Contents

RMBS

Subprime spike for RMBS

While the US ABS and CMBS secondary markets are in hiatus, RMBS supply actually rose yesterday, thanks to a spike in subprime bid-lists. Interactive Data figures put non-agency BWIC volume at US$885m for the session.

The subprime space was characterised by a positive tone, with a mix of various vintage senior and mezz paper out for bid. Dealer offerings were mostly unchanged following the market's recent rally.

A US$4m piece of HASC 2007-HE1 2A3 was talked in the mid-50s during the session, having been talked last month in the mid-40s. Countrywide paper from as far back as 2002 - such as CWL 2002-1 A, which had a low-70s cover - was also circulating.

Another subprime tranche, MABS 2006-FRE2 A5, was talked in the high-40s - close to the mid/high-40s cover it attracted on 7 December, according to SCI's PriceABS archive. A US$900,000 piece of MABS 2003-WMC2 M2 was covered in the very high-90s, with talk up to the low-100s.

In the prime space, JPMMT 2006-S4 A5 was talked in the very high-80s. The bond was previously talked at around 90 on 19 December and in the mid/high-80s on 26 November.

A US$19.872m piece of the prime hybrid GSR 2005-AR5 3A1 tranche was also talked in the mid/high-80s. Finally, the Alt-A hybrid GSAA 2005-9 2A3 tranche was also out for the bid yesterday, making its first appearance in PriceABS. The bond was talked in the mid-90s.

JL

RMBS

RMBS BWIC volume gains ground

US RMBS secondary supply continues to climb. Agency volume rose sharply yesterday, while non-agency - although down on the previous session - was considerably higher than earlier in the year, at US$799m.

US$17m of the Alt-A fixed rate tranche RAST 2006-A10 A7 was talked at around 80 yesterday, according to SCI's PriceABS data, while a US$36m slice of Alt-A hybrid tranche CWHL 2005-22 1A1 was talked in the mid-80s and covered in the low-80s.

That was not the largest piece to be covered, however, with US$45.9m of BSARM 2007-1 3A1 covered at 83. Talk back in 3Q12 had been in the low-80s.

In the subprime space, the US$20m MLMI 2006-FF1 M2 tranche was talked in the mid/high-80s during the session. Last year talk had been in the mid-70s in October and high-50s back in August.

A large all-or-none non-agency list, primarily consisting of ARM bonds, is expected today. The option ARM RALI 2006-QO5 2A1 tranche was talked yesterday at around 70, having last year been talked in the mid-60s.

JL

Structured Finance

SCI Start the Week - 14 January

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

Pipeline
New deals have begun to be announced for the first part of the year, with seven transactions joining the pipeline last week. There was a mix between the different ABS sub-sectors, ILS, RMBS and CMBS.

The ABS deals entering the pipeline comprised: US$940m Capital Auto Receivables Asset Trust 2013-1 and ¥25bn Driver Japan Two in the auto space, as well as CARDS II Trust Series 2013-2 (a Canadian credit card securitisation) and US$540.55m State of North Carolina State Education Assistance Authority Series 2013-1 (a FFELP student loans deal).

The ILS was US$150m Vitality Re IV and the RMBS was US$398m Sequoia Mortgage Trust 2013-1. The CMBS deal was US$1.4bn WFRBS 2013-C11.

Pricings
A number of deals have priced already. Three CMBS deals printed last week, as did a couple of ABS.

The CMBS new issues consisted of US$1.45bn FREMF 2013-K24, US$1.35bn MSBAM 2013-C7 and US$600m Queens Center Mortgage Trust 2013-QC. Meanwhile, the ABS prints were US$1.35bn Nissan Auto Receivables Owner Trust 2013-A and US$1.25bn Santander Drive Auto Receivables Trust 2013-1, both auto deals.

Markets
Secondary US RMBS supply increased over the week, as SCI reported on Thursday (SCI 10 January). Agency and non-agency volume in the middle of the week was considerably higher than it had been a week earlier. Notable from Wednesday's session was a couple of sizable tranches circulating, not least a US$45.9m piece of BSARM 2007-1 3A1, which SCI's PriceABS data shows was covered at 83.

It was not all one-way traffic for the US CMBS sector, however, whose rally paused and saw some widening on Tuesday (SCI 9 January). The session was the first time in four days that CMBS spreads had not fallen "smartly", according to Trepp, with legacy super seniors mostly wider.

After BWIC activity reached only US$44m in the first week of the year, the US CLO market started to gain traction last week with a more impressive US$400m in volume. Bank of America Merrill Lynch securitised products strategists note that the primary pipeline also looks very healthy.

"This week the CLO market caught up to the sharp moves that were seen in other securitised products markets starting last week. Triple-A levels were in about 5bp, while triple-B and double-B were 50bp and 100bp tighter respectively," they add. New issue spread price talk is around 130-135 DM for triple-As.

Finally, it has also been an auspicious start to the year for US consumer ABS, believe Citi analysts. They say: "The ABS market begins the year on a high note, with several new issue announcements totaling more than US$2bn, good secondary trading flows and some modest spread tightening. There appears to be a lot of interest in improving yield and willingness to consider more esoteric asset types."

