Contents

CMBS

CMBS ticks tighter on rising supply

Generic US CMBS secondary spreads were mostly unchanged yesterday, although legacy conduit AM and AJ tranches tightened slightly. BWIC volume was up to around US$344m, with SCI's PriceABS data showing 59 line items for the session.

"CMBS spreads did not fluctuate a whole lot yesterday, but whatever movements did take place certainly tilted in the direction of more tightening. Overall, weaker legacy super seniors finished the day flat to perhaps a basis point tighter, while the tone remained positive throughout," says Trepp.

Recently-issued paper such as VNDO 2012-6AVE A traded during the session, while the CGCMT 2013-GC11 AS tranche was covered at plus 101. However, the majority of tranches out for the bid were from the 2005-2007 vintage.

For example, the BACM 2005-4 B and BACM 2005-5 D bonds were both circulating, talked at around 101 and at very-high 0s respectively. GEBL 2005-2A C was talked in the low-80s and was traded in the session, while the BLX 2005-1A A tranche was talked between the high-70s and 80 area and also traded.

2006-vintage CMBS was represented by tranches such as BAYC 2006-SP2 A, GSMS 2006-GG6 B and LBSBC 2006-1A M1 - which were talked in the mid/high-70s, mid-90s and low/mid-60s respectively. In addition, GEBL 2006-2A B made its first appearance in the PriceABS archive, talked in the low/mid-80s.

For paper from 2007, the WBCMT 2007-C30 A4 tranche was talked and covered at 107. The JPMCC 2007-CB20 C tranche - last seen talked in the low- and mid-80s on 25 January - was talked yesterday in the mid-90s.

Meanwhile, GCCFC 2007-GG9 AJ was talked at 80 and in the low/mid-80s, before being covered at 86. The same tranche traded two months ago at 77, which is also around where it was being talked on 3 January.

GCCFC 2007-GG11 AJ was also out for the bid. It was talked at 540, in the mid-500s and 575-545.

Finally, the benchmark GSMS 2007-GG10 A4 bond ended the day unchanged at 117bp over swaps. Its most recent cover in PriceABS comes from 19 April, when it was covered at 127.

JL

Structured Finance

ECB boost for SME ABS

The ECB has begun consultations with the European Council and EIB in order to promote a functioning market for SME ABS. While the move has been welcomed as a step in the right direction, market participants are not expecting any significant progress in the near future.

ABS analysts at JPMorgan highlight the cautious tone taken by the ECB. With consultations only now beginning, they note that it will probably take quite some time before any policy is implemented.

ECB president Mario Draghi has indicated that it is not the ECB's role to clean up bank balance sheets or provide monetary financing, which leaves purchasing assets such as mortgages and SME loans as one of the available options. "The ECB president also pointed out that because of the difficulty in pricing such assets, however, one solution could be packaging them in ABS structures while applying a guarantee through the EIB or similar supranational body," the JPMorgan analysts observe.

The prominent role of ABS in restarting lending to the real economy is expected to improve the perception of the asset class among regulators. The recent public placement of IM Cajamar Empresas 5 also demonstrates that investor appetite exists, even for ABS backed by peripheral collateral.

However, it is worth noting that this deal wasn't wrapped. SME ABS wrapped by supranational entities have not always been so well received and "may not therefore necessarily be an immediate panacea" - albeit it is a step in the right direction.

The analysts identify three key features that would ensure funds do trickle down to the real economy. "To begin with, to be successful, a scheme should focus on providing capital relief for banks - since funding needs have been largely alleviated through recent non-conventional measures undertaken by the ECB. Secondly, any advantage to financial institutions should be met with the requirement to pass those benefits on to corporate borrowers via a net lending target similar to the one adopted by the Bank of England's FLS."

Finally, they suggest that the private sector should also be given an opportunity to participate in investing in any wrapped SME ABS. This would both restart investor interest in the asset class and overcome one of the blockages in the credit transmission mechanism to the real economy.

JL

CLOs

CLO redemption risks examined

An unusual EOD notice has been issued for the Integral Funding CLO, after a scheduled optional redemption failed to complete on 15 April because of delays in the settlement of collateral sales. Although noteholders' risk of loss has not increased materially as a result, the experience highlights the small but non-trivial risk to CLO investors of relying on trustees' and managers' effective execution of activities relating to redemption, according to Moody's in its latest CLO Interest publication.

As a 2007 static balance sheet CLO with a rapidly amortising capital structure and healthy par collateralisation, Integral Funding was a prototypical candidate for redemption. However, the transaction failed to raise sufficient cash proceeds to pay the required redemption price of the class D notes as scheduled, which the issuer attributed to delays in the settlement of collateral sales.

The failed redemption and subsequent EOD have no immediate credit implications for the remaining class D noteholders, but give rise to a timing issue, Moody's observes. The notes - which are now the most senior in priority in the capital structure - continue to benefit from sufficient collateralisation, with par coverage of about 4x. Because the class D is now the controlling class of notes and in light of the EOD, the noteholders can direct the trustee to enforce remedies to protect their interests, including acceleration and liquidation.

However, neither the issuer nor the trustee expects the EOD to result in acceleration or liquidation. Rather, they expect that the forthcoming settlement of executed sales to result in full repayment of the class Ds.

Moody's has nevertheless identified a number of key factors relating to operational risks in optional redemptions: the timing of trade settlements; structural provisions that dictate how issuers, CLO managers and trustees undertake optional redemptions; and idiosyncratic factors, such as a CLO manager's sales strategy and the extent of a CLO's operational decentralisation. "The risk of a failed redemption has become more acute in light of prevailing market conditions, as record trading volumes strain the market's capacity for timely settlement. In such an environment, the ability of key transaction parties - such as the trustee, manager or issuer - to ensure sufficient lead time between trades and the scheduled redemption date and to closely monitor settlement statistics is critical for appropriate management of the settlement process," the agency explains.

It points out that Integral Funding is unique among CLOs in that it is comprised of multiple vehicles under management by different collateral managers - Credit Suisse Alternative Capital, Nicholas-Applegate Capital Management, Octagon Credit Investors, Stone Tower Debt Advisors, West Gate Horizons Advisors and WhiteHorse Capital Partners - who do not have to coordinate their activities or decisions. Such decentralised operations served to magnify operational risks by introducing a layer of complexity to the logistics of coordinating collateral sales and collecting principal proceeds by the trustee.

