Contents

CMBS

Volatility spooks Euro CMBS market

After a brief flurry of activity, the European CMBS market has once again quietened down this week. Broader market volatility appears to be keeping investors on the sidelines, although positive developments within CMBS are providing encouragement.

"With the bank holiday, half term and some volatility in broader equity and credit markets, investors have been handed a good excuse to take a break and see which way the market goes. There was good buying early last week, but activity has quietened down since then," reports one trader.

Higher-yielding seniors and second- and third-pays were once again in high demand. As well as providing solid yield, the trader notes that they are seen as safe bets for returning principal.

"For deeper mezzanine bonds, it is still difficult to get traction. Generally on BWICs they have been trading low or not trading at all, whereas by contrast the senior-end paper has been trading higher than expected," the trader adds.

News in the market has been mixed, with potential negative headlines affecting TMAN 6 apparently coming to nothing (SCI 17 May). The borrower behind the Orange loan had suggested that senior noteholders and equity might rank pari passu and, although the special servicer has since said that is not the case, it did contribute to weakness in the name.

More positively, the trader notes that yieldier names - such as Infinity Soprano and TMAN 4 - have been trading up, although a little softness has returned this week. After the positive reception of Taurus 2013 (GMF 1), speculation about the next multifamily deal to hit the market - anticipated to be a further Gagfah-related refinancing - has also been rife.

"We hear a lot of rumours about the new multifamily deal coming. It was originally scheduled to be sized at €1bn, but - after Taurus - we understand it is now going to be closer to €2bn," says the trader. "I do not know when that will come out and - with the current weakness - now might not be the best time, but it certainly has people interested."

JL

RMBS

Highly anticipated RMBS list arrives

A US$8.5bn 256 line-item BWIC of non-agency bonds hit the US RMBS market yesterday. It was sold in five groups, with Credit Suisse, Goldman Sachs and Bank of America each understood to have bought a batch and Morgan Stanley snapping up two.

The BWIC is the largest all-or-none list to trade since the Fed's Maiden Lane sales last year (SCI passim). It consisted of subprime, Alt-A and prime RMBS issued up to 2007 and was sold by Lloyds.

"A week's worth of anticipation has finally come to fruition as the very large US$8.5bn BWIC comes to market. Early indications are that the list traded well, with most RMBS segments said to be recouping recent losses, although definitive colour has not been forthcoming as of yet. One potential positive aspect is that the list traded to four different dealers suggesting that risk has been fairly well distributed across the Street," comments Interactive Data.

SCI's PriceABS data shows several names that were out for the bid yesterday, including the US$149.6m WFMBS 2004-Y 3A1 tranche, which was talked around 101. That is consistent with the levels it had been talked at in the previous two sessions and is slightly higher than the low/mid-par talk of 22 February and also higher than talk in the mid/high-90s from 22 August last year.

The highest price talk in the PriceABS data was for another WFMBS tranche - WFMBS 2004-Z 2A2 - at 103, with talk for the majority of tranches appearing to be in the 80s and 90s. Several tranches were also talked in the single digits.

FMIC 2005-2 M4 was talked in the low-single digits, as were HASC 2005-NC2 M3, HEAT 2005-9 M3 and PCHLT 2005-3 M5. The HEAT 2005-7 M3 tranche achieved mid-single digits talk and the HEAT 2005-5 M5 tranche was talked in the high-single digits.

CWL 2005-14 M3 (talked in the mid-40s), CWL 2005-7 MV5 (mid-50s), CWL 2005-9 M2 (low-50s), CWL 2005-3 MV2 (high-90s) and CWL 2005-BC2 M5 (mid-80s) were all out for the bid. The NHELI 2005-FM1 M2 tranche also circulated during the session, with talk in the low-90s, up from the mid/high-80s, mid-80s and mid-70s talk seen in February.

A couple of other names of interest were CWALT 2005-28CB 2A4 (which was talked in the low/mid-90s) and MSAC 2005-WMC3 M5 (which was talked in the high-80s, having been talked earlier this year in the low-70s and in September and October of last year in the mid/high-50s). Tranches from 2007-vintage deals were rarer, but HEMT 2007-2 2A4 was talked in the low-80s.

JL

ABS

SLM split 'mildly positive' for SLABS

Sallie Mae intends to split its existing businesses into two separate publicly-traded entities - an education loan management business and a consumer banking business. The aim is to "unlock value and enhance long-term growth potential".

The education loan management business will comprise the company's portfolios of federally guaranteed (FFELP) and private education loans, as well as most related servicing and collection activities. John Remondi will lead this entity as ceo.

It is anticipated that this entity will have the opportunity to acquire approximately US$130bn of additional FFELP loans for its servicing portfolio and would look to expand its DL programme servicing and collection roles as well.

Meanwhile, Sallie Mae's private education loan origination and servicing businesses - including Sallie Mae Bank and the private education loans it currently holds - will operate separately under the Sallie Mae brand. Joseph DePaulo, evp, banking and finance, will lead this business as ceo.

This entity will focus on deposit gathering and expanding into other consumer lending, initially funding itself through deposits. It is likely to eventually shift to securitised funding.

The separation, if completed, is anticipated to be effected via a tax-free distribution of common stock to Sallie Mae's shareholders. The precise allocation of assets between the two companies remains under consideration, however.

Based on current information, the education loan management business' principal assets are likely to consist of approximately US$118.1bn in FFELP loans, US$31.6bn in private education loans, US$7.9bn of other interest-earning assets and a loan servicing platform that services loans for approximately 10 million federal education loan customers. In aggregate, this company will own approximately 95% of Sallie Mae's existing assets and remain obligated for the company's senior indebtedness.

The consumer banking business' assets are likely to include approximately US$9.9bn of total assets, comprised primarily of: private education loans and related origination and servicing platforms; cash and other investments; and the Sallie Mae Upromise Rewards programme.

The strategic separation represents a natural business evolution since FFELP originations ended in 2010, according to Remondi. Development of the FFELP residual market is also expected to facilitate continued capital returns that have sparked a nearly 75% share price improvement in the last 12 months.

