Contents

CMBS

Turning the corner?

Growing optimism in European CMBS market

It has been a tough couple of years for European CMBS, but there are signs that the environment may be changing. Primary issuance is likely to pick up this year, while the rate of enforcements is expected to shrink as borrowers become more engaged and look to achieve orderly workouts.

Primary issuance has been widely forecast to reach between €5bn and €10bn this year, picking up sharply on recent levels. One London-based lawyer says he has been asked to look at three deals already, all of which are expected to complete in the first half of the year.

"We have not yet seen the resurgence of new CMBS that was hoped for, but there is growing optimism that 2013 will be more positive. Florentia late last year really addressed a lot of the issues around Article 122a, so I think we could also see some more agency transactions this year," he says.

CMBS loan maturities are expected to peak at about €22bn this year and borrowers will be keen to consider all financing sources. In the absence of more traditional sources of financing, CMBS may be an increasingly attractive option.

"It will also be interesting to watch the NPL space. There seems to be a slow-down on large portfolios sales, but there is still activity with one-off sales and smaller portfolios," says Charles Roberts, partner at Paul Hastings.

He continues: "Some of the banks are starting to figure out that they can restructure assets before selling and therefore improve their value. The NPL market seems to have lost its steam in the US and it may well have a bit of a slow-down in Europe, but it will be a long time before NPL sales stop completely. There is still a lot of this distressed debt that we will all be dealing with for several years."

Another change in the market is the rate at which deals are being enforced on and assets sold off. There has been a far greater willingness to manage the sales process in the right way rather than engage in fire-sales.

"Something we are going to see is more restructuring-managing rather than enforcement. Enforcement leads to termination of the swaps, whereas restructuring allows you to work around that," says the first lawyer.

He adds: "Servicers are keen to act. If borrowers are happy to sit back, then the servicer will enforce; but if the borrower is willing to engage, then that is generally a better approach and saves some money. Borrower engagement decides how likely enforcement will be."

One jurisdiction in which this scenario may be slightly different is Germany. Legal changes made last year in the country have made the enforcement process much easier.

"Borrowers were previously treated as equal to creditors, which was very contradictory. It has now become much more like UK law, with creditors getting a bigger say during default and enforcement," the lawyer explains.

He adds: "We saw the Petrus and Margaux loans enforced last year, and servicers and creditors are now much more willing to enforce. There is a lot of secondary property in Germany and this now really puts the option of enforcing back on the table."

A final concern is the volume of secondary property loans reaching maturity across the continent. Roberts concludes: "At the moment, neither asset sales nor available debt capital provide borrowers with enough cash to pay off their debt, let alone make distributions to equity. While the market is hoping for a recovery, ultimately, a significant level of enforcements or write-downs will be inevitable."

JL

Structured Finance

Action consequences

Increased focus on rating agency performance

Competing rating agencies could gain market share due to the US Department of Justice's civil lawsuit against S&P (SCI 6 February). But it is also hoped that ratings standards and ratings transparency will improve as a result.

Speculation is rife about why Moody's isn't being targeted by the DOJ, along with S&P. Moody's ceo Ray McDaniel was recently reported as saying the firm has no knowledge of any impending complaint by the DOJ.

Gene Phillips, director at PF2 Securities Evaluations, suggests that one reason for the DOJ suing S&P and not (yet) Moody's may come down to the difference in culture between the two firms. "The DOJ case against S&P relies somewhat on the emails and instant messages sent by and among S&P staff. Generally, senior Moody's personnel would have been careful not to disclose contentious information electronically, so perhaps it may be harder to build a case against the firm. Moody's teams often included lawyers internally who were certainly aware of the liability of electronic communication and may have influenced the remainder of the team, whereas S&P outsourced much of its legal analysis."

Another potential motive circulating the market is revenge for S&P's 2011 downgrade of the US from triple-A to double-A plus. Egan-Jones also downgraded the US and recently had two of its five licenses revoked by the SEC (SCI 23 January).

Indeed, many observers are wondering why the DOJ is involved. Furthermore, if the DOJ loses its case against S&P, it begs the question as to whether the SEC will step in and suspend the rating agency's license.

It has been suggested that the DOJ brought a civil suit against S&P in such a way as to circumvent the First Amendment. But while the First Amendment may afford S&P certain constitutional protections in expressing its opinion by way of its ratings, the First Amendment defence might not be useful to the rating agency in guarding against claims such as those made by the DOJ, which argues that S&P knew its opinions (i.e. its ratings) to be incorrect. In other words, the First Amendment defences may fail to protect against such claims of false representation.

In the meantime, other rating agencies can be expected to gain market share, according to Phillips. "The DOJ alleges that S&P knowingly published incorrect ratings - and this is nothing to be scared of for other rating agencies, providing they have got their ratings right. If S&P loses its license or has it suspended as a result - even if this suspension is related to fraud and isn't directly related to performance - one can see the positive influences such a shock may have on the other rating agencies, probably encouraging them to raise their standards."

He stresses the importance of this latter point. "Competition among rating agencies needs to be linked to performance. If there are too many rating agencies in the market, the danger is that standards will fall, as they compete for market share."

Phillips points to academic studies and testimonial evidence that suggest the key driver of ratings decline was the introduction of Fitch. "That's not to say that Fitch's standards were lower, but knowing that they could lose business to Fitch potentially encouraged Moody's and S&P to lower their standards," he explains. "In areas of structured finance in which Fitch was less of a competitive threat, such as in CLOs, the performance of these transactions remained OK during the crisis and we didn't really see a loosening of ratings standards - but possibly even a tightening. But Fitch turned out to be successful in the RMBS arena, so the other two agencies appear to have loosened their standards to continue providing ratings in the sector."

Another positive result that could emerge from the DOJ suit is renewed interest in ratings transparency. While it's not always the case that a ratings model produces the correct result, if the model is made publicly available and well-communicated, it's difficult to manipulate.

"S&P allegedly massaged its ratings model to achieve the desired ratings and investors wouldn't have known this. Yet it's much more difficult to adjust a model if it's transparent rather than a black box," Phillips notes.

There are currently 10 NRSROs registered with the SEC, with Kroll Bond Rating Agency notable for gaining market share in the securitisation space. However, Phillips argues that the market doesn't necessarily need more ratings competition based on there being more rating agencies; rather, it needs competition to be based on performance.

"Performance measurement remains in its infancy," he suggests. "There is little political will to revisit this topic and it's said to be complex - although I believe it doesn't have to be complicated. The concept is that investors are unable to differentiate among the rating agencies, but a healthy competitive environment needs comparability."

Looking ahead, one future ramification of the DOJ case could be whether other litigants use information from this filing or alter their approaches based on the alleged shortcomings at S&P. Rating agencies have historically been extremely effective at defending themselves against RMBS-related litigation, which has resulted in lawsuits typically focusing on banks, with rating agencies no longer being included among the defendants.

CS

CLOs

Equity equations

US CLO 1.0 versus 2.0 equity relative value explored

There are several considerations for CLO equity investors looking for relative value in CLO 1.0 and 2.0 deals. While the new issue market provides ease of entry, the legacy space can offer impressive spreads.

"New issue CLOs generally have cleaner portfolios comprised of nearly all loans, better defined documentation, higher coupons and more subordination. Legacy deals generally hold a higher proportion of non-loan collateral, can have more lenient indenture language and are generally perceived as somewhat riskier," says Kenneth Kroszner, RBS CLO analyst.

While both legacy CLOs and 2.0 product offer value, each may appeal more specifically to different types of investor. Sophisticated investors that can quickly get to grips with the language in the indentures and understand the nuances of those deals might find more relative value in legacy deals.

"The 2.0 universe is growing, which is good, but the legacy universe still has a lot more bonds to search through, yielding more relative value opportunity in the 1.0 space - especially in deals with less pristine portfolios, more off-the-run managers or less defined documentation," Kroszner notes.