CS

Structured Finance

Agency appoints Canada chief

Fitch has named Andrew Smitiuch as senior director and Canadian business head. He will be based in Toronto and lead all aspects of the rating agency's business and relationship management efforts in the country, reporting to md Douglas Murray.

Smitiuch has spent most of his career at RBC Capital Markets, where he was most recently md responsible for senior corporate relationships. He has also worked at John Labatt and Allstate Insurance.

Structured Finance

Advisory launches Connecticut credit unit

New York-based NewOak Capital has launched NewOak Credit Services in Danbury, Connecticut. The unit will support NewOak's mortgage operations, from origination to servicing, oversight and securitisation.

NewOak ceo Ron D'Vari says the infrastructure revamp is in response to the sea-change of regulations and transparency requirements. NewOak Credit Services intends to recruit locally.

Structured Finance

SIX, Triangle in data partnership

Triangle Park is partnering with SIX Financial Information to provide clients with an expanded range of market data. Triangle Park clients now have the ability to incorporate security prices supplied by SIX Financial to their workflow tools to perform tolerance and variance checks for compliance and audit purposes.

Triangle Park provides difficult-to-procure workflow tools and market data sets for monitoring trading execution, liquidity of OTC assets and day-to-day market volatility. The partnership adds access to SIX Financial's extensive database so clients can verify market prices and validate portfolio values.

CDS

Pension fund brings CDS antitrust suit

The Sheet Metal Workers Local No. 33 Cleveland District Pension Plan has filed a class action lawsuit against 12 banks in the Illinois Northern District Court. The action alleges that the banks - together with ISDA and Markit - conspired to thwart competition in the CDS market, thereby raising fund managers' costs.

The defendants comprise Bank of America, Barclays, BNP Paribas, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley, RBS and UBS. The complaint claims that the banks acted together to protect lucrative revenues they earn from acting as intermediaries to credit derivatives trades. Further, it alleges that the banks used their dominance of boards and committees at Markit, ISDA and the DTCC to limit transparency in the market and to block new market entrants.

CMBS

NY law firm adds partner

Morrison & Foerster has added partner Lawrence Ceriello to its real estate finance group in New York. He specialises in the origination of loans backing CMBS.

Ceriello also has extensive experience handling mezzanine debt and workouts of distressed real estate, as well as equity investments and the purchase, sale, restructuring and foreclosure of performing and non-performing commercial mortgage and mezzanine loans. He joins from Nixon Peabody.

CMBS

REIT beefs up CRE capabilities

Annaly Capital Management has added several members to its commercial real estate platform. The additions will all be in place in time for Annaly's acquisition of CreXus Investment Corp, which will close on 23 May (SCI passim).

Annaly's CRE platform will be headed by md Robert Restrick, who has been coo of CreXus for the past two years. He has also served as head of structured products and portfolio management at CWCapital Investments.

Donald Haber joins Annaly as md and head of CRE credit. He was previously co-cco at Cantor Commercial Real Estate and has also served as cco for the US CMBS unit at Barclays Capital.

Peter Morral joins as executive director, focused on origination. He was previously head of institutional client and large loan originations at UBS and has also worked in the CMBS new issuance group at S&P, large loan group at Wachovia Securities and securitisation group at Bank of America Securities.

Gary Romaniello also joins as executive director, focused on origination. He was previously executive director at CIBC World Markets, where he was responsible for the origination of CRE loans on a national basis for the bank's balance sheet as well as for securitisation.

Matt Higgins joins as origination evp. He was previously executive director at UBS Real Estate Securities, where he was responsible for sourcing, structuring, negotiating and originating secured commercial real estate debt on both a fixed and floating rate basis, which is the same role he performed at Morgan Stanley.

Michael Jo joins as associate general counsel, head of legal and structuring for CRE. He was previously at KSL Capital Partners, Fortress Investment Group and CWCapital managing legal, strategy and execution of high-yield real estate debt investments and CMBS.

Henry Gom joins as svp, focused on origination and business development. He was previously svp at Savills, where he was responsible for restructuring and sourcing investments with global lenders, institutional owners, regional operating partners, real estate funds and REITs, and has also worked at Citi Property Investors and Merrill Lynch.

Finally, Greg Kiely joins as svp, focused on underwriting. He was previously real estate finance director at CIBC World Markets, where he was responsible for the original underwriting and subsequent asset management of a portfolio of floating rate senior mortgage loans and credit facility commitments, and has also worked in the CRE division of Barclays Capital.

CMBS

CMBS advisory firm launches

Sabal Financial Group has expanded its CMBS business by launching Sabal Commercial Advisors. Sabal Commercial will leverage the company's existing CMBS loan underwriting and due diligence platform to provide a single-source solution for transaction support services.

Sabal Commercial will provide loan origination underwriting and loan re-underwriting services. The loan origination underwriting services will include due diligence and underwriting of both CMBS and non-CMBS CRE loans for CMBS conduits and lenders, while in the loan re-underwriting space it will provide due diligence and re-underwriting for investor client purchases of CRE loan portfolios or loan pool tranches.

The new CMBS unit will be led by business development manager Ned Smith and due diligence and operations manager Sarah Suther. The company has a team of underwriters located throughout the US.

Insurance-linked securities

Insurer adds two to capital markets team

Aon Benfield Securities has boosted its capital markets capabilities by adding Robert James and Michael Pedraja, who each join as md and report to ceo Paul Schultz. They will be based in Chicago and advise clients on mergers and acquisitions, insurance and reinsurance company formations and capital raising initiatives.

James joins from Willis Capital Markets & Advisory, where he was responsible for strategic advisory and mergers and acquisitions advice. He has also worked at Allstate, MetLife, AIG, Countrywide and Grange Insurance.

Pedraja joins from Barclays, where he focused primarily on the insurance industry. He has also worked at Credit Suisse and has more than 17 years of experience in investment banking.

Risk Management

Legal challenge to CFTC clearinghouse decisions

The DTCC has filed a lawsuit challenging three interrelated actions by the US CFTC and asking a federal court to vacate the CFTC's approval of CME Rule 1001 and ICE Rule 211. It says the CME and ICE Rules are anticompetitive and undermine the core principles of the Dodd-Frank Act (SCI 17 January).