ABS analysts at Barclays Capital believe a potential business separation along the lines laid out by Sallie Mae would be neutral to mildly positive for the company's ABS. "Although the FFELP servicing business would no longer benefit from revenue generated through private credit student loan origination, it would be relieved of any current and forthcoming regulatory burdens associated with private credit student loans. Thus, we view the potential split as mildly positive for SLM's FFELP ABS," they explain.

The Barcap analysts add: "Similarly, although Sallie Mae Bank would likely miss the annuity revenue stream generated by FFELP loan servicing, it could focus all of its efforts on originating private credit loans consistent with the credit characteristics of the originations of the past couple of years while growing its deposit base and expanding into other consumer lending. As such, we view the potential split-up as neutral for SLM's private credit student loan ABS."

The completion of the separation is expected to occur within 12 months. Sallie Mae says it remains committed to its 2013 objectives, including the continued monetisation of its ownership interests in existing student loan securitisation trusts, while maintaining its current dividend and excess capital distribution practices until the completion of the transaction. It expects to create fully independent, focused governance structures for each of the new entities by significantly reducing the size of each company's board of directors and increasing the numbers of newly appointed directors, with particular emphasis on relevant industry expertise.

The reorganisation of senior management has already begun: Remondi has been named ceo, succeeding Albert Lord, who is retiring. Remondi has served as president and coo since 2011. Prior to that, he served as vice chairman and cfo.

The proposal has prompted negative rating actions on SLM's unsecured credit rating. Fitch downgraded it to double-B plus (watch negative) from triple-B minus, while Moody's and S&P placed their respective Ba1 and triple-B minus ratings on watch negative.

A number of Sallie Mae private student loan ABS bonds have been circulating in the secondary market over the last few days. The SLMA 2006-A A5 tranche was being talked at mid/high-80s, according to SCI's PriceABS data. Talk for SLMA 2010-A 1A and 2A bonds was mid-104 and mid/high-105 respectively.

CS

Structured Finance

Real-time reporting service rolled out

Law Debenture's new Dynamic Analytical Reporting Tool System (DARTS) went live with its first CLO manager in May. The real-time service leverages business intelligence to retrieve, report and analyse European ABS and CLO performance data.

With the rise of the CLO market, traditional investor reporting had become cumbersome, while collateral managers were unable to receive results of hypothetical test requests in an efficient manner. Law Debenture Agency Solutions (LDAS) identified two areas that needed to be improved: investors required a flexible and transparent reporting tool; and collateral managers required a tool to facilitate asset substitutions.

"DARTS enables collateral managers to run multiple trading scenarios within minutes, enabling them to execute time-critical trades, as well as test cure analyses, par coverage ratio analyses and so on. Typically, it could take hours, if not days, to process the results. With DARTS these results are available in minutes," explains Neil Lewis, senior relationship manager at LDAS.

He continues: "In addition, investor compliance reports are now available in a more user-friendly format with the ability to generate trend and historical analysis, thus comparing previous reports. With these customised reporting tools available for investors, the deal manager's reputation will also be enhanced, providing an obvious advantage when looking for new investments towards their future CLO issuances."

Users of DARTS can drill down into and manipulate the data in order to run a variety of trading scenarios within minutes. Investor dashboards display all of the test results, as well as historical trends and accompanying graphics.

Developed in collaboration with existing clients, other functionality offered by DARTS includes: the ability to warehouse loan notices; the provision of 'what-if' scenarios around principal pay-downs and reference rate changes for loan facility transactions. Furthermore, at a time when investors are required under CRD IV to prove that they understand a securitisation, DARTS can provide analysis in support of this.

LDAS provides administrative and agency solutions for structured and non-structured transactions within the financial services industry. DARTS was designed to be used by collateral managers and investors in CLO transactions. It can equally be used by other associated parties and on securitised, leveraged or financial transactions, including by borrowers/lenders, auditors, rating agencies, arrangers and corporate service providers.

Structured Finance

SCI Start the Week - 3 June

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

Pipeline
It has been another busy week for the pipeline, with ABS, RMBS, CMBS and CLO transactions all being announced. Much of the activity was in RMBS, where Nationstar announced six series of notes.

Nationstar is bringing Nationstar Mortgage Advance Receivables Trust Series 2013-VF1, 2013-VF2, 2013-VF3, 2013-T1, 2013-T2 and 2013-T3 to the market, with a total size of US$2.022bn. These deals were joined by US$303.3m EverBank Mortgage Loan Trust 2013-2, Phedina Hypotheken 2013-I and Sequoia Mortgage Trust 2013-8.

Meanwhile, ABS transactions entering the pipeline comprised £1bn Motor 2013-1, US$584m PHEAA SLT 2013-1 and US$104.3m South Texas Higher Education Authority 2013-1. The CMBS were US$1.4bn COMM 2013-CCRE8 and C$220m TD Canada Trust Tower Senior Secured Mortgage Bonds.

Finally, the CLOs consisted of US$412m Anchorage Capital CLO 2013-1, US$400m GLG Ore Hill CLO 2013-1 and US$471m Mountain Hawk II CLO.

Pricings
New prints were largely focused in ABS and CLOs, but there was also one RMBS.

The ABS were US$986.04m Ally Auto Receivables Trust 2013-SN1, €800m Bavarian Sky German Auto Loans I, US$121.41m CarNow Auto Receivables Trust 2013-1, US$599.7m Edsouth Indenture No.4 Series 2013-1 and €3.133m Florence SPV 1.

The RMBS new issue was US$442.54 JPMorgan Mortgage Trust 2013-2, while the CLO pricings comprised €834m Atlantes SME 2, US$413m Atlas Senior Loan Fund III, US$416m Dryden XXVIII Senior Loan Fund, US$421m NewMark CLO 2013-1 and US$516m Tryon Park CLO 2013-1.

Markets
US CLO BWIC volume totalled US$450m last week, just over half of the total from the week before. Bid-lists were spread across the entire ratings spectrum and included both legacy and CLO 2.0 tranches, according to Bank of America Merrill Lynch securitised products strategists.