Deal news
• Markit CMBX Series 6 is due to launch on 25 January (SCI 8 August 2012), featuring a new sub-index. Given increased demand for a transparent hedging tool referencing newer CMBS issuance, the index is expected to be actively used by both issuers and investors.
• Bank of America has reached a US$10.3bn settlement to resolve outstanding repurchase agreements on residential loans sold to Fannie Mae. BofA will pay approximately US$3.6bn in cash and will repurchase around US$6.75bn in mortgage loans sold to Fannie Mae to extinguish existing repurchase requests and all future rep and warranty claims for loans sold from 1 January 2000 to 31 December 2008.
• Further details have emerged on the resolution of the 110 East 42nd Street loan, securitised in WBCMT 2007-C33, which had been modified via an A/B note split. At the loan's retirement, the B-note failed to recover any principal (see SCI's CMBS loan events database), serving as a warning to the wider market.
• Argo Group International has formed Harambee Re 2013-1, its debut sidecar transaction. Unlike other sidecars, which typically write either reinsurance or retrocession business, the vehicle is believed to be the first to support both a reinsurance and an insurance portfolio.
• A New York federal judge has denied a motion to reconsider a decision which allowed the FHFA to proceed with a number of fraud claims against Ally Financial and other banks in connection with losses suffered by Fannie Mae and Freddie Mac. However, a few claims based on owner-occupancy and LTV ratios were dismissed.
• Morningstar has added the US$123m IRET Portfolio loan, securitised in the CGCMT 2006-C5 CMBS, to its watchlist due to a decrease in DSCR and occupancy. Two of the nine properties in the pool are occupied by single tenants, with lease expirations for the largest tenant in each property fairly well-staggered over the next few years.

Regulatory update
• The Consumer Financial Protection Bureau (CFPB) has adopted a new rule to protect buyers from irresponsible mortgage lending. Clarification as to what will constitute a qualified mortgage (QM) has also been provided.
• The inclusion of RMBS in the Basel 3 Liquidity Coverage Ratio (SCI 7 January) has been welcomed as a resounding positive for the market. Together with the postponement of the full implementation of the LCR and a reduction in the overall level of required liquid assets, the news has sparked the beginning of what is expected to be a gradual tightening in spreads as a result.
• A number of mortgage servicing companies have reached an agreement with the OCC and the Federal Reserve Board to pay more than US$8.5bn in cash payments and other assistance to help borrowers. The sum includes US$3.3bn in direct payments to borrowers and US$5.2bn in assistance, such as loan modifications.
• The Reserve Bank of India has reviewed its guidelines on CDS, based on feedback received from the market and the suggestions of the Technical Advisory Committee on Money, Foreign Exchange and Government Securities Markets. In addition to listed corporate bonds, CDS contracts are now also permitted on unlisted but rated corporate bonds.
• IOSCO has published a consultation report on financial benchmarks seeking comment on policy issues. Meanwhile, ESMA and the European Banking Authority (EBA) have also moved to strengthen Euribor and benchmark rate-setting processes and launched a European consultation of their own.

Deals added to the SCI database last week:
Asti RMBS; BBVA PYME FTA 9; BPL Mortgages series 5; Lakeside Re III; SMA Portfolio series 2012-LV1.

Deals added to the SCI CMBS Loan Events database last week:
FLTST 3; FUBOA 2001-C1; GRND 1; LBUBS 2006-C7; LBUBS 2007-C2; MESDG CHAR; OPERA CMH; REC 3; RIVOL 2006-1; SMPER 2007-1; TITN 2005-CT2; TITN 2006-2; TITN 2007-1; TITN 2007-CT1; TMAN 7; WINDM X; WINDM XII; WINDM XIV.

Top stories to come in SCI:
Structured finance recruitment trends
2013 ILS outlook

CMBS

DRA/Colonial mod breaks new ground

The US$742m DRA/Colonial Office Portfolio loan - split pari passu between the BSCMS 2007-PW17, BSCMS 2007-PW18 and MLMT 2007-C1 CMBS - has received an extension modification. The move is being hailed as a positive, given that sales from better-performing properties will be used to fund reserves.

The loan was transferred to special servicing in August after occupancy declined due to lease rollovers (see SCI's CMBS loan events database). According to S&P, the borrower estimated that tenant re-leasing and improvements would total US$30.7m for 2012 and US$25.7m for 2013, while projected DSCR was expected to fall to 0.62x by year-end 2012.

The modification includes a two-year extension of the loan to July 2016, with the interest rate remaining unchanged at 5.61%. The loan can be extended by an additional year, to July 2017, if its balance has been reduced by half through collateral sales. Interest will be reduced by 1% for the third year extension.

The borrower also deposited US$15m to exit a limited guaranty agreement, which will be used for reserves to cover tenant improvement and capital expenditure costs. Additionally, the borrower must attempt to sell a portion of the collateral to generate US$50m in proceeds by June 2013, with US$25m to be deposited to reserves and the remainder used to pay down the loan. Even if the borrower fails to sell the properties by June, it must still deposit US$25m into reserves in June 2013.

The modification appears to be substantially better for the trust than was initially expected, according to CMBS analysts at Barclays Capital. "Given the modification trends over the last few years, we had initially expected a possible A/B split, considering the equity infusion required. Instead, the modification uses sales from better-performing properties to fund reserves. Additionally, the note rate will remain unchanged for the next four years, minimising the risk of potentially large interest shortfalls," they explain.

The lender may set release prices for individual properties based on current market conditions. However, the mod also prohibits any sale proceeds from being distributed to the borrower, with any excess deposited into the master account. The Barcap analysts note that although the ultimate performance of the loan will be tied to the success of re-leasing efforts and the commercial property market over the next several years, the modification does reduce their base-case loss assumption on the collateral to less than 5%.

They add that the modification was disclosed in a new template format, which provided greater transparency on the rationale behind the modification decision than is traditionally reported. For instance, the template provides two updated appraisals that valued the portfolio at US$670m-US$700m on an as-is basis and US$730m-US$750m assuming the properties are stabilised.

"This new and improved reporting standard should greatly improve investor confidence in distressed loan workouts by the special servicer and allow for better analysis of modifications," the analysts conclude.

