that it intends to resign as collateral manager on the transactions without cause. Further, it has proposed Chenavari Investment Managers as successor collateral adviser.
• Halcyon Neptuno II Management has assumed from Bankia investment management responsibilities for Neptuno CLO II. 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.
• Receivers of the properties securing the Gemini (Eclipse 2006-3) CMBS have made a number of appointments in relation to the asset management of the portfolio.
• Fitch says that potential disincentives on behalf of the borrowers in the Preps 2005-2, 2006-1 and 2007-1 mezz SME CLOs are mitigated, following noteholder consent to the issuers' proposal to revise the payment waterfall and pay expense reserves senior in the priority of payments. The expenses reserves will be capped at €2m each.
• 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.

Regulatory update
• 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.
• A recent Reed Smith memo highlights three areas of concern for the securitisation industry with CRA 3 - rating agency rotation, public disclosure and civil liability (see also SCI 16 August). The European Council has published what may be the final form of the second amendment to the rating agency regulation, confirming that it will assent to it becoming effective if the European Parliament passes it at its first reading.
• The FHFA is to proceed with most of its fraud claims against Societe Generale in connection with losses suffered by Fannie Mae and Freddie Mac related to the purchase of US$1.3bn of RMBS. A trial is scheduled for January 2015.
• 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.

Top stories to come in SCI:
Year-end outlooks

CDO

CDO trading themes emerge

Last week saw US$3.8bn of US CLO issuance, after November posted the highest volume per month since August 2007 (US$8bn). The week witnessed heavy BWIC activity too, with US$2.5bn of CDO paper out for the bid.

CDO strategists at JPMorgan point to a number of trading themes that are emerging as 2012 draws to a close. First is that the US CLO term curve continues to develop.

Seasoned triple-A rated bonds are being covered at 110bp-120bp, while triple-As still in reinvestment are being covered at 120bp-140bp. Seasoned double-As are being covered at mid- to high-100bp, with benchmark double-As at around 200DM. Recent CLO 2.0 paper has also proved popular in secondary, as some investors cash in to take advantage of the liquidity while others bid for paper with high current coupon.

The second trading theme is that US CLO equity continues to attract investors seeking high income. Longer-dated equity is now covering at around an 11% yield in a base case/low CDR scenario and a 10% yield in a stressed case. Shorter equity tends to trade at around a 13% yield in the base case and 10% yield in a stressed case, according to the JPMorgan strategists.

Third, there is strong trading interest in European CLOs. Spreads tightened across the board last week, with investors seeking to capitalise on the basis to both European high yield and US CLOs (see SCI's PriceABS archive).

Finally, Trups CDO BWIC volume has ticked up recently, with some of the lists attracting strong bids (SCI 5 December). Front-pay bank Trups CDO bonds hit new post-crisis tights last week, covering in the high-4% to high-5% yield range, depending on WAL. Second-pays were covered in the 8% yield area.

Owing to tighter spreads in 2012, the strategists anticipate lower incremental returns next year, albeit CLOs will remain one of the cheapest spread sectors. Their end-2013 US CLO targets factor in a 30bp-40bp compression for triple-As and 50bp-100bp-plus for BBB/BB. Scope for spread tightening beyond these projections could occur in a bull scenario, if yields of comparables like high yield and CMBS further compress.

CS

ABS

Credit chief takes over ABS fund

Simon Finch, credit cio at CQS, has replaced Alistair Lumsden as fund manager for the CQS ABS Fund. He will lead a team of 11 professionals in New York and London, where he is based. Finch has spent almost five years at CQS and was previously head of ABS at Abbey National.

Structured Finance

Alternative investment group grows

KPMG has boosted its alternative investment funds (AIF) practice in Los Angeles and San Francisco. The practice focuses on providing audit, tax and advisory services to hedge, private equity, real estate and infrastructure funds, as well as fund of funds.

Martin Griffiths joins in Los Angeles as federal tax principal. He will lead the real estate tax practice for the West Coast. He has broad experience in pass-through entities such as REITs and was most recently at Irvine Company.

Peter Ritter joins the San Francisco federal tax practice as principal. He comes over from O'Melveny & Myers where he was tax partner and has significant expertise in the formation, operation and liquidation of public and private REITs.

Daniel Prager joins the federal tax AIF practice in Los Angeles and will focus on growing the AIF practice in the Western US. He was most recently of head of corporate finance for Telefónica Czech Republic. Earlier in his career he was vp for tax at Ares Management.

Richard Hinton joins the San Francisco AIF practice as a seconded partner with a focus on the hedge fund industry. He has held several positions within the audit and advisory functions, both in the UK and globally and established the team responsible for rolling out KPMG's FATCA proposition to clients in the UK.

Graeme Fletcher becomes international corporate services principal. He was previously in KPMG's Atlanta office and will now be based in San Francisco. He will be responsible for developing an alternative investment-focused international tax effort for the Bay Area marketplace.

Structured Finance

Tikehau bolsters investment, advisory groups

Etienne Gorgeon, Frédéric Sallerin and Vincent Favier have joined Tikehau Group. The appointments bolster the buy- and sell-side teams at Tikehau Investment Management (TIM) and Tikehau Capital Advisors (TCA).

Gorgeon becomes director of investments for open-ended funds and managed funds at TIM. He was most recently fixed income cio at Edmond de Rothschild Asset Management and previously held roles at Fortis, AXA IM and F&C.

Sallerin also joins TIM and takes an institutional client sales role. He was most recently at Sparinvest in Paris and previously worked at Française des Placements in the institutional sales team.

Favier will become investment manager at TCA next month. He was md at Amber Capital, where he led the French office, and has also worked at Worms & Cie and Oliver Wyman.

CDO

RBC in further CDO recruitment

Ming Tang has joined RBC Capital Markets as CDO and CLO trader, continuing the firm's expansion into the CDO space. He is based in New York and reports to Allen Fu, who joined as head of CDO trading two months ago (SCI 10 October).

Tang joins from StormHarbour Securities. Prior to that he was md at DFG Investment Advisers and previously analysed and rated CDOs during a stint as associate director at S&P.