The DTCC says that, under the threat of a lawsuit from CME last year, the CFTC ignored the Administrative Procedure Act and Commodity Exchange Act to take action enabling the approval of the Rules. It sanctioned anticompetitive behaviour which allowed the clearing houses to require reporting of cleared swap data to their captive swap data repository.

RMBS

RMBS vet joins Angel Oak

Thomas Dolan has joined Angel Oak Funding as md. He has significant mortgage capital markets experience, including in sales, trading, loan origination and portfolio management.

Dolan was previously partner at RMBS Management and head of whole-loan sales and trading at Jefferies. He has also worked at ABN Amro, E*Trade Financial, JPMorgan, Morgan Stanley, Société Générale and Salomon Brothers.

RMBS

Assured reaches RMBS settlement

Assured Guaranty has reached a settlement with UBS to resolve claims related to RMBS that were issued, underwritten or sponsored by UBS and insured by Assured under financial guaranty insurance policies. Assured will receive an initial cash payment of US$358m.

UBS will also reimburse Assured for a portion of all future losses on certain transactions under a collateralised loss-sharing reinsurance agreement to be put in place by 3Q13. The settlement resolves all RMBS claims that the company has asserted against UBS.

RMBS

REIT makes two senior appointments

Two Harbors Investment Corp has appointed Marcin Urbaszek as md and promoted Victor Baev to the same level. They will help pursue new business initiatives within the residential mortgage market.

Urbaszek was previously at Credit Suisse, where he was responsible for sourcing and executing strategic and financing transactions for the firm's corporate clients. He has also worked at Citigroup, JPMorgan and Bank of America.

Baev joined the RMBS team at Two Harbors' parent Pine River in 2009. Before that he was at Credit Suisse and he has also worked at Dresdner Kleinwort and Barlcays Capital.

RMBS

Wide-ranging rep, warranties settlement agreed

MBIA Inc and its subsidiaries have agreed a comprehensive settlement with Bank of America. MBIA Corp will receive a net payment of approximately US$1.7bn, consisting of around US$1.6bn in cash and US$137m principal amount of MBIA's 5.7% senior notes due 2034, as well as a US$500m line of credit.

In exchange for the payment, MBIA will dismiss the ongoing litigation against Countrywide and other parties relating to breaches of representations and warranties (SCI passim). Bank of America and MBIA have also agreed to the commutation of all of the MBIA Corp policies held by Bank of America, which have a notional insured amount of approximately US$7.4bn and of which US$6.1bn are policies insuring CDS held by Bank of America referencing commercial real estate exposures.

Under the terms of the settlement agreement, Bank of America will receive five-year warrants to purchase 9.94 million shares of MBIA common stock at a price of US$9.59 per share. Bank of America also agreed to dismiss its claims in the pending litigation concerning the restructuring transactions announced by MBIA on 18 February 2009 and the pending litigation concerning the senior debt consent solicitation completed by MBIA in the fourth quarter of 2012.

Barclays credit analysts note that the settlement is a positive development for Bank of America credit and MBIA-wrapped non-agencies. It clears uncertainty for the bank and also removes the likelihood of a near-term liquidity event at MBIA Corp, with the US$500m credit line helping stave off rehabilitation "for at least a few more years".

The cost of the settlement was absorbed through the bank's 1Q13 earnings and should not affect future earnings. Bank of America CDS tightened 10bp on the back of the announcement, while cash spreads also tightened 6bp-10bp.

The payment from Bank of America will be used to repay the remaining outstanding balance and accrued interest on MBIA Corp's secured loan from National Public Finance Guarantee Corp. The secured loan balance was approximately US$1.7bn as of 1 April.

That balance has since been reduced by US$110m thanks to a separate settlement with Flagstar Bank. The Flagstar agreement settles a lawsuit filed by MBIA at the start of this year relating to approximately US$1.1bn of RMBS backed by second-lien mortgages which were insured by MBIA in 2006 and 2007.

ABS

Strong card ABS performance continues

Positive macro news and improving consumer health pushed US credit card ABS performance to levels not seen in more than two decades, according to the latest monthly index results from Fitch. Credit card ABS performance once again hit or held near-record levels on most fronts.

Prime 60+ day delinquencies touched record lows, while retail late-pays approached record lows. Excess spread has also reached new all-time highs for both indices and monthly payment rates held near all-time highs.

Fitch's 60+ Day Delinquency Index declined to 1.55% from 1.65%. Late payments are now down by 27.57% since the same period in 2012.

At the same time, Fitch's Prime Credit Card Charge-off Index increased by 7bp to 3.98%. Despite increasing slightly for two consecutive months, charge-offs remain 23.02% below the same period in 2012 and have decreased by 65% since the peak in 2009.

Gross yield increased for the second straight month to 18.77%, its highest level in 15 months. As a result of the increase in gross yield, one-month excess spread increased by 6.28% to an all-time high of 12.18%. Three-month average excess spread increased to 11.52% from 11.37% and is up by 12.72% since the same period in 2012.

Finally, Fitch's monthly payment rate (MPR) index climbed close to its historical high reached in the February distribution period after a seasonal decline last month. The normalisation of MPR resulted in an increase of 197bp month-over-month and is up by 11.33% since the same period in 2012.

"Improved consumer confidence last month may be an early indicator that consumers are beginning to feel a return of the 'wealth effect'. Evidence of this is the surge in both equity and home prices, which expanded at the largest rate since 1996," Fitch notes.

Meanwhile, performance of Fitch's Retail Credit Card Index also remained positive, with delinquencies reaching their lowest level in over seven years. 60+ day delinquencies came in at 2.56%, slightly higher than the level of 2.43% reached in the January 2006 reporting period.

Delinquencies are now down by approximately 19% from the same period in 2012. Charge-offs also declined by 11.60% to 6.02%, after increasing by 12.56% the month before.

Structured Finance

Project Aspen JV formed

Ireland's NAMA and Starwood Capital Group have established a joint venture relating to the sale of NAMA's €810m portfolio of commercial real estate non-performing loans known as Project Aspen. Under the terms of the agreement, NAMA will sell the portfolio to the new joint venture entity, which will be 20% owned by NAMA and 80% owned by a consortium led by Starwood. Other members of the consortium include Key Capital Real Estate and Catalyst Capital.

