Contents

Structured Finance

Not giving in

Solid 2013 anticipated for European securitisation

The European securitisation market has been dominated by regulatory pressures, but - as participants become more comfortable with the changes being imposed - secondary market rallies have made primary issuance increasingly attractive. Supply in 2013 is expected to be broadly steady, with issuance anticipated right from the start of the year.

Kevin Ingram, partner at Clifford Chance, believes that while regulatory concerns have been driving the conversation in Europe for the last few years, it is now economic issues that are heading the agenda. He says: "Policymakers can be divided into the economists and the regulators, and - depending on circumstances at any given time - you may have the economists or the regulators setting the tone."

Ingram continues: "The economists see the benefits of certain activities to the wider economy, while the regulators are more focused on shutting down risk. Recently it has been the regulators to the fore, but now the need for growth is so acute that the trend is towards the economists coming to the fore again."

With Francois Hollande elected in France, Ingram senses that the push at the heart of the EU is now more towards growth than simply shutting down risk. The Bank of England has also toned down bank liquidity requirements during periods of stress.

"There remains a wall of regulation, but we are now at the stage of fine-tuning for much of this legislation. It is a more nuanced debate now than it was previously; instead of proposing to ban everything perceived to be risky, I think securitisation is now being viewed as having the potential to support the real economy, as long as it is safe. So the priority now is convincing policymakers that is, in fact, safe," Ingram adds.

Next year should see enhanced regulatory clarity, although - with the delay of CRD IV - exact implementation dates have become uncertain. Ingram notes that banks have nonetheless made changes in the types of assets they hold in anticipation of the coming regulations.

"Anticipation of CRD IV has resulted in banks holding fewer short-term exposures, for example. There have also been portfolio disposals and banks repositioning themselves to take into account regulation down the line. Banks have been thinking about the sorts of businesses they would like to be in the new regulatory landscape," he says.

An element of the new landscape is a shift in the full recourse nature of the European ABS market. Tweaks to laws in Russia and the introduction of new provisions in Ireland and Spain could be significant.

"In Spain you have clear-cut payment reduction mechanisms and in Ireland you are seeing debt forgiveness potentially reducing full recourse. That is clearly aimed at keeping people in their homes, but there are some questions around implementation," says Neal Shah, md at Moody's.

He continues: "There is also the moral hazard issue, so this needs to be resolved. Ireland is in limbo as no-one wants to foreclose or forgive debt, so people are still in their homes. In Spain some parts of the market are illiquid. People have been foreclosed in some instances, but the property often has not been sold."

Not all changes are for the worse though. Underwriting changes in both the UK and the Netherlands are viewed as positive.

"There are proposed changes to the Dutch tax framework, where they have proposed to reduce tax deductibility over 15 years. It is important because the country is highly leveraged as a result of the tax benefit and the change provides one way of working out the excess leverage in the system," says Shah.

Beyond the UK and the Netherlands, promising signs are emerging that other European markets are opening up. Shah reports a lot of interest in Russian RMBS, where AHML and smaller originators are tapping domestic demand, and notes that there have been some deals from South Africa too, mainly refinancing existing issuance.

Ning Loh, vp at Moody's, adds: "ABS in the core European jurisdictions should continue to do well. We are seeing continued issuance in UK, German and French auto loan and lease transactions and we even provisionally rated earlier this year a Polish deal destined for domestic investors."

The recently-launched Prime Collateralised Securities label could be a significant boon for opening up peripheral markets. The first PCS-approved deal (Bilkreditt 3) launched last month and more are expected to follow in 2013. CRD IV references high quality labelling schemes as being potentially eligible for liquidity calculations, so the PCS label could also help with liquidity buffers.

"Whether PCS will actually result in more investors is unknown at the moment. I do not think it will be viewed as anything negative, but it is not clear currently how much of a positive it is being seen as by investors either. However, it potentially could be helpful in a number of ways, including restarting markets that have had no securitisation at all or encouraging investors to return to existing markets," says Ingram.

He continues: "Healthier markets, such as RMBS in the UK and Netherlands, do not need restarting as such. But, of course, they would benefit from a more even regulatory playing field for securitisation. Though PCS is promoting best practice around securitisation of quality real economy assets, hopefully the regulators will take note and this can lead to PCS-labelled assets being viewed more positively in regulations."

One arranger notes that PCS is easy for banks to comply with and does not hinder issuance. As it provides good PR to be able to say a deal is PCS-approved, he expects it to open up the ABS market to peripheral sectors, as well as bolstering core markets.

"PCS can be the catalyst for investors returning to the market. A concrete step has been taken and that is very important," says the arranger.

He continues: "It is important because you want the market to be providing solutions rather than having to rely on government schemes. I think PCS gives governments a chance to step back and let the market work through these issues without further interference."

The ability of the PCS label to draw investors into the market is not yet clear. Whether two particular issuance trends from 2012 continue will also be significant.

"There was a lot of 144a placement into the US, not least because, as I understand it, the dollar-sterling and dollar-euro swap rates were favourable. There is a question about how much ABS issuance will be placed into the US 144a market in the year ahead," Ingram says.

He continues: "Another market trend was for material amounts of some transactions to find their way into Asia, particularly Japan. There have also been deals with Aussie dollar tranches, and which new investor markets will be tapped going forward will be interesting to monitor."

Within Europe, some investors may also begin to feel that the market has stabilised enough to come back, Ingram adds. Insurers may even be tempted to re-enter the market as the discussions and delays around Solvency II continue.

With or without PCS, investors that come to the market in 2013 are set to be confronted by tight spreads. That has not put investors off so far, however.

"Spreads have tightened for everything, driven by a massive lack of supply and very high demand, because you even have US-based investors looking at Europe right now. The supply and demand technical is keeping spreads tight and they could go tighter in 2013," says the arranger.

He adds: "We have seen more French deals and even a Norwegian deal, so issuance will be strong. The key thing though is that the investor base could widen to the point where even when supply does pick up there may not be spread widening."

The auto ABS sector has been fairly stable and while residential issuance is expected to shrink slightly, the arranger believes that CMBS will be forced to increase as the sector grapples with the coming refinancing wall. Bank deleveraging will make it hard for issuance levels to increase, but with such strong demand supply should at least stay pretty steady.

"I am getting more requests about Eastern European collateral, so I think we might see some Russian and Polish assets being securitised. Assets are not growing too much in Western Europe, so we do need to look further afield to find where the real value will be," the arranger adds.

All the spread tightening in the secondary market for ABS and RMBS, coupled with consistently high appetite, should lead to better pricing in the primary market. This would further encourage issuers to bring deals.

That, in turn, could start a virtuous circle by providing further secondary impetus. One trader reports that the biggest turnover in secondary has been where there has been primary supply.

"That has been backed up by junior parts of CMBS and non-prime RMBS. UK primary supply will be lower and FLS has had an effect there. Central bank policy action has made issuers much more liquid than they were four or five years ago," the trader says.

He continues: "Some dealers are quite long and I think that is deliberate. A lot traded to the dealer book and then did not trade out again, so I think dealers have been building back up and pre-positioning for 2013 and a possibly rally in Q1."

The rally over the last half of 2012 has not moved the market back to the levels seen in 2007 and 2008, but several callable deals have passed their call dates and stepped up. There is a chance some of those deals might be refinanced, while after RMS 16, 17 and 18 have all been called, there is a good chance the next deals in that series could also be called.

Meanwhile, the European CLO market remains comatose. A revival of the sector is not expected in 2013, not least because loan performance is so much worse than in the US.

"Europe has kicked the can down the road in terms of performance, while equity returns are lower. What is the appeal of European CLOs if you can get better returns and more transparency in the US market?" asks Chandrajit Chakraborty, cio and managing partner at Pearl Diver Capital.

Given current loan prices, the weighted average cost of a European CLO would be 200bp, with equity returns of low double-digits. While the arbitrage is expected to eventually make more economic sense in 12 months or so, loan supply is another stumbling block to the re-emergence of the market.

Ramping up enough assets for a CLO portfolio is estimated to take about six months at present, but there is limited bank appetite to warehouse the assets. The emergence of hybrid portfolios - including high yield assets and FRNs - could be one alternative.

Nevertheless, bank issuers remain the most obvious candidates to bring new issues in Europe because they can retain the necessary portion under Article 122a. Private equity firms have the resources to retain too. Otherwise, it is a case of identifying an anchor equity investor that can be involved with the selection of the portfolio and retain a portion of the transaction for the duration.

Resecuritisation is also moribund, although unlike CLOs it is not being mourned. "Anything the industry can do to not look like it is creating complex investments for the sake of being complex is a good thing for moving away from the perceptions of the past," says the arranger. "I would hope resecuritisation does not return because it could be quite damaging. Never say never, but I think regulators would not be very impressed to see that begin again."