CS

CMBS

B-note bother forecast

Further details have emerged on the resolution of the 110 East 42nd Street loan, securitised in WBCMT 2007-C33, which had been modified via an A/B note split. At the loan's retirement, the B-note failed to recover any principal (see SCI's CMBS loan events database), serving as a warning to the wider market.

The US$90m loan - secured by a New York office building - was transferred to special servicing in July 2010 when it first became delinquent. The special servicer, LNR, modified the loan into a US$65m A-note and a US$18.1m B-note, after applying US$6.9m of LOC proceeds to reduce the principal balance.

The A-note coupon and maturity date did not change. CRE debt analysts at Deutsche Bank note that US$20m of 'borrower's new equity' was delivered at closing in the form of letter of credits, which were to accrue at a 10% annual compounded return.

"In addition, up to US$5m of the transaction expenses an affiliate lender incurred in its acquisition of control was treated as new equity and eligible to the same preferred return. 12% of the 'new equity' was to be used on operating costs and the remaining amount was to be used for capex or TI/LC expenses," they add.

Proceeds from a capital event were to first be disbursed to pay interest and principal on tranche A before the new equity return. Then on a pari passu basis, 70% was to go to the lender and 30% to borrower for the hope note - unless the proceeds were insufficient to pay the B-note in full, in which case the lender would waive any shortfall.

"Strangely it took more than a year after the modification (August 2012) until the loan was transferred back to the master servicer, where it remained current until last month when - almost five years before its maturity date - the loan was retired. The B-note suffered a 100% loss, while the A-note came out basically unscathed," the Deutsche Bank analysts continue.

They note that B-notes frequently fail to recover any principal. They add that the "loose language" used in creating these kind of structures could cause yet more economic harm to bondholders.

"It is our view that the term 'hope note' was always a misnomer. They seldom had any hope of recovery, but the ultimate concern is that they are hopeless now - not in a depressed environment which necessitates write-downs beyond the original A/B split, but in a recovery cycle," they conclude.

JL

RMBS

Mortgage rule, QM definitions released

The Consumer Financial Protection Bureau (CFPB) has adopted a new rule to protect buyers from irresponsible mortgage lending. Clarification as to what will constitute a qualified mortgage (QM) has also been provided.

The latest iteration of the rule requires lenders to ensure prospective buyers have the ability to repay their mortgage and protects borrowers from 'no doc' and interest-only lending practices. The CFPB has also proposed amendments to its ability to repay rule, which would exempt certain non-profit creditors that work with low- and moderate-income consumers and make exceptions for certain homeownership stabilisation programmes.

Lenders will be presumed to have complied with the ability to repay requirement if they issue QMs. If adopted, the amendments would be finalised this spring.

"The CFPB released the final definitions of a QM and the ability to repay which were, in most cases, in line with market expectations. We believe the rules, which go into effect in January 2014, successfully balance prudent underwriting and credit availability," say RMBS analysts from Bank of America Merrill Lynch. While the ability to repay rule was largely as expected, the QM definitions provide much needed "bright lines", the analysts add.

QMs must meet certain requirements, such as no excess upfront points and fees and the absence of riskier features such as negative-amortisation payments. There will also be a cap on how much income can go towards debt, with QMs generally only being provided to borrowers with debt-to-income ratios of less than 43%.

There are two kinds of QMs, with different protective features for consumers and different legal consequences for lenders. The first are QMs with a rebuttable presumption and the second are QMs with a safe harbour status.

QMs with a rebuttable presumption are higher-priced loans, generally given to consumers with weak credit history. While lenders must legally presume the borrower can repay the loan, consumers can challenge that presumption by showing that they did not have sufficient income to pay both the mortgage and their other living expenses.

QMs with a safe harbour status are generally lower-priced loans which are given to consumers who are judged to be less risky. These QMs will give lenders the greatest certainty that they are complying with the ability to repay rule, although consumers can challenge their lender if they believe the loan does not meet the definition of a QM.

The regulators and government agencies are expected to next turn their attention to QRM. QRM had been held up by QM and concerns about factors such as premium capture, so there is currently no expected release date.

"With the definition of QM in place, the regulators and government agencies will now turn their focus to defining QRM. QRM will be a subset of QM and will determine whether or not a securitiser will have to retain risk for mortgages that are securitised," the analysts conclude.

JL

RMBS

Value seen in MBIA-wrapped bonds

Absent a payout from Bank of America on alleged rep and warranty breaches or an increase in intercompany support facilities, it is unclear how MBIA will continue to pay claims on its structured finance exposures, suggest RMBS analysts at Barclays Capital. Indeed, the insurer's recent consent solicitation (SCI 28 November 2012) indicates that it might be preparing for a restructuring in the event that a settlement to its claims cannot be reached.

To secure noteholder consent to its solicitation, MBIA purchased US$170m par value of the 5.7% December 2034 notes, representing 52% of the outstanding face amount. Bank of America subsequently announced that it had acquired US$136m (41%) of the notes through its Blue Ridge Investments subsidiary. The bank is now understood to be seeking a court order to reverse the change in the bond indentures by arguing that MBIA Inc's ownership of the unsecured notes prevented it from being included in the vote for the consent solicitation.

But BofA's purchase of the 5.7% notes is also said to enable it to obscure the amount of any rep and warranty payout to MBIA if a settlement is ultimately reached. This would prevent other plaintiffs from using the settlement amount as a precedent in their own settlement negotiations with the bank.

Although MBIA has continued to pay claims on its wrapped exposures, its financial situation appears precarious. The Barcap analysts believe that the insurer is most exposed to losses in its CMBS pools and to remaining claims on its wrapped second-lien RMBS. Some claims on its other insured exposures are also likely, although these are expected to be manageable.