"There was a number of CLO 2.0 double-B lists where some investors were looking to take advantage of the strength in that part of the capital structure," the analysts note. Secondary spreads were flat last week after tightening the week before to 90bp, 130bp, 185bp, 275bp and 535bp for triple-A through double-B tranches respectively.

Meanwhile, the much-anticipated US$8.5bn 256 line-item BWIC of non-agency bonds hit the US RMBS market on Thursday, as SCI reported last week (SCI 31 May). The list was sold in five groups to four banks and was the largest all-or-none BWIC to trade since the Fed's Maiden Lane sales last year.

The list consisted of subprime, Alt-A and prime RMBS issued up to 2007. At 103, the highest price talk in SCI's PriceABS data from the session was for WFMBS 2004-Z 2A2, with talk for the majority of tranches appearing to be in the 80s and 90s.

Away from RMBS, Barclays Capital analysts note that US CMBS spreads widened sharply last week, with the AJ/mezz space down by four points. "Credit spreads have been hurt by the sell-off in the 10-year rate, which appears to be driven by fears of a less accommodative Fed rather than an improvement in the economic outlook," they observe.

Vintage dupers widened by about 5bp and AMs gapped by 15bp-20bp. In the new issue space, 3.0 triple-Bs were trading at 325bp over swaps as of Thursday's close, which was about 10bp off the levels of the week before.

European CMBS once again quietened down last week, as SCI reported on Thursday (SCI 30 May). While higher-yielding seniors and second- and third-pays were once again in demand, one trader reports that it is still difficult to get traction for deeper mezzanine bonds.

"Generally on BWICs they have been trading low or not trading at all, whereas by contrast the senior-end paper has been trading higher than expected," he says. Potential negative headlines affecting TMAN 6 spooked investors (SCI 17 May), but yieldier names - such as Infinity Soprano and TMAN 4 - have been trading up and expectations for the next multifamily deal are high.

Deal news
• UCI has launched a fixed price tender offer for 11 Spanish RMBS tranches from across the UCI 10 to UCI 17 deals. The bank is offering to purchase up to €300m of the €3.4bn currently outstanding across the bonds.
• Losses resulting from the severe tornado that struck Moore, Oklahoma on 20 May are credit negative for the US$200m Combine Re Series 2012 indemnity catastrophe bond. Because of strong subordination, relatively low preliminary loss estimates and the reinsured company's small market share in Oklahoma, the agency does not expect losses to rise to the level where the notes will experience principal write-downs, however.
• The principal balance of mortgages assigned at closing for the Bluestone 2005, Bluestone 2006 and Bluestone 2007 RMBS was overstated by the unintentional inclusion of fees and interest arrears following a clerical error. This has resulted in under-collateralisation of the notes by £208,821, £1.33m and £4.36m respectively.
• Cowen and Company has been retained as liquidation agent for Ambassador Structured Finance CDO. The collateral will be auctioned via two public sales on 4 June.
• A sixth auction is due to be conducted for Libertas Preferred I on 20 June. The securities will only be sold if the proceeds equal to the total senior redemption amount.

Regulatory update
• The Making Home Affordable Program has been extended from 31 December 2013 to 31 December 2015. The new deadline was determined in coordination with the FHFA to align with extended deadlines for the Home Affordable Refinance Program (HARP) and the Streamlined Modification Initiative for homeowners with loans owned or guaranteed by the GSEs.
• The Alternative Investment Management Association has produced a paper that highlights the key areas where deeper coordination of OTC derivatives regulation is required to achieve the G20 objective of maintaining global markets. The paper provides examples of potential regulatory conflicts or unnecessary overlap between EMIR and the CFTC's derivatives rules in a number of key areas, including clearing obligations, reporting obligations, segregation rules, collateral rules and margin requirements.
• ISDA has published the Recommendation for Financial products Markup Language (FpML) version 5.5. One area of expanded coverage relates to the European reporting requirements detailed by ESMA in its technical standards published last autumn, including coverage of listed derivatives as mandated by EMIR.
• The FHFA and Citi have reached a settlement in connection with a suit FHFA filed on 2 September 2011, alleging that the defendants misled Fannie Mae and Freddie Mac into buying US$3.5bn in RMBS. In a stipulation filed with the court, the parties stated that they "have reached a settlement disposing of all claims asserted" in the action. The terms of the settlement were not disclosed.

Deals added to the SCI database last week:
BMI CLO I; CarFinance Capital Auto Trust 2013-1; Citibank Credit Card Issuance Trust 2013-2; CNH Equipment Trust 2013-B; FCT Ginkgo Compartment Personal Loans 2013-1; Goldfish Master Issuer series 2013-2; HLSS Servicer Advance Receivables Trust Series 2013-T2; HLSS Servicer Advance Receivables Trust Series 2013-T3; Holmes Master Issuer series 2013-1; JPMCC 2013-JWRZ; Kenrick No.2; New Mexico Educational Assistance Foundation series 2013-1; Storm 2013-III; Volta Electricity Receivables Securitisation Notes; WFRBS 2013-C14; World Omni Auto Receivables Trust 2013-A

Deals added to the SCI CMBS Loan Events database last week:
BSCMS 2006-T22; COMM 2006-C7; COMM 2006-C8, CD 2007-CD4 & GECMC 2007-C1; CSFB 2001-CF2; CSFB 2005-C6; CWCI 2006-C1; DECO 6-UK2; EPC 3; EURO 24; LBCMT 2007-C3; LBUBS 2008-C1; RIVOL 2006-1; TAHIT 1; TAURS 2006-3; THEAT 2007-1; TITN 2007-CT1

Top stories to come in SCI:
Developments in Russian RMBS

CDS

Tranche repositioning recommended

The strong rally in MBIA credit risk in the aftermath of the company's legacy exposure settlements is one driver of changing relative value in the CDS and tranche markets. Relative valuations in standard CDX and iTraxx index tranches are now at extremes relative to the last 10 years.