Ingram expects banks to look to issue in the first part of 2013. Secondary spreads are tight and so primary activity could begin in early Q1.

"The interesting things to observe next year will be who will want to go to market and when that will be. We may also see less-frequent issuers being encouraged to come in early in the year on an opportunistic basis," says Ingram.

He concludes: "There is also a lot of infrastructure and utility secured corporate bond activity out there. Project bonds are flavour of the month politically, so we might see that market kick-starting strongly."

JL

Structured Finance

Asian attraction

Yield available, although challenges remain

The structured finance markets in Asia face significant constraining factors in 2013. A preference for covered bonds will limit RMBS issuance on the mainland, while deal volume in Japan and Australia is expected to be flat to lower, with demand continuing to outstrip supply.

Gregory Park, managing partner at Northstone Peak, notes that the structured finance market in Asia remains markedly changed by the global financial crisis. He expects a healthy number of deals to be done next year, but more in the private space with fewer competitors.

"There has been a noticeable change post-Lehman, with several arrangers and active conduits exiting the market," says Park. "Asia is a challenging region filled with different legal, regulatory and cultural barriers, but exactly the place where one can find alpha."

The expansion of the Asian covered bond market was being predicted a year ago (SCI 23 December 2011) and developments in 2012 have brought that prospect a step closer, which may be to the detriment of RMBS. Korean covered bond legislation has been put forward for parliamentary approval in January, while the Monetary Authority of Singapore (MAS) also launched a covered bond consultation paper this year.

"Currently only the Korea Housing Finance Corporation (KHFC) can issue covered bonds. We have done the first two deals already and there is a third one on the way, but the government wants to expand the market to allow any bank to issue covered bonds," says Warren Lee, global head of capital market solutions at Standard Chartered.

He continues: "Hopefully that will pass and open up a new asset class in Asia. We are also expecting MAS to release some guidelines in the New Year. I think this push has all been driven by Asian central banks seeing the benefits of Australian legislation introduced two years ago, which has allowed banks to achieve lower funding costs by issuing covered bonds."

If covered bond markets are launched in Korea and Singapore, Lee suggests that Hong Kong will not be far behind. He says that central banks are more enthusiastic for banks to do covered bonds than RMBS at the moment.

"Beyond Japan and Australia, the only real RMBS issuance was from Korea. There was some from Hong Kong back before the crisis, but it has not been active for a while. Outside of Korea, banks' loan-to-deposit ratio is less than 100%, so they have no need to fund mortgages," he says.

The Australian market has long been RMBS-focused. Issuance levels decreased in 2012 and although there is scope for the market to expand, there are certain constraining forces in place.

"There are good signs here. The AOFM, which was a large participant when the Federal government set it up to assist non-bank securitisations, has been less and less required," says Jonathan Rochford, portfolio manager at Narrow Road Capital.

He continues: "Previously, the AOFM would take the subordinated triple-A tranche and other investors would take the senior triple-A., but recently they have not been required to take that sub piece. That indicates a stronger market here, with issuers able to get away all the tranches they want to get away. There are buyers across the spectrum."

A notable trend this year has been increased tiering between issuers in the secondary market. While government bond yields are falling, RMBS remains attractive. Central banks and other investors have been picking up Australian government bonds, where yields are below 3%, but could pick up yields of over 4% for the same duration by favouring senior triple-A RMBS.

Rochford adds: "There may be some people out there who are open to that and looking for a very safe investment. That market could develop, but then again the central banks generally just want Australian government debt. There is potential there, but it is not something we have seen happening just yet."

The market has not been helped by changes to the way in which rating agencies view lenders' mortgage insurance (LMI). LMI ratings have been downgraded, so some RMBS tranches that used to be double-A are now single-A, which may be putting some investors off.

In addition, a policy document was released by APRA in October, guiding towards a future where it will be harder for banks to issue for liquidity. APRA will not allow banks to buy subordinated tranches, so although securitisations can include these tranches for liquidity purposes, it is hard to find buyers for them.

"There are not enough government bonds out there, so there have to be some alternative liquid assets for the banks that regulators can be comfortable with. To get comfortable, they have typically said banks are able to securitise, but they must keep the top 90% or so of the deal structure bullet-proof," says Rochford.

He continues: "The problem is that the more junior parts of the remaining 10% is then very hard to sell. Other banks cannot buy it and there are only a couple of big players for the subordinated tranches, so the options are limited."

That means that if anything changes in the space and a participant pulls away, pricing at the lower end could increase significantly. "That will be something to watch over time because there is probably a point where volumes start to ramp up. With more of those lower-tier notes, there may be a limit to how much the market can absorb. Also, if banks are pushing old sub tranches off their balance sheets, then pricing there has the potential to move out," Rochford observes.

Overall, however, spread levels in 2013 are expected to be consistent with those seen this year. Rochford notes that supply should be able to match demand, limiting the potential for pricing to change too dramatically.

"There is not a rush of people flooding in to buy RMBS, so I do not think spreads will be pushed down. If more buyers did come into the market, then I think what you would see is regional banks and non-banks stepping up and making more loans and issuing deals, so in meeting that demand they would keep spreads pretty flat," he says.

Rochford continues: "There is an equilibrium around the point that we are at now, where you get some issuance away but not a huge amount like in 2004-2007. If pricing goes down, then that is where issuance could really ramp up, so spreads will not be allowed to tighten too dramatically."

The picture in Japan is similar: RMBS is the dominant sector and although there is potential for the market to expand, total issuance for the year is not expected to increase. In fact, Japanese deal volume is predicted to decrease.

"We expect issuance in 2013 will be only slightly lower than it was this year. The main product is Japan Housing Finance Agency (JHF) RMBS, which is similar to the US agency RMBS sector. The JHF supports the mortgage market and is very popular with borrowers," says Kaoru Kondo, structured finance research analyst at Bank of America Merrill Lynch.

She continues: "The JHF is planning around ¥1.565trn in issuance next fiscal year and we think the final volume will be ¥1.5trn. That is about the same level of issuance that we saw in 2010, but it is slightly less than this year, which was ¥1.8trn."

JHF RMBS should benefit from increased demand as a result of a bill recently approved by the Japanese cabinet. The bill will increase the country's consumption tax from 5% to 8% in April 2014, which is likely to cause a last-minute surge in demand for housing next year.

Primary spreads have become increasingly tighter with every passing month and Kondo believes they may now be too tight. She says: "The Monthly Series 67 in late November launched with OAS of just 2.4bp, which is 19.2bp tighter than spreads at the start of the year. Nominal spreads have tightened 10bp from 44bp in January."

Kondo continues: "Unfortunately, in the Japanese market, there is a lack of attractive investment opportunities. However, spreads should widen a bit next year, starting with the Series 68 issuance at the end of this month."

Secondary spreads have also tightened over the year. Kondo reports that 2011 and 2012 vintage OAS have narrowed by 4.3bp and 9.5bp respectively.

"We are seeing a change in the secondary market and if that trend affects the primary side, maybe we can see the spreads widening. However, that widening will be limited because the supply and demand is so strong," she notes.

Private label RMBS passed ¥400bn this year. At ¥409.8bn, 2012 has the highest private label RMBS issuance since 2008, with regional financial institutions resuming issuance.

"The private label market is not as big, but we have seen RMBS originated by regional institutions and major Japanese banks. Comparatively, there has been a lot of issuance this year and we think 2013 will match it," says Kondo.

If the planned legislation comes into force in mainland Asia, then a lot of the mortgages that would have been used for RMBS will go into covered bonds. Beyond mortgages, the success of ABS all hinges on liquidity in the market, says Lee.

He adds: "In 2012 there were competing sources of funding which were cheaper. In the past years, the local currency market has been very strong."

Lee continues: "The local currency market is huge. The Korean RMBS and ABS local currency market is about US$40bn and even in countries like Malaysia there is a US$1bn-equivalent market. Those deals are much smaller than international deals, but auto loans and credit card deals are being done."

Beyond RMBS, securitisation prospects vary greatly from jurisdiction to jurisdiction. Moves by China to re-open its securitisation market (SCI 6 September), while limited, have been welcomed. A relatively small quota of deals was allowed in 2012 and Lee hopes the next quota may be larger and help to open the market up.

In Australia, issuers are struggling to gain traction outside of RMBS. A handful of auto deals were issued this year, such as Bank of Queensland's REDS EHP Trust series 2012-1E, but otherwise non-RMBS deals have been few and far between, and small.

"ABS has increased as a percentage of total issuance this year, with RMBS volumes down and ABS volumes essentially flat. For the long-standing issuers like Bank of Queensland, there is demand and good volumes can be done," Rochford says.

The Japanese market beyond RMBS is similarly limited. Auto ABS and credit card receivables securitisations are the most common and auto issuance actually reached a record high this year, although Kondo cautions that ABS issuance is still small.