He continues: "Those types of deals can trade at a discount to the rest of the market. On the other hand, deals are relatively more uniform in the 2.0 space." Less experienced investors can also benefit from the extra time afforded to them in new deals to examine documentation and negotiate with managers.

Jeff Herlyn, principal at Tetragon Financial Management, notes that there are also significant structural differences between CLO 1.0 and 2.0 deals (SCI 24 August 2012). "It really depends on how you measure the return as to whether you prefer one or the other. The original 1.0 vintage issuance was a roughly Libor+1000bp return when it came to market. The forward Libor curve, which the IRR models are all based on, was roughly 5% and that worked out to a typical 15% risk-adjusted return."

He continues: "Today the market is even better than Libor+1000bp, but the forward curve is more like 2%, so you get returns of 12%-14%. The absolute yield might be lower, but on a DM basis the market is more attractive today than it was during CLO 1.0."

The option value has also changed, which could be attractive for 2.0 deals. If the underlying assets continue to tighten and rally, then the option becomes more valuable, allowing equity investors to exit a trade sooner and so monetise gains more quickly.

Extra call rights and the ability to re-price tranches provide additional noteworthy benefits. A further advantage is the significant part an equity investor plays in shaping the deal in the 2.0 space and the ability to negotiate the language used in the indenture. Over the last couple of years there have even been equity buyers negotiating for a slice of the manager's fee.

"An equity investor who commits to taking the majority of the tranche is in a strong position. Their influence can make sure there is re-pricing language in there or it can help decide the length of the non-call period, along with numerous other provisions," says Kroszner.

He adds: "The equity investor base is definitely growing, which could diminish the power that the majority equity holder has over time. But, as of today, they still wield great influence over a deal's provisions."

Herlyn agrees that, from an equity holder's perspective, structural features tend to be tighter in 2.0 deals. But he also notes that overall quality has improved and many of the issues that were encountered in the run-up to the financial crisis do not exist today.

He continues: "Clearly one of the risks equity takes today is that you are locking in debt refinancing at a time when the market could continue to rally, so to the extent that portfolios turn over you might get your margin squeezed. The call feature controlled by equity does provide something of a counterbalance to that though."

Fellow Tetragon principal David Wishnow says that balancing the risks inherent in CLO 1.0 deals with those in 2.0 must be central to investors' decisions. "There are different risks in 2.0 than there were in 1.0 and people need to be cognisant of that. When you did a 1.0 deal, the liabilities were very low, but what you are locking in now is relatively high," he explains.

He continues: "Returns are still comparable, but there are different risks. One of the risks is that you have shorter reinvestment periods. If you hit the end of a reinvestment period and then go into a default cycle, then that is not good because you will not be able to reinvest at higher spreads."

That is largely what happened with the 2002-2003 vintage, which is why that vintage did not meet expectations. Meanwhile, there have also been changes in the investor base and European demand for US CLO equity is weaker than it was.

"There is clearly a change in the equity investor base. The strong demand we saw 10 years ago was made up to a good extent by off-shore buyers who were accessing the US loan market in the most efficient way they could, which was CLO equity," says Herlyn.

Regardless of whether investors look to legacy or new issue CLOs, the spread available from the equity piece continues to make it particularly attractive. "The landscape is changing and the investor base is broadening out as people look at how successful CLOs have been over the last few years. A lot of non-traditional and cross-over accounts have started to look toward CLO equity as a means to grow AUM and increase returns," confirms Kroszner.

He concludes: "With an active new issue market, CLOs offer a stable supply of higher quality bonds with attractive yields. There are just not many other asset classes where investors can find 10%-plus returns in meaningful size."

JL

RMBS

Viable exit

Private label refi initiatives gaining traction

Providing performing borrowers in non-agency RMBS pools with a viable exit from their high-interest mortgages is attracting increasing attention among US policymakers. A couple of options are emerging, but a legislative approach - whereby mortgages are refinanced rather than crammed-down - would be preferable from an investor perspective.

A featured address at last month's ASF conference by Michael Stegman, counsellor to Treasury Secretary Geithner, has added impetus to the debate on refinancing non-agency borrowers. "Although nothing is written in stone on this issue, I feel the policymakers in Washington are moving in the right direction," observes Vincent Varca, md of structured finance at FTI Consulting.

He adds: "In his prepared remarks at ASF, Michael Stegman laid out a blueprint with a nod toward addressing RMBS investors' concerns. By targeting legislation as the tool rather than using existing Making Home Affordable authority, he's acknowledging that refinancing mortgages is preferable to mandatory principal reductions or cram-downs."

Stegman's remarks also appeared to recognise that the GSEs need to shrink and that private capital needs to enter the mortgage market. Varca agrees that removing the GSEs' competitive advantage is key to creating a healthier mortgage market.

An initiative to refinance private label borrowers is expected to be an offshoot of the current HAMP and HARP programmes. The aim would conceivably be to refinance the mortgages into GSE loans, thereby circumventing the need for a new appraisal, as per the existing streamlining programme.

"The current streamlining programme targets only mortgages owned by Fannie or Freddie and has therefore not impacted non-agency pools. But it appears that the government is now seeking to expand the concept of borrower relief, which makes sense from an economic perspective," explains Varca.

The initiative is likely to target borrowers whose mortgages are in negative equity or who can't access mortgage finance, perhaps due to low FICO scores or high debt-to-income ratios. Stegman specifically pointed out in his address that 30% of non-agency MBS are backed by higher-risk, interest-only or balloon loans, implying that those loans will be included in any refi programme.

The impact of a legislative approach is anticipated to be negligible on most non-agency RMBS investors, who typically mark their bonds at discounts to par. But 10%-15% of the universe is in premium bonds, so these bondholders are likely to feel hard done by.

"As long as the government goes down the legislative route, it shouldn't be such a big issue. Investors understand refi risk and the impact of prepayments on valuations. Although this will happen on a larger scale than was expected, the concept makes sense," Varca notes.

One proposal aimed at borrowers in non-agency pools that appears to be gaining traction is Senator Jeff Merkley's Rebuilding American Homeownership plan, which was unveiled last July. The programme proposes that bank originators buy borrowers' current underwater mortgages and replace them with a new mortgage, called a Rebuilding America Homeownership (RAH) mortgage. These would then be sold to a newly established trust, funded by the issuance of bonds backed by these mortgages and guaranteed by the US government.

Oregon last week adopted a pilot programme based on the Merkley plan to target current but underwater borrowers in Multnomah County. As such, it became the first state to have a refi programme outside of HARP and FHA streamline approved by the US Treasury.

Dubbed the Rebuilding American Homeownership Pilot Program (RAHPP), it is scheduled to launch in April and will be funded by the Treasury's Hardest Hit Funds (HHF). It features two refinancing options: a 15-year mortgage at 4% fixed interest and a 30-year mortgage at 5% fixed interest.

A number of states previously received HHF funds to help underwater borrowers who demonstrate hardship to receive interest rate and principal modifications to avoid foreclosure. RMBS analysts at Wells Fargo anticipate that other states will now follow Oregon's lead, especially to the extent that lawmakers do not pass legislation on a national scale.

The US Treasury, meanwhile, is also said to be considering another proposal aimed at borrowers in non-agency pools. Dubbed the Mortgage Rate Modification (MRM) programme, it would entail modifying the interest rates of loans that have mark-to-market LTV ratios of 125% or more to the current Freddie Mac primary market survey rate.

For the first five years after the modification, the Treasury would pay the RMBS trusts the difference between the borrower's monthly interest payment based on their original contract rate and the monthly interest payment based on the current market rate. After five years, the borrower's monthly interest payment would continue to be based on the market rate but the Treasury would no longer pay the difference to the trusts.

Such a plan would impose a substantial burden on the related non-agency trusts, according to MBS strategists at Morgan Stanley. "Since modified loans would remain in the same non-agency pools, albeit with lower rates, the likelihood they will voluntarily prepay post-modifications substantially decreases," they explain. "Consequently, the duration of these bonds would likely extend substantially. The prospect of interest shortfalls looms large when the five-year subsidy proposed by the Treasury ends."