A structured sale of the loan portfolio commenced in February 2013, with more than 60 parties actively participating in the process. NAMA and Starwood entered into exclusive discussions in early April.

NAMA will provide a senior secured loan to the joint venture, with an initial LTV of less than 60%. The loan will carry a commercial rate of interest and is expected to be repaid within five years.

Structured Finance

Capital raising mandate signed

Credit hedge fund manager Varden Pacific has mandated alternative assets placement agent MCAM Group to raise capital internationally for its flagship Varden Pacific Opportunity Partners fund. The strategy returned 29.1% net of fees last year and year-to-date through April the strategy is up by an estimated 3.4%.

Currently managing over US$250m, Varden Pacific's focus is to capitalise on international credit opportunities and residual dislocations within the structured credit markets and specifically within the corporate-backed structured credit space. "Regulatory catalysts, changes in rating agency methodology and new mark-to-market rules are pressuring holders to sell these assets for non-economic reasons. With few product experts globally and significant barriers to entry, a material supply/demand imbalance has occurred. We look to utilise our product and industry expertise to identify these 'orphaned' assets, in turn providing our investors attractive returns on a risk-adjusted basis," comments Varden Pacific coo and co-founder Dennis Lin.

The firm was established in 2010 by Shawn Stoval (former head of Morgan Stanley's North American structured credit client trading group), Lin (former global head of US dollar interest rate swap trading at Credit Suisse) and Brad Scelfo (a former senior director within the structured and derivative-based product groups at Credit Suisse and Barclays Capital).

Structured Finance

Solid performance for MM tranches

Money market (MM) tranches that are part of global structured finance transactions performed well throughout the crisis, according to Fitch. This is reflected in the solid ratings performance of these tranches, as well as their strong repayment trends, the agency reports.

MM tranches include those where the term of assets and liabilities is matched (for example, ABS) and those where long-term assets are funded with short-term liabilities (for example, RMBS). The former accounts for the majority of Fitch-rated tranches issued between 2000 and 2012 and is the typical structure for US-issued MM tranches.

"All Fitch-rated money market tranches with matched assets and liabilities have either paid in full or been affirmed at F1+," says Fitch senior director Gioia Dominedo. "This reflects the seniority of the tranches and the short weighted average life, predictable cashflows and low default rates of the underlying assets."

MM tranches with matched asset-liability structures also benefit from full redemption over a short time frame. Fitch assigns short-term ratings to these tranches with the expectation that full repayment will be made in 13 months or less. In fact, these tranches paid in full after an average of only eight months.

The very small percentage of downgrades (2%) and withdrawals (2%) on Fitch-rated MM tranches relates entirely to transactions with an asset-liability mismatch. These deals are structured such that the MM tranche is reissued on an annual basis, with a backstop facility in case this does not occur. Therefore, its rating is credit-linked to a transaction counterparty instead of being solely based on asset performance.

A small number of downgrades and withdrawals have been triggered by corresponding downgrades of transaction counterparties. Withdrawals have also resulted in certain cases from the termination of the reissuance mechanism.

The number of Fitch-rated money market tranches reached new highs in 2011 and 2012, largely driven by US ABS issuance. At the same time, the investor base for such instruments is expanding as corporate treasurers and short-term fund managers continue to look for cash alternatives.

Structured Finance

Euro SME deals remain 'uneconomic'

The market for European SME securitisations remains shut, despite significant spread contraction, Fitch reports. The agency notes that this is mainly because securitisations of loans to SMEs, if placed with investors, are uneconomic from the lenders' perspective.

"The prevailing view is that SME securitisation - due to the lack of liquidity in the market, as well as the perceived additional risk - should yield a premium over more liquid reference RMBS," Fitch says.

It cites Lloyds' Sandown Gold 2012-1, which came at a spread of 200bp over Libor for the triple-A rated tranche, as the last significant placement in the SME sector. The transaction closed in early 2012 and spreads have tightened significantly since. Based on discussions with investors, the agency estimates that the minimum primary market spread for triple-A rated SME securitisations would be between 80bp to 100bp over Euribor for core European jurisdictions in the current environment.

Conversely, loan spreads charged by the lenders range between 1.2% to 2.5%, depending on jurisdiction - albeit they have been increasing slowly. Asset spreads in Italy and Spain are at the lower end of the range, according to Fitch.

"As a result, for SME securitisations to be economically viable, either the spreads demanded by investors have to decrease further or assets spread charged by lenders will have to rise," it observes.

Unsurprisingly SME lenders prefer to access ECB liquidity, which is significantly cheaper compared to selling to investors. In 2012 Fitch was aware of a total of 27 SME securitisation transactions: all but one were retained for ECB repo purposes and 15 came from Italy. The total volume of rated notes stood at around €35bn, with the spread on the rated tranches averaging around 50bp.

Meanwhile, the pricing of Commerzbank's recent SME covered bond suggests that investors viewed the structure as a covered bond rather than an SME securitisation (SCI 11 February). Fitch says that the recourse to Commerzbank provides a basis to hedge the risk if the asset quality of the underlying SME portfolio should deteriorate, an issue often raised by investors in the context of lacking liquidity of SME securitisations.

CLOs

CLO pricing service offered

Markit has launched a new pricing service for CLO tranches. The service covers more than 5,000 investment grade tranches of US and European CLOs and is expected to be used for price discovery, price verification, valuation and risk management.

The service uses observable market data and best-in-class models to value CLOs. Markit will provide customers with detailed information on data inputs and the assumptions used in the evaluation process, ensuring transparent valuations, it says. Customers will also gain access to the firm's team of CLO evaluators, in addition to a price challenge process.

The new service is an expansion of Markit's evaluated pricing business for securitised products and corporate, sovereign and municipal bonds. Later this year, the CLO pricing service will be expanded to cover mezzanine and equity tranches.

CMBS

CMBS delinquency rate drops

At 9.03%, the Trepp CMBS delinquency rate last month posted its lowest reading in more than two years. The 47bp drop in the delinquency rate was the biggest one-month gain since Trepp began publishing the number in autumn 2009.

All major property types saw their delinquency rates fall in April. Hotel and apartment loans led the pack, each with more than 100bp in improvement.