Given the various lawsuits filed by and against the firm, multiple outcomes are possible for MBIA, some of which could be beneficial for holders of wrapped RMBS. "Overall, we believe that many MBIA-wrapped securities look reasonably attractive at current prices and offer appealing risk-return profiles. While there are certainly scenarios that could provide little to no recovery to wrapped non-agency bondholders, we believe that the market is already discounting most of the value of the guarantee for many MBIA-wrapped bonds," the analysts observe.

They estimate that absent a rep and warranty settlement with BofA, yields on many MBIA-wrapped securities are in the low- to mid-single digits range. If a favourable settlement with the bank is reached, yields on these securities could rise to 7%-10% and potentially into double digits for select second-lien securities.

CS

Structured Finance

Reinsurer acquires asset manager access

Allied World Financial Services will buy a minority stake in Crescent Capital Group. As part of the deal, Crescent will also manage US$500m of Allied World's investment portfolio, to be deployed across a diversified set of credit strategies.

Crescent invests at all levels of the capital structure and specialises in below investment grade credit and structured products. Strategies include investing in senior bank loans, high yield debt, mezzanine debt, distressed debt and select private equity securities.

Structured Finance

StormHarbour enhances Spanish presence

StormHarbour has opened a new Spanish office in Madrid and appointed Juan Del Rivero as senior advisor. The firm appointed its first senior advisor last year with the addition of Eric Daniels (SCI 26 January 2012).

Del Rivero was formerly partner and chairman for Spain and Portugal at Goldman Sachs, where he spent 23 years. He has since been advising Uria & Menendez, Azora Gestion and Omega-Capital.

Structured Finance

Markit names new India head

Markit is increasing its Indian presence, under the leadership of new regional head Sid Banerjee. He joins from Deutsche Bank, where he was coo for India, and replaces Gautam Moorjani, who has been appointed head of global product services in New York.

Markit will also add almost 200 new employees by the end of the year, who will be engaged in development, testing, analytics, data mining and management. They will all be based in Markit's new offices in Noida.

CDS

Derivatives 'cease and desist' issued

The OCC has issued a cease and desist order against JPMorgan Chase for unsafe and unsound practices and violations of law or regulation related to derivatives trading activities conducted on behalf of the bank by the chief investment office (CIO). The CIO's credit derivatives trading resulted in more than US$6bn in losses for the bank (SCI 15 May 2012).

The OCC found that the CIO group had the following deficiencies: inadequate oversight and governance to protect the bank from material risk; inadequate risk management processes and procedures; inadequate control over trade valuation; inadequate development and implementation of models used by the bank; and inadequate internal audit processes.

CDS

Assenagon targets credit growth

Assenagon Group has appointed Michael van Riesen as md and head of branch at Assenagon Asset Management in Munich. He takes responsibility for the distribution of new products focused on corporate credit activities.

Van Riesen was most recently at DekaBank in Frankfurt, where he was responsible for the sales and product platform of capital market products to savings banks. He has also worked at UniCredit, ABN Amro, DZ Bank and Dresdner Bank.

Assenagon believes credit offers considerable growth potential and its credit business expansion has been led by Michael Hünseler since August 2012. Assenagon Credit Management, now XAIA Investment, spun off from Assenagon last year (SCI 26 November).

CLOs

Mid-market specialist enlisted

Jeff Knopping has joined KCAP Financial as md in charge of origination. He was previously md in the private capital and special situations groups at William Blair & Company.

Prior to joining William Blair, Knopping was at GE Capital, where he co-founded the DCM business and led all capital markets activities for GE Commercial Finance. He was also global sponsor finance cio and spent six years at Citigroup.

Insurance-linked securities

Cat bond trader recruited

GC Securities has appointed a dedicated secondary cat bond and ILS trader in New York as it seeks to expand its capabilities. Sung Yim was previously at Goldman Sachs and has also held roles at 2Trees Capital, Platinum Re, Ritchie Capital Management, Specialty Catastrophe Services and Axa Reinsurance.

RMBS

Most FHFA claims to proceed

A New York federal judge has denied a motion to reconsider a decision which allowed the FHFA to proceed with a number of fraud claims against Ally Financial and other banks in connection with losses suffered by Fannie Mae and Freddie Mac. However, a few claims based on owner-occupancy and LTV ratios were dismissed.

The court also dismissed certain claims against Ally, Barclays, Credit Suisse and RBS in connection with securities purchased from other parties. A trial for the claims which were not dismissed is scheduled for January 2015.

The FHFA filed 17 lawsuits last year in connection with US$200bn of RMBS (SCI passim). Ally Financial, which previously did business as GMAC, underwrote US$6bn of that total.

ABS

Record low for credit card charge-offs

US credit card ABS finished 2012 strongly. Fitch's latest index results show charge-offs reached another record low as the year ended.

Prime credit card charge-offs went below 4% for the first time since 2006. They declined 18bp in December to 3.98% as a result of declining bankruptcy filings delinquencies throughout the year.

Late stage delinquencies increased 3bp to 1.73% although do seem to be stabilising, which suggests charge-offs will plateau over the coming months. Fitch's 60-plus day delinquency index declined almost 25% year-over-year.

ABS outstandings increased in September 2012 but have since declined each month to US$99bn, which is the first time they have been below the US$100bn mark since 1995. ABS ratings on prime credit card trusts are expected to remain stable.

ABS

Container fundamentals examined

The fundamentals of container leasing remain strong, according to ABS strategists at Wells Fargo. They note that container lessors should continue to benefit from a tight supply environment while demand increases.