Whichever form the refi initiative takes, Varca's impression is that it is in its early stages and comes fairly far down the list of the government's priorities. "The mechanism is already in place and the process is well-understood. While this makes the process more straightforward, the politics involved could delay the process. Many homeowners are still suffering, but the fact that the government has already helped millions of borrowers could mean this initiative is perceived as being less urgent than, say, gun control, immigration reform and so on," he concludes.

CS

CLOs

Cairn CLOs stir European market

The European CLO market is picking up after a quiet start to the week. Participants have been kept occupied by both primary and secondary activity, with Cairn CLOs in particular capturing the market's attention.

"The US holiday made for a quiet start, but the market is up and running now. One of the interesting trends we are seeing at the moment is more people looking to trade mezz to lock in gains and stay long cash. I think a lot of them are waiting for the 'next big thing' to come up," reports one trader.

He continues: "There may also be some softening on the single-A side of the CLO space. From the guys we speak to, dealers are quite long on that part of the capital structure and they are trying to shift paper at below 400 DM. However, I do not think the buyers are there at that level."

A Cairn CLO tranche (CRNCL 2006-1X M) cropped up on a BWIC during yesterday's session. SCI's PriceABS data shows that it was talked between the mid-40s and low/mid-60s. It had also been talked on Monday in the mid-50s and low/mid-60s.

"We think it should have been high-60s, but bids were lower than that. It would have been interesting to see the story with that one compared to the new Cairn deal, which has just printed today," notes the trader.

That new deal is the €300.5m Cairn CLO III, which the trader notes priced "quite well". The transaction's €181.5m class A notes came at 140bp, the €28m class Bs at 235bp, the €20m class Cs at 325bp and the €11m class Ds at 425bp.

The trader concludes: "All in all, the market is picking up a bit. There is still not as much activity as there was in previous months, but there is enough to be keeping us busy. Secondary supply for the rest of the week should be pretty good."

JL

CMBS

CMBS creeping tighter again

The US CMBS secondary market continues to tighten as supply recovers from the low levels seen at the start of the week. SCI's PriceABS data shows 91 unique line items from 34 tranches for yesterday's session, with a variety of talk and covers.

GG10 dupers have gradually tightened this week to reach swaps plus 137/136, having closed out last week at 144bp over. CMBS 2.0/3.0 junior triple-As are about 5bp tighter and double-As to triple-Bs are 10bp tighter.

At US$445m, BWIC volume was moderate, in line with the prior session. Various vintage mezzanine tranches accounted for roughly half of the bonds out for bid, with a further US$1.57bn of IOs also circulating, according to Interactive Data.

The majority of paper was from 2006 and 2007, such as CD 2006-CD2 D, which was talked in the high-20s. The CD 2006-CD2 F tranche was talked in the mid-singles and low/mid-singles. MLCFC 2006-4 G was talked in the mid-singles and low-singles, which is also where it was being talked as long ago as September.

The US$3m BSCMS 2007-T28 D tranche attracted a mid-70s cover, meanwhile, with talk in the low-70s and mid/high-60s. In addition, a high-70s cover was seen for CGCMT 2006-C5 B, following talk from the low-70s to low/mid-80s. Talk in the previous session was between the high-60s and low/mid-80s.

In terms of senior paper, US$15.1m of the GCCFC 2007-GG11 A4 tranche was talked at par. The tranche was covered twice last month - first at 80 on 11 January and later at 82 on 16 January. Its earliest recorded cover in the PriceABS archive comes from 4 June 2012, when it was covered at 286.

Investors also moved to pick up recently issued paper, with the US$10m GSMS 2012-ALOH B tranche covered at swaps plus 113. It was covered at 97 and par last month.

Finally, older vintages were also available. One name that traded in the session is JPMCC 2004-C3 F, which had been talked in the high-50s, mid-60s and mid/high-70s. Talk in the previous session was in the mid-50s and high-50s, with talk last month in the low/mid-50s and mid-50s.

JL

Structured Finance

SCI Start the Week - 18 February

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

Pipeline
Last week was a quiet one for the pipeline, with ABS dominating proceedings. Among the five newly announced deals, three were auto ABS.

Those auto deals were E-Carat Compartment No.5, €718.5m VCL 17 and US$350m World Omni Master Owner Trust Series 2013-1. In addition, a US$271.75m container ABS (TAL Advantage V Series 2013-1) and a £750m whole business securitisation (Arqiva Financing) were announced.

Pricings
ABS dominated the new issue prints as well. An RMBS, four CMBS and three CLOs also priced during the week.

The ABS comprised: US$1bn Ally Master Owner Trust 2013-1, US$750m Chase Issuance Trust 2013-1, US$1.252bn CNH Equipment Trust 2013-A, US$323.62m South Carolina Student Loan Corp 2013-1, US$567.9m Springleaf Funding Trust 2013-A and US$375m World Financial Network Credit Card Master Note Trust Series 2013-A.

The RMBS was A$750m Series 2013-1 WST Trust, while the CMBS consisted of US$1.53bn FREMF 2013-K25, US$498.5m GSMS 2013-KING, C$250.4m Institutional Mortgage Capital series 2013-3 and US$193m Morgan Stanley Capital I Trust 2013-WLSR.

Finally, US$598m Galaxy XV, US$411.9m Nomad CLO and US$520.46m Sheridan Square CLO rounded out the issuance.

Markets
US CMBS spreads continued to tighten last week, with GG10 dupers reaching swaps plus 137/136 by mid-week, as SCI reported on Thursday (14 February). Secondary supply in Wednesday's session was moderate, with around US$450m coming through BWICs.

US RMBS started the week quietly as heavy snow hit the north-eastern US. Monday's session still saw reasonable supply, however, as SCI reported on Tuesday (12 February).

SCI's PriceABS data shows agency RMBS tranches - such as FNR 2012-19 JS - attracting covers in the session, as well as a limited amount of non-agency supply. The CWL 2002-S3 A5 tranche stood out in the session as an early-vintage name and was talked at low-par.

European ABS, RMBS and CMBS secondary markets were generally active but unchanged, according to analysts at JPMorgan. "Busy week in the secondary space, with a large number of BWICs - mostly containing CMBS bonds - coming to the market. Despite this, spreads closed the week unchanged across all asset classes," they note.

Deal news
• The expropriation of subordinated bondholders at SNS Reaal has implications for the entire CDS market. The move has engendered questions about the value of sub protection and concern that CDS liquidity could be hit unless these issues are addressed.
• Markit has launched IOS, PO and MBX indices referencing 3% and 3.5% Fannie Mae pools issued in 2012. MBS analysts at Barclays Capital suggest that the closest comparable index for the 3.5 2012 cohort is the 3.5 2010 index, albeit the 2012 cohort is expected to pay slower and thus trade better than the 2010 cohort.
• Several noteworthy price points were observed on the XA and five-year A2 tranches of the recently-priced MSBAM 2013-C8 CMBS. The unusual call protection provisions on two large loans securitised in the deal - the Boston Park Plaza and the Hyatt Regency Hill Country Resort - are said to have driven the move.
• A recent presentation by the borrower behind TITAN 2007-1 NHP provided an insight into the first 12 months trading of HC-One and its business plan going forward (see SCI's CMBS loan events database). The information provided suggests that the turnaround of the ex-Southern Cross nursing home CMBS is progressing at a slower pace than was originally envisaged.
• Punch Taverns has announced proposed amendments to the capital structure of both its Punch A and Punch B securitisations, with mixed implications for the bonds. Elsewhere, the pub sector continues to offer good value, with managed pubco paper looking most attractive.
• Arqiva Financing, a £750m UK whole business securitisation originated by the Arqiva group, has hit the market. The transaction is unique in that the bank lenders will grant term facilities to FinCo - a newly created SPV outside the securitisation group - rather than providing funding directly to the borrower.
• NorthStar Realty Finance Corp indicated in its 4Q12 earnings call last week that it may unwind some of its CRE CDOs over the next several years. According to RBS figures, NorthStar currently manages six CRE CDO, with a total collateral balance of approximately US$2.3bn - the majority (81%) of which is secured by CMBS.
• CR Investment Management has been awarded the asset management mandate for the Treveria D-Silo facility backing the Treveria II/Sunrise II loan respectively securitised in the DECO 2006 E4X and EMC VI CMBS. The firm will advise and work with Treveria on the implementation of the business plan, which will create value by selling-down the portfolio over time.
• TCW Asset Management Company (TAMCO) has assigned its rights and obligations under the investment advisory agreement for TCW Global Project Fund III to EIG Management Company, effective from 31 January. The transaction is a project finance CDO.
• Fitch says that programme features rather than the nature of the underlying assets were the key factor in determining how it approached Commerzbank's SME structured covered bond programme. The agency applied its covered bond criteria rather than structured finance criteria when rating the programme, despite it not being governed by the German Pfandbrief regulation due to the ineligibility of the underlying SME loans for inclusion in Pfandbrief cover pools.