The resolution of distressed CMBS loans was a major driver that lowered the delinquency rate last month. Over US$1.6bn in loans were resolved with losses during the month.

The removal of these loans from the ledger of delinquent assets created 30bp of downward pressure on the delinquency number. This was approximately double the volume of loan resolutions in March.

Additionally, over US$800m in loans that were delinquent in March managed to pay off without a loss in April, including three large MSREF Portfolio loans (totalling over US$500m). Almost all of these notes were listed as non-performing loans that were past their maturing dates, as of March. The removal of these loans from the delinquent category added 15bp of downward pressure to the rate.

Loans that cured put an additional 35bp of downward pressure on the delinquency rate. Improvement in this category was led by several large loan modifications, including the US$375m Belnord loan (see SCI's CMBS loan events database). Its modification paved the way for the note to cure after languishing in the 90+ days delinquent bucket earlier in the year.

Another example is the US$194.6m Babcock and Brown FX3 portfolio loan. It was written down by over US$67m, but brought current with the assumption of the note by the new borrowers.

Meanwhile, there were US$1.6bn in newly delinquent loans in April, which put about 30bp of upward pressure on the delinquency rate. This was well below the average of US$2.7bn in new delinquencies in February and March.

CMBS

IRP RFC issued

The CRE Finance Council has released for comment version 7.0 of its investor reporting package (IRP). The association plans to publish CREFC IRP v7.0 on 1 July, with an effective date of 1 October.

The exposure draft includes final changes to the following: updated CREFC overview narrative; updated change matrix; updated data dictionary and legend; IRP new fields/field deletions to capture additional data and remove unnecessary fields; new templates; new loan and REO liquidation reports; revised loan modification report; and new best practices section. It is open for a 30-day comment period, followed by a 90-day implementation period.

CMBS

CMBS pay-offs trending upwards

The percentage of US CMBS loans paying off on their balloon date stood at 64.6% for April, according to Trepp. This was eight points above the March reading of 56.6%, with the rate now exceeding 60% in six of the past eight months.

The April rate of 64.6% is well above the 12-month moving average of 52.8%. By loan count as opposed to balance, 73.6% of loans paid off. The 12-month rolling average by loan count is now 60.8%.

CMBS

Servicer ratings, REO aging linked

There is a meaningful relationship between US CMBS servicer ratings and the aging of real estate owned (REO) inventories, according to Fitch. The agency notes that servicers with the highest ratings have shorter liquidation time lines than lower rated servicers.

Fitch says it analysed this relationship in response to market concerns regarding the growing and potential aging inventory of assets with CMBS special servicers. The results include a summary of foreclosure and liquidation times for CMBS servicers, as well as the current aging of each servicer's REO inventory. Given that the hold time of REO assets already with special servicers exceeds the four year average, higher losses at liquidation are likely, the agency observes.

CMBS

New Taurus CMBS nears

Further details have emerged on Taurus 2013 (GMF1), the European multifamily CMBS that will refinance the WOBA mortgage loan, previously securitised within the Windermere IX and Deco XIV Pan Europe 5 transactions (SCI 30 April).

Fitch has assigned preliminary ratings to the transaction, which comprises: €710m triple-A rated class A notes, €130m double-A class Bs, €120m single-A class Cs, €95m triple-B class Ds and €19.81m triple-B class Es. The deferred arrangement fee certificates (DACs), which reference the notional balance of the class A notes, are expected to be rated single-A.

The issuer will apply the issuance proceeds to repay a term loan advanced to it by Bank of America in February to facilitate lending to the transaction's underlying borrower, the WOBA group. The deal is arranged by BAML and HSBC.

The majority of the collateral (97.5%) securing the loan is located in Dresden, exposing the transaction to concentration risk, according to Fitch. The agency considers the collateral quality to be comparable with other multifamily portfolios in Germany.

It notes that the portfolio's performance is on an "upward trajectory", with occupancy having increased to 94% from 90% in 2007. Over the same period, the portfolio's net cold rent per square-metre has also increased to €4.86 from €4.38. Minimum capital expenditure requirements agreed with the city of Dresden should also benefit the portfolio.

The loan benefits from a moderate reported LTV of 60.3%, while annual scheduled amortisation of 1% per annum further reduces its exit LTV. The transaction benefits from a six-year tail period between loan scheduled maturity (2018, with a one-year extension option) and legal final maturity of the notes (2024).

Other structural features include: controlling class set at the most junior level subject to valuation events; combined issuer waterfall after loan maturity (where interest on the classes A and B rank ahead of principal on the same classes, but remaining funds are allocated on an IPIP basis for classes C to E); and the DACs pay interest ahead of classes B to E for the first three years and zero after. Fitch notes that there is uncertainty as to whether the issuer has to withhold income tax from payments to the DACs holders, although the rating analysis doesn't address this risk.

CMBS

Ten-year conduit loans set to pay off

Of the US$14.4bn in Fitch-rated performing conduit CMBS loans set to mature this year, US$3.2bn (22.2%) are defeased. As interest rates remain low and conduit issuance remains robust, the agency expects ten-year loans maturing over the next year to continue to pay off at or near their maturity dates.

"Roughly 60% of loans maturing in 2013 were originated in 2003 and 2004, including 16% which are already defeased," says Fitch senior director Karen Trebach. "Given that many 2003-2004 loans have been amortising for about nine years and that the overall initial leverage wasn't egregious, most should repay without a hitch."

Conversely, loans from the 2006 and 2007 vintages - representing about 20% of 2013 maturities - have significantly higher leverage. In addition, US$9.3bn in loans that already matured in 2013 or in previous years are currently delinquent. Another US$20.9bn of loans that have an original maturity date beyond 2013 are also currently delinquent, including US$16.7bn in ten-year loans from the 2006-2007 vintage.

CMBS

Multifamily liquidation plan outlined

The court-appointed receiver for the estate of an alleged Ponzi scheme involving Management Solutions (SCI 14 February 2012) has released a new liquidation plan for a large portfolio of multifamily properties owned by the estate. The 34 properties include three loans securitised in CMBS 2.0 deals (accounting for US$30.8m), two loans securitised in legacy CMBS (US$10.7m) and four agency CMBS loans (US$59.6m).