CLOs

Alpstar Capital to resign

Alpstar Capital has notified Alpstar CLO 1 and 2 investors that it intends to resign as collateral manager on the transactions without cause. Further, it has proposed Chenavari Investment Managers as successor collateral adviser.

The move follows a request for controlling noteholders to consent to the replacement of Alpstar by Chenavari (SCI 5 November), which was subsequently withdrawn on 22 November.

Clause 4.6 of the deals' collateral management agreement sets out the conditions to the appointment of a successor collateral adviser, including that the successor collateral adviser is acceptable to the trustee. Certain of these conditions have been satisfied; namely, the successor collateral adviser is acceptable to the collateral manager, the holders of a majority of the principal amount outstanding of the controlling class have approved of the appointment and the appointment has received the requisite rating agency confirmation.

Having considered information and representations made to it relating to the successor collateral adviser, the trustee anticipates that it will accept the successor collateral adviser, subject to receipt of satisfactory legal opinion.

Insurance-linked securities

ILS pro brought in

XL Group has hired Craig Wenzel as capital markets svp. It is a new role created as part of a push by XL's reinsurance operations group into ILS.

Wenzel joins from Deutsche Bank, where he was capital markets and treasury solutions md in New York. He was responsible for co-ordinating catastrophe product origination globally and has also previously worked in the debt capital markets group at JPMorgan.

Risk Management

OTC data alliance created

Xenomorph and Numerix have formed a partnership to provide a technology solution for derivatives trade pricing and risk management. Users of the Numerix Portfolio OTC pricing platform will now also be able to access Xenomorph's TimeScape analytics and data management system through a single framework.

TimeScape streamlines the capture, cleansing, storage, integration, analysis and distribution of market data and risk statistics for all current and future asset classes managed within Numerix Portfolio. Integrating the two technologies combines the ability to provide uniform pricing and risk for all OTC derivatives with that data model.

The offering will reduce operational risk by decreasing front-office spreadsheets, providing a consistent framework for review by clients, auditors and regulators, say the providers.

RMBS

RMBS research head appointed

Greg Reiter has joined Wells Fargo Securities as md and head of residential mortgage research. He will be based in Charlotte, North Carolina, and report to head of structured products research Marielle Jan de Beur.

Reiter will lead the RMBS research team in developing strategy, publishing research and generating investment ideas for institutional investors. He joins from Freddie Mac, where he developed RMBS securitisation strategies, and has previously held sell-side positions at RBS and UBS and buy-side positions at World Bank and Charles Schwab Investment Management.

RMBS

RMBS charges for former board members

The US SEC has charged eight former members of boards which oversaw five Memphis, Tennessee-based mutual funds for violating their asset pricing responsibilities. The funds were invested in RMBS backed by subprime mortgages and fraudulently overstated the value of the securities during the crisis, the SEC says.

The eight accused fund directors are Kenneth Alderman, Jack Blair, Albert Johnson, James Stillman, Allen Morgan, Randall Pittman, Mary Stone and Archie Willis. They were responsible for determining the fair value of fund securities where market quotations were not readily available, but the SEC says they delegated this responsibility to a valuation committee without providing proper guidance on how fair value should be determined.

The SEC says the directors then made no meaningful effort to monitor how fair value was being determined. As investors rely on board members to establish an accurate process for valuing investments and the board members abdicated their responsibilities, investors were "left in the dark", says the SEC, and were therefore less able to made informed decisions.

RMBS

Further FHFA claim to proceed

The FHFA is to proceed with most of its fraud claims against Societe Generale in connection with losses suffered by Fannie Mae and Freddie Mac related to the purchase of US$1.3bn of RMBS. A trial is scheduled for January 2015.

The transactions were issued by Societe Generale and underwritten by Deutsche Bank and Bear Stearns. In denying most of the defendants' motion to dismiss, the US District Court for the Southern District of New York found that there were sufficient factual allegations in the complaint to make out a fraud theory. The court granted defendants' motion to dismiss with respect to Virginia Securities Act claims against non-selling defendants and certain claims against the underwriters, with respect to certificates purchased from other parties.

The federal judge overseeing the FHFA's lawsuits against numerous banks (SCI passim) has also denied the banks' motion to exclude an expert report describing the FHFA's proposed methodology for selecting mortgage loans to be re-underwritten as part of its effort to prove its claims at trial, according to a recent Lowenstein Sandler memo.

ABS

Timeshare delinquencies normalising

US timeshare ABS delinquencies for 3Q12 were largely in line with those seen in the quarter before, says Fitch. Delinquency trends have largely normalised at their historical levels following dramatic increases in 2008 and 2009.

The agency's latest timeshare index results show delinquencies for the quarter were 3.28%, down very slightly from 3.29% the quarter before. Delinquencies for the same period last year were higher at 3.56%.

Defaults also decreased in 3Q12 to 0.6% from 0.81% in 2Q12, in line with the 0.62% seen in 3Q11. Fitch notes that the decrease last quarter follows the decline in delinquencies over them summer as timeshare default trends typically lag those of delinquencies. The agency's outlook for timeshare ABS remains stable.

ABS

2013 Euro ABS credit quality up, issuance down

The credit quality of new European ABS and RMBS issuance in 2013 will be better than that of existing transactions, expects Moody's. However, deals will be smaller and that will affect issuance volume for the year ahead.

The agency adds that the performance of existing transactions will be correlated to sovereign strength, with asset performance being stable in highly-rated countries but deteriorating in lower-rated countries.

"Although transactions issued in 2013 will have counterparties with lower ratings and less geographically diversified pools than in the past, the credit quality of the underlying loans, particularly in RMBS and SME ABS, will improve as a result of tighter underwriting criteria for loans originated since 2011," says David Bergman, vp and senior analyst.

Dutch, French, German and UK ABS and RMBS are expected to come under minimal further pressure following Moody's actions on bank ratings and current proposed changes to its structured finance methodologies. The rating agency believes that less than 10% of transactions in those regions would be affected - generally by fewer than two notches - with the remainder unaffected.