She says: "Private label auto ABS is much better than other markets and although there is less aggressive Japanese auto demand, captive finance companies and non-banks are providing more attractive auto loans. The market has been stable and volume has been increasing recently."

CDOs, CLOs and CMBS have been all but non-existent and Kondo does not expect these markets to be active in 2013. The CLO market is more active in mainland Asia.

Standard Chartered issued another four CLOs this year and Lee notes that the pricing achieved was even below the pre-crisis level for synthetic deals. Other Asian banks are said to be looking to establish a similar model to manage capital through the CLO market.

"We understand that with Basel 3 coming in, many other banks are looking at CLOs, but they have not issued anything yet. Many banks here are still capital-rich, but Basel 3 is a game-changer for the market and so 2013 could see things change," Lee says.

One area of potential change is a greater willingness for overseas investors to buy into Asian risk. If yield-hungry investors from the US and Europe decide that 2013 is the time to open their books to Asian names, then Lee is confident that issuers would be keen to look at offshore issuance.

"Right now, most US investors are not looking at Asian credit. I do not think they are ready just yet for auto deals coming out of Asia, swapping into US dollars and issuing into the 144a market," he says.

He continues: "When spreads got tight in the US and Europe eight years ago, European investors were willing to take Asian RMBS to pick up yield, and we are hoping to see that again in 2013. As US and European triple-A pricing tightens to the level where investors look at Asia, they could pick up an extra 30bp-40bp in yield just by virtue of it being a new asset class."

Lee notes that Asian portfolios also have far lower default and delinquency rates, further strengthening the appeal. Demand within Asia remains strong, but whether supply can satisfy it remains to be seen.

"The Asian investor base is starting to come back for structured finance. Japanese investors' book size is almost as big as it was in 2007 and some of the Asian accounts are also looking to pick up some of these highly-rated instruments at a premium over where comparable instruments are," concludes Lee. "It is the same thing that has happened in the US and in Europe. It has happened in Japan and now the rest of Asia is catching up."

JL

Risk Management

Transition time

CDS product development and growth anticipated

Next year will be a watershed for credit derivatives, as the market is scheduled to transition to a centrally-cleared and electronically-traded environment that is expected to be a more transparent channel for trading and investing. Product development and growth are anticipated as a result, with CDS being perceived less as a standalone product and more as one of a range of credit instruments with which to express views.

Given the evolution of the product and the impact of the financial crisis, few market participants focus purely on CDS these days, confirms Quantifi ceo Rohan Douglas. "The focus is across the broader spectrum of credit, to include credit derivatives. The sell-side is consolidating across the broader credit business, while buy-side funds are increasingly incorporating different types of credit instruments - bonds, CDS, indices, tranches and loans," he explains.

He adds: "Banks have gone through turmoil and liquidity isn't what it used to be - this is providing both the motivation and opportunity to broaden. Credit has matured as an asset class and the individual instruments are more interrelated now. But the utility of CDS remains in terms of allowing users to express a view."

It is hoped that as central clearing is implemented and exchanges launch new products, there'll be even more investment options for end-users. Certainly, risk appetite is growing as investors hunt for yield and chase leverage.

"Credit has performed well," Douglas observes. "Many institutions managed on a tactical basis over the last few years, but now the pendulum is swinging towards the need to generate yield, so they are beginning to make decisions on a strategic basis."

Credit derivative strategists at Morgan Stanley expect the CDS market to become more equity-like, where relative value and volatility plays account for a larger portion of the opportunity set. They suggest that potential for growth is not only in depth, but also in breadth, with more granular strikes and potentially longer maturities emerging.

"In terms of innovation and development, we think products that offer investors a way to take a view on portfolios of credit will be very popular," the Morgan Stanley strategists add. "CDX and iTraxx have become by far the best source of liquidity for taking views on the credit market as a whole over the past decade or so, and we're seeing increased interest for a wider variety of products that do the same."

They point to the strong interest and volumes in ETFs over the past year as an example. The advent of iBoxx standardised total return swaps (SCI 14 June) also allows investors to easily go long and short the market. Additionally, some green shoots are being seen in the bespoke market - an indication that investors with strong credit-picking capabilities are seeking to implement their views in a more efficient way, according to the strategists.

Their top trade ideas as the market heads into 2013 include going long junior mezzanine across regions and indices, buying volatility and taking advantage of dislocations in the cash/CDS basis. Idiosyncratic views on the broader market can be expressed with single name CDS, while macro views can be implemented via the tranche or options market.

"The CDS market has come a long way over the last 10 years in terms of standardised contracts and liquidity," says Peter Bakker, portfolio manager at Channel Capital Advisors. "We're headed in the right direction in terms of moving toward a more exchange-traded environment."

Indeed, he expects liquid names to eventually migrate to being traded entirely on-exchange. "The need for OTC products will remain, but once contracts become widespread they become increasingly plain vanilla. With an expanding universe of plain vanilla products, OTC instruments become more transparent because they price off the plain vanilla market. Once CDS become mainstream, an option on a CDS is a smaller step, for example."

The structured side of the credit derivatives market this year has seen a renewed focus on large-scale risk transfer deals structured for regulatory capital reduction, given an increasing meeting-of-minds on pricing between originators and investors. Several funds have been established to invest in these assets, although Ashurst partner James Coiley says that some have struggled to find attractive portfolios.

Loan and trade finance portfolios are popular, with less activity but much discussion of transactions on derivative exposures. Activity in this area is sensitive to where banks are in terms of capital ratios and internal balance sheet reduction targets.

However, interest broadly remains in transactions that are less capital-intensive. Many banks in core economy countries are now well funded and so collateralised funding activity - whether through bond, repo or derivative formats, or a combination - has tended to migrate towards more difficult jurisdictions and assets.

In terms of flow product, ISDA's definitions update is ongoing (see box). "In addition to the original core issue around the treatment of basis packages, there is a shopping list of different issues that could be addressed - for example, in connection with successors to sovereign reference entities and detail issues on the treatment of guarantees. But it is easy for changes which sound simple in outline to result in unintended consequences," Coiley notes.

Going into next year, he believes that activity will continue to bifurcate between infrastructure and documentation developments on the vanilla side of the market and the application of CDS and CDS-like products for regulatory capital-driven trades on the more sophisticated side, as an alternative or complement to outright disposals of loan portfolios to the shadow banking sector.

As banks exit certain businesses, opportunities are likely to arise for non-bank institutions to provide liquidity in segments that banks withdraw from, as well as opportunities to trade in and around new venues. Next year will be a watershed, according to Douglas, because the market will be right in the middle of this transition. He says that uncertainty remains the biggest challenge.

"The introduction of central clearing, for example, will affect margining and how banks price trades, as well as manage risk and trade flow - the impact of which is unclear. Market infrastructure will nonetheless have to change. As more trades are electronically settled, the emphasis on accurate valuation and risk management increases," Douglas notes.

While sophisticated players were early adopters of valuation and risk management analytics, the onus is now on smaller institutions to invest in this area because the environment has become more complex. "The impact of volatility and market forces is critical - even for vanilla products - because institutions need to be able to price counterparty risk accurately," Douglas explains. "Funding costs have increased in importance and are being priced into trades, meaning that the buy-side is feeling the impact of the changes more explicitly. But institutions that proactively manage this change will reap the rewards."

James Cawley, ceo of Javelin Capital Markets, notes that the credit derivatives market has undergone three catalysts for change recently. First was the re-election of President Obama.

"There was a sense on Wall Street that Mitt Romney would win and repeal the Dodd-Frank Act," Cawley explains. "This belief had stalled regulatory momentum, but now it's all systems go. All products regulated by the CFTC, as mandated by Dodd-Frank, must be cleared by August 2013 - a watershed event."

Indeed, the second catalyst is the passage of the CFTC's clearing mandate last month (SCI 29 November). "This calls for interest rate swaps and CDS index products to migrate over the next nine months to a cleared environment. Some customers aren't prepared for this, so the coming year will be an intense period of implementation. Large funds have until 10 March to comply, which isn't much time from an operations-readiness perspective," adds Cawley.

The final catalyst is the CFTC's requirement for real-time trade processing: the Commission has ruled that trades must be cleared within 60 seconds, with a two-minute window until the end of February. If the window had been any longer, it would have undermined the anonymity of SEF platforms, according to Cawley.

"The credit risk involved with not settling trades immediately would have meant that clients remained with the incumbent dealers," he observes. "Now customers will vote with their feet: anonymous platforms offer more choice, are low cost and are better from a counterparty risk perspective. The market has also been opened up to new dealers, given there is no need to sign an ISDA master agreement, which had previously precluded competition."

However, Cawley suggests that regulatory arbitrage is emerging due to the CFTC's lack of certainty on SEF rules and inconsistencies regarding designated contract markets (DCMs). "DCM rules are less onerous than SEF rules with respect to transparency around block trades, for example. But this ignores the intent of Congress and needs to be changed."