Regulatory update
• New Imperial College research presented at the latest 'Peregrine Perspectives' discussion series suggests that credit default swap spreads are a poor proxy for sovereign default risk. Discussion around this research found that there is little evidence to suggest that the EU-wide ban on naked CDS positions will achieve its aims.
• FHA reform discussions are gaining momentum, with the House Financial Services Committee holding the first of two meetings scheduled for February to discuss changes to the FHA programme. Testimony at the hearing stressed that the FHA should focus on its original core mission: insuring mortgages for low- and moderate-income borrowers and first-time home buyers.
• The US District Court for the Southern District of New York last week ruled that Flagstar Bancorp was liable for representation and warranty breaches on two HELOC RMBS that had been guaranteed by FSA. The decision is the first final court judgment in a rep and warranty case and is expected to influence other court decisions, including MBIA's case against Countrywide.
• The UK FSA has fined UBS for failures in the sale of the AIG Enhanced Variable Rate Fund, which led to UBS customers being exposed to an unacceptable risk of an unsuitable sale of the fund. UBS also failed to deal properly with complaints from customers about sales of the fund, the FSA says.

Deals added to the SCI database last week:
Avis Budget Series 2013-1; CarMax Auto Owner Trust 2013-1; CIFC Funding 2013-II; Discover Card Execution Note Trust 2013-1; Discover Card Execution Note Trust 2013-2; Extended Stay America Trust 2013-ESH; FREMF 2013-K25; GreatAmerica Leasing Receivables Funding series 2013-1; GSMS 2013-KYO; High Speed 1; MidOcean Credit CLO I; MSBAM 2013-C8; Navistar Financial Dealer Note Master Owner Trust II Series 2013-1; PFS Financing Corp 2013-A; Red & Black TME Germany 1; SLM Student Loan ABS Repackaging Trust 2013-R1; SLM Student Loan Trust 2013-1; Tesco Property Finance 6.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2007-2; BACM 2007-5; BSCMS 2005-PW10; BSCMS 2005-PWR9; BSCMS 2006-PW13; CD 2007-CD4; CSMC 2006-C4; DECO 2005-C1; DECO 2006-E4; ECLIP 2006-2; EMC VI; EURO 25; GECMC 2005-C4; GRF 2006-1; GSMS 2007-GG10; JPMCC 2007-LDP10; LBCMT 2007-C3; LBUBS 2007-C7; MALLF 1; MSC 2005-T17; MSC 2007-T27; RIVOL 2006-1; TAURS 2006-3; TITN 2006-2; TMAN 6; VNDO 2012-6AVE; VWALL 1.

Top stories to come in SCI:
Relative value in US CLO equity
Focus on European CMBS

RMBS

Re-mods lengthening RMBS cashflows

Overall modification rates for US non-agency RMBS were significantly lower in 2012 than they were two years before, but borrowers that have been previously modified account for an increasing share of those mods. The higher share of re-modifications is expected to lengthen cashflows, especially for deals that form part of the servicing transfers announced in the past few months.

About 40% of recent subprime and 10%-20% of other sector modifications are re-modifications, according to Barclays Capital figures. MBS analysts at the bank suggest that servicers are pursuing re-modifications for three reasons: some initial mods did not reduce payments enough and are consequently seeing defaults; servicers are reaping the benefit of HAMP principal reduction alternatives; and servicing transfers are also leading to repeat modifications.

Around half of the loans that undergo re-mods do so after 30 months of the prior mod, while approximately three-quarters of re-mods occur at least 18 months after the first mod. At the same time, most re-mods happen within the first 12-18 months of delinquency after the prior mods turn delinquent, with about a quarter coming from modified current loans.

The Barcap analysts note that the share of re-mods is higher on loans with higher updated CLTVs and in non-judicial states. The payment reductions on re-mods, however, are in a tight range - regardless of the prior mod payment reductions.

An analysis undertaken by the analysts shows that standalone servicers, such as Ocwen and Nationstar, tend to have around two times the share of re-mods than bank servicers such as Chase and Countrywide. As bank loans are increasingly transferred to Ocwen and Nationstar servicing, the rate of re-mods is consequently expected to rise.

Repeat mods perform worse than the average first-time mod, according to the analysis, indicating that re-modification is a negative signal in terms of a borrower's equity and/or ability to pay. "This difference could also be a result of the fact that servicers, such as Ocwen, that are less selective in offering mods and have worse re-default rates are also the ones that are re-modifying the most loans," the analysts observe.

Re-mods generally perform better in prime than in subprime, although the differences are expected to shrink as some prime/alt-A servicing transfers over to Ocwen/Nationstar and re-modifications become less selective for such assets.

CS

RMBS

REIT demand returns

Higher MBS yields and rising stock prices have changed the investment landscape for US mortgage REITs from announcing share buybacks just a few months ago to raising new equity for MBS purchases. Indeed, mortgage REITs have announced US$1.7bn in new capital offerings so far this year, according to Bank of America Merrill Lynch figures.

Although REITs' book equity declined in 4Q12 on lower MBS valuations, they increased leverage to limit any reduction in portfolio holdings - thus preventing the large asset sales that some had thought likely. Annaly Capital Management's leverage, for example, increased from 6.0 to 6.5 in Q4. Its US$129bn MBS portfolio experienced about US$6.1bn in prepayments and a US$5.6bn decline in MBS holdings during the quarter.

Some REITs also took advantage of attractive dollar rolls post-QE3 to offset interest margin compression due to higher repo costs and lower MBS yields, according to MBS analysts at Bank of America Merrill Lynch. American Capital Agency Corp, for instance, reduced its repo activity but increased leverage by raising funding through the dollar roll market.

"REIT management's commitment to maintaining or increasing portfolios is evident in the leverage manoeuvring in Q4 and recent capital raises," the BAML analysts observe. "MBS ROEs are now back in the 12%-16% range, making the REIT investment model modestly more attractive."

They continue: "Stock prices have rebounded as dividend yields remain high and P/BV ratios are now above 1 for many REITs. This creates an environment conducive to capital raising and multiple offerings have been announced in recent weeks."

While REITs are expected to continue raising capital if yields and stock prices remain near current levels, total volumes will likely be lower than in 2011-2012. The analysts project that REITs will account for US$25bn net MBS purchases in 2013.

"These purchases will provide support to the market, but Fed purchases and overweight normalisation by money managers continue to dominate the technical picture," they note.

CS

Structured Finance

Securitised products vets shift roles

Morgan Stanley has made a number of changes to its securitised products group. Yared Yawand-Wossen, who has over 18 years with the bank, has a new role in charge of ABS and non-agency RMBS. He continues to report to Robert Hershy, who has been at Morgan Stanley more than 28 years and becomes global head of the bank's new CLO business.