Asset performance in highly-rated countries should be stable because they will be less negative macroeconomic conditions and tightened underwriting criteria, Moody's notes. Over the next two years the rating agency forecasts that GDP growth will remain flat or weak in the euro area as a whole, but the low interest rate environment and stable or falling unemployment levels in many countries should support affordability and performance stability.

However, Irish RMBS and Italian, Portuguese and Spanish ABS and RMBS are expected to see performance deteriorate by a moderate to significant degree in 2013. The primary drivers of this deterioration will be the worsening credit quality of transaction counterparties, continued collateral performance deterioration and Moody's proposed methodology changes.

"The current inactivity in most euro area housing markets will continue in 2013 due to the weak macroeconomic environment. Rising illiquidity in housing markets will reduce recovery values and lengthen recovery times," the agency says. Lenders in Ireland and Spain are expected to continue to modify loans, which will partially mitigate delinquencies in existing transactions.

Finally, overall new ABS and RMBS issuance volumes in Europe are expected to be lower next year than they were this year, although the number of deals will remain the same. Regulatory uncertainty, a lack of eligible receivables and the use of covered bonds as collateral for repo trades will suppress issuance and lead to smaller deal sizes.

ABS

Lower quality, higher issuance for auto ABS

The credit quality of US auto ABS will decline marginally in 2013, reflecting lenders' gradual return to higher but reasonable levels of risk taking, according to Moody's 2013 outlook for the sector. The agency also projects higher issuance, driven by investor demand to satisfy a need for short-term cash surrogate investment, as well as a need for yield from deeply subordinated non-investment grade tranches.

"We are changing our outlook for US auto ABS to stable, after having maintained a positive outlook for the last two years," says Mack Caldwell, a Moody's svp. "The change reflects the growing appetite for risk among both lenders and investors."

Three trends are expected to drive the marginal credit quality decline in 2013. First, the credit characteristics of loans moved from sponsor-managed portfolios will be weaker.

Second, some prime lenders will intentionally begin to lend to less creditworthy borrowers because of the saturation of lending in the prime sector. Finally, the subprime auto market will have the means to expand.

Moody's predicts that bank and bank-affiliated sponsors will issue more auto ABS in 2013 in order to diversify funding and provide a means for growing existing auto platforms.

Structured Finance

PPIF liquidations continue

The latest PPIP report shows that all funds have ramped up distributions, with liquidations expected to continue over the coming months. BlackRock is the latest manager to liquidate its PPIF.

The move is not surprising for several reasons, according to ABS analysts at Barclays Capital. First is that the PPIP structure is an inefficient way to hold non-agency RMBS once deleveraging began at the end of the three-year investment period.

Second, better leverage/funding terms are available now in the repo and re-REMIC markets than when the PPIFs were launched. Finally, the recent strong rally likely made the decision to liquidate easier for some of the funds.

Structured Finance

Further CPO guidance issued

The CFTC last week issued a letter providing additional guidance to securitisation vehicles regarding whether they may be excluded from the definition of commodity pool. The letter also stated that the Commission won't take enforcement action against the operators of certain securitisation vehicles that don't issue new securities after 12 October for failure to register as a commodity pool operator, provided that a number of criteria are satisfied. Finally, securitisation vehicles that cannot claim relief either under the latest letter or CFTC Letter No. 12-14 (SCI 15 October) have until 31 March 2013 to register as a commodity pool operator.

A recent Mayer Brown client memo notes that the latest letter appears to endorse a broader principle: that a securitisation entity would not be treated as a commodity pool if the swaps do not create an 'investment exposure'.

Structured Finance

Latin American SF outlook 'strong'

The credit quality of new transactions from Latin America's core securitisation markets of Argentina, Brazil and Mexico will be strong in 2013, says Moody's. Performance of existing outstanding transactions will remain stable in Argentina and Brazil, but will vary for existing Mexican transactions.

"In Argentina, new transactions in 2013 will have a high degree of total credit enhancement, consisting of substantial excess spread and significant subordination levels," says Moody's svp Maria Muller. "In Brazil, new transactions will be stronger than transactions brought to market over the past two years because of more selective underwriting on the part of sponsors."

New Brazilian regulations being rolled out will require new transactions to have structures that eliminate commingling risk entirely, which will further de-link the credit risk of the transaction from the corporate credit risk of the sponsor. Issuance volumes in 2013 in Brazil will see a rebound after a slow 2012, while volumes in Argentina are expected to remain steady.

Delinquency levels of existing transactions in Argentina and Brazil rose this year, but the deterioration in asset performance remains within Moody's original expectations. High levels of credit enhancement have protected investors and Argentinean delinquencies are expected to improve a little next year.

In Mexico, Moody's says the credit quality of new transactions will be strong, particularly RMBS issuance from the government-related issuers such as INFONAVIT and FOVISSTE. The credit quality of existing securitisations other than RMBS issued by the non-bank Sofol sector will remain strong, although the performance of Sofol RMBS mortgages to low-income borrowers will continue to face serious challenges.

Structured Finance

Asian SF outlook 'stable'

Fitch has a stable outlook for structured finance in Asia, supported by the economic performance of Korea and Singapore, which dominate the market. The continuous build-up of credit enhancement through note amortisation and debt servicing ability are also supporting factors.

Fitch-rated Korean transactions should be able to withstand the effects of a slowing economy and high household debt. The agency expects moderate deterioration in Korean asset performance but does not expect this to have any effect on current ratings.

In Singapore, CMBS is expected to be underpinned by a generally stable property market in 2013. Fitch notes that the hotel and office sectors are susceptible to a global economic downturn due to Singapore's status as a regional business hub and will watch those sectors closely.

The agency also expects covered bond issuance in Asia ex-Japan will increase next year as a result of legislative proposals by Korean and Singaporean regulators. There is also interest from India, Taiwan, Malaysia and Hong Kong, although they are not expected to see issuance until 2014.

Structured Finance

Solvency II concerns underlined

Relatively high capital charges for securitisations under the new Solvency II European insurance rules could lead European insurers to dramatically reduce exposure to the asset class and invest in covered bonds instead, S&P argues (see also SCI 21 September). The agency notes that capital charges for senior securitisations under the draft Solvency II rules' standard formula are up to 10 times higher than those for similarly-rated covered bonds.