The big question for credit derivatives in 2013 appears to be: what is the SEC's agenda? The agency is yet to pass a rule regarding clearing or execution, and has blown through the rule-setting deadlines under Dodd-Frank.

Cawley indicates that it seems the SEC has no stomach to pass such regulations. But he says the recent resignation of Chairman Mary Shapiro may pave the way for a "regime change".

"The industry needs someone that will do something to clean up Wall Street," he comments.

Indeed, the wild card for credit derivatives heading into 2013 is regulation, according to Channel Capital Advisors portfolio manager Frits Liew-kie-song. He notes that the EU's recent ban on short selling, for example, may make investors more reluctant to commit capital. But it could potentially also pave the way for the ban to be extended beyond sovereign CDS in coming years.

Another concern is that over time the sovereign CDS product will die by degrees as the regulators erect barriers to liquidity. "Part of the issue is the pace of implementation: while MiFID2 and EMIR have taken years to be implemented, the short selling rules have happened in a short space of time," Coiley concludes. "There is a feeling that legislation is being introduced by Q&A: ESMA releases responses to a set of FAQs, which then effectively stand as law."

CS

Structured Finance

Knight grows structured credit sales team

Jerrard Zive has joined Knight Capital Europe as structured credit sales md, reporting to head of structured credit Alan Packman. Zive joins from Nomura where he was credit, ABS and illiquid sales md and has previously held similar roles at Bank of America, Société Générale, ICAP and Scotia Capital.

Structured Finance

Carrington targets real estate markets

Christopher Whalen has joined Carrington Holding Company as evp and md for Carrington Investment Services, and will lead its investment banking operations. He will focus on fundraising as well as developing and marketing new products for Carrington's various business units.

Carrington says Whalen's appointment will be key in growing the company's influence in the institutional mortgage and real estate markets. He was previously senior md at Tangent Capital Partners and is co-founder and vice chairman of the board of Institutional Risk Analytics.

CDO

ABS CDO transferred

Clinton Group has transferred the collateral management agreement for Adirondack 2005-2 to Cairn Capital. Moody's has determined that the move will not impact any current rating on the class A to E notes. In reaching this conclusion, the agency says it considered the experience and capacity of Cairn to perform the duties of collateral manager to the issuer.

CDO

Aladdin settles SEC MAST charge

The US SEC has charged Aladdin Capital Management with falsely telling clients it was co-investing alongside them in two CDOs. Aladdin actually made no such investments and its affiliated broker-dealer, Aladdin Capital, collected placement fees from the CDO underwriters.

The co-investment representation was a key selling point for its multiple asset securitised tranche (MAST) advisory programme. Aladdin Capital Management and Aladdin Capital have agreed to pay more than US$1.6m to settle the charges and former cfo Joseph Schlim has agreed to pay US$50,000.

Aladdin Capital Management and Schlim have also agreed to cease-and-desist orders without admitting or denying the allegations.

Insurance-linked securities

ILS manager reshuffles, proposes board additions

Twelve Capital has nominated two independent board members to boost its insurance and capital markets business and named a new managing partner. The firm strengthened its risk and operations teams just last month (SCI 12 November).

Effective as of 1 January, Twelve Capital will propose the election of Frank Schnewlin and Andreas Casutt to the board of directors. Schnewlin is vice chairman of the board of Swiss Life Holding and vice chairman of the board of Vontobel Holding, while Casutt is managing partner of Niederer Kraft & Frey.

The new managing partner is Christoph Bürer, who co-founded the firm in 2010 and previously structured capital market and insurance-linked transactions at Horizon21. Urs Ramseier, who was previously managing partner and chairman, will remain as chairman of the board and focus on strategic issues and portfolio management.

Insurance-linked securities

Allied World makes ILS acquisition

Allied World Assurance Company Holdings plans to expand its Allied World Financial Services platform through the purchase of a minority stake in Aeolus Capital Management. As well as acquiring a minority stake in the ILS asset manager, Allied World will increase the amount of capital it deploys in the reinsurance and retrocession market through Aeolus and will extend its capital commitment to Aeolus for at least three years.

RMBS

New general counsel for REIT

Rebecca Sandberg has been appointed general counsel of Two Harbors Investment Corp. She was previously deputy general counsel and secretary and takes over from Timothy O'Brien.

Sandberg served as Two Harbors' senior counsel before serving as deputy general counsel. Prior to Two Harbors she was senior associate at Fulbright & Jaworski and then Stoel Rives.

O'Brien, who has served as general counsel for Two Harbors since its inception, will remain in his role as partner and general counsel for Pine River Capital Management and will also serve as general counsel for Silver Bay Realty Trust Corp.

RMBS

NCUA files largest suit yet

The NCUA has filed suit in Federal District Court in Kansas against JPMorgan and Bear Stearns. It claims there were violations of federal and state laws in the sale of US$3.6bn of RMBS to four credit unions.

It is the agency's largest suit to date and alleges that Bear Stearns made misrepresentations with the underwriting and sale of RMBS to US Central, Western Corporate, Southwest Corporate and Members United Corporate federal credit unions. The credit unions became insolvent and were liquidated as a result of losses from the RMBS.

The complaint alleges Bear Stearns made numerous misrepresentations and omissions of material facts in the offering documents of the securities sold to the failed corporate credit unions. The complaint states underwriting guidelines in the offering documents were "abandoned" and the misrepresentations caused the credit unions to believe the risk of loss was minimal, when the opposite was true.

The NCUA has eight similar actions pending and has already settled claims worth more than US$170m with Citigroup, Deutsche Bank and HSBC (SCI passim).

ABS

Slowing improvements drive credit card outlook

Moody's has changed its outlook for US credit card ABS to stable from positive as collateral improvements slow.

"Our outlook for the sector was positive in 2012 based on the expectation that collateral performance would see a significant decline in charge-offs, which occurred," says Moody's avp - analyst Gregory Gemson. "For 2013, we expect only slight improvements in charge-offs, which is consistent with a stable outlook."

The stable outlook for credit card ABS is consistent with the outlook for most of the credit card ABS bank sponsors. Moody's notes that the credit strength of the sponsoring bank is an important consideration in credit card ABS ratings, given the sponsor's ongoing role as underwriter and servicer for the collateral backing the securitisation.

Collateral performance is expected to be resistant to both economic deterioration in a fiscal cliff scenario and to loosened card account underwriting guidelines. If under the fiscal cliff the government is unable to resolve the budget crisis and avoid automatic spending cuts and tax increases, it would very likely precipitate a recession.

"Still, our charge-off rate index would increase only slightly in this scenario, to just over 4% by the end of 2013, as compared with our base case charge-off expectation of just below 4% - because the credit quality of the receivables in the trusts today is exceptionally strong," adds Gemson. "A large portion of receivables generated by weaker borrowers exited the card trusts when sponsors charged them off during the recession and issuers have generally not added new receivables to their trusts in recent years."

In addition, collateral performance will not deteriorate in 2013 due to the origination of new, lower-quality accounts because the credit quality of these new accounts is still quite strong, says Moody's. Sponsors also have little reason to add a substantial amount of new receivables from unseasoned accounts to their trusts, given the current high level of seller's interest in most securitisation vehicles.

"Looking beyond 2013, we expect the relatively pristine collateral performance and conservative underwriting standards to give way to competitive pressures as card banks once again pursue growth by offering credit cards to riskier obligors," Gemson continues.

ABS

Stable outlook for ABCP

The global ABCP market continues to prove resilient in the face of adversity, according to Fitch, having weathered an onslaught of market disruptions and regulatory challenges over the past few years. In the agency's view, at more than US$300bn, global ABCP outstandings remain a sizable force in the short-term capital markets and a valuable offering from both issuer and investor perspectives.

"Dominated by large bank traditional multi-seller programmes, the surviving issuers are poised for the long haul, having cleansed their portfolios and implemented structural changes to address pending regulatory changes," it says.

Fitch's credit outlook for global ABCP in 2012 was stable, consistent with the outlooks for the global financial institutions that act as liquidity and credit enhancement providers to ABCP programmes. ABCP rating actions next year, if taken, will most likely reflect the health of sponsors, support providers and other relevant counterparties.

ABS

Mexican equipment ABS critiqued

Fitch says that several recent Mexican equipment lease ABS have credit risks that may not have been adequately addressed. The agency is therefore concerned about recent transactions coming to market that carry a triple-A national scale rating from other credit rating agencies.

Fitch highlights three key credit concerns: small, lowly-rated sponsors securitising a large portion of their balance sheet; the presence of pre-funding periods and revolving structures that are susceptible to operational risks and underwriting policies of the originator; and high obligor concentrations relative to credit enhancement.