Other events this year, such as the strong outperformance of CDS over cash bonds and the significant reduction in eurozone tail risk, have also played a significant part in redefining risk and relative value in the sector. Credit derivatives strategists at Morgan Stanley now see greater value further up the tranche capital structure.

"We think the value in the tranche capital structure is higher up now. Senior tranche investors are now paid more than double the spread they would have gotten paid in 2005-2007 for the similar index spread levels. As volatility declines, senior tranches become even more attractive," the Morgan Stanley strategists observe.

Equity tranches on safe portfolios are currently unattractive from a risk-reward perspective, they suggest. They are exposed to negative idiosyncratic risk, including LBOs, and on a correlation basis are trading at the richest levels seen in the 10-year history of the index tranche market.

"The bull story for equity tranches is that there is a lot of investment dollars in credit markets looking for double-digit yields. We believe that synthetic equity in IG and cross-over portfolios could gain visibility, given the sharp rallies in securitised products and the positive tone around the MBIA rally," the strategists note. Some junior legacy CSO tranches have rallied by 10 to 30 points as a result.

The strategists consequently favour long positions in IG19 7%-15% and IG9 10-year 3%-7% tranches, as well as the iTraxx 19 five-year 6%-12% tranche. These longs are lower beta and lightly levered, without carrying the idiosyncratic risks of the 0%-3% tranche.

Alternatively, they recommend being long risk in mezzanine tranches on legacy seasoned portfolios with a fallen angel tail - IG9 and iTraxx S9. In terms of selling excess protection on mezz versus equity, a ratio of 2x-3x makes sense, depending on the type of index and the type of market exposure.

A second trade to express a correlation view is selling protection on tail names and buying equity protection. This is a market-neutral trade, which should make about eight points if correlation drops by 10%.

For a high yield default hedge, buying protection on iTraxx S9 June 2015 maturity 0%-3% is recommended. The tranche has rallied by over 50 points over the course of a year and is at the tightest levels in nine months, with investors becoming in-the-money from the second default onwards.

JL

RMBS

Clean-up calls gather pace

The recovery in US home prices has prompted a modest pick-up in RMBS clean-up calls. Coupled with rising asset prices from QE, several deals now have a high likelihood of being called in the next two years.

Barclays Capital RMBS analysts estimate that over 20 transactions have been called so far this year, more than the number called in all of 2012 (SCI 18 April). Servicers are set to exercise their call rights more frequently as collateral values rise and banks become more comfortable with holding legacy loans.

The pre-crisis norm was for deals to be called within six months of becoming callable, but since 2008 almost 50% of deals have been called more than a year after becoming callable. This likely reflects a more discerning approach from servicers around which deals they call and at what loan value levels.

Another shift since the crisis also relates to timing, with calls becoming far more irregular. Almost half of all deals called in 2011 seem to have been called in the month of July alone, while April of this year saw 14 deals called, almost all by Wells Fargo.

Identifying which deals are likely to be called in the future largely depends on the deal collateral value and the identity of the master servicer, the Barcap analysts suggest. Deals called so far this year have estimated collateral values of US$106.8, whereas non-called deals that became callable this year have estimated values of US$101.9.

In the last few years, the average collateral value of deals that were called has been lower when the deal first became eligible versus when it was actually called. This compares to earlier years when the call was almost always exercised rapidly and collateral values changed very little between the eligibility date and actual call date.

Average collateral values at the call date have also risen since 2008. Before then, the average collateral value at the call date was around US$101-US$102.

This suggests that post-2008 servicers became more selective about which deals they would call. "This may be a function of bank servicers becoming more hesitant to add assets onto their balance sheets until the economics of the call are significantly in their favour," the analysts observe. "As such, only very clean deals have generally been called over the past few years."

Whereas Alt-A and subprime transactions accounted for half of all deals called in 2005 and 2006, every deal called in 2012 and 2013 has been jumbo prime.

The identity of the master servicer is key. JPMorgan, Wells Fargo, First Horizon and Citigroup have called deals more frequently over the last five years than other rights holders. Along with RFC, they account for around 80% of calls, while servicers such as Bank of America, Ocwen and Nationstar call less frequently. The reluctance of independent servicers - such as Ocwen and Nationstar - to call deals may reflect the later vintage, subordinated nature of the transactions they have historically serviced.

Certain shelves are also more likely to be called than others. For example, JPMorgan since 2009 has only called deals from shelves such as WAMMA, CHASE, WAMU and CFAB, with no calls from BSABS or BSARM.

Bonds priced at a discount to par, such as POs and subordinate tranches, generally benefit the most from a clean-up call. For instance, the analysts estimate that the yield on a 2004 CMSI sub bond would increase from 7.5% to 16.2% if a call is exercised in a year. Conversely, senior pass-throughs and IOs are likely to be adversely affected by a call as they typically trade at a premium in the current environment.

JL

Structured Finance

Leveraging value-at-risk

Richard Green, director at Venn Partners, answers SCI's questions

Q: How and when did Venn Partners become involved in the securitisation market?
A: Venn Partners was established in 2009 by a team of four former bankers. We've grown to a team of 20 since then.

The business focuses on three areas: European CRE lending; bank solutions; and advisory and analytics. Our CRE lending platform - called Venn Finance - was in gestation for about nine months before launching in January with the arrival of Paul House. He was formerly head of EMEA real estate at Citi.

Venn Finance provides senior and selected mezzanine funding, targeting £500m of lending in 2013. In addition to direct lending from our own balance sheet, the idea is to provide a loan management platform and act as an aligned investment partner to support institutional investors wanting to participate in the new credit opportunities emerging in the market.

With Siem Industries Group as a cornerstone investor, we closed our first loan in April and the second in May. The pipeline is developing quickly.

In terms of the bank solutions business, we mainly work with European lenders who want to exit their non-core assets. The disciplines we cover include origination, underwriting, structuring and bringing in co-investors.