Pension funds - which could soon be subject to regulation based on Solvency II - may also have an incentive to move away from the securitisation sector. "Given that the insurance sector potentially represents more than 10% of the investor base, we expect that the regulation could cause securitisation volumes to fall, while covered bond investment could rise," says S&P credit analyst Mark Boyce.

He adds: "Solvency II regulation remains subject to change and transitional periods could soften the blow on the insurance industry. The implementation date of the legislation could be delayed for another one or two years and, even then, insurers may have up to 10 years of additional breathing room before having to implement the new capital adequacy rules. Still, some insurers have already begun to move away from investing in securitisations and we expect this to continue if the final Solvency II rules closely resemble the current draft."

Structured Finance

Increased clarity on LLD requirements

The latest amendments to the ECB's collateral eligibility framework include information on loan level data (LLD) requirements for posted securitisations and the European DataWarehouse (ED). Data will have to be reported to the ED at least on a quarterly basis, no later than one month after the IPD. If data is not provided within one month of the IPD, repo eligibility will cease.

A nine-month transitional period will apply to all asset classes from their respective implementation date (SCI 27 November). After three months of LLD submission into ED for each asset class, compulsory minimum compliance standards commence. 'No Data' (ND) thresholds will migrate over this period until full compliance is achieved.

ABS analysts at JPMorgan highlight RMBS as an example. From April 2013, at least 30% of the mandatory fields in the asset class template must be completed. During the third quarter, this minimum requirement rises to 70%.

New ABS issued nine months after the implementation date must fully report all mandatory data fields at their launch. Already existing ABS that do not conform to any of the LLD templates will remain eligible until March 2014.

Structured Finance

CRA 3 concerns highlighted

A recent Reed Smith memo highlights three areas of concern for the securitisation industry with CRA 3 - rating agency rotation, public disclosure and civil liability (see also SCI 16 August). The European Council has published what may be the final form of the second amendment to the rating agency regulation, confirming that it will assent to it becoming effective if the European Parliament passes it at its first reading.

With regard to rotation, the proposal is not as bad as some had feared, according to Reed Smith. The requirement is limited to new resecuritisations (CDOs) and references originators not issuers.

If a rating agency rates a new resecuritisation, it may not rate any other resecuritisations with underlying assets of any originator that are held in that resecuritisation for a period of four years. "In other words, rating agencies will not be required to revolve on a given resecuritisation. They will, however, be limited as to the other resecuritisations they can rate in the four years following their rating of a resecuritisation," the memo explains.

In connection with public disclosure, Article 8a continues to be problematic, however. It requires the issuer, originator and sponsor of a securitisation established in the EU to make joint public disclosure, including as to the performance of underlying assets, regardless of whether the securitisation is public or indeed rated.

"This is broader in scope than the disclosure obligations in Article 122a - for example, it applies not just to credit institution originators but to all originators - and it is not clear why a regulation on credit rating agencies has been used to impose these obligations," the memo continues. ESMA is to develop technical standards regarding what must be published, with the information published on a website set up by the authority.

Finally, the civil liability regime set out in the new Article 35a of CRA 3 is not limited to structured finance, but may have significant repercussions on the willingness of rating agencies to provide ratings. It is limited to intentional and/or grossly negligent breaches of the standards set out in the regulation, but this is expected to be carefully scrutinised by rating agencies as they appraise their business models.

Structured Finance

RFC issued on Libor

The UK FSA has proposed new rules and regulations for financial benchmarks, following the recommendations of the Wheatley Review of Libor. One of its key recommendations was that while the setting of Libor should remain an industry-led activity, the submission to and administration of the rate should be regulated by the FCA.

The proposals also call for: benchmark administrators being required to corroborate submissions and monitor for any suspicious activity; those submitting data to benchmarks being required to have in place a clear conflicts of interest policy and appropriate systems and controls; and two new significant influence controlled functions created under the FSA's Approved Persons Regime for the administrator and submitting firms.

At least initially, the only regulated benchmark in the UK will be Libor. However, the new regime provides a framework for regulation that can be extended to cover additional benchmarks in the future, were the government to consider it appropriate to do so.

The FSA is seeking comments on ensuring the continuity of Libor and broadening participation in the rate.

CDO

ABS CDO auctions due

Auctions have been scheduled for 31 December for two ABS CDOs - Independence IV CDO and RFC CDO I. The collateral will only be sold if the highest bid results in the sale proceeds being at least equal to the auction call redemption amount.

CDO

Stable outlook for structured credit

Moody's has published its global structured credit outlook for 2013. The release covers the structured finance CDO, Trups CDO, market value CLO and CSO sectors.

Moody's outlook is stable for most SF CDO transactions, but positive for those backed by CLO tranches. As a result, the agency expects to make no changes to the ratings on the majority of US SF CDO tranches in 2013 and upgrade some of the ratings on tranches in CLO-squared transactions.

Moody's outlook for European SF CDOs is negative, however. Exposures to collateral in the euro area will be the main reason for poor performance in European SF CDOs. More than half of the pools in these transactions have direct exposures either to the weakening euro area via exposures to distressed local housing markets (RMBS collateral) or to commercial real estate loans that are facing increasing amounts of refinancing risk (CMBS collateral). Given that European SF CDOs are subject to further deterioration in already distressed local housing markets, especially in Ireland and in Spain, the resulting decline in credit quality could lead to rating downgrades in certain cases.

Meanwhile, the credit performance for Trups CDOs is anticipated to be stable in 2013, reflecting stabilising bank defaults and deferrals, improved capital adequacy of insurance firms and the continued deleveraging of Trups CDOs. Transactions will also benefit from deleveraging of senior notes due to collateral prepayments and diversions of excess interest, as well as amortisation of out-of-the-money interest rate swaps. Finally, new regulatory rules will accelerate the redemption of Trups collateral, which will benefit senior notes in bank Trups CDOs.

Moody's outlook on insurance Trups CDOs is stable, primarily owing to the stable outlook for the underlying insurance sectors - other than the US life insurance sector, for which the agency has a negative outlook. Insurance Trups CDOs are expected to benefit from deleveraging of the senior notes because of collateral prepayments and excess interest, as well as low levels of defaults in the underlying portfolios.