Many originators in this asset class are relatively small, thinly-capitalised and low-rated or unrated entities. In many cases, ABS account for a large percentage of their funding and the loans transferred to the transaction represent the bulk of the company's assets.

Further, many of these sponsors are utilising securitisation proceeds to fuel aggressive growth strategies, according to Fitch. The combination of these factors makes it difficult for the agency to sufficiently delink the transaction rating from its originator in order to achieve a triple-A national scale rating, it says.

In the absence of strict eligibility criteria, long pre-funding periods may allow for collateral quality migration that is difficult for investors and rating agencies to monitor and measure. As a result, these transactions could be excessively susceptible to operational risks and the underwriting capabilities of the originator.

Finally, Fitch believes that the amount of credit enhancement in these recent transactions is insufficient to address the high obligor concentration risk, particularly when the identity, credit quality and size of obligors are uncertain.

The agency notes that employing traditional ABS features - such as credit enhancement, cash controls, independent governance, early amortisation events and tight triggers - mitigates risk, thus enabling a transaction to achieve a rating above that of its relevant sponsor. Nonetheless, Fitch stresses that the existence of certain originator attributes can significantly limit the degree to which the transaction rating can be delinked from the seller/servicer.

For ABS in Mexico, the agency has no formal cap on the degree of notching above an originator's rating, but reviews each situation based on its attributes to determine the level of interdependence. While Fitch believes that AAA(mex) ratings are achievable in many cases, not all transactions can be structured to reach this level.

ABS

Downgraded ABCP remains investable

Investors continue to buy the US and EMEA ABCP programmes downgraded from P-1 toP-2 in 2012, Moody's reports. For sponsors and sellers, many of the downgraded ABCP programmes remain attractive funding platforms, the agency says.

Moody's notes that bank downgrades rather than asset deterioration drove the ABCP downgrades. "Although ABCP has traditionally been structured and marketed as a P-1 product, for most investors, the downgraded programmes remain investable to the extent that they retain the highest rating of at least two major credit rating agencies," says Eli Laius, a Moody's avp - analyst. "Nevertheless, investors would likely avoid any of the P-2 rated programmes, should another rating agency also downgrade them."

In Moody's view, investors who have continued to buy ABCP through the credit crisis still see the benefits of the product, compared to unsecured financial paper and corporate paper. For sponsors, ABCP provides an alternative funding tool in managing their clients' financing needs. For sellers, ABCP still provides a source of funding diversification and an attractive alternative source of working capital finance, especially in the SME sector.

The downgrades of 21 programmes globally were the result of the downgrading of the banks that provide liquidity and credit support to the programmes, rather than any deterioration in portfolio asset quality. Many of the downgraded programmes remain active: 16 continue to issue either US CP or European CP, with a respective aggregate outstanding amount of US$34.4bn and US$33.8bn, as of 30 September.

Some of the downgraded multi-seller programmes have since added transactions to their portfolios, while others intend to add transactions before the end of the year, according to Moody's.

ABS

Italian ABS assumptions revised

Moody's has revised key collateral assumptions in 41 Italian ABS transactions backed by leases and loans to SMEs. The new loss assumptions generally have no rating impact, but the agency has taken individual rating actions on a small number of transactions with insufficient credit enhancement.

The rating revisions follow Moody's review of the entire Italian lease and SME ABS sectors and were mainly driven by ongoing collateral performance deterioration fuelled by the deteriorating economic environment in Italy. Moody's has a negative outlook for Italian leasing and SME collateral and its latest indices show a negative trend for delinquencies and defaults in the leasing and SME sectors.

The agency's cumulative default index for leasing deals rose to 5.6% in July, marking a 16% year-on-year increase. The 90-plus day delinquency index for SME deals rose to 4.9% in October, up from 0.9% a year earlier.

ABS

Spanish SME assumptions revised

Moody's has revised its key collateral assumptions in 94 Spanish SME ABS. In most cases, the new loss assumptions have had no rating impact due to sufficient credit enhancement levels. However, the agency has taken individual rating actions on a small number of transactions with insufficient credit enhancement.

These revisions follow Moody's review of the entire Spanish SME and small ticket lease ABS sector and were mainly driven by ongoing collateral performance deterioration, fuelled by the deteriorating economic environment in Spain. The revised assumptions relate to the default probability of the underlying pools, as well as the expected recovery rates following a default.

Ultimately, Moody's new default assumptions generally reflect an implied default probability rating in the low Ba range for the best performing pools, in the mid- to high-single-B range for the average deals and in the low-single-B or even Caa range for the worst performers. In addition, fixed recovery rate assumptions now range from 30% to 60%.

The rating agency expects that continued weak domestic demand will weaken SME revenues and increase borrower defaults in the country. Moody's expects Spanish GDP to contract by 1.4% in 2012, which will likely drive up leases and loans to SMEs in arrears.

Structured Finance

Canadian covered bond framework published

Canada Mortgage and Housing Corporation (CMHC) has released details of the legal framework for Canadian covered bonds. The framework is designed to support financial stability by helping lenders further diversify their sources of funding and by attracting more international investors to the market for Canadian covered bonds.

"The new framework establishes a high standard of disclosure for covered bonds for lending institutions across the country," comments Karen Kinsley, president and ceo at CMHC. "The framework strikes a balance between issuer and investor needs and takes into account evolving international best practices."

As part of the 2012 Federal Budget, amendments were made to the National Housing Act charging CMHC with administering a legal framework for covered bonds. Federally and provincially regulated financial institutions that meet the requirements of the programme will be able to issue covered bonds under the framework.

The framework will operate on a cost-recovery basis. Assets that may be held as covered bond collateral include loans secured by one-to-four unit residential properties located in Canada. Insured mortgages are not permitted to be used as covered bond collateral and covered bond issues are not guaranteed by CMHC or the Government of Canada.

Issuers of registered covered bonds will benefit from being able to reach a broader investor base, according to CMHC, as some international investors are restricted from purchasing bonds issued under a non-legislative framework. Issuers will also benefit from gaining access to an alternative source of funding.

Structured Finance

Stress tests underline ratings resilience

Fitch says that stress tests it conducted across a range of structured finance asset classes globally shows that its ratings would be resilient in the face of further stress. The tests suggest that the extent of macroeconomic stress that would be required to result in severe multiple category downgrades to its triple-A ratings is very remote. In many instances, the severe scenarios assessed would require the occurrence of previously unprecedented events, including sustained unemployment levels that far exceed historical levels.

Fitch also tested moderate scenarios to assess the extent of macroeconomic stress that would be expected to cause significant downgrades to lower investment grade ratings. The scenarios identified were generally considered unlikely, but in some cases were within the range of downside outcomes that the agency considers plausible.

Certain consumer transactions generally show more stability in the face of stress. "In the consumer ABS sector, where asset performance has been very strong in recent years and transactions pay down rapidly, it would need extraordinary levels of stress to materially break the triple-B ratings," says Heather Dyke, senior director in Fitch's EMEA SF credit officer group.

For both European and US CMBS, the circumstances that would be expected to result in the severe triple-A downgrades are also considered to be extremely remote. "For US CMBS, the cashflow decline that would be required exceeds any post-war historical recessionary period," explains Alla Sirotic, senior director in Fitch's US SF credit officer group.

Across asset classes and regions, the rating performance of peak period 2006/2007 vintages would be expected to be relatively worse due to their more adverse initial credit profile, combined with a lower credit enhancement cushion that has been eroded due to credit losses to date. Conversely, many pre-2006 transactions that have performed well through the recent crisis would be expected to continue to be particularly resilient.

Structured Finance

Securitisation framework revisions proposed

The Basel Committee has published a consultative paper entitled 'Revisions to the Basel Securitisation Framework'. The Committee says its objectives are: to make capital requirements more prudent and risk-sensitive; to mitigate mechanistic reliance on external credit ratings; and to reduce current cliff effects in capital requirements.

There are three major elements to the proposed revised framework. First, two possible hierarchies would be introduced that would be significantly different from those employed in the existing securitisation framework. These two proposed hierarchies differ in aspects such as the specific approach to be applied for certain types of exposures; the order and scope of application of approaches; and the flexibility that is given either to jurisdictions or to banks to opt for one approach or the other.

Second, enhancements to the current ratings-based approaches and the supervisory formula approach that are part of the Basel 2 securitisation framework are being proposed. The proposal contains a revised ratings-based approach and a modified supervisory formula approach, both of which are intended to create a more risk-sensitive and prudent calibration.

To accomplish these objectives, underlying assumptions of the current framework have been revised to reflect lessons learned during the crisis. The enhanced approaches also incorporate additional risk drivers, such as maturity.

Finally, new approaches will be introduced, such as a simplified supervisory formula approach and different applications of the concentration ratio-based approach that was included in the Basel 2.5 enhancements.