Daniel Simet will take over Yawand-Wossen's former role as head of securitised product sales for the Americas. He has spent three years at the bank, most recently as fixed income regional sales manager in Chicago.

Structured Finance

Ortec builds up UK presence

Graeme Condie has joined Ortec Finance to strengthen the firm's investment performance business in the UK. He has over 25 years of experience in investment performance and will actively participate in product innovation.

PEARL, Ortec's investment performance solution, provides investors with a performance measurement and attribution platform to analyse and quantify a range of asset classes, including derivatives, debt instruments and alternatives.

Structured Finance

Bank announces corporate trust chief

Deutsche Bank has made Sally Gilding global head of corporate services in its global transaction banking division. She has been at the bank for 15 years, including roles as head of trust and agency services in Hong Kong and head of global debt services in EMEA.

The corporate services group provides a wide range of administration support in conjunction with other securities or cash management services. Gilding will now be based in London and David West will take over as head of trust and agency in Asia Pacific.

Structured Finance

Securitisation vet to lead advisory unit

Simone Schmidt has been recruited to establish and lead the German financing advisory services unit of Catella, as the firm broadens its service offering to deliver debt and equity as well as valuation services for all markets. She most recently worked at Ersten Abwicklungsanstal, the property liquidation unit of WestLB, and before that at Morgan Stanley, RBS and Deutsche Bank. Schmidt possesses broad experience within structured finance from transactions carried out in Germany and the rest of Europe.

CLOs

CLO management changes made

Prudential Fixed Income has named Brian Juliano and Bent Hoyer as co-heads of its CLO business, replacing Sara Bonesteel. Bonesteel now takes on a lead role for Prudential's US portfolio management team.

Bonesteel's new team is responsible for developing overall investment strategies for the US general account portfolio across all asset classes. The former head of alternative investments remains as md.

Juliano is principal and portfolio manager, while Hoyer is vp. The pair will be responsible for leading the development and administration of Prudential's CLO business.

Insurance-linked securities

Senior hires for ILS specialist

ILS Capital Management has named Tom Libassi as vice chairman and Paul Nealon as chief risk officer. General partner Jerome Faure is leaving the firm.

Libassi was previously md at Strategic Value Partners, where he focused on US business development and strategic relationships. He was also senior md at GSC Group, where he focused on distressed debt transactions. He takes responsibility for all aspects of his new firm's global business development.

Nealon was previously cio and chief risk officer at Ariel Holdings. He also held a string of senior management positions in the ACE Group. He takes responsibility for all aspects of ILS Capital Management's risk management process.

Risk Management

Quant pro joins software provider

David Kelly has joined Calypso Technology as director of financial engineering, reporting to engineering svp Tej Sidhu. He has almost 20 years' experience as a trader, quant and technologist.

Kelly was most recently director of product development at Quantifi, where he oversaw quantitative and technical staff in providing clients with pricing and risk solutions. He has also worked as a senior trader on Citigroup's CVA desk and as head of global analytics at JPMorgan.

Risk Management

OTC derivatives alliance formed

Polaris Financial Technology has entered into a partnership with Numerix to allow its customers to leverage Numerix's model library and risk analytics. The deal expands Numerix's scale and reach, strengthening access to global markets.

Polaris clients will gain access to improved risk monitoring, increased transparency and improved decision making via use of Numerix's CrossAsset Server and CrossAsset Integration Layer. The partnership will be particularly relevant for Basel regulatory compliance by ensuring consistent pricing, stress testing and accurate CVA reporting.

RMBS

RMBS trader moves on

David Lehman has joined Hudson Advisors in New York. He is vp, with responsibility for re-performing/sub-performing residential mortgage whole loans and mortgage servicing rights.

Lehman previously worked at Navigant Consulting. He has also held RMBS trading positions at WaMu Capital Corp and Morgan Stanley as well as analyst roles at Credit Suisse and Deloitte.

RMBS

New role for legal vet

Joel Katz has joined Cantor Fitzgerald as md. In his new role he covers banks in Cantor's DCM mortgage securities department.

Katz previously worked at Keefe, Bruyette & Woods and has previous industry experience from time spent at Sandler O'Neill, William R Hough, Raymond James, Freddie Mac and Fannie Mae. He has been in the industry for three decades.

ABS

Innovative WBS marketing

Arqiva Financing, a £750m UK whole business securitisation originated by the Arqiva group, has hit the market. The transaction is unique in that the bank lenders will grant term facilities to FinCo - a newly created SPV outside the securitisation group - rather than providing funding directly to the borrower.

The deal comprises £350m class A and £400m class B fixed-rate pari passu notes. Fitch and S&P have assigned preliminary triple-B ratings to both tranches.

The Arqiva group provides communications infrastructure and media services, operating at the heart of the broadcast, satellite and mobile communications markets in the UK. The debt issuance will refinance part of the current liabilities of the Arqiva group, including a portion of the borrower's existing hedging arrangements, which comprise a mix of long-dated interest rate and inflation-linked swaps.

At closing, FinCo will on-lend proceeds from the issuance to the borrower - Arqiva Financing No.1 - via intercompany loans that will be fully amortising or will feature an expected maturity date designed to accelerate amortisation upon failure to refinance. In addition to tapping the capital markets, Arqiva will use bank facilities that rank pari passu with the rated notes and issue structurally subordinated junior debt.

FinCo will become the senior lender and benefit fully from the securitisation protections as its loans rank pari passu with the rated notes. A notable feature is that although the term loans granted to FinCo will mature in three and five years respectively, the corresponding facilities extended from FinCo to the borrower will fully amortise over 25 years, thereby removing refinancing risk from the borrower.

Structural features - including a mandatory cash sweep of 50%, which begins six months after transaction close and steps up to 100% by year three and limits dividend distributions - aim to accelerate amortisation of the FinCo loan. Arqiva thus has an incentive to refinance the FinCo facilities voluntarily, substantially replacing bank debt with further note issuance and ensuring that FinCo can meet the payments due to the bank lenders on final maturity.

The securitisation will retain the borrower's existing out-of-the-money inflation-linked hedges after paying the current accreted value and additional restructuring. FinCo will replace the borrower as the beneficiary of the remaining borrower hedges, removing the risk that the borrower may be required to settle the mark-to-market on the mandatory swap break.

The bank lenders benefit from a guarantee from an intermediate holding company that allows them to take control of the equity ownership of the securitisation group if FinCo cannot meet its payment obligations.

Structured Finance

FASB boon for DVA

FASB has issued for public comment a proposal to improve financial reporting by providing a comprehensive measurement framework for classifying and measuring financial instruments. The proposals are expected to reduce volatility from debt value adjustments, as well as increase the transparency of financial institutions' statements.

The 'Proposed Accounting Standards Update, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities' forms part of FASB's broader joint project with the IASB to improve and converge the accounting for financial instruments. "The proposed accounting standard would measure financial assets based on how a reporting entity would realise value from them as part of distinct business activities, while the measurement of financial liabilities would be consistent with how the entity expects to settle those liabilities," states FASB chairman Leslie Seidman. "This revised proposal is responsive to the feedback the FASB received on our 2010 Exposure Draft, it simplifies the multitude of classification methods currently in use and it offers an opportunity for convergence with the IASB's proposal issued last November."

The Exposure Draft also would narrow the availability of the existing fair value option for financial assets and financial liabilities. In the limited cases where the fair value option would be allowed for financial liabilities, changes in the fair value attributable to an organisation's own credit risk would be reported in other comprehensive income (OCI), rather than net income.

Under the new proposal, the classification and measurement of a financial asset would be based on the asset's cashflow characteristics and the entity's business model for managing the asset, rather than on its legal form (in other words, whether the asset is a loan or a security). Based on this assessment, financial assets would be classified into one of three categories: amortised cost; fair value through OCI; or fair value through net income.