Away from Trups, the credit quality and overcollateralisation (OC) levels of market value (MV) CLOs will remain stable in 2013. Cash will continue to accumulate in deals and some MV CLOs will mature during the year. However, any major and sudden disruptions or setbacks resulting from the fiscal cliff or the euro area crisis are anticipated to negatively affect the performance of MV CLOs.

New issuance in the sector will remain minimal due to more stringent advance rates and an unfavourable environment for structures with market value triggers. Refinancing of existing deals will depend on deal economics, but is unlikely as well, according to Moody's.

Finally, the overall credit quality of CSOs will be stable in 2013. The portfolio credit quality of the handful of deals referencing loans will be stronger than of those referencing bonds, Moody's notes.

As in 2012, persistent weakness in European economies will weigh on the performance of European CSOs. Current projections for modest economic growth in the US are credit neutral for US CSOs; however, the rising threat of a mild recession from the fiscal cliff is credit negative for US CSOs.

In 2013, the number of deal terminations because of CSOs coming to term is anticipated to remain high. The shortening time to maturity is credit positive for CSOs.

CDS

FCM business model shifting

A structural shift in the futures commission merchant (FCM) business model is underway, according to TABB Group. The competitive landscape for FCMs means that investment and interest rate income are no longer the keys to profitability, at a time when they are facing rising operating costs in a significantly weaker revenue environment.

The new landscape will favour larger FCMs that provide investors with cutting-edge execution technology, efficient ways to manage and deploy capital and improved customer service, TABB says. Dodd-Frank and CFTC rule changes are driving operating costs higher, forcing FCMs to work on improvement projects - internally and in customer-facing parts of their businesses - to compete.

TABB expects at least a dozen FCMs, 10%-15% of the total number, to exit the business by the end of 2013 as economics change and competition builds.

CDS

Overseas Shipholding results in

The final price for Overseas Shipholding Group Inc CDS was determined to be 35.5 at an auction held on 6 December. 12 dealers submitted initial markets, physical settlement requests and limit orders to the auction, to settle trades across the market referencing the entity.

CLOs

Preps borrower disincentives mitigated

Fitch says that potential disincentives on behalf of the borrowers in the Preps 2005-2, 2006-1 and 2007-1 mezz SME CLOs are mitigated, following noteholders consent to the issuers' proposal to revise the payment waterfall and pay expense reserves senior in the priority of payments. The expenses reserves will be capped at €2m each.

Given their senior position in the waterfalls, cash in the amount up to €2m will be retained in the expenses reserves on the respective scheduled redemption date of each transaction. These funds will not be available for repaying class A principal and class B interest and principal.

In Fitch's view, retaining this cash in the expenses reserve will have an immediate detrimental impact on the rated notes, since it could otherwise be applied to the rated notes. However, the agency believes that holding the expenses reserve until legal final maturity will not affect the notes' current ratings.

Additionally, it believes that retaining cash in the expenses reserves will have a positive impact on overall transaction performance. The expenses reserves will increase the transactions' ability to operate after the scheduled redemption date and facilitate the execution of documents related to recoveries and workouts. In Fitch's view, the availability of funded expenses reserves helps reduce the moral hazard problem - that is the risk of companies not having incentives to repay their loans by anticipating that the issuer has no funds to proceed against them.

Prior to the noteholders' consent, the expenses reserves ranked junior to the interest and principal payments of the rated class A and class B notes. Accordingly, they could be funded only if the underlying loan pools generated cash in excess of the amounts needed to repay the class A and class B interest and principal.

CMBS

Asset managers named for Gemini

Receivers of the properties securing the Gemini (Eclipse 2006-3) CMBS have made a number of appointments in relation to the asset management of the portfolio.

Valad Investment Management Services has been appointed as asset manager for the office, industrial and leisure portfolio and certain retail properties. Vale Asset Management has been named as asset manager to the English shopping centre portfolio. Cogent Property Solutions - which has been undertaking oversight and shadowing of the asset management arrangements since 2010 - is also expected to take on the role of asset manager to certain Scottish retail assets.

Meanwhile, CBRE Property Asset Management - which has been undertaking oversight and shadowing of the property management arrangements since 2009 - has now been appointed to undertake property management of the portfolio.

CBRE Loan Servicing is currently working with the asset managers to formulate a business plan for the workout of the portfolio. The servicer expects to provide a further update on strategy in 1Q13.

CMBS

CMBS delinquencies inch up

The delinquency rate for US CMBS loans moved up by 2bp in November to 9.71%, according to Trepp. Loans that were newly delinquent during the month - totalling around US$3.7bn - put upward pressure of about 68bp on the rate.

Loan resolutions remained elevated in November, with over US$1.7bn resolved with losses. The removal of these loans from the delinquent category accounted for 33bp of downward pressure on the delinquency rate. Loans that cured during the month put downward pressure of 32bp on the rate.

The effect of loan resolutions, loans curing and newly delinquent loans created a net deterioration of 3bp in the rate. The remaining difference was the 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, lodging loans were hit particularly hard, Trepp notes. The hotel delinquency rate jumped by 100bp in November.

The only other major property type to see a rate increase was office. Retail, multifamily and industrial loans all improved modestly.

CMBS

Criteria update hits Euro CMBS

S&P has placed on credit watch negative its credit ratings on 240 tranches in 77 European CMBS, following an update to its criteria for the sector that is now in effect (SCI 8 November). The move affects tranches where the agency believes there is at least a one-in-two chance that ratings will be lowered, following the application of the updated criteria.

The impact on individual ratings primarily stems from S&P's calculation of hedge break costs and analysis of tail periods under the updated criteria, as well as from changes in certain capitalisation rates used in its property analysis. In addition, any rating changes will also reflect the agency's view of a portfolio's prevailing performance and the anticipated future performance of the underlying assets, given the continued level of stress that European CMBS collateral is experiencing.