At present, we're involved in buying residential mortgage portfolios from Northern European banks, which could eventually be refinanced via RMBS. We're also active in the regulatory capital space, structuring synthetic securitisations whereby loans remain on-balance sheet and protection is bought on a tranche of the exposure for capital relief purposes.

Our first year was spent advising UK and European banks and government treasuries around run-off financial institutions. This is where our third business comes into play: the genesis of our analytics platform - Venn Risk Analytics (VeRA) - was advisory work for a European run-off bank disposing of a large legacy ABS portfolio. VeRA was 18 months in the making and is an all-encompassing solution for valuations and risk analytics for the structured finance market.

Q: What are your key areas of focus today?
A: One of the bedrocks to our three focus areas is bottom-up loan-level modelling and analysis, including a simulation and correlation of key risk parameters. This is a level of risk management that's common in the derivatives markets, but less so in structured finance.

This ultimately enables us to provide a fundamental valuation and risk analysis that captures the uncertainty around that value and which can be compared to the market price and the valuation of other bonds to assess relative value within a consistent framework. Standing behind these models are credit memos for each sector.

Much of our work is focused on creating risk frameworks for clients. They're proving especially helpful for run-off banks, for example, in terms of indicating when and at what price they should sell assets in order to maximise tax payers' money.

The process involves setting out a methodology for underwriting assets and calculating valuations. The idea is to sell once the price has reached its fundamental valuation, thereby providing a specific mandate for the portfolio manager.

It also allows all stakeholders to be involved in the decision-making and avoids potential break-downs in communication by systematising the process. In addition, it satisfies regulatory requirements for financial institutions to have greater risk analytics and management processes against structured finance positions.

Q: How do you differentiate yourself from your competitors?
A: We're independent and can provide an end-to-end process from macro analysis to valuations. Venn leverages people with a variety of skill-sets, combining sell- and buy-side expertise with rating agency and advisory know-how. Not only do we understand the underwriting process, but we also understand the secondary market.

The key is combining these skill-sets with the technological expertise to develop risk systems. Not many other firms do this: some can provide the technology, but don't provide the credit analysis on top of it; others offer credit views without the depth of analysis provided by technology.

We provide a set of credit models that forecast performance across different asset classes. Clients receive detailed valuation and risk reports tailored to them.

Where good models and data exist from other providers, we'll integrate with them. There's no point in reinventing the wheel regarding existing market infrastructure.

Transparency is another differentiating factor. Many asset managers that provide valuations to their clients are unwilling to reveal their assumptions, but our reports show the assumptions around defaults and correlations and so on.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: Europe remains seven or eight years behind the US in terms of availability of loan-level data, but it is catching up due to the European DataWarehouse and other central bank requirements. The ED is making a real difference because it allows investors to undertake nuanced analysis of each individual mortgage rather than across buckets of characteristics.

Our modelling method plays into this trend: it begins at the macroeconomic level for each country, flows into the credit models and forecasts cash available to run down the waterfall where our industrialised systems then analyse the resulting cashflows to the bond under a large array of simulations, and across portfolios, very quickly.

The hunt for yield means that investors are moving down the capital structure and moving into new asset classes or peripheral bonds. VeRA can be the foundation for getting new asset classes 'on policy', by quantifying economic capital at risk and demonstrating that the institution is protected at certain levels.

The market has changed: at its peak, it was a sellers' market and investors often weren't given enough time to properly analyse new issues. But now they have a stronger position and technology is supporting this.

Most arrangers offer deal models in systems such as Intex and so on, so that the buy-side can model base-case and stress-case scenarios. But we can then provide detailed valuation and risk analysis reports. Investors are recognising the importance of this type of analysis, but not many have committed the time or resources to build the necessary analytics.

Another area of opportunity is in connection with the requirement for European banks to run stress tests. VeRA enables them to do this quickly and less resource-intensively. Banks typically remain siloed, but we're helping to knock down the barriers.

Our team is made up of credit analysts, structurers, originators (covering most European financial institutions) and risk distribution. We work hard to ensure that the team is integrated, as each discipline reinforces the other - for example, we strive to ensure that our solutions are both technically sound and reflect the competing demands of sellers and buyers of risk. This also allows for coordination on projects that include multiple moving parts.

Q: What major developments do you need/expect from the market in the future?
A: Europe remains fragmented, but increasing sophistication around analytics proves that the region is maturing. Pre-2007 it was difficult for many to keep up with the pace of the market; now that it is reopening again, technology is allowing investors to be better equipped. There is a realisation that availability of data makes for a healthier market: the more that people put their views out there around different bonds, the better it is for transparency.

Away from technology, another healthy sign for the market is that certain segments of the European CMBS market can attract refinancing. We've seen a number of single-borrower deals print, for instance. Typically, they are simpler to analyse than conduit deals and some are designed to attract a natural buyer base looking for longer-dated fixed-rate investments.

German multifamily is also proving attractive, given that it fulfils the bid for duration and granular assets otherwise directed at RMBS. Indeed, the size of the syndication book for Taurus 2013 (GMF1) indicates that investors are increasingly looking across asset classes.

There are signs of life in the conduit space too, with a handful of investment banks looking to restart their conduit programmes. However, secondary and tertiary properties are still struggling to refinance.

But the most significant long-term risk to the ABS market remains regulatory uncertainty. The regulatory environment keeps changing; the longer this uncertainty prevails, the longer a recovery will take.

Having said that, there was such a strong reaction to the last Basel 3 consultation that we believe the proposals will likely be watered down somewhat. The sense we get is that some central banks and regulators are finally beginning to understand the importance of securitisation to the real economy. We anticipate a sensible conversation between the industry and regulators around which compromises can be made.

CS

Structured Finance

US trading head named

Barclays Capital has named Adam Yarnold as head of US securitised products trading. He is based in New York and reports to Scott Wede, former head of US securitised products trading and now head of global securitised products trading.

Yarnold takes on management oversight for all the securitised products trading desks in the US. He joined Barclays in 2009 from Braver Stern.