Moody's notes in its latest Credit Outlook publication that the proposals will reduce volatility from debt value adjustments and increase the transparency and utility of financial institutions' statements. "Under the proposed rules, the fair value option will be greatly restricted," the agency explains. "Usage would be subject to certain conditions that would preclude its use for the standard debt instruments that have been fair valued by banks in recent years. Eliminating the fair value option will enhance banks' financial statements transparency and utility to investors and creditors."

The restriction of the fair value option will not completely eradicate non-performance risk from financial statements, however. Liabilities that are carried at fair value under accounting rules other than the fair value option will continue to have the entity's credit standing factored into determination of their fair value.

The proposal also would require financial liabilities to generally be carried at cost, unless the reporting organisation's business strategy is to subsequently transact at fair value or the obligation results from a short sale. The proposal would retain the embedded derivative requirements for hybrid financial liabilities.

For financial assets and financial liabilities measured at amortised cost, public companies would be required to disclose their fair values parenthetically on the face of the balance sheet. Non-public entities would not be required to disclose such fair value information either parenthetically or in the notes.

Stakeholders are asked to provide written comments on the proposal by 15 May.

Structured Finance

Cover pool criteria hit

The ECB's change to its repo eligibility criteria for covered bonds is credit negative for programmes with cover pools containing ABS, according to Moody's.

"In our view, the change in repo eligibility is credit negative because it will reduce the purchase prices of cover pools containing ABS assets, should the pools need to be sold," comments Martin Rast, a Moody's vp - senior analyst. "This increase in refinancing risk affects the value of all ABS assets in cover pools, including those originated within the issuer group. We also note that the change in repo eligibility might prompt issuers to gradually restructure their programmes in order to maintain repo eligibility and contain issuance spreads."

Of the covered bond programmes that Moody's rates in EMEA, only five French programmes contain ABS assets, ranging from 7% to 100% of the pool. One of them (DEXMA) contains around 11% public-sector ABS, while the other four contain RMBS notes in different shares of 8% to 100%.

"The change in ECB repo eligibility is likely to make it more expensive for issuers to issue covered bonds that are secured by a cover pool that contains ABS notes, because investors will request higher returns on those covered bonds," adds Rast.

CDO

ABS CDO auction due

Dock Street Capital Management has been retained to act as liquidation agent for Davis Square Funding VI . The collateral will be auctioned via four sales on 26 and 27 February. Sales number one and two will comprise subprime RMBS assets; sale number three will consist of ABS CDO, CMBS and prime/Alt-A RMBS assets; and sale number four will comprise ABS CDO, small business loan, subprime RMBS and prime/Alt-A RMBS assets.

CDO

TRUPS CDO cures anticipated

Fitch believes that steps taken by the US Treasury to wind down the Capital Purchase Program (CPP) could lead to incremental cures in some TRUPS CDOs. Fitch estimates there are currently 109 issuers across Fitch-rated TRUPS CDOs that remain participants in the programme, with the exposure reaching 208 issuers at its peak.

The Treasury intends to wind down the remaining CPP investments over the next year through a series of repayments, restructurings and sales, including auctioning investments in banks that are not expected to pay in the near future. With the dividend step-up from 5% to 9% five years after issuance, banks have a strong incentive to exit the CPP.

Securities issued under CPP are considered junior to TRUPS and, to the extent a bank is deferring on its TRUPS interest, it may be limited in its ability to distribute payments to securities issued under the CPP programme. Fitch suggests that these incentives, combined with the Treasury's intent, will likely lead to an acceleration in the pace of banks' exits from the programme - which in turn may have implications for CPP recipients held across TRUPS CDOs that are currently deferring on their TRUPS.

Across the agency's CDO universe, 12 previously deferring former CPP participants were able to cure their deferrals and exit the CPP programme. Nine out of these 12 cured their TRUPS interest within a year prior to exiting the programme. In addition to these 12 issuers, seven cured their TRUPS but remain in the CPP programme.

Conversely, only four of the 45 currently deferring issuers that received CPP funds have exited the programme. Of these four issuers, two cured their TRUPS prior to or at the time of their CPP exit, only to re-defer shortly after. The remaining 41 deferring issuers remaining in the CPP programme collectively represent US$1.3bn in notional value across Fitch-rated TRUPS CDOs.

Only 218 of the 707 banks that originally used CPP remained in the programme, as of December 2012.

CDO

CRE CDO late-pays fall

Following a sharp spike late last year, US CRE CDO late-pays fell for a second straight month to 12.7% last month (from 13.4% in December), according to the latest index results from Fitch. New delinquent assets in January consisted of only two term defaults, one matured balloon loan and one credit-impaired security.

The largest new delinquency is a term default on a B-note and mezzanine debt backed by a 410,000 square-foot Atlanta office building. Property cashflow declined significantly after the largest tenant (accounting for 37% of NRA) vacated the property at the end of October 2012.

In January, asset managers reported approximately US$50m in realised principal losses from the disposal of several assets. The largest reported loss was a 33% realised loss on the discounted sale of a 350,000 square-foot REO office property located in San Diego, California. Foreclosure occurred in December 2011 and the loss was anticipated at the last rating action for the transaction.

CDO

Supply anticipated from CRE CDO unwinds

NorthStar Realty Finance Corp indicated in its 4Q12 earnings call yesterday that it may unwind some of its CRE CDOs over the next several years. According to RBS figures, NorthStar currently manages six CRE CDO, with a total collateral balance of approximately US$2.3bn - the majority (81%) of which is secured by CMBS.

Five of these transactions - NSTAR I, NSTAR II, NSTAR III, NSTAR V and NSTAR VII - are failing at least one coverage test, which is diverting payments from equity to pay down the most senior outstanding class of notes. CMBS analysts at RBS believe these deals could be collapsed by NorthStar exercising its right to redeem the notes early.

The non-call period for the most recently issued deal with a failing coverage test (NSTAR VII) ended on 27 June 2011. However, in order to redeem the notes, there must be sufficient liquidation proceeds to pay the par amount of all outstanding rated notes.

"Should early redemption of these NSTAR CRE CDOs occur, we believe it may have two primary impacts," the analysts note. "First, it could bring to market a significant amount of CMBS mezzanine bonds primarily issued prior to 2006. Second, the bonds issued off of these five NSTAR CRE CDOs may trade much closer to par on this news."

SCI's PriceABS data shows that a US$4m slice of the NSTAR 2005-4A C tranche was covered yesterday at 79 handle.

CDS

SNS, IBRC credit events determined

It has been a busy few days for the ISDA EMEA Credit Derivatives Determinations Committee with respect to resolving that two credit events have occurred. The DC is meeting today (14 February) to discuss whether auctions should potentially be held to settle CDS trades on the reference entities in question.

First, the DC determined that a restructuring credit event occurred in respect of SNS Bank, having discussed the nationalisation of the reference entity and the expropriation of its subordinated debt (see also SCI 12 February). The second credit event to be determined is a bankruptcy credit event in respect of Irish Bank Resolution Corporation (IBRC), following the appointment of joint special liquidators to wind up its business and operations.

CDS

Naked CDS ban scrutinised

New Imperial College research presented at the latest 'Peregrine Perspectives' discussion series suggests that credit default swap spreads are a poor proxy for sovereign default risk. Discussion around this research found that there is little evidence to suggest that the EU-wide ban on naked CDS positions will achieve its aims.

Lara Cathcart, senior lecturer at Imperial College, presented evidence that trading activity alone doesn't have a meaningful impact on sovereign default risk, as it doesn't cause the cost of borrowing for countries to increase. Panellist Paul Crean, co-founder and cio of Finisterre Capital, explained that investors often use CDS as liquid tools to hedge their underlying exposures against spread widening, not necessarily out of concern about a possible default

The EU ban is based on the belief that a high volume of naked positions can increase the likelihood of default of troubled countries by increasing their cost of borrowing. However, Crean cited evidence that the nominal volume of CDS positions alone is not big enough to have a meaningful impact on countries' bond markets.