The affected tranches have a principal balance of about €14.67bn (for euro-denominated transactions) and £15.15bn (for sterling-denominated transactions). The credit watch placements affect approximately 31% (by number) of the European CMBS tranches that S&P currently rates and primarily relate to investment grade ratings.

Specifically, the agency has placed on watch negative the ratings on 171 investment grade tranches in 70 transactions and 69 speculative grade tranches in 52 deals. It intends to resolve the credit watch placements over the next six months.

CMBS

CMBS loss severities inch up

The weighted average loss severity for all US CMBS loans liquidated at a loss was 40.8% in 3Q12, slightly up from 40.5% in the prior quarter, says Moody's. From 1 October 2011 to 15 September 2012, US$15.7bn of CMBS loans were liquidated - up by US$1.2bn over the same period the previous year.

The weighted average loss severity for all liquidated loans excluding those with de minimis losses (defined as losses of less than 2%) was 52.7%, an increase from 52.3% last quarter. Loans with losses of less than 2% account for about one-fifth of the sample size.

"Loans backed by manufactured housing and mobile home properties had the highest weighted average loss severity, at 48.5%, while loans backed by self-storage properties had the lowest weighted average loss severity, at 33.8%," comments Moody's vp and senior credit officer Keith Banhazl.

Total cumulative realised losses from the 1998-2008 vintages rose by 21bp in the third quarter, to 2.3% from 2.1% in the second quarter. The 2000 CMBS vintage had the highest cumulative loss rate, 4.3% in the third quarter, up from 4% in the second quarter. The 2001 CMBS vintage had the second-highest cumulative loss rate, 3.5%, up from 3.3%.

Of the 10 metropolitan statistical areas with the highest dollar losses, New York had the lowest severity (at 22.9%) and Detroit had the highest (at 59.2%).

Two notable liquidations took place during the quarter. The Westin O'Hare loan (securitised in MSC 2006-IQ12) liquidated with a US$83.5m loss, for a loss severity of 83.2%, and the Highland Mall loan (JPMCC 2002-CIB4) liquidated with a US$73.2m loss for a loss severity of 120% (see SCI's CMBS loan events database).

The three vintages with the highest loss severities are 2006 (at 48.8%), 2008 (48%) and 2007 (45%). These vintages constitute 56.7% of CMBS collateral and 73.8% of delinquent loans.

"For the 2005, 2006 and 2007 vintages, we expect aggregate conduit losses (inclusive of realised losses) of 7.6%, 10.8% and 13.0% respectively of the total balance at issuance, with most of the losses yet to be realised," says Banhazl. "The aggregate realised loss for those vintages is currently below 2.5%."

CMBS

Two-year low for CMBS late-pays

CMBS late-pays fell by 12bp last month to 8.17% from 8.29% in October, according to Fitch's latest index results for the sector. This marks the rate's lowest level since November 2010, when it stood at 7.96% of the then outstanding Fitch-rated universe of US$430bn.

In November, resolutions of US$1.5bn outpaced additions to the index of US$1.3bn. In addition, US$6.6bn in Fitch-rated deals closed in November, more than offsetting the US$4.6bn in portfolio run-off. Last month also marked the highest month for Fitch-rated issuance in five years.

Current and prior month delinquency rates for each of the major property types are: 9.92% for multifamily (from 10.45% in October); 9.83% for hotel (from 9.58%); 8.88% for industrial (from 8.76%); 8.63% for office (from 8.72%); and 7.28% for retail (from 7.35%).

CMBS

Quincy Tower on watchlist

Morningstar has added the US$40.8m Quincy Tower loan, securitised in GSMS 2004-GG2, to its watchlist after the largest tenant gave notice that it will not be renewing its lease upon the scheduled expiration in March 2013. Barring immediate re-leasing, this tenant's exodus would reduce the property's occupancy to 43%.

The property is currently 99.5% occupied. Analytic Services, a public service research institute, occupies 133,353 square feet (57% of the GLA) on a lease that expires in March 2013. The firm will then move its headquarters to a building in Falls Church, VA.

The property has performed well since issuance, according to Morningstar. The net cashflow in 2010 and 2011 was 25% higher than at underwriting and the property has always maintained occupancy near 100%.

The loan is scheduled to mature in July 2014, allowing over a year for the space to be re-tenanted prior to loan maturity. In addition, over US$875,000 is held in a tenant reserve, as of November 2012.

"We don't believe that the loss of this tenant has caused an immediate value deficiency on the loan, but will closely monitor re-leasing efforts and any additional tenant rollover. The strength of the market, the loan's historical performance and the loan maturity being over eighteen months away all help mitigate the risk of default," Morningstar notes.

CMBS

Latest US CRE price trends examined

US central business district (CBD) office real estate prices continue to outperform other core commercial sectors, according to the latest Moody's/RCA CPPI report. CBD office prices increased 9.6% over the three months to November and 17.4% over 12 months.

"The CPPI national all-property composite price declined 0.5% in October as a 0.6% gain in apartment was offset by the decline in core commercial," says Tad Philipp, Moody's director of CMBS research. "Though commercial real estate prices have climbed 27.7% since the November 2009 trough, they remain 22.4% below the December 2007 peak."

The apartment sector has recovered to within 12.2% of its December 2007 peak, while core commercial is 25.2% below its December 2007 level. Distressed transactions now make up around 25% of recent repeat sales observations, down from around 33% between early 2010 and mid-2011. Prices excluding distressed transactions have regained 70.6% of their peak-to-trough loss.

As well as the six major metro areas as designated by the CPPI, Moody's also looked at nine other large metro areas or combinations of metro areas within a region. South Florida, Philadelphia/Baltimore, San Diego and Seattle outperformed the national all property index since June 2001.

Denver and a Texan group of Dallas, Houston and Austin have both seen appreciation since June 2001, but less than that of the national all property index leaders. Atlanta, Las Vegas and Phoenix have prices below June 2001 levels.

CMBS

Rating confirmation clarified

Fitch has clarified that it will not provide rating confirmations in connection with the appointment of a special servicer in EMEA CMBS. The agency says this stance formalises concerns it previously expressed regarding proposals originating from individual creditor classes, whose interests may not be aligned with those of other affected noteholders.