The Committee plans to publish a more complete and technical discussion of the modelling and recalibration work underpinning the proposed revisions to the securitisation framework. In the coming months, it will conduct a quantitative impact study (QIS) on the proposals.

Comments on the proposals should be submitted by 15 March 2013.

Structured Finance

Loan-level regulatory implications noted

Opinion is divided among market participants as to whether the ECB and Bank of England's loan-level data requirements will bring meaningful benefits for investors and whether such benefits outweigh the cost to originators of providing this information in the appropriate formats, according to Reed Smith in a recent client memo. While increased compliance costs are a disincentive to ABS issuance, if the prognosis of the ECB is correct, this might be compensated for by increasing the investor base.

Reed Smith points to the wider regulatory implications of the loan-level data initiatives. First, where investors need to demonstrate compliance with the ongoing monitoring requirements of Article 122a and its equivalents for insurers, hedge funds and similar entities, the disclosure templates are likely to be held up as a model for the appropriate level of detail. Second, these requirements are likely to be instructive as to what should be disclosed for the purposes of the new Article 8a 'Information on Structured Finance Instruments' of the Credit Rating Agency regulation.

"With respect to Article 8a, the market is awaiting guidance from ESMA and it would be particularly disappointing if it were necessary to disclose broadly the same information in different templates on the ESMA credit rating agency regulation website and to the ECB," the memo notes.

Structured Finance

Strengthening performance forecast for US SF

Strengthening performance and issuance tailwinds in most US structured finance sectors are likely to push growth further in 2013, according to Fitch. However, one key area to watch in the coming year will be the potential drag created by fiscal cliff-related issues.

"Securitisation re-established its importance to the global capital markets in 2012 and we expect this positive trajectory to continue in 2013," comments Kevin Duignan, head of global structured finance and covered bonds for Fitch. "The US structured finance market has seen increased interest from both domestic and international investors, who are increasingly recognising securitisation as a valuable tool in managing risk and liquidity."

The looming fiscal cliff is a concern, however. "While the fiscal cliff is not expected to impact most sectors directly, any broader macro declines triggered by the fiscal cliff fall-out could create some drag," adds Duignan.

The consumer ABS sector would be the most adversely affected by any resulting increase in unemployment and taxes. That said, Fitch believes the auto and credit card sectors are well-positioned to withstand additional stress, given the current low level of delinquencies and losses.

Indeed, lower delinquencies and consumer bankruptcies have resulted in credit card charge-off levels not seen in over 20 years. That said, they are expected to begin to normalise to the tune of 2%-3% and 5%-6% respectively in 2013.

Nonetheless, the proven track of credit card ABS performance will likely lead to increased issuance next year. Additionally, Fitch expects more Canadian credit card issuers to tap the US market.

The agency holds a similarly stable outlook for auto ABS, with rating upgrades anticipated to increase in 2013. This is because more subordinate bond tranches are up for review next year and most have exhibited strong asset performance to date.

The outlier, however, would be FFELP student loans. The prospect of going over the fiscal cliff presents substantial headwinds to student loan ABS, given its close linkage to the US credit rating. Another factor clouding the outlook for student loans is higher-than-anticipated default and rating volatility for many pre-crisis private student loan deals.

Equally, CMBS loans may face macroeconomic pressures in 2013, particularly if the fiscal cliff is not resolved. Nevertheless, the sector has seen a wave of positive momentum, which should provide ratings stability next year - especially for investment grade deals. If the macro environment remains stable, CMBS financing is expected to expand.

From the standpoint of property types, income growth for both hotels and multifamily properties has been strong over the past three years and next year they may reach earlier peaks, according to Fitch. Performance is likely to be mixed for both office and retail properties, with major metro office markets continuing to see rental growth and smaller and suburban markets continuing to exhibit weakness. As for retail, strong properties will dominate weaker rivals, which will continue to suffer substantial declines in value if they lose tenants.

Meanwhile, two areas where Fitch envisions the most growth potential in the coming year are RMBS and CLOs. While CLO issuance has been increasing significantly since late Q3, the agency expects new issuance to continue its surge well into next year. As for RMBS, 2013 is shaping up to be the year that larger financial firms begin to return to the private label RMBS market.

However, unresolved regulatory issues have the potential to hold back the speed of the market's recovery. "Numerous Dodd-Frank related issues - particularly related to risk retention - remain unresolved and, until there is greater clarity on this and related issues, the structured finance market won't be able to make a full recovery," Duignan concludes.

Structured Finance

FMI disclosure, assessment framework issued

The CPSS and IOSCO have published a disclosure framework and assessment methodology for their 'Principles for financial market infrastructures' (PFMIs), the new international standards for financial market infrastructures (FMIs). The disclosure framework is intended to promote consistent and comprehensive public disclosure by FMIs in line with the requirements of the PFMIs, while the assessment methodology provides guidance for monitoring and assessing observance with the PFMIs.

The disclosure framework and assessment methodology were issued for public consultation in April as two separate documents (SCI 16 April). The final versions have been revised in light of the comments received during that consultation. Given that disclosure and assessment are closely related, the CPSS and IOSCO have revised the disclosure framework so that it more closely mirrors the assessment methodology and combined the two documents into one for the final versions.

The disclosure framework will be used by an FMI to provide transparency about its activities, risk profile and risk management practices - thereby supporting sound decision-making by FMIs and their stakeholders, CPSS and IOSCO note. The assessment methodology is primarily intended for use by external assessors at the international level, in particular the IMF and the World Bank. It also provides a baseline for national authorities to assess observance of the principles by the FMIs under their oversight or supervision and to self-assess the way they discharge their own responsibilities as regulators, supervisors and overseers.

The assessment methodology may also serve as a useful tool for an FMI when, for example, carrying out self-assessments of its observance of the PFMIs or deciding whether the introduction of new services would hamper its ability to observe the PFMIs.

Structured Finance

Evaluated pricing service enhanced

Interactive Data has released a new set of enhancements to Vantage, which are designed to more effectively meet the requirements of both the buy-side and sell-side in their efforts to assess the key inputs used by Interactive Data in its evaluated pricing processes. Recent features added to the service include: intuitive visualisation of key transparency data; user-friendly evaluations reports; automated evaluations workflow; and additional displays of market colour and assumptive data for European bonds, as well as other features to support the growing demand for transparency data in the EMEA and Asia Pacific regions.

Structured Finance

Stable outlook for Aussie, NZ SF

Fitch does not expect any widespread deterioration in the performance of assets underlying Australian and New Zealand structured finance transactions and covered bonds in 2013. The key to this outlook, which is unchanged from this year's, is the continuation of the stable economic conditions that Australia has experienced over the past two decades. The New Zealand economy is also expected to remain stable, along with a continuing low interest rate environment.

Fitch says 97.8% of Australian and New Zealand SF ratings are on stable outlook. The remaining 2.2%, confined mostly to subordinate tranches of non-conforming transactions, are on negative outlook. Australia's and New Zealand's largest banks have active covered bond programmes, all of which are on stable outlook.

"Fitch believes that continued low levels of unemployment, stable economy and the Reserve Bank of Australia's 2012 cuts in the benchmark cash rate will ensure strong performance of structured finance and covered bond assets over the next 12 months," says Ben Newey, director in Fitch's Australian structured finance team.

Factors that could change the outlook include the continued threat of global and macroeconomic shocks to the Australian and New Zealand economies and an increase of currently high household indebtedness. All of these have the potential to affect the ability of individuals to service debt if economic conditions were to deteriorate, particularly through higher unemployment.

Structured Finance

Increasing stability for Japanese SF

Fitch expects slightly more Japanese structured finance transactions to maintain a stable outlook in 2013 than in 2012. Issuance is expected to increase modestly but not by enough to satisfy demand.

Stable outlooks will be supported by steady asset performance and structural protection. Non-distressed CMBS tranches should show stable rating performance, benefiting from increasing credit enhancement caused by sequential payment structure, as the workout of defaulted loans progresses, but tranches currently rated at distressed levels could see further downgrades.

The apartment loan CMBS and RMBS sectors should also maintain rating performance, with stable pool performance and structural protection mechanisms. Although Japanese issuance is expected to increase and there is strong domestic demand, there is limited availability of underlying assets and therefore Fitch says investors may be forced to continue to look at international opportunities.

CDO

ABS CDO dominance to decline?

CDO analysts at JPMorgan have surveyed notional 2012 CDO trading volumes based on BWIC data observed from 3 January to 11 December. They calculate that year-to-date global CDO BWIC volume stands at US$71bn, comprising 90% US and 10% European assets.

For US assets, triple-As made up half of the volume, while most of the European volume has been in mezzanine. ABS CDOs account for US$39bn of the overall supply, while US CLOs account for US$22bn.