"CDS spreads are the symptoms, not the cause, of a country getting into trouble," he continued. "Greece didn't get into trouble because of CDS - it got into trouble because of their spending policy. Investors were desperate to hedge out their risk and turned to CDS."

He added that banning naked CDS will cause liquidity deterioration for investors trying to hedge their exposures and, as a likely effect, force borrowers into shortening the maturity of their debt. At some point interest rates will normalise and investors are going to need this ability to hedge, he noted.

Crean concluded: "What is frightening is that the ban on naked CDS is coming in at the very point that investors will need CDS protection more than ever."

CDS

ICE to clear iTraxx indices

ICE Clear Credit has received regulatory approval to clear the Markit iTraxx Europe CDS indices. Clearing for the contracts will launch on 25 February.

ICE Clear Credit will be the first US-based clearing house to offer clearing for the Markit iTraxx Europe indices, including the Main, Crossover and HiVol indices, which fall under the CFTC clearing requirements. In addition to dealer-to-dealer clearing, ICE Clear Credit will be the first North American clearing house to offer buy-side clearing on these indices.

"By adding the iTraxx Europe indices to the list of instruments we clear at ICE Clear Credit, we are helping our customers meet the requirements of the Dodd-Frank clearing rules and providing an opportunity for them to benefit from the capital efficiency of clearing all of their CDS indices in one regulatory jurisdiction," comments ICE Clear Credit president Christopher Edmonds.

In addition to the iTraxx indices, ICE Clear Credit received regulatory approval to clear European corporate single names. Clearing for North American and European single names will launch for the buy-side later this quarter.

CLOs

Euro CLO upgrades outnumber downgrades

S&P's European CLO performance index report shows that upgrades outnumbered downgrades by seven to one in 2012. The agency took 460 note-level upgrades across the sector, versus 59 downgrades.

According to the Q4 index report, this is mainly due to the deleveraging of these transactions. However, the pace of the upgrades began to decelerate in the last quarter.

Over the quarter, €5bn of European CLOs exited their reinvestment periods, with more than €20bn of CLOs to follow suit in 2013. Furthermore, a notional amount of €35.8bn of European CLOs is expected to exit their reinvestment periods between 2013 and 2015.

CLOs

Cairn CLO readied

Further details have emerged on the €300.5m Cairn CLO III (SCI 25 January). Revised guidance for the transaction was released on Friday ahead of expected pricing this week.

The CLO comprises €181.5m class A notes (with preliminary Aaa ratings from Moody's), €28m class Bs (Aa2), €20m class Cs (A2) and €11m class Ds (Baa2), along with two unrated subordinated notes (€44.5m M1s and €15.5m M2s). S&P also rated the class A notes triple-A.

The target portfolio comprises mainly corporate leveraged loans to obligors domiciled in Western Europe. At least 90% of the portfolio must consist of senior secured loans, with up to 10% consisting of second-lien loans, unsecured loans, mezzanine obligations, senior secured bonds and senior unsecured bonds. The portfolio is expected to be 50% ramped at close.

Talk for the class A tranche was 140bp area, revised from 140-145bp. The class Bs were being talked in the mid-200s, class Cs in the low-300s and class Ds in the low-400s.

CMBS

Control of TFLA loan eyed

The US$150m JW Marriott Las Vegas Resort & Spa loan, securitised in the CSMC 2007-TFLA CMBS, realised a US$66.9m appraisal reduction this month. The move could shift control of the loan from the junior lender (Galante Holdings) to the class K notes and potentially resolve the ongoing litigation by three CRE CDOs to block it from exercising its fair value purchase option (see SCI's CMBS loan events database).

The application of the appraisal reduction to US$10m on the junior participations and US$31.7m on the class L notes would mean that the class K notes become the most subordinate class to have a remaining balance equal to at least 25% of the initial balance of the class, thereby transferring control. Accordingly, the majority certificateholder of the class K notes of CSMC 2007-TFLA may now own the fair value purchase option, providing them with the assignable right to purchase the defaulted loan from the CMBS trust at a price equal to its fair value.

According to RBS figures, Cedarwoods CRE CDO II owns US$11.25m and RREF CDO 2006-1 owns US$5.43MM of the transaction's class K notes.

CMBS

Slow progress for NHP turnaround

A recent presentation by the borrower behind TITAN 2007-1 NHP provided an insight into the first 12 months trading of HC-One and its business plan going forward (see SCI's CMBS loan events database). The information provided suggests that the turnaround of the ex-Southern Cross nursing home CMBS is progressing at a slower pace than was originally envisaged.

Three updated valuations were published prior to the presentation, of which the £527m 'WholeCo' valuation (as of December 2012) is most relevant to the transaction, according to European ABS analysts at Deutsche Bank. They note that in terms of assessing ultimate recoveries, it is the future value of the business that is relevant, which will ultimately be driven by the performance of the operating company HC-One.

With this in mind, the Deutsche Bank analysts suggest that the projections contained in the presentation are "significantly negative" for the transaction. In particular, it is now envisaged that the withholding of rent - which was originally projected to last for two periods in July 2011 - to fund investment in the operating business will be a constant feature going forward. This means that the swap will continue to not be paid in full and thus not amortise.

Moreover, the business plan projects operating company EBITDARM effectively staying flat until 2015, despite investment from bondholders via continued deferral of interest below the class A notes. "While the ultimate outcome of the transaction is, to our mind, still far from clear today, the publication of the presentation makes clear any recovery beyond the class A level is dependent on outperformance versus business plan," the analysts observe.

CMBS

CRE prices on the up

US commercial real estate prices increased by 8.1% on a composite basis during 2012, according to the latest Moody's/RCA Commercial Property Price Indices (CPPI). Central business district (CBD) office and apartment were the hottest sectors, with price increases of 19.1% and 11.2% respectively for the year. Suburban office was the only sector to see a price decline in 2012, edging down by 0.8%.

"The CBD office sector has been a leader in the post-crisis recovery and both its major and non-major market components posted double-digit returns in 2012," comments Moody's director of commercial real estate research Tad Philipp. "The performance of apartments in major markets was just 'warm' during 2012, but the results from non-majors was enough to make it a 'hot' sector overall."

To put last year's results in perspective, commercial property prices at year-end 2012 stood 33% above the January 2010 real estate trough and 20% below the industry's November 2007 peak. "Even though suburban office was the only sector to experience a price decrease during the year, it ended 2012 on a positive note by gaining 2.7% in the fourth quarter," adds Philipp.

Retail and industrial real estate sectors had modest gains for the year, increasing by 5.0% and 3.7% respectively. Retail ended the year with strong momentum, up by 6.9% in the fourth quarter, while industrial prices declined by 0.6% in the same quarter.

The major markets of Boston, Chicago, Los Angeles, New York, San Francisco and Washington, DC, as a group saw a price gain of 9.6% during 2012, outpacing the 6.9% increase in non-major markets. Major markets ended the year 9% below its peak level, while non-major markets finished the year 28% below peak.

"Major market CBD office and major market apartment were the only two indices to finish 2012 above peak levels," Philipp continues. "Major market apartment topped its previous peak by 1.3%, while major market CBD office topped its former peak by 0.6%."

At approximately 1,200, the fourth quarter saw the highest level of repeat sales observations since the inception of the price indices in 2000, reflecting a surge of year-end transaction volume. "The share of distressed transactions declined at year-end 2012 to approximately 18%, roughly half the level of distress seen at the first quarter 2010 high-water mark," says Philipp. "Apartment had the lowest share of distressed transactions at just above 11%, while suburban office had the highest at 28%."

CMBS

CMBS 3.0 asset enters special servicing

The US$35m Doubletree by Hilton JFK Airport loan has been transferred to special servicing. Securitised in JPMCC 2012-CBX, the loan represents the first CMBS 2.0/3.0 asset to enter special servicing due to property performance.