Replacing a special servicer is one source of influence over rating-sensitive outcomes that may or may not be in the wider interests of holders of all rated notes, Fitch explains. In general terms, the agency notes that there is potential for conflicts of interest to arise from: a connection between the controlling class and the prospective special servicer; and conflicting preferences between the controlling class and other noteholders.

If the trustee is in doubt about a request to appoint a special servicer, noteholders can be consulted about what special servicer arrangements best serve their interests. Fitch expects to continue to receive notification of all changes in transaction parties, including those governed by the servicing agreement. If warranted by such a change, the agency says it will take rating action as appropriate.

CMBS

CMBS pay-off highs maintained

In November, 62.6% of US CMBS loans reaching their balloon date paid off, according to Trepp. The percentage of loans paying off in September and October was 68.2% and 60.7% respectively. Prior to September, the pay-off level had only surpassed 60% twice since the beginning of 2009.

By loan count (as opposed to balance), 67.7% of loans paid off last month. On this basis, the pay-off percentage was the highest since January 2009. The 12-month rolling average by loan count is now 55.5%.

RMBS

Non-conforming RMBS stress tested

Triple-A rated UK non-conforming RMBS tranches can withstand significant macroeconomic stress, according to Fitch. On average, these notes have enough credit protection to cover around nine times the losses expected in the agency's base case, and would only suffer losses if 60%-65% of mortgage portfolios were to default and house prices were to fall by 60% from current levels.

In a severe scenario, in which a majority of triple-A rated non-conforming notes are downgraded to below investment grade, only 16% would be downgraded to distressed rating levels and 18% would remain triple-A. This scenario would reflect a combination of unemployment reaching 24%, mortgage interest rates rising to around 12% and house prices halving from current levels. Fitch considers this scenario very unlikely.

Almost all post-2006 non-conforming triple-A tranches would be downgraded under the severe scenario. This reflects the modest rate of deleveraging and limited refinancing options in the non-conforming market since the 2007 financial crisis, while earlier deals benefitted from deleveraging as constant prepayment rates were between 20%-40% prior to the crisis.

However, the results under the moderate scenario show that higher original credit enhancement levels of triple-A non-conforming tranches post-2008 are adequate to protect the ratings. The moderate scenario - in which over half of triple-B notes are downgraded by at least one category - would require unemployment to rise to around 10% and mortgage interest rates to rise by around 3%, while house prices fall by a further 32%. These moves are also well beyond Fitch's base-case assumptions.

Triple-A rated UK non-conforming notes are more susceptible to a downgrade under the moderate scenario than UK prime, with 16% expected to be downgraded compared with zero for prime notes. This highlights the universal over-enhancement of all triple-A rated prime notes, while also emphasising the greater differentiation amongst triple-A rated UK non-conforming notes, as some are downgraded in the moderate scenario and others benefit from credit-enhancement that exceeds 100%.

RMBS

Fiscal cliff warning

If negotiations over the fiscal cliff are unsuccessful, the reduced spending and tax increases will have a meaningful impact on both the broader economy and specific programmes important to the US housing market, Fitch warns.

One programme that could be eliminated is the Mortgage Debt Relief Act of 2007, which allows borrowers to avoid paying tax on the amount of forgiven debt. Short sales tend to transact at better prices than other types of distressed sales, but a repeal of this benefit can be expected to reduce such activity. Short sales increased by 35% over the year ending in 3Q12, according to Renwood RealtyTrac.

Fitch believes that if the automatic spending cuts and tax increases were to go into effect, the recent home price improvement trend could also be reversed. Additionally, this could slow the resumption of new transactions. However, due to the significant amount of economic stress already being factored into the current rating analysis of new issue and legacy securitisations, further rating migrations would likely be limited.

RMBS

Mortgage insurer approach updated

Moody's has updated its methodology for rating global mortgage insurers. The agency has introduced a new rating factor - Housing Market Attributes - that assesses the state of local housing markets. In addition, it has revised its capital adequacy metrics - which will now cap insurance financial strength ratings - and recalibrated the rating scorecard.

Based on this new rating methodology, Moody's expects established mortgage insurers with sound credit profiles to fall into the single-A range. The agency notes that since US mortgage insurer ratings migrated down significantly during 2007-2008, the revised methodology is unlikely to lead to rating changes.

However, the ratings of the Australian mortgage insurers - which are currently under review for possible downgrade - may be more appropriately positioned in the low single-A range, driven primarily by fundamental factors. Moody's expects to conclude its review of Australian mortgage insurers in early 2013.

"The market experience and structural developments in the mortgage insurance industry prompted us to re-examine our rating assumptions and framework for rating mortgage insurers globally," comments Ilya Serov, a Moody's vp - senior credit officer. "Our revised methodology reflects the more recent performance of the industry, better captures regional differences in our ratings and improves the consistency and comparability of Moody's-rated mortgage insurance companies globally."

RMBS

South African RMBS reassessed

Moody's has taken rating actions on eight South African RMBS, following its reassessment of the sector. The review takes into consideration the risks to RMBS ratings following the deterioration of the credit quality of the South African sovereign.

Specifically, Moody's has downgraded the global scale ratings of one senior note and 19 junior notes, as well as confirmed the global scale ratings of two senior notes and two junior notes in eight South African RMBS. The agency has also downgraded the national scale ratings of one senior note and 16 junior notes, as well as confirmed the national scale ratings of two senior notes and three junior notes in the same eight transactions.

The rating actions are driven primarily by the reassessment of credit enhancement adequacy for each of the rated notes, given the increased risk of economic instability and political uncertainty as reflected by the lowering of the country ceiling of South Africa. The downgrades range from one to three notches, with an average of one notch. One South African RMBS transaction - Private Residential Mortgages (Proprietary) Limited - Series 1 - remains under review for downgrade, pending resolution of a restructuring proposal.

In performing the reassessment, Moody's incorporated the new maximum achievable rating in South Africa as a consideration in the asset loss distributions to ensure the increased probability of high severity loss scenarios is captured. Key drivers for the downgrade of the South Africa's government bond rating included: a decline in the government's institutional strength amid increased socio-economic stresses and a negative investment climate caused by infrastructure shortfalls; and high labour costs and political instability.