The liquidation plan states that the properties will be divided into three groups to prevent 'cherry-picking' of the best assets: group A will consist of 15 higher-quality apartments to be sold as a pool only; group B will consist of five properties in the Columbus, Ohio area to be sold as a pool only; and group C consists of properties that are distressed or have other issues and will be sold individually. Group A includes the US$5.6m Cleborne Terrace (securitised in FN466860), US$10.7m Retama Ranch (CFCRE 2011-C1), US$28.9m Retreat at Stonebridge Ranch (FREMF 2011-K704), US$3.6m Stonebrook Idaho (BSCMS 2004-PWR4), US$12.6m The Charlestonian (FN467174) and US$12.5m Wyndsor Court (GNR 2004-67) notes. The group B pool includes the US$8.3m Brooksedge (CFCRE 2011-C1) and US$11.7m Stonebridge (CFCRE 2011-C2) notes, while group C includes the US$7.1m Lake Ridge (CD 2007-CD4) loan.

Court filings indicate that the receiver intends to require buyers to assume the outstanding loans or honour existing prepayment provisions. As such, Barclays Capital CMBS analysts expect most of the performing loans to be assumed with little or no effect on the trust. But they note that the special servicer may allow a prepayment or modification on the relatively weaker Stonebridge Apartments loan (which is underperforming at 1.11x DSCR NCF, as at year-end 2012) or Lake Ridge Apartments loan (0.95x DSCR NCF, as of September 2012).

Insurance-linked securities

PERILS coverage enhanced

PERILS has extended its market coverage to include Italy, providing data for both earthquake and flood perils. The data includes market-wide property sums insured and event loss information.

PERILS will collect property sums insured and event loss data from primary insurers in Italy on a CRESTA zone and property line of business basis. Based on the collected data, the firm will produce independent and objective estimates of market exposures (total sums insured) and market losses. It is hoped that this information will be used for a range of applications, including natural catastrophe risk assessments, the development of new insurance products and industry-loss-based risk transfer instruments.

In addition, PERILS has collected event loss data for the earthquakes that took place in Emilia-Romagna on 20 and 29 May 2012. The resulting market-wide insured property losses are €802m (for 20 May 2012) and €436m (29 May 2012), or a total for both events combined of €1.24bn, making it the biggest ever insured loss for the Italian market.

Eduard Held, head of products at PERILS, says: "The inclusion of Italy marks another milestone in the expansion of the services provided by PERILS. Italy adds a new and important insurance market to our database, one which has significant exposures to natural catastrophes."

Risk Management

Cross-border swap rules proposed

The US SEC has issued proposed rules and interpretive guidance for parties to cross-border security-based swap transactions. The proposal explains which regulatory requirements apply when a transaction occurs partially within and partially outside the US. The proposed rules also set forth when security-based swap dealers, major security-based swap participants and other entities - such as clearing agencies, execution facilities and data repositories - must register with the SEC.

The aim of the proposal is to outline a substituted compliance framework in order to facilitate a well-functioning global security-based swap market. It is an approach that recognises that market participants may be subject to conflicting or duplicative compliance obligations in the global derivatives market, the SEC notes.

"We should take a robust and workable approach to this particularly complex and predominantly global market," comments Mary Jo White, SEC chair. "The global nature of this market means that participants may be subject to requirements in multiple countries and this type of overlapping regulatory oversight could lead to conflicting or costly duplicative regulatory requirements. Market participants need to know which rules to follow and I believe that this proposal will serve as the road map."

The comment period for the proposed rules and interpretive guidance for cross-border security-based swap activities lasts for 90 days after they are published in the Federal Register.

Separately, the Commission voted unanimously to reopen the public comment period for all rules not yet finalised, stemming from Title VII of the Dodd-Frank Act. The comment periods for these rules - and a policy statement describing the expected order for these new rules to take effect - will be reopened for 60 days after notice is published in the Federal Register.

Risk Management

Dodd-Frank bills put forward

The US House Financial Services Committee has passed a number of derivatives-related bills aimed at clarifying and amending Title VII of the Dodd-Frank Act. The bills seek to address cross-border, swaps push-out and end-user margin requirements.

First, H.R. 1256 seeks to harmonise cross-border approaches by requiring the CFTC and SEC to jointly issue rules regarding cross-border application of Dodd-Frank. The two agencies have so far approached this issue in dramatically different ways: the CFTC chose to issue regulatory guidance instead of going through the normal rulemaking process as the SEC has recently done.

"The CFTC has also taken a rule-by-rule, transaction-by-transaction approach to judging foreign regulator's rulemakings, versus the SEC's more reasoned and appropriate comprehensive, ultimate outcome-level basis," observes SIFMA acting president and ceo Kenneth Bentsen. "This has already led to real world consequences, with business leaving our shores. Congress should ensure regulatory rulemaking on this critical issue is coordinated and pass this legislation to ensure the CFTC and SEC are in lock-step."

Meanwhile, H.R. 992 makes necessary changes to Section 716 of Dodd-Frank - the so-called swaps push-out provision. "Both Federal Reserve chairman Ben Bernanke and former FDIC chairwoman Sheila Bair opposed the provision, believing it would actually increase risk, not reduce it. We urge the House to pass this bill," Bentsen continues.

Finally, while Dodd-Frank explicitly states that end-users would be exempt from margin requirements when using derivatives, it was never explicitly noted in statute. H.R. 634 would put that exemption into statue, thus providing regulatory certainly and relief for non-financial businesses that rely on derivatives for their operations.

RMBS

Loan buy-backs benefit ZUNI RMBS

The ZUNI 2006-OA1 transaction last month received a payment of about US$50m emanating from loan buy-backs and loss reimbursements. The pay-out equates to around 15% of the bonds outstanding (US$322m), making it one of the larger instances of RMBS loan-level repurchases in recent months, according to MBS analysts at Barclays Capital.

The deal's PSA states that Thornburg (now bankrupt) is responsible for repurchasing defectively originated loans. However, half of the loans in the ZUNI transaction were originated by Countrywide and eventually transferred to Thornburg. Further, as per the mortgage loan purchase and servicing agreement (MLPSA) between the two, Countrywide was responsible for repurchasing the mortgage loans from Thornburg that were found to breach reps and warranties.