Structured Finance

Data provider adds duo

Lewtan has recruited Miten Amin as market applications director and Youriy Koudinov as market applications and securitised products director. Amin will be based in London while Koudinov will be based in the US.

Amin has 12 years of structured finance experience in investment banking and will focus on formulating and driving the company's strategy for investor and issuer based solutions in Europe and Asia. He was most recently at MHJ Financial and has also worked in the structured finance teams at Hoare Capital Markets and ABN Amro, as well as serving as head of ABS and CLO syndicate at Commerzbank.

Koudinov has 16 years of fixed income and structured finance experience and his new role includes market research, product strategy and customer relationship management. He was most decently director of fixed income research for structured products at TIAA-CREF and has previously worked at Credit Suisse, First Boston and Access Industries.

Structured Finance

Euro ABS mandates minted

Cervus Capital Partners has launched two European ABS mandates: European Amortising ABS Mandate I and II. The first mandate was set up for high net-worth individuals and family offices; the second was specifically set up for a Dutch institutional investor.

Both mandates have the same investment guidelines and target mid/high-single digit returns in short-dated European ABS. The focus will be on Western European ABS, backed by residential mortgages, consumer loans and leases. Loans to SMEs will also be targeted, as well as ABS CDOs.

Structured Finance

UK bank poaches RBS pair

Marc Sefton and Kieran McSweeney are leaving RBS to join Shawbrook. They will jointly lead a new wholesale funding division.

Sefton was a director at RBS originating and executing structured finance debt facilities, having previously worked at Barclays Capital. McSweeney led a team focused on the origination and execution of strategic debt solutions in the UK specialty finance sector, having previously worked at Morgan Stanley and Barclays Capital.

Structured Finance

Indian rating agency offer made

McGraw Hill Financial is making a voluntary open offer to acquire up to 15,670,372 shares in Indian rating agency CRISIL, representing 22.23% of the total equity shares outstanding. Full acceptance of the offer would increase McGraw Hill's total stake in CRISIL from 52.77% to 75%.

McGraw Hill would maintain CRISIL as an independent company. The cash offer of R1210 per share represents a premium of 29% to the closing share price on 31 May and the tender offer period will begin next month, before concluding in early August.

Structured Finance

Broker sets up London base

Gottex Brokers has opened a London office providing credit trading services in structured credit and rates, global high yield and investment grade credit. It will serve clients in EMEA and around the world and will manage relationships with institutional investors such as asset managers, hedge funds, family offices and pension funds.

The new London credit team comprises Robert Burns, Abid Hussain and Elka Truchan. Burns joins from Avoca Capital, where he was director of sales and marketing, Hussain joins from Kleinwort Benson, where he was head of high-yield fixed income, and Truchan joins from Vyapar Capital Market Partners, where she was e-commerce and sales director.

Patrick Knaus and Frederic Vibert both also join the firm and will be based in Lausanne. Knaus joins from UBS, where he was most recently executive director of the rates and structured notes department, and Vibert joins from the agency brokerage of GFI Group, where he was head of fixed income and FX for Europe and Middle East.

Structured Finance

Restructuring officer brought on board

Gleacher & Company has appointed Christopher Kearns of Capstone Advisory Group as ceo and chief restructuring officer. The company has also retained Capstone to assist with its restructuring process and announced an exit from its investment banking business.

Kearns will remain employed by Capstone while serving as Gleacher's principal executive officer. He co-founded Capstone in 2004 and has since served as executive director and manager.

Capstone will assist in Gleacher's restructuring process, including evaluating strategic alternatives and providing restructuring advice and assistance. Gleacher will also exit its investment banking business immediately, affecting 20 jobs, two months after shutting down its RMBS group (SCI 11 April).

CDS

Electronic markets head appointed

GFI Group has named James Toffey as global head of electronic markets. He will be responsible for spearheading GFI's services for traders and market makers of cash and derivative financial and commodity products.

Toffey was previously ceo and president at Tradeweb Markets, which he founded. He also launched Benchmark Solutions two years ago (SCI 21 July 2011).

CMBS

CRE vet made underwriting chief

Ladder Capital has named George Kok as head of underwriting. The commercial real estate specialist will report to co-founder and cio Greta Guggenheim.

Kok joins from Bank of America Merrill Lynch, where he was md and co-head of real estate structured finance. Before that he led conduit programmes at Merrill Lynch and co-led Morgan Stanley's conduit programme.

Insurance-linked securities

Portfolio manager joins Bermudian team

Lancashire Capital Management has appointed Mathieu Marsan as portfolio manager and actuary in Bermuda. He joins from Pentelia Capital Management, where he spent the last six years.

Marsan's duties at Pentelia included risk modelling, portfolio construction and management of all ILS asset classes. He has also worked as an insurance derivatives trader for Ritchie Capital Management and before that was an actuarial advisor at Desjardins Financial Security.

Risk Management

Tech consultancy adds collateral management pro

Catalyst Development has appointed Storme Thompson as managing partner. She specialises in collateral, cash and treasury management and will report to senior partner Peter Stone.

Thompson was most recently at Credit Suisse where she was vp in the strategic change group, implementing programmes across collateral, clearing and liquidity management. Before that she spent over a decade at Deutsche Bank.

Risk Management

London clearing transition confirmed

ICE Clear Europe will provide clearing services for NYSE Liffe's London-based derivatives market from 1 July. The subsidiaries of ICE and NYSE Euronext entered into a clearing services agreement late last year, when ICE agreed to acquire NYSE Euronext (SCI 21 December 2012).

RMBS

New name for investment firm

UCM Partners is rebranding as Semper Capital Management, effective from 1 June. The firm's senior management, investment personnel and ownership remain unchanged.

The firm specialises in RMBS, CMBS and ABS, offering investors access to a range of securitised debt investment platforms, from private absolute return to public index-based strategies.

RMBS

NY AG files foreclosure paperwork suit

New York Attorney General Eric Schneiderman has filed a lawsuit against HSBC Bank USA and HSBC Mortgage Corporation for failing to follow state law in its foreclosure actions. By failing to lodge certain paperwork in a timely fashion, HSBC and other companies are alleged to have prevented homeowners from accessing settlement conferences which could help them keep their homes.