The property has generally performed reasonably well, according to MBS analysts at Barclays Capital, with DSCR NCF at 1.17x as of September 2012. However, the hotel's Hilton Doubletree franchise agreement was terminated 'for cause', effective from 17 February. The borrower is seeking to replace the franchise with Radisson, but it is not clear if this will be accepted by the special servicer (Midland).

"The loss of the franchise likely will lead to an interruption of cashflow as the property transitions and may lead to significant costs to handle the franchise transfer," the Barcap analysts suggest. "As such, the servicer has requested that the borrower post reserves to cover operating losses, property improvement and franchise termination fees. Additionally, if the replacement franchise is of lower quality, it could hurt potential revenues for the property."

Previous CMBS 2.0/3.0 assets to enter special servicing include three apartment properties, accounting for US$31mn combined balance in CRCRE 2011-C1 and CRCRE 2011-C2, because the borrower was involved in an unrelated alleged Ponzi scheme. The US$50m Ridgeview Apartments loan, securitised in DBUBS 2011-LC2, transferred to special servicing last September due to a dispute over loan covenants (see SCI's CMBS loan events database).

CMBS

Ballston Common loan watchlisted

Morningstar has added the US$42.2m Ballston Common Mall loan, securitised in PCM Trust 2003-PWR1, to its watchlist after it passed its maturity date last month. There has been no indication from the servicer as to the borrower's refinancing plans.

The loan is secured by 310,704 square-feet of inline retail space within an enclosed mall in Arlington, Virginia. In the years immediately preceding the loan's origination, the sponsor (Forest City Enterprises) invested approximately US$14.8m in capital improvements, including the construction of a cinema on the site.

The property was appraised for US$76m at issuance, equating to an issuance LTV of 66% on the pooled asset and 71% on the entire debt stack. The 10-year loan has amortised on a thirty-year schedule over its entire term and is fixed at 5.85%.

The largest tenants in the collateralised portion of the mall include Regal Cinemas (22% of GLA), Sport & Health Club (10%) and CVS (4%). None of these tenants is a near-term risk of lease rollover, according to Morningstar.

The property reported a DSCR of 1.77x at year-end 2010, 1.6x at year-end 2011 and 1.49x through the first nine months of 2012. Occupancy has inversely trended higher over those reporting periods, from 75% to 79% to 84%.

Morningstar notes that, despite the drop in DSCR over the past several reporting periods, the DSCR as of the last full year-end was higher than underwritten levels. Net cashflow as of year-end 2011 stood at US$6.4m, compared to US$5.6m at issuance.

Servicer notes indicate that the borrower is considering a major renovation of the property, but it's unclear how this would affect refinancing efforts. Morningstar's analysis determined that the loan appears to be adequately levered; however, it warrants monitoring if the rumoured renovations delay take-out financing and necessitate a transfer to the special servicer.

Risk Management

CTD functionality offered

Numerix has launched new functionality for cheapest-to-deliver (CTD) curve construction and the analysis of collateral, with the aim of increasing cost-saving opportunities, minimising funding costs and determining how trade valuations vary under different collateral choices. Built on Numerix CrossAsset analytics architecture, the solution can be leveraged by both buy- and sell-side institutions to analyse CTD collateral at any point in time over the lifecycle of a trade.

The tool analyses CTD collateral based on the definition of the individual CSA agreement entered using real-time market data. Once CSA terms are entered, the solution automatically builds all appropriate curves and linkages between curves. Users can leverage it to analyse not only CTD collateral, but also what may be cheapest at any point in time.

Risk Management

Risk infrastructure examined

The rationalisation of pricing and risk infrastructures is key for sustainable front office risk taking, according to a new Celent report. In order to optimise the consumption of capital at a firm-wide level, the firm says that desk-level pricing and risk infrastructures need to be aligned with enterprise middle office risk, collateral and capital management applications.

Derivatives markets pricing and valuation practices have been shaped by both industry initiatives and regulations around capital adequacy, risk management and accounting standardisation, as well as OTC derivative trade processing and risk control objectives, Celent observes. The evolution in pricing practices, methodologies and technologies underpins many of the broader elements of how derivatives will be managed in the coming years.

Among the key themes that play into derivatives pricing, risk management and margining/collateralisation practices are: dynamic pricing of counterparty credit risk in the front office workflows; the move to market standard OIS/CSA discounting practices in the valuation of OTC derivatives; the industrialisation of derivatives pricing infrastructures and operations; a growing thrust to equip the frontline for accurate and timely delivery of pricing, risk and profitability measures; and the drive to optimise complex linkages around funding costs, buffer capital and productive capital.

"Forward-thinking firms that can anticipate and triangulate elements of pricing, risk and capital consumed at the frontline in a cohesive and timely manner before trading decisions are made will be more adept to achieve the right results," Celent notes.

Risk Management

Margin requirements near finalisation

The Basel Committee and IOSCO have published a second consultative paper that represents a near-final proposal on margin requirements for non-centrally cleared derivatives. Several features of the proposal are intended to manage the liquidity impact of the margin requirements on financial market participants.

The proposed requirements would allow for the introduction of a universal initial margin threshold of €50m. The results of a quantitative impact study (QIS) conducted in 2012 indicate that application of the threshold could reduce the total liquidity costs by 56% relative to a margining framework with a zero initial margin threshold.

The proposal also envisages a gradual phase-in to provide market participants with sufficient time to adjust to the requirements. The requirement to collect and post initial margin on non-centrally cleared trades is proposed to be phased in over a four-year period starting in 2015 and begin with the largest, most active and most systemically risky derivative market participants.

These policy proposals are articulated through a set of key principles that primarily seek to ensure that appropriate margining practices will be established for all non-centrally cleared OTC derivative transactions. The principles will apply to all transactions that involve either financial firms or systemically important non-financial entities.

The Basel Committee and IOSCO are seeking public comment on the near-final proposal and specifically solicit feedback on: the treatment of physically-settled FX forwards and swaps under the framework; the ability to engage in limited re-hypothecation of collected initial margin; the proposed phase-in framework; and the adequacy of the conducted QIS.

Responses to the consultative document should be submitted by 15 March. 

Risk Management

FPL electronic trading guidelines released

FIX Protocol Ltd (FPL) has published recommended best practices and accompanying implementation guidelines for the electronic trading of bonds. The aim is to enable bond market participants to benefit from cost-effective and efficient connectivity to the growing number of bond trading platforms emerging across the US and Europe.

The best practices and implementation guidelines provide recommendations to both existing and emerging venues, broker-dealers and market makers on how they can use the FIX Protocol to support their platforms. This development complements recommendations released in 2012 to support the trading of credit default swaps and interest rate swaps, which are currently being implemented by a number of swap execution facilities (SEFs).

The guidelines have been produced by market participants keen to encourage the adoption of standards by fixed income trading venues. Written by industry experts, the recommendations explain how FIX can be implemented in a consistent manner to lower implementation costs and deliver maximum industry-wide benefit.

Additionally, further functionality has been added to the FIX Protocol to meet emerging needs for bond trading.

RMBS

Mixed performance for Mexican RMBS

Persistent servicer challenges and declining recovery rates colour the performance of Sofoles-sponsored transactions, Fitch notes in a special report on Mexican RMBS. Performance varies across three segments: transactions sponsored by government entities Infonavit and Fovissste perform well; bank RMBS exhibit mixed credit metrics; and non-bank sponsored transactions backed by Sofoles loans remain stressed.

Almost one-third of the Sofoles-sponsored RMBS portfolio rated by Fitch is 180+ days delinquent. Late-stage delinquencies signal more REOs in 2013, particularly since legal hurdles impeding liquidations have been resolved.

This non-bank segment continues to adapt to complications related to primary servicer substitutions that began in 2010. Some early evidence shows that portfolios with performance-based fee structures perform better than transactions with fixed-rate servicing contracts.

Relative to the non-bank segment, bank-sponsored RMBS perform well with minimal delinquencies and REO liquidations. However, Fitch notes that within this segment, HSBC Mexico-sponsored transactions suffer from liquidity pressure and poor asset quality.