Zuni investors and Thornburg's Chapter 11 trustee filed a lawsuit in April 2011 against Bank of America due to its failure to repurchase the faulty loans and a settlement was reached in February. Based on loan-level data, it appears that Bank of America agreed to repurchase certain mortgages, with the proceeds paid to bondholders this month.

RMBS

Lebanese MBS closed

BLC Bank and BSEC - Bemo Securitisation have closed a US$185m securitisation for Lebanese real estate company Solidere, constituting the largest-ever asset-backed issuance in the local capital markets. The transaction involves the establishment of a securitisation fund under Lebanese law for the purposes of liquidating at face value a portion of Solidere's land sales receivables portfolio.

The deal comprises three tranches of securities: a US$130m class A note, which was subscribed to by local banks; US$45m class Bs, which were retained by Solidere but may be resold after the redemption of the class As; and a US$10m class Cs, which will be retained by Solidere for the life of the transaction. The class A notes yield a fixed coupon of 5% for a WAL of 1.33 years (expected final maturity is 2.5 years).

RMBS

Fannie performance data published

Fannie Mae is to make loan-level credit performance data available on over 18 million single-family mortgages that it has acquired since 2000. The move aims to help investors model the credit performance of loans owned or guaranteed by the GSE as it works with the FHFA to develop potential risk sharing transactions.

"Transparency is a key component to encouraging private capital to re-enter the housing market," comments Andrew Bon Salle, evp, single-family underwriting, pricing and capital markets at Fannie Mae. "Our goal is to enable better modelling and understanding of the credit performance of Fannie Mae loans. Bringing private capital in to share some credit risk will help lay the foundation for a stronger mortgage finance system for the future."

The dataset that Fannie Mae is releasing includes credit performance information on 30-year fully amortising, full documentation, single-family, conventional fixed-rate mortgages. These mortgages were originated beginning in January 1999 and delivered to the GSE between 1 January 2000 and 31 March 2012.

Credit performance data includes voluntary prepayments, repurchases and delinquencies of up to 180 days. Activity that occurs up to the period at which a loan becomes 180 days delinquent - such as mortgage modifications, short sales, deeds-in-lieu of foreclosure, third-party sales and Fannie Mae's acquisition of REO properties - will also be included. The dataset will be updated on a quarterly basis.

RMBS

Unemployment weighs on Spanish housing

Spain's unemployment rate is anticipated to average 27.5% this year and next, peaking at 28.5% in 1Q14. However, the lagging impact on the housing market means that mortgage delinquencies will continue to rise beyond then, according to Fitch.

The depth of the Spanish recession means that unemployment is increasingly affecting 30- to 50-year-old higher-educated nationals on permanent contracts, who are more likely to own a house. The jump in the percentage of households with no employed adults to 16% last year from 14% in 2011 also makes delinquencies more likely, although Spain is less of an outlier on this measure.

Increasing long-term joblessness (12% of the workforce has been out of work for a year or more) will also feed through to mortgage delinquencies because contributory unemployment benefits expire after two years. The number of people receiving such benefits has levelled off over the past two years as the long-term unemployed lose these rights.

Fitch expects unemployment to stabilise below 30% next year as government measures to support employment take effect and output contraction comes to an end. A material fall in real wages - which is likely to be partly attributable to the government's wage-setting reforms - should also tilt the economy towards labour retention. An increase in foreign investment - such as the recently announced initiative to promote German investment in Spanish SMEs - could also provide some support to employment, provided the inflows are significant.

The slow pace of household deleveraging means that Spanish homeowners will remain exposed to worsening economic conditions for longer than homeowners in other markets that experienced a housing boom, such as the US and UK. In Spain household indebtedness represented 133% of disposable income in 2012, down just 7 percentage points from the peak, compared with an average drop of 26 percentage points from peak levels in the UK and US.

RMBS

Difficult road ahead for FHFA nominee

President Obama has nominated Representative Mel Watt to replace Edward DeMarco as director of the FHFA. No action is expected in the short term, however, given the contentiousness of GSE reform.

The US Senate has to confirm a nominee before an appointment is made. This has proved difficult in the past due to the politically-charged nature of the debate over GSE reform, particularly around the issue of using principal forgiveness in some circumstance as a loan modification tool.

MBS analysts at Bank of America Merrill Lynch note that a vote on the nomination by the Senate Banking Committee could occur next month. If the committee votes affirmatively, then Republican Senators would have an opportunity to signal whether or not they support the nominee. If it's clear that Republicans will not support the nomination, it would likely be dropped at that point, the analysts suggest.

In an indication of how difficult winning confirmation is likely to be, Republicans have called for the administration to explicitly lay out how it will unwind the GSEs, before any nominee is considered for the post.

Nevertheless, SIFMA has already expressed the need for Watt - if confirmed in the role - to "explicitly address the continued threat" to the return of private capital to mortgage markets by proposals to use eminent domain to seize mortgage loans. Acting president and ceo of the association, Kenneth Bentsen, comments: "As we have said, we believe this unprecedented use of eminent domain would cause severe damage to struggling housing markets, impede the return of private sector funding for mortgage lending, bring risk to taxpayers and is likely unconstitutional on its face. The continued persistence of these proposals requires a federal response."

RMBS

RMBS shortfalls trending higher

Morningstar Credit Ratings has reviewed monthly occurrences of interest shortfalls for 1Q13. The data shows that interest shortfalls continue to slowly trend higher across different collateral types, tranche types and vintages.

The analysis focused on nearly 25,000 bonds with an active balance from across roughly 4,000 deals in the Morningstar RMBS database. As of the March 2013 remittance cycle, 16.7% of the deals in the sample experienced a shortfall in at least one tranche.

Broken down by tranche, 6.2% of all classes were shown to have an interest shortfall in March of 2013. This is up from 6% in January and 5.7% in October 2012.

Junior tranches had the largest three-month increase of 10.5% when analysing by tranche type. The overall prevalence of interest shortfall is actually lower for junior tranches than for mezzanine tranches in the analysis because the sample omitted tranches that had experienced an actual or unrealised loss.

Interest shortfalls continue to be more likely to occur in subprime deals, according to Morningstar. The 2007 vintage, in particular, experienced a large increase in occurrences of interest shortfalls in the analysis.