These factors combine to create weakening macroeconomic conditions that will elevate consumer credit risk, according to Moody's. In addition, retail credit consumers will also come under further pressure, should the current low-interest rate environment change.

RMBS

Rating watches resolved

Fitch has resolved the rating watch status of various classes in the US prime, Alt-A, subprime and re-REMIC RMBS sectors. The classes previously on rating watch negative generally reflected increasing tail risk, as well as rating sensitivity to the agency's updated loan loss model and surveillance criteria (SCI 13 August).

For classes on watch negative, 89% of them have been downgraded, while 11% were affirmed. Of the downgrades, 99% are 1-2 rating category revisions and 75% are in the prime sector or in the Alt-A sector issued prior to 2005.

The deterioration in performance in pre-2005 RMBS has been driven by adverse selection in the small remaining mortgage pools, Fitch notes. Recent performance deterioration is compounded by structural features in pre-2005 transactions.

The agency expects the dollar amount of senior class credit protection to continue declining in most transactions due to: the lack of hard subordination floors; structures that pay scheduled principal pro rata to subordinate classes; and the lack of performance triggers that redirect unscheduled principal cashflows from subordinates to senior classes. Since 2010, the dollar amount of senior class credit protection has declined by 33%.

RMBS

The changing value of credit

Even among all the changes in the mortgage investment market, the ability to successfully evaluate and profit from structured real estate investments still relies on understanding a borrower's credit picture. Gordon Crawford, vp analytics for DataQuick, explains why

For years credit scores provided by the three major credit bureaus set the standard for evaluating creditworthiness. Lenders and investors were able to use credit scores to accurately determine the risk of default and provide risk-based pricing accordingly.

And these credit scores are still used. But why did the number of defaults among borrowers once deemed prime increase dramatically in the wake of the mortgage market's meltdown? Why was the foreclosure crisis not limited to subprime borrowers?

Part of the issue is in the nature of the score itself. A score is not a static number with a value that doesn't change.

Unlike a test, where answering nine out of 10 questions correctly always equals 90%, a credit score's exact value fluctuates. The effect is similar to inflation, where a dollar in 2012 buys much less than a dollar in 1972.

For example, in 2005, the default rate for a borrower with a score near 700 was around 2%. However, a borrower with a credit score near 700 in 2009 had a default rate of nearly 10% - a 500% increase!

Overlooked in the focus on credit was the relationship between credit and risk. While a borrower in 2009 with a score of 700 was still a less risky customer than a borrower with a 600, the risk was higher than the 2005 borrower with a 700 score. So credit scores still do a very good job of separating high-risk consumers from low-risk ones.

To combat this, investors need to understand how to better measure the relationship between a credit score and current levels of risk. The credit scoring agencies are taking some steps to assist in this.

One is providing annual updates to provide more transparency to the current default data for different levels of credit scores. Another is utilising data from all three credit bureaus to build tri-score models that incorporate all of the available credit data. This reduces the risk that missing or erroneous data from one bureau would provide an inaccurate credit rating.

Gauging total credit risk
Another method of judging risk in the RMBS purchasing process is to build a more complete borrower picture beyond credit score data. Investors will be looking to technology platforms that can quickly and accurately review all information available - income, credit, debt load and payment histories - when completing loans.

Lenders and investors should look to tools that can provide additional information on the borrower's creditworthiness that enable them to make informed decisions on loan applications. This can include information related to localised housing price trends, borrower payment history, utilisation of credit and other factors that can be used to determine risk.

Among some of the most common risk factors to look at beyond the actual credit score are:
• missed/late payments: this is the most obvious red flag, but investors should also keep an eye on other revolving debt payments. Changes to payment patterns among other accounts may suggest that borrowers could be trying to balance growing debt loads and be unable to support a new housing payment.
• delinquent accounts: miss too many payments and delinquent trade lines become another obvious warning.
• increase in utilisation of credit: investors should also be on the lookout for unusual increases in credit utilisation prior to application. As more borrowers are facing financial struggles, an increase in the activity on a credit card or a sudden access of secured lines of credit may signal future issues with the borrower.
• unusual activity in other accounts: investors should try and gauge the borrower's history with their activity on other accounts. The key to managing these signs is the ability to view a complete picture of a borrower's financial status.

This information may be imbedded in the loan file from the originating lender or delivered through trusted information partners. Lenders have always realised the importance of managing the information available to them to more effectively underwrite loan applications. The expanded role of loan quality initiatives by major investors - including GSEs - will drive additional due diligence, requiring investors to incorporate tools that help them to obtain data on up-to-the-minute credit changes after the application is submitted, trade line validation and other research.

Reducing risk for investors
Fannie Mae's Loan Quality Initiative (LQI) has worked to eliminate the delivery of ineligible loans and reduce the risk of repurchase. Fannie Mae conducted an extensive analysis to determine the primary indicators of repurchase requests and launched the LQI to identify and implement policy, process and technology enhancements to improve compliance with underwriting and eligibility guidelines.

A primary focus is to identify critical loan data earlier in the process and validate it throughout the course of the loan. Specifically, the LQI shifts Fannie Mae's compliance screens upstream, away from evaluating loans after they go into default and toward scanning loans proactively before being accepted from the lender.

Investors need to be aware of the standards the GSEs demand to ensure the loans they buy have been evaluated prior to completing underwriting. The more accurate the credit data upfront, the more likely the loan will successfully be underwritten and closed.

Managing the quality of borrower credit could be one of the most daunting tasks facing investors as they evaluate the latest RMBS offerings. Thankfully, the technology and experience is available in the marketplace to help support investors' need for quality.

Using credit and risk evaluation tools will enable investors to more accurately determine the relationship between credit scores and risk, while evaluating additional data that can be used to paint a better picture of the borrower's ability to repay. These tools will also enable investors to be more efficient, leveraging automation to perform the most time-consuming tasks of monitoring, sorting and analysing securities.

In the end, knowledge is power and the more data investors have on the borrowers they are purchasing, the more accurately they can make smart, profitable decisions.

Crawford can be reached at gcrawford@dataquick.com