Spreads on pre-crisis container bonds are consequently expected to tighten inside of 100bp during 1Q13. At the same time, the Wells Fargo strategists believe that the current premium over corporate investment grade spreads granted to container 2.0 investors will shrink, with primary container 2.0 spreads tightening to inside of 250bp during the second half of the year.

One issue that container ABS investors face in 2013 is the opening of call windows in the spring. The strategists note that investors should assume bonds will be called if the spread environment is positive.

"We view a sustained and severe fall in global trade as the largest risk to container ABS revenue," they add. "Therefore, the sector is likely subject to macro risks, such as eurozone economic malaise, decreased Chinese growth and slower US demand."

Another risk is oversupply, due to over-ordering of containers by lessors. However, short order lead times and high utilisation rates mitigate this risk, the strategists observe.

Finally, the impact of financial distress by an individual counterparty is much lower during periods of demand growth and tight container supply.

Net container ABS issuance is forecast to reach US$1.5bn-US$2bn in 2013, down from the record annual issuance seen last year.

ABS

RRN upgrades on the cards

S&P believes that, in certain circumstances, the remarketing of reset-rate notes (RRNs) issued in connection with certain US student loan ABS might result in an upgrade of the notes' ratings. If RRNs are remarketed into US dollars, it would terminate the existing swap agreement and thereby eliminate the class' direct exposure to counterparty-related risk.

RRNs typically have an initial reset period, at the end of which they can be remarketed to investors and offered as a different type of security (for example, another RRN or a term note). Additionally, the new remarketed security may be denominated in a different currency or indexed to a different reference rate.

RRNs denominated in a foreign currency but backed by US dollar student loan collateral typically enter into a swap agreement to hedge the currency mismatch. When an RRN is remarketed into US dollars, the existing swap agreement for that note is terminated.

Previously, S&P took rating actions on 17 Sallie Mae-, Nelnet- and Goal Capital-sponsored FFELP student loan ABS because their swap agreements did not comply with the agency's counterparty criteria. It lowered ratings to the counterparty's issuer credit rating plus one notch. Within those 17 transactions, 22 classes were foreign currency-based RRNs that were hedged at issuance with a foreign currency swap.

During 2012, S&P observed one example of a remarketed RRN that resulted in higher ratings on one student loan ABS transaction. On 25 October, the SLM Student Loan Trust 2004-5 class A5 note was remarketed into US dollars from its prior euro denomination and the existing swap agreement for that class was terminated. The agency subsequently upgraded the ratings to triple-A to reflect its view of the credit enhancement available in stressed scenarios.

The remarketing of RRNs is expected to continue this year, particularly with regard to a number of Sallie Mae FFELP transactions, which contain tranches of foreign currency RRNs.

Structured Finance

Treasury calls time on TALF

TALF is being wound down, following the repayment of the programme with interest. Accounting for interest and other gains above principal, repayments to date from the programme total US$173m - with additional payments expected in the future.

TALF supported the issuance of nearly three million auto loans, more than one million student loans, nearly 900,000 loans to small businesses, 150,000 other business loans and millions of credit card loans. As part of the programme, the US Treasury originally pledged US$20bn in credit protection through the Troubled Asset Relief Program (TARP) against potential losses on TALF loans.

In light of repayments over time and the number of TALF loans outstanding, Treasury's credit protection commitment was subsequently reduced to US$4.3bn in June 2010 and to US$1.4bn in June 2012. Today, due to the fact that the accumulated fees collected through TALF (US$856m) exceed the total principal amount of TALF loans outstanding (US$556m), Treasury's commitment of TARP funds to provide credit protection is no longer necessary.

Borrowers have continued to repay their loans early at a rapid pace, according to the Treasury, in part because interest rates on TALF loans were designed to be higher than market rates under normalised conditions. Additionally, most three-year TALF loans have matured.

The final TALF loan is scheduled to mature on 30 March 2015. All loans remain well collateralised and current in payments of principal and interest, Treasury says.

The Treasury and Federal Reserve will continue to consult on the administration of the TALF program. Any excess interest, fees and gains collected above the remaining principal on outstanding TALF loans will be divided between Treasury (90%) and the Federal Reserve (10%).

Structured Finance

Mixed outlook for Japanese SF performance

Moody's believes that strict underwriting standards in Japan will support the performance of RMBS and ABS receivables in the jurisdiction during 2013. The weak real estate market is expected to have a negative effect on CMBS transactions, however.

Overall performance of RMBS collateral in new and existing deals will remain stable this year, according to the agency, due to the good credit quality of borrowers and the unchanged outlook for the Japanese economy. Japanese residential mortgages are originated under strict underwriting standards. Similarly, in the ABS sector strict underwriting standards, the unchanged outlook for the Japanese economy and continued household deleveraging will lead to receivables pledged as collateral for new and existing deals having good credit quality in 2013. Lenders of consumer-related loans have tightened their underwriting standards due to tighter regulations.

However, the collateral performance of existing CMBS deals will remain weak for at least the next 12 months, because of the weak Japanese property market and the ongoing defaults on loans with high LTV ratios. Lenders in Japan have generally been reluctant to extend loans with high LTVs, making it difficult for such borrowings to be refinanced.

Structured Finance

CDOs set to help fill CRE gap

New issue CRE CDOs are being hailed as the "next frontier", with the potential for volumes to increase to between US$5bn-US$10bn in 2013. Four transactions totalling US$1bn were issued in 4Q12 (see SCI's deal database).

"Given the increased demand for CRE CDOs in the secondary market over the past couple of years, it's long been thought that the primary market may re-open with several experienced CRE CDO managers as well as a few new entrants considering issuance," CDO analysts at RBS confirm. "This appears to have finally occurred, with the asset class potentially filling an important void in commercial real estate finance, as nearly US$500bn of loans are expected to mature over the next five years without extension options."