Risk Management

Counterparty credit risk uncovered - part one

Terri Duhon, managing partner at B&B Structured Finance and author of 'How the Trading Floor Really Works', discusses counterparty credit risk on interest rate swaps

For as long as derivatives have been around, counterparties have taken contingent credit risk to each other. Originally, the efforts to quantify and manage this risk were relatively simple, but over time they have evolved and become more sophisticated. As well, the derivatives transactions themselves have become more complex and the size and diversity of each counterparty's positions have grown.

Overlay this with the new (and still debated) regulatory guidelines around credit value adjustment (CVA) and counterparty credit risk seems like an impossible concept to understand. This article - which examines counterparty credit risk on interest rate swaps - is the first in a series that aims to make the counterparty credit risk space accessible to everyone and ultimately relate counterparty credit risk to CVA.

In the broad scheme of things, while everyone is jumping up and down about the counterparty credit risk in the credit derivative market, the bigger risk in terms of transaction notional is from the interest rate swap market - which is more than ten times the size of the credit derivative market. Interest rate swaps are also easier to think through because we can broadly ignore correlation as a risk factor, as will be explained in the following articles on CDS and Wrong Way Risk.

The concept of counterparty credit risk is to some extent a function of dealers maintaining a hedged derivative trading book. For example, the dealer pays fixed e.g. 3% (versus receiving floating) with a client. It hedges by receiving fixed e.g. 3.04% (versus paying floating) from another dealer on the same notional, currency and maturity, assuming all other terms are equal.

The risk about which the dealer is concerned is that the client defaults when the dealer is in-the-money on the client trade. In this example, that occurs when interest rates have risen.

For example, if interest rates move to 4%, the dealer is 100bp in-the-money on the client trade. If the client now defaults, the dealer has to replace the trade with the client to keep his trading book hedged.

The 'replacement trade' is executed at 4%, which is the current market rate. This crystalises a loss for the dealer, which it will now want to claim back from the client. (We will talk about the process of making this claim in a following article on the ISDA framework.)

What the dealer wants to know when it executes the trade is with some degree of certainty what amount of money it could lose if the client defaults. Thankfully, we have loads of historical data in the interest rate swap market.

In particular, we care about the volatility of interest rate swap prices. In other words, how much can we expect interest rate swap prices to move, and hence how much might the dealer be in-the-money, over the life of the client trade? We care about the entire life of the client trade because we don't know when a client default might occur.

Breaking the calculation down into intuitive steps, we can use daily historical volatility to tell us with a certain degree of confidence (e.g. 95% or 99%) what the maximum amount the mark-to-market could be on the trade with the client tomorrow. Then from that point, we can see what the maximum amount the mark-to-market could be on the trade with the client the following day.

This allows us to draw a picture of what the potential future exposure is on this interest rate swap with the client. Intuitively, the potential mark-to-market on this trade should get increasingly higher as time goes on because it's more and more possible for interest rates to move away from the original market price.

However, the increase in the potential mark-to-market of the swap over time is countered by the approaching maturity of the interest rate swap. Eventually, the decrease in the duration reduces the potential mark-to-market and is the dominant feature of the calculation.

Finally at maturity, the potential future exposure is almost zero because there is only one net payment left and same-currency interest rate swaps don't have principal exchange. Thus, the maximum potential exposure is around about half-way between the trade date and maturity. For example, the maximum potential exposure on a five-year interest rate swap could be on the order of 4% of the swap notional (see the diagram below).

On the day the dealer executes with the client, we say that there is equal probability that interest rates can go up as well as down. (This is obviously debatable in reality, but it simplifies the analysis.) This means that the dealer has equal counterparty credit risk when it pays fixed on the interest rate swap as when it receives fixed on the interest rate swap. Thus we do the same calculation regardless of the direction of the trade.

At this point, we have only dealt with the market risk component of the counterparty credit risk. That is, we have looked at how the dealer's counterparty credit risk can be affected by movements in the interest rate market - the more interest rates move, the higher the dealer's potential exposure.

The second component is the credit risk of the client. That is, we now need to look at how the dealer's counterparty credit risk can be affected by its counterparty's creditworthiness - the less creditworthy the counterparty, the higher the probability that the dealer will be exposed to the potential exposure.

Simply put, we can think of the credit risk in loan terms. When the dealer does a five-year US$100m interest rate swap with the client, we can think of this as similar to giving out a loan which increases from zero (which is the mark-to-market of the swap on the trade date) to US$4m (which is the maximum potential exposure) and then decreases over time back down to zero. US$4m is the 4% maximum potential exposure mentioned in our example, times the swap notional of US$100m.

The dealer should be compensated for taking or hedging credit risk to the client in the same way it would be if it gave this loan to the client. In other words, in a simplified world, if this client has a credit spread of 50bp, then the dealer would receive 50bp over and above its borrowing cost (assume Libor) for lending money to the client or pay 50bp to buy CDS protection to hedge its credit risk to the client.

Let's assume that the dealer's average potential future exposure on the swap is 2% or in this example, US$2m. Thus to protect the dealer from this risk, the dealer could buy protection via CDS on the client on its potential future exposure of US$2m or set aside the present value of 50bp on US$2m when it does a five-year US$100m interest rate swap with the client.

This works out to a cost of approximately 1bp running on the full $100m notional of the swap. In theory, this should widen the dealer's bid-offer by 1bp on either side.

In reality, not all dealers use the same assumptions or hedging strategies and this is a competitive market. Also, dealers take into account the other interest rate swap trades done with this counterparty, as well as any collateral agreement (generally the Credit Support Annex executed as part of the ISDA Master) and any other credit risk to this counterparty. It may be that the risk to the dealer is far less than 1bp running or it could be that this interest rate swap reduces the credit risk to the client because it is an unwind of a previous trade.

Over time of course there is no guarantee that the mark-to-market on the swap will behave as we have assumed with our calculations. Thus, the management of this risk is a never-ending process of re-evaluating and re-balancing hedges.

Regardless, the theory is the same: analyse each trade based on the market risk of the product itself and the credit risk of the client, and then analyse the trade in the context of the overall existing exposure to the client. When we break it down into these steps, it no longer seems as complicated as it does at first glance.

The next article in the series will examine how correlation changes the analysis for credit default swaps.