When looking to foreclose on a homeowner, residential mortgage lenders, servicers and their agents must file a request for judicial intervention (RJI) and attend a settlement conference within 60 days. However, institutions such as HSBC have delayed filing the necessary paperwork, while homeowners have faced additional interest, fees and penalties.

Schneiderman says HSBC repeatedly failed to file the RJI in a timely manner, with close to 300 instances from four counties alone. In some cases homeowners waited two years for the RJI to be filed, all the while falling further behind in payments.

The lawsuit seeks to compel HSBC to file RJIs in all cases where it has already filed a proof of service and to file future RJIs at the same time as it files a proof of service. The Attorney General has also pledged to bring similar actions against other mortgage lenders.

RMBS

FHFA suit settled

The FHFA and Citi have reached a settlement in connection with a suit FHFA filed on 2 September 2011, alleging that the defendants misled Fannie Mae and Freddie Mac into buying US$3.5bn in RMBS. In a stipulation filed with the court, the parties stated that they "have reached a settlement disposing of all claims asserted" in the action. The terms of the settlement were not disclosed.

ABS

Private SLABS on review

Moody's has placed under review for possible downgrade 60 classes of notes from 24 private student loan securitisations sponsored, administered and currently serviced by Sallie Mae. The move was prompted by the increased risk of servicing disruption as a result of SLM's intention to separate its education loan management business and consumer banking business.

The notes under review include 58 senior classes and two subordinated classes. Approximately US$15.8bn of ABS bonds are affected by the action.

Under SLM's plan, private student loans will be serviced by a consumer banking business, which will be materially smaller and less diversified than SLM in its current integrated form. The small scale and lack of diversification will increase the probability of servicing disruption, Moody's notes, which would negatively affect performance of the underlying private student loan portfolio.

In addition, the securitisations do not include back-up servicing provisions. The presence of a back-up servicer would facilitate a smooth servicing transfer in the event of a financial distress of the existing servicer and, consequently, enable stable performance of the underlying student loans.

During the review period, Moody's will analyse specific details of the new servicing arrangements as they emerge and assess their potential impact on performance of the underlying private student loan pools.

ABS

NCSLT SLABS reviewed

Moody's has downgraded 74 classes, upgraded nine classes and confirmed 14 classes of notes in 15 National Collegiate Student Loan Trust ABS backed by private student loans. The loans are primarily serviced by the Pennsylvania Higher Education Assistance Agency, with US Bank acting as the special servicer. GSS Data Services, a wholly owned subsidiary of Goal Structured Solutions, is the administrator for all trusts.

The primary rationale for the downgrades is the performance deterioration in the underlying student loan pools and the consequent substantial erosion of total parity levels for all transactions. The total parity has declined to a range of approximately 75%-87%, as of March 2013, from a range of approximately 85%-92% as of April 2011. To reflect the elevated delinquencies and defaults on the underlying loan pools, Moody's increased its lifetime expected net losses on all 15 transactions to a range of 25%-49.6% from a range of approximately 24%-36%.

The upgrades of nine classes of notes are due to the build-up in subordination as a result of the principal pay-down of outstanding notes, which more than offsets the negative impact of increased expected net losses and decreased total parity.

The ratings of the class A tranches also reflect the agency's view that the probability of occurrence of an event of default (EOD) is low. Therefore, the ratings on these tranches continue reflecting sequential principal payments and the resulting differentiation in their credit quality. Despite the large amount of credit enhancement supporting the first-pay class A tranches, the probability of an EOD - however low - negatively affects their credit quality and prevents them from achieving a Aaa rating.

The ratings of the most junior class A notes of the 2005-2, 2006-1, 2006-2, 2006-3 and 2007-1 deals could be upgraded in the future, if the remaining expected net losses are 10% lower. The ratings of the most junior class A notes of the 2004-2, 2005-1, 2005-2, 2005-3, 2006-1, 2006-2, 2006-3, 2006-4, 2007-1 and 2007-2 transactions could be downgraded if the remaining expected net losses are 10% higher. The ratings of the most junior class A notes of 2001 Master Trust, 2003-1, 2004-1, 2007-3 and 2007-4 would not be affected if remaining expected net losses are 10% higher or lower.

Structured Finance

Multi-credit fund launched

Babson Capital Europe has launched the Babson Capital Global High Yield Credit Opportunity Fund. The open-ended multi-credit fund aims to provide investors with access to high yielding beta exposures across performing global loan and bond markets, with opportunistic allocations to CLOs and stressed/distressed debt.

"Combining these individual components into a single strategy will address the needs of those investors looking for relative value and dynamic asset allocation within the global high yield credit class," the firm says.

It adds that it has seen increased demand from investors who want to reduce the number of components within asset allocation. "Rather than hiring separate loan and bond managers, pension funds and their advisors are instead selecting specialist credit managers with global expertise across the various high yield sectors, who can tactically take advantage of market opportunities."

In response, Babson Capital Europe created bespoke mandates for its institutional clients, which dynamically allocate between senior loans, high yield bonds and other below investment-grade assets in both North America and Europe. With over US$750m raised in dedicated multi-credit segregated accounts in the last 12 months, the firm is now launching an open-ended strategy to compliment other pooled funds across its global high yield platform.

Structured Finance

Project finance to see capital markets boost

S&P expects new ways of financing infrastructure projects throughout EMEA, developed in the face of declining bank lending, to prompt an increase in debt issuance in the industry in 2013. The agency says that the outlook for credit quality in the sector will remain stable over the rest of this year.

"The project finance industry will likely see a pick-up in the issuance of capital market debt in 2013, backed by governments, financial institutions and multilateral agencies," confirms S&P credit analyst James Hoskins. "In recent years, we've seen only limited issuance of project finance capital market debt in EMEA, with the vast majority of infrastructure funding requirements being met by bank lending. But we expect to see debt issuance start flowing again this year, thanks to a number of alternative financing structures - established to help project companies achieve strong investment-grade ratings - at last gaining momentum."