Recent deals involved a variety of structures ranging from traditional CRE CDOs to CLO- and CMBS-style vehicles. The collateral manager typically retained the most junior 30%-40% of the structure.

Traditionally, CRE CDOs were actively managed, providing the manager with the ability to reinvest proceeds for 5-6 years and trade a portion of the loans (typically no more than 10%). However, the recently issued deals have been static or included a reduced reinvestment period of two years, as well as more robust credit enhancement.

Since CRE CDOs combine many attributes of both CMBS (collateral) and CLOs (structure), the RBS analysts believe it's useful to compare these asset classes when assessing relative value. "Our analysis suggests that new issue CRE CDOs may provide compelling relative value to new issue CLOs, driven by their limited liquidity and smaller investor base. Legacy CRE CDOs may offer even greater relative value, as they often have lower ratings - which further limits the buyer base - despite our analysis suggesting that many deals have limited credit risk," they observe.

Structured Finance

Bullish outlook for EM securitisation

S&P says it is bullish on structured finance in emerging markets going into 2013, though it warns that each country's unique situation warrants careful scrutiny. A rebounding Mexican economy and Brazil's uncertain regulatory environment is expected to anchor Latin American activity, while the focus in EEMEA will be split between Russian and South African domestic activity and cross-border issuance in Turkey and emerging Europe.

"In general, we expect investors seeking greater yield and diversification to spark demand in structured finance in various emerging markets," the agency notes. "However, historically low interest rates and potential costs associated with regulatory requirements likely will continue to trim savings and temper issuers' economic incentive for bringing structured financings to market."

Structured finance appears to be flourishing in emerging markets, with structures traditionally associated with the more established economies arriving in different jurisdictions. This has been the case with the long-awaited emergence of covered bonds in Latin America, ruble-denominated unsecured consumer loans in Russia and loan participation notes in Angola. Indeed, emerging markets are anticipated to trend towards increased asset and geographic diversification, as consumer and corporate credit markets deepen their roots across the globe.

While S&P expects issuance to grow again in Mexico, the Brazilian outlook is clouded by upcoming regulatory changes and the continued effects of the Banco Cruzeiro do Sul and Banco BVA insolvencies on their securitisation platforms. In the coming years, meanwhile, Peru and Colombia will be candidates for rapid securitisation expansion as their capital markets continue their fast-paced development.

In addition, residential and commercial real estate opportunities will spur origination volumes across EEMEA, including Russia and South Africa. Turkey and other countries continue to test the waters with covered bonds.

Finally, originators based in speculative-grade countries - for example, sub-Saharan Africa - will likely continue to tap future flow technology to mitigate sovereign risks and reduce funding costs.

Structured Finance

Covered bond rules benefit bondholders

New rules governing Canadian covered bonds provide some increased protections for bondholders but are largely a confirmation of existing contractual agreements, says Fitch. Concerns about increased credit risk were raised last month (SCI 21 December 2012).

The rating agency says that the Canada Mortgage and Housing Corporation's (CMHC) guidance requirements are positive as they are likely to protect bondholders in a declining home price environment by effectively increasing nominal OC levels when house prices fall. The guidance also improves reporting requirements, but Fitch notes that the availability of historical performance data remains extremely limited.

After the CMHC released its guidance, the Bank of Canada (BoC) announced that Canadian dollar-denominated covered bonds would be accepted as collateral under its standing liquidity facility (SLF). The BoC's announcement that covered bonds can be used for the SLF does not extend to issuers pledging their own covered bonds to the facility, so while the BoC's announcement may be beneficial to Canadian investors in domestic covered bond issuances, it will not aid the liquidity of the conventional mortgages eligible to serve as cover pool collateral under registered programmes.

Structured Finance

Financial benchmark consultations launched

IOSCO has published a consultation report on financial benchmarks seeking comment on policy issues. Meanwhile, ESMA and the European Banking Authority (EBA) have also moved to strengthen Euribor and benchmark rate-setting processes and launched a European consultation of their own.

The IOSCO report discusses concerns regarding the potential inaccuracy or manipulation of benchmarks and identifies benchmark-related policy issues across securities and derivatives and other financial sectors. Comments on the consultation paper are sought by 11 February.

IOSCO's concerns include: the appropriate level of regulatory oversight of the process of benchmarking; standards that should apply to methodologies for benchmark calculation; credible governance structures to address conflicts of interest in the benchmark setting process; and the appropriate level of transparency and openness in the benchmarking process.

ESMA and the EBA have conducted a review of Euribor's administration and management and made recommendations to the Euribor-European Banking Federation (EEBF) to improve the governance and transparency of the rate-setting process. They have also published recommendations to national authorities on the supervisory oversight of banks participating in the Euribor panel.

The European bodies have also published a consultation on principles for benchmark setting processes in the EU, with responses due by 15 February. They believe the steering committee which governs the rate-setting process is not sufficiently independent and believe EEBF does not assume enough direct responsibility. They also say the definition of Euribor is not sufficiently clear.

ESMA and the EBA recommend that: governance must improve, including increasing the independence of the Euribor steering committee from the banking industry by diversifying its membership; the steering committee should hold more regular meetings; the references for Euribor should focus on maturities with the highest usage and volume of underlying transactions; and the definition of Euribor should be clearer.

They also say the EEBF should assume responsibility for the quality of the data being submitted by the panel banks and subsequently being collated, calculated and distributed and the EEBF's governance and code of conduct should be improved and reinforced. Further, it should perform internal audits and the calculation agent should have its own code of conduct related to reference-rate setting, perform internal audits and be subject to an annual EEBF audit.