The JPMorgan analysts point out that while ABS CDO volume may be large on a notional basis, it is smaller on a market value basis, given generally lower prices than in CLOs. Equally, the dominance of ABS CDOs is due to the Maiden Lane liquidations and - although the sector may still be active next year against the backdrop of a recovering US housing market - unless there are more large sales, the CLO share may revert to a more normalised proportion in 2013.

CDS

FpML recommendation released

ISDA has published a recommendation for FpML version 5.4, which focuses on further enhancing a robust framework for global regulatory reporting. In addition, the coverage for several asset classes has been expanded to fully represent Dodd-Frank reporting requirements. Besides the support for swap data recordkeeping and reporting requirements, the recommendation for FpML version 5.4 includes support for Part 22, legal segregation with operational commingling (LSOC).

CDS

Bankruptcy credit event called

ISDA's Americas Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Edison Mission Energy. An auction will be held in respect of outstanding CDS transactions referencing the entity. Further information regarding the auction will be published in due course.

CLOs

Update for CLOs with peripheral exposure

Fitch has updated its criteria assumptions for European CLOs with respect to partial exposure to peripheral eurozone countries where rating caps have been applied. The average exposure to assets in Spain, Ireland, Portugal and Greece across all Fitch-rated CLOs is 10%.

The agency does not expect any material rating changes as a result of this update, owing to the currently limited exposure to these countries. The update will be applied to transactions when they next face a rating review.

For portfolios with partial exposure to the four countries, Fitch will apply rating caps on a case-by-case basis, depending on the size of the exposure. For all Fitch-rated CLOs, the agency has determined that the exposure is currently sufficiently small not to warrant a rating cap. This may change over time, especially if more CLO assets from core eurozone countries successfully repay or refinance than those in capped peripheral eurozone countries, leaving rising concentration to adversely selected assets from capped peripherals.

To factor in the expected increase in performance volatility, Fitch has also increased its correlation assumption and reduced recovery rates for assets within these countries.

CLOs

Stable outlook for US CLOs

The credit quality of new CLOs in the US in 2013 will be similar to that of CLOs originated in 2012 and remain stable in Asia (ex-Japan), according to Moody's. The agency expects credit quality to deteriorate in Europe, however.

Moody's outlook for CLO collateral performance is stable for US CLOs and Asia (ex-Japan) balance sheet CLOs, but negative for that of European CLOs and Japanese SME CLOs. The economic outlook remains uncertain, with more downside than upside risk; the greatest source of risk remains the euro-area crisis. Amortisation in existing deals will offset collateral deterioration, bolstering senior tranche performance in all regions, however.

New issuance will reflect regional economic prospects. The bulk of new issuance will be in the US, where Moody's expects growth of approximately 30%, with some meaningful activity in Asia (ex-Japan), a trickle of transactions in Europe and minimal issuance in Japan.

"Debt investors are demanding conservative structures, which can still offer equity investors expected returns in the low- to mid-teens in current market conditions," says Moody's md Yvonne Fu.

"The primary risks to our outlook stem from US domestic fiscal policy and the still unresolved euro area crisis," adds Moody's md Jian Hu.

The credit quality of existing European CLOs is likely to weaken further, particularly the proportion of assets whose credit quality is consistent with ratings of Caa or lower. Because of ongoing de-leveraging, Moody's outlook for senior notes is stable, but negative for junior notes.

"Collateral performance will be weak, although we don't think the default rate will spike," says Moody's vp - senior analyst Guillaume Jolivet. "European CLO portfolios have only small exposures to Greece, Ireland, Italy, Portugal and Spain, which minimises their exposure to sovereign risk. But barring a quick and clean resolution of the euro-area crisis, European CLO issuance will again be minimal."

Moody's is maintaining its negative outlook for European cash transactions because of their exposures to sovereign, counterparty and operational risk. The credit performance of these CLOs is expected to vary widely, reflecting the very different collateral pools backing these transactions. In contrast, the credit performance of synthetic transactions will likely be stable as they approach their maturity, given their portfolio diversification.

Meanwhile, issuance of US SME CLOs is expected to pick up next year. Moody's notes that issuance has largely echoed that of balance sheet CLOs, although at a much lower level.

"SME collateral is less liquid than BSL collateral and SME issuers generally do not have access to alternative high-yield bond markets to refinance debt, which increases the risk of default. However, these risks will be mitigated by relatively lower leverage, stronger covenant and better potential for restructuring," the agency says.

Moody's is maintaining its negative credit outlook for German SME CLOs, based on the difficult refinancing environment for SME loans in the portfolios of these transactions. The agency is also maintaining its negative outlook for French SME CLOs because of the sensitivity of obligors to the difficult and deteriorating operating environment in France. New issuance in both Germany and France is anticipated to be minimal in 2013.

Finally, the forthcoming expiration of the Moratorium Law in March 2013 will be credit negative for collateral quality in Japanese SME CLOs. However, Moody's says that deals will continue to deleverage, mitigating the negative outlook for loan performance.

CMBS

Euro CMBS deterioration highlighted

The credit quality of European CMBS pools is expected to deteriorate in 2013. Moody's says that further losses on secondary properties will be unavoidable and exacerbated by the €16bn refinancing wall, which peaks next year when 135 loans will require refinancing.

At the same time, overall new issuance will remain muted. Moreover, the rating agency anticipates that most collateral pools will gradually transform into shrinking portfolios of distressed or non-performing loans over the coming years.

"The majority of European CMBS collateral pools are increasingly vulnerable to deteriorating asset quality and losses," says Ramzi Kattan, a Moody's avp - analyst.

While prime properties in core liquid markets are being successfully refinanced or worked out at minimal loss, it is becoming more difficult to avoid losses on the remaining secondary properties located in riskier and less liquid markets, according to Moody's. Over the next five years, the rating agency estimates that European CMBS pool-level losses will be as high as €10bn, yet the constrained lending environment for European commercial real estate debt will persist for years to come.

Moody's anticipates that around 60% of CMBS loans will not repay in 2013. While most European CMBS collateral is experiencing credit deterioration and benefits from very limited access to commercial real estate (CRE) lending, a small number of loans and transactions with strong institutional sponsors, good quality property or moderate leverage have outperformed or repaid on time. These loans and transactions could help to reduce the enormity of the refinancing issue, the agency suggests.

CMBS

Tower 45 watchlisted

Morningstar has added the US$170m Tower 45 loan - securitised in the MLCFC 2007-5 CMBS - to its watchlist, due to a small decrease in DSCR over the first half of 2012 combined with some upcoming lease rollover.

The property has generated higher than underwritten cashflows for each of the past four years. However, the NCF has fallen off during the first half of 2012 (US$5.7m, versus US$7.2m during the first half of 2011) and occupancy has dropped from 99% at year-end 2010 to 86%, as of June 2012.

According to the master servicer's comments, an increase in free rents has been among the factors leading to the decrease. In addition, 135,378 square-feet is either currently available (77,991sf) or becoming available by April 2013 (57,387sf). This total represents roughly 30% of the collateral's total square footage, according to Morningstar.

"The loan merits monitoring, given its size and the upcoming lease rollover," the agency observes. "However, we do not view it as a default risk, given the strength and experience of the sponsor [SL Green], the property's historical performance and the strength of the market. We also note that the loan was very lowly-levered at issuance."

Risk Management

ICE buy-side support strengthened

MarkitSERV has enhanced its connectivity and trade management support for buy-side clearing of credit default swap transactions at ICE Clear Credit. The first production trades using MarkitSERV's enhanced service were cleared by ICE on 28 November. The latest enhancement supports an additional ICE Clear Credit API and allows clearing members the ability to perform take-up using their existing integration to ICE Clear Credit when the trades are submitted via MarkitSERV.

Risk Management

Tri-party collateral services offered

CME Clearing Europe has appointed BNY Mellon to provide tri-party collateral management services, supporting the CCP and its buy- and sell-side clients. Services will be provided through MarginEdge, BNY Mellon's comprehensive derivatives margin management service for listed, OTC and bilateral OTC derivatives.

Andrew Lamb, CME Clearing Europe ceo, comments: "The requirements to clear OTC derivatives centrally is a key focus for both sell-side and buy-side firms. We feel that flexibility and certainty in collateral arrangements are necessary for all parties and that BNY Mellon's tri-party collateral management service offers those elements."

RMBS

Riskier collateral expected in US RMBS

Next year's vintage of US RMBS is expected to have riskier collateral, as well as weaker representation and warranties from smaller financially less-established originators than those issued in 2012. Meanwhile, a stronger housing market will help stabilise the performance of outstanding RMBS, according to Moody's.

The agency expects that in 2013 issuers will introduce a new asset class backed by rental cashflows from single-family residential properties (SCI passim). It also expects that overall issuance of private-label RMBS will increase because of unabated investor appetite and the removal of regulatory uncertainties that restricted issuance in 2012.