The agency cites the introduction of the UK Government Guarantee Scheme and the UK Treasury's proposed Private Finance 2 initiative as examples. "Outside of the UK, the main impetus of capital market project finance issuance remains the European Investment Bank's (EIB) Project Bond Initiative," comments Hoskins.

He adds: "While we note that work continues on previously announced pilot projects, the weakened credit quality of some public sector counterparties - coupled with stresses on sovereign ratings - have stymied project development in some jurisdictions. That said, in view of the EIB mandate and EU funding, we remain confident that the first projects supported by the Project Bond Initiative will reach financial close during 2013."

CDO

CRE CDO unwound

Newcastle Investment Corp has divested 100% of the assets in Newcastle CDO IV. The firm sold US$153m face amount of collateral at an average price of 95% of par. The sale will result in US$77m of third-party debt being paid off at par and the termination of the trust.

Newcastle directly holds approximately 50% of the CDO's capital structure. This transaction will result in approximately US$68m of proceeds to the firm.

It will recover par on US$60m of CDO debt that had been repurchased in the past at an average price of 52 cents and US$8m of proceeds to its subordinated interests. The final distribution of funds from CDO IV is expected to occur on 24 June.

CDO

Further Trups CDO auction due

A sixth auction is due to be conducted for Libertas Preferred I on 20 June. The securities will only be sold if the proceeds equal to the total senior redemption amount.

CDS

CDS auctions due

Two auctions to settle credit derivative trades are to be held next week. The first is in connection with Bankia CDS on 5 June, while the second is related to URBI, Desarollos Urbanos, Sociedad Anonima Bursatil De Capital Variable CDS the day after.

CDS

Call for reassessment of CDS ban

ESMA has published technical advice evaluating the impact of the regulation on short selling and certain aspects of credit default swaps on European financial markets. The document is in response to a European Commission request for technical advice to inform its report to the European Parliament and Council on the impact of the regulation, due by end-June.

The advice was requested only a short time after the implementation of the regulation on 1 November 2012 and so there were limits to the market data available, as well as limited regulatory experience in supervising the regulation's requirements to draw on, ESMA notes. The report makes a number of recommendations that should help to improve how the regulation works in practice, with the overall recommendation that the regime be reassessed at a future date when more data and experience have been accumulated.

ESMA was asked to report on the observable effects of the regulation and carried out an analysis on: the market impact of the transparency requirements, restrictions on uncovered short selling and uncovered sovereign CDS and of any temporary measures restricting short selling; and whether the current provisions of the regulation and their application are fulfilling the needs of market participants in terms of transparency and the needs of the regulators to perform their supervisory functions.

Among the report's key findings was that no compelling impact on the liquidity of EU single name CDS and on the related sovereign bonds markets could be noticed, except in a few countries. However, the liquidity in European sovereign CDS indices has been somewhat reduced.

Regarding the ban on uncovered sovereign CDS transactions, key recommendations were: that higher legal certainty could be pursued by clarifying wording in the legal text (for example, on the correlation test); and that refinements to the detailed provisions could be envisaged for use of sovereign CDS indices for hedging purposes, cross-border hedging under certain liquidity and correlation circumstances, and group hedging by a particular and dedicated entity.

CLOs

Next Euro CLO nears

Further details have emerged on CELF Advisors' forthcoming €300m European CLO - Carlyle Global Market Strategies Euro CLO 2013-1. The deal comprises six tranches of fixed and floating rate notes.

S&P has assigned preliminary ratings to the €180m class A notes (triple-A), €33m Bs (double-A), €17m Cs (single-A), €13m Ds (triple-B) and €21m Es (double-B). The capital structure also includes a €36m unrated subordinated class.

The portfolio at closing is expected to be diversified, primarily comprising broadly syndicated speculative-grade senior secured term loans and senior secured bonds.

CMBS

Weak recourse provisions critiqued

Loan documents for a number of recent CMBS contain revisions to recourse liability provisions that are credit negative for CMBS, according to Moody's. These provisions define the lender's ability to pursue both the borrower and the borrower's deep-pocketed controlling sponsor, if the borrower commits any 'bad boy' acts.

Bad boy recourse liability provisions dissuade and penalise certain acts of the borrower that harm the lender's collateral or the lender's ability to efficiently realise on that collateral, if necessary. But the recent revisions to the recourse liability provisions: cap recourse liability; eliminate full loan recourse liability for breaches of subordinate debt and transfer restrictions and/or SPE separateness covenants (substituting recourse for losses in its place); and omit guarantor net worth covenants. If recourse liability provisions are insufficiently precise or inadequately punitive, borrower activities that transaction documents once strictly forbade become simply part of a cost-benefit analysis that a borrower can consider when times get tough, Moody's suggests.

A handful of recent transactions have incorporated a hard cap of 10%-20% of the loan amount on the sponsor's recourse liability for both losses and full recourse. In Moody's analysis, if loan documents stipulate a cap on recourse, the agency takes into account the amount of the sponsor's recourse liability as a percentage of the full loan to determine whether the cap weakens a deep-pocketed sponsor's incentives to discourage bad borrower behaviour. If the incentives are weak, it adjusts credit support levels to account for the increased risk of bad borrower behaviour.

Some recent loan agreements have also provided that certain bad acts that have traditionally triggered full recourse liability will instead trigger liability for only the losses a lender has suffered. Moody's says that the inability to definitively prove such losses renders recourse liability potentially toothless. In the agency's analysis, it consequently adjusts credit support levels as necessary to account for this increased risk.

Finally, a small number of recent transactions have omitted a net worth covenant from the recourse guaranty for guarantors that are entities. Moody's says that this is credit negative because a guarantor's incentive to prevent a borrower's bad acts flows directly from the guarantor's desire to protect its own assets from liability relating to the loan.

Without an adequate minimum net worth covenant, the sponsor could divest itself of its assets particularly when the guarantor is an entity rather than a person. As a consequence, the sponsor might have little or