Structured Finance

Euro SF volume tough to call

European structured finance volume for 2013 remains difficult to call. For example, while S&P expects overall investor-placed issuance to fall over the year, Fitch forecasts a rise of 5%.

Fitch predicts that public and retained European structured finance issuance this year will be broadly unchanged from 2012, at about €200bn. Of this figure, 40% is expected to be placed with investors, up from 35% last year and 31% in 2011.

"Several factors suggest to us that issuance volumes will stay under pressure in 2013. Europe is once again in recession and we therefore expect that the supply of new lending to consumers and companies will stay depressed - as will borrowers' demand for credit - in turn constraining securitisation volumes," comments S&P credit analyst Mark Boyce.

The agency points to recent actions by policymakers to rejuvenate lending to the real economy, which appear to have depressed securitisation issuance further. It notes that the Bank of England's Funding for Lending Scheme is already substituting for some RMBS volumes that UK issuers may otherwise have placed with investors. Indeed, UK RMBS supply remains the key variable in the overall forecast.

Fitch also cites the economic slowdown, tighter bank lending criteria and in some cases falling house prices as factors that continue to limit asset origination. Regulation also remains a potential hindrance to supply, it says.

The widening of the liquid asset criteria in banks' Liquidity Coverage Ratios to include some RMBS is a sign that regulators recognise the role the structured finance sector can play in bank funding, according to Fitch. But the capital rules proposed in Basel 3 and Solvency II could still limit the appetite for securitised debt among banks and insurers. The agency believes that the latest proposals from the Basel Committee on the capital treatment of securitisation exposures are inconsistent with the strong performance of most structured finance securities.

On a more positive note, secondary market spreads have declined substantially across most structured finance asset classes, in the face of strong demand and scarce supply. This could tempt some issuers back into the primary market.

Meanwhile, collateral quality deterioration in some asset classes - particularly in southern Europe - could persist, due to weak eurozone economic growth. The tough commercial real estate lending environment, combined with a 2013 spike in loan maturities, could also lead to further credit deterioration among CMBS transactions. Additionally, sovereign and counterparty downgrades could lead to further rating actions this year.

CDO

ABS CDO auction due

An auction has been scheduled for Birch Real Estate CDO I, to be conducted on 23 January. The trustee shall only sell the collateral if the sale results in proceeds greater than or equal to the auction call redemption amount.

CDS

Clearing customers gain capital efficiency

The CFTC has issued an order granting a request made by Ice Clear Credit (ICC). The order sets forth terms and conditions under which ICC and its clearing members that are dually registered as futures commission merchants and broker-dealers may hold credit default swaps and security-based CDS in a cleared swaps customer account, as well as portfolio margin such contracts held in the cleared swaps customer account.

The SEC has issued a complementary exemptive order permitting security-based CDS to be held outside a securities account and commingled and portfolio margined with CDS in a cleared swaps customer account. ICC clearing members have been allowed to hold and portfolio margin their proprietary CDS and security-based CDS in a single account since November 2011. This order will extend the same level of capital efficiency to the customers of ICC's clearing members.

CLOs

SME CLO methodology updated

S&P has updated its methodology and assumptions for assessing CLOs backed by European SMEs. The new criteria are expected to have a neutral to negative impact on investment-grade ratings of existing transactions.

The criteria update addresses credit quality and cashflow mechanics. They apply to CLOs backed by granular and well-diversified pools, but do not apply to concentrated portfolios or portfolios of equity or hybrid debt of SMEs, such as German participation rights.

S&P expects the impact of the new criteria to be less pronounced than previously thought, but notes they could still be neutral to slightly negative. The criteria will be effective from 17 January for all new and outstanding SME CLO transactions within its scope.

CLOs

Lack of CLO supply highlighted

Lack of supply is the top concern for the second consecutive time, according to JPMorgan's 1Q13 global CLO client survey. This is attributed to the outlook of very low to negative net supply across markets.

Other concerns were fairly equally distributed between lack of arbitrage and collateral stress. Extension risk scored fairly low in the latest survey, however.

Meanwhile, the proportion of respondents with high to very high cash increased from the prior survey. "Although reinvestment of coupon and principal cashflows is difficult to predict, this suggests investors have decent cash to put to work in early 2013," CDO analysts at JPMorgan observe.

Appetite is biased towards mezzanine and subordinate risk. Demand for equity is weighted at a ratio of 2:1 for primary versus secondary.

The buyer/seller ratio declined slightly from last quarter's all-time high of 13.6x, but remains elevated at 10.1. This suggests strong demand continues to exist.

With respect to primary spreads, most respondents have end-1Q13 targets that are a little tighter than current levels. So, while investors foresee tighter spreads, the consensus is that the move will be modest - at least in the next few months.

Looking ahead, respondents seem most concerned with post-reinvestment period language in primary CLO deals. Covenant-lite loan buckets and the refinancing and/or repricing of individual debt tranches are close behind.

CMBS

Office, retail late-pays eyed

US CMBS delinquencies closed out 2012 with seven straight months of decline, while late-pays on office and retail loans remain an area of concern, according to Fitch's latest index results for the sector.

CMBS delinquencies fell by 18bp last month to 7.99% from 8.17% a month earlier. In December, resolutions of US$1.7bn outpaced additions to the index of US$1bn.

Additionally, US$4bn in new Fitch-rated deals closed during the month. No loans over US$100m transferred into the index last month, for the second straight month.

Multifamily, hotel and industrial delinquency rates improved last year. Multifamily delinquencies dropped the most of any major property type, beginning the year at 14.42% and falling by 430bp to close out 2012 at 10.12%. The second most-improved sector in 2012 was hotels, which began the year with delinquencies of 12.02% and finished 315 bp lower at 8.87%.