The credit quality of transactions in 2013 will be marginally weaker than those in post-crisis transactions to date. While some transactions will continue to comprise pools with higher weighted average LTVs and lower weighted average FICOs, others will contain more loans with riskier attributes, such as those secured by investment properties.

"Lender guidelines have not materially loosened recently, but growing investor appetite for prime jumbo RMBS and a limited supply of 'super-prime' borrowers has incentivised lenders to originate more loans near the fringes of their underwriting criteria," says Linda Stesney, a Moody's md.

At the same time, legacy RMBS pools will continue to stabilise throughout 2013, with slight decreases in delinquency levels. "As the level of equity for remaining non-delinquent borrowers improves with the tepid recovery in home prices, the number of strategic defaults will decrease, especially in the prime jumbo sector," says Debash Chatterjee, a Moody's associate md. "Lengthy loss mitigation timelines will persist, but a rise in short sales will help shorten liquidation timelines and lower both loss severities and ultimate losses."

Large mortgage servicers are increasing their short sales and modification activity as they strive to meet the performance requirements of their recent settlement with state attorneys general. Moody's expects more streamlining by servicers, with larger players strategically downsizing and transferring loans to smaller, nimbler outfits.

"The CFPB's review of small and medium-size servicers is a positive for the industry in that it will force more accountability on the practices of smaller and otherwise unregulated entities," says Stesney. "But the incremental costs will drive additional consolidation in the industry."

RMBS

'Stapled financing' success seen in Spain

Repossessed Spanish residential properties have sold this year for 65% less than their initial valuations, a significant deterioration from previous years, Fitch reports. The acceleration in price declines reflects the desire of lenders to offload real estate exposure, the rising number of repossessed properties, newly completed developments coming on line and the introduction of Spain's bad bank.

Lenders have become increasingly willing to accept higher discounts to offload properties (SCI 12 September). The change in strategy was most evident after stringent impairment requirements were introduced in February. Some institutions are now selling properties at average discounts of up to 50% below the price at which the property was valued when repossessed, according to a study of 17,373 Spanish properties undertaken by Fitch.

Banks willing to offer finance to purchasers buying repossessed homes from them at preferential rates or high loan-to-value ratios have been able to sell homes for approximately 15 percentage points more than repossessed homes sold without financing. Fitch suggests that the success of this 'stapled financing' in boosting sales prices does not bode well for Sareb, which has to sell approximately 89,000 retail assets and may not be able to offer finance.

The continued need to sell properties, the weak labour market and limited access to the capital markets for most of Spain's banks means the bottom of the residential market is unlikely to be reached in the short term. "We think it will take several years to absorb the stock of properties that have to be sold, even if sales volumes were to rise back to their 2003-2004 levels of 250,000-300,000 per year. There are approximately one million newly built homes for sale, 200,000 repossessed properties and an unknown number of arrangements to exchange debt for property," Fitch concludes.

RMBS

Fed MBS purchases to continue

The Federal Open Market Committee has directed the New York Fed's Open Market Trading Desk to continue purchasing additional agency MBS at a pace of about US$40bn per month. The FOMC also directed the desk to maintain its existing policy of reinvesting principal payments from the Federal Reserve's holdings of agency debt and agency MBS in agency MBS. The amount of additional agency MBS to be purchased each month will be announced on or around the last business day of the prior month.

RMBS

ABX hits post-crisis high

The ABX 2006-2 AAA sub-index passed a milestone last week, reaching the highest price since October 2008 (66.78). The most recent high for the index occurred in February 2011, just before a confluence of global macro events and changes in servicer advance strategies led to a 30% price drop in the latter part of 2011.

The index has recovered the entire 2011 price drop over the last year, but the past week's near-vertical price rise brings into question how much more upside is left over the near term, according to ABS analysts at Bank of America Merrill Lynch. "We remain bullish on non-agencies for the near term (January-February 2013 timeframe), but [last] week's ABX price move appears to us to be an early example of what we anticipated across many sectors in our 2013 outlook: a rally, followed by an extended trading range period. We still see further gains in the cash non-agency market by early 2013, but we would wait for a better entry point on ABX after [last] week's move."

Prior to last week, the most recent sharp rise in the ABX index occurred just before the Fed's formal QE announcement in September of US$40bn in agency MBS net monthly purchases. Last week's ABX price jump preceded the Fed's announcement that it will also buy a net US$45bn of treasuries on top of the US$40bn of MBS (SCI 13 December). Taken together, that adds up to a projected US$85bn in bond buying per month by the Fed, or a significant US$1.02trn for 2013.

RMBS

Dutch house price expectations revised down

Fitch has revised downwards its house price expectations for the Netherlands. The agency now expects Dutch house prices to decline by up to 25% from their peak levels, compared to previous expectations of 18%.

This change is driven primarily by the likely changes to the tax regime and expected austerity measures, which could reduce the disposable income available to borrowers. Furthermore, stricter underwriting standards, requirement for new mortgages to be on an annuity basis for beneficial tax treatment and gradual reduction in maximum allowed LTV could especially affect affordability for first-time buyers. Low housing transaction volumes indicates many people might be postponing either buying their first house or moving up the property ladder until policy uncertainty is removed and house prices bottom out.

Following a contraction in GDP in 3Q12, Fitch expects GDP to contract by 1.1% this year and a further 0.2% in 2013. The agency also expects the Dutch economy to return to growth in 2014 (by +1.4%). In spite of a downbeat economic environment, unemployment levels in Netherlands - while higher than pre-2007 levels - still compare favourably with most other countries.

As a result, Fitch believes that the current trend of around 5%-7% annual correction in Dutch house prices is likely to continue until mid-2014, when house prices are expected to bottom out. Increased affordability, along with clarity around the impact of the government measures and some resolution to the eurozone crisis should increase borrower confidence and provide a floor to house prices by the end of 2014.

In the meantime, limited supply of new housing, the relative liberalisation of the rental market, improved affordability for new mortgage borrowers - given significant correction in house prices - and a benign interest rate environment are likely to prevent a much bigger correction in house prices.

Based on the revised house price expectations, Fitch has revised its house price decline assumptions for single-B rating level from 18% to 25% (peak to trough) and for triple-A rating level from 37% to 43% (peak to trough). The Market Value Decline (MVD) assumptions have also been updated and, combined with the current house price index, reflect a more conservative view compared to the criteria published in June 2012.

For a typical prime non-NHG Dutch RMBS, the impact of the revised assumptions would be marginal, with credit enhancement to achieve a triple-A rating likely to change by around 50bp. Credit enhancement for other rating categories will also be impacted, with change at the lowest rating level of single-B likely to be in the region of 20bp. This change is unlikely to have material rating impact on existing ratings, however.

RMBS

DSA guidelines are RMBS positive

The investor reporting guidelines proposed by the Dutch Securitisation Association (DSA) will substantially improve the quantity and quality of information available to investors in Dutch RMBS, says Fitch. The agency expects reporting which complies with the DSA's framework to warrant issuer report grades (IRGs) of at least 4 stars, higher than the current 2-star average.

Loan-level disclosure is not part of the DSA's standard templates, but most Dutch issuers are expected to begin providing it next year. If loan-by-loan information is provided alongside compliance with the DSA guidelines, transactions will achieve a top level 5-star IRG.

The DSA templates do require more foreclosure and repossession information and greater detail on the Nationale Hypotheek Garantie portion of mortgage portfolios than has typically been available. Fitch says that they also give greater clarity on key terms and definitions and on how certain financial ratios are calculated.

Fitch notes that all of the regularly active Dutch RMBS originators are members of the DSA, so the templates are likely to be widely used. They may also begin to be used for other asset classes beyond RMBS in the future.

RMBS

Stable outlook for Japanese RMBS

S&P expects the credit quality of Japanese RMBS to remain relatively stable over the next 12 months. This outlook is based on the agency's view that positive factors for performance - such as a relatively low unemployment rate and prolonged, record-low interest rates - will continue to offset the negatives, including a decline in property prices and a slow-down in economic growth in Japan.

Delinquencies and defaults in Japanese RMBS collateral pools have declined in 2012 from the recent peak in 2009-2010 and are expected to remain flat or decrease somewhat in 2013.

The resilience of the labour market significantly benefited the performance of residential mortgage loans, according to S&P, even as the Japanese economy faced adverse shocks from the global economic slowdown of 2008-2009 and the March 2011 earthquake and tsunami. Deflation, coupled with a fall in nominal wages, would constrain households that are repaying mortgage loans, but the strict underwriting standards of most of Japan's mortgage lenders have sustained the credit quality of their borrowers.

Major Japanese manufacturers have announced many voluntary early retirement programmes so far this year. In addition, favourable treatment under the government's Employment Adjustment Subsidy Program ceased in 2012.

These negatives may dim the outlook of the labour market. Nevertheless, S&P expects its current ratings on Japanese RMBS to remain stable, based on its forecast of a continued, low unemployment rate for the next 12-18 months.