Conversely, office loans were the poorest performers last year and remain a cause for concern heading into 2013, according to Fitch. Office delinquencies began 2012 at 6.84% but rose by 157bp to close out the year at 8.41%. Retail also ended 2012 in worse shape than it started in, but overall has remained the most stable property type.

Current and previous delinquency rates for December are: 10.12% for multifamily (from 9.92% in November and 14.42% at year-end 2011); 8.87% for hotel (from 9.83% and 12.02%); 8.61% for industrial (from 8.88% and 10.25%); 8.41% for office (from 8.63% and 6.84%); and 7.14% for retail (from 7.28% and 6.89%).

CMBS

Apartments fuel CRE price rise

A 1.2% rise in apartment prices drove a 0.4% increase in US CRE as a whole in November, according to the latest Moody's/RCA CPPI report. Apartment prices are expected to continue to increase over the next few years, although commercial prices will trend flat to down.

Apartment prices have risen 10.6% over the 12 months to November and the sector has recovered 75.3% of its post-crisis loss. CBD office outperformed all sectors on a 12-month basis, with prices increasing 18.1% to recover 79.4% of peak-to-trough losses.

Core commercial prices were flat in the month, with the strong post-crisis CRE price recovery seemingly largely played out. The peak refinancing years of 2016 and 2017 are expected to see property price levels consistent with where they are today.

Moody's says it expects increasing cap rates to largely offset improving fundamentals. Cap rates will rise in all property sectors as the economy recovers, increasing the financing cost for acquisitions.

Apartment NOI growth should outweigh the rising cap rates, but core commercial prices will surrender part of their post-crisis recovery. The office and industrial sectors will see NOI declines over the coming years.

Risk Management

CCAR solution enhanced

Moody's Analytics has enhanced its enterprise risk management platform, RiskFoundation, to help banks better manage their Dodd-Frank Act Stress Test (DFAST) and Comprehensive Capital Analysis and Review (CCAR) data and reporting requirements. RiskFoundation version 1.3 integrates reporting solutions with data modelling capabilities, and incorporates the 2013 CCAR scenarios recently released by the Federal Reserve. Users can also create FR Y-14 monthly, quarterly and annual reports from a single solution.

Risk Management

Compression continues apace

TriOptima says it eliminated US$84trn in OTC derivatives notional principal outstanding in 2012, comprising US$80.5trn in interest rate swap notionals and US$3.5trn in credit default swap notionals. Almost US$72trn in reduced interest rate swap notionals were the result of ongoing efforts by LCH SwapClear, its member institutions and TriOptima to reduce outstandings in the clearinghouse.

The firm also began collaborating with SGX in 2012 and will support other clearinghouse initiatives as they develop. Its plans for 2013 include expanding the range of emerging market currencies for interest rate compression, adding products eligible for triReduce Commodities and introducing cross-currency terminations.

Since TriOptima introduced its triReduce portfolio compression service in 2003, more than US$322trn in notional principal outstandings have been eliminated: US$245trn in interest rate swap notionals and US$77trn in CDS notionals.

RMBS

AIG files ML2 suit

AIG and some of its affiliates last week filed a complaint in New York State Supreme Court seeking a declaration from the court as to the proper interpretation of a contract it entered into with Maiden Lane II. AIG sold in December 2008 approximately US$20bn in RMBS tranches that it had purchased between 2005 and 2007 to Maiden Lane II, as part of the Federal Reserve's bailout of AIG.

In connection with an AIG lawsuit against Bank of America concerning some of the RMBS that AIG had sold to Maiden Lane II, officials for the New York Fed last December told Bank of America that AIG had also sold to Maiden Lane II all litigation claims relating to the RMBS, a Lowenstein Sandler memo notes. In its complaint against Maiden Lane II, AIG is seeking clarification that it did not transfer to Maiden Lane II the right to sue BofA and other financial institutions for damages the banks allegedly caused AIG and its shareholders in respect of RMBS it was sold.

RMBS

Loan-level data disclosed

Fannie Mae has begun releasing monthly loan-level disclosure data for its single-family MBS as part of its loan-level disclosures initiative. The data will be updated monthly and will be provided for MBS beginning with an issue date of 1 April 2003.

"We believe that releasing monthly loan-level data is a significant step toward meeting investors' desires for enhanced transparency," comments Renee Schultz, svp of single-family products at Fannie Mae.

RMBS

Settlement prompts servicer refocus

Fitch believes the settlement between regulators and 10 residential loan servicing companies (SCI 9 January) is positive for those companies, as it marks an end to the foreclosure review proceedings and will allow them to refocus on the services they provide. The settlement includes the payment of US$8.5bn, either as cash payments or assistance to help borrowers, and effectively ends the case-by-case independent foreclosure reviews mandated by the enforcement actions issued in April 2011.

In Fitch's view, the end to the extended independent review process will allow servicers to refocus on completing other initiatives required by the various regulators, as well as to reassign internal staff that have been involved with the lengthy review process. In addition, the agreement makes the final compensation structure clear and eliminates further cost for the independent reviews that will allow the servicers to better establish their future cost to service and potentially allow funds to be released for improvements in the quality of their services.

The additional scrutiny, mandated changes and costs have caused many institutions to re-examine strategies and question their commitments to the market, according to Fitch. Three of the 10 servicers under this agreement are no longer active in the US residential servicer market. Many have actively pursued a strategy to offload non-agency and, in some cases, higher risk agency portfolios to concentrate on new, low-risk products.

Fitch further believes that the industry as a whole has addressed foreclosure documentation and process changes that resulted from regulation and policy changes. However, it foresees a backlog of foreclosures remaining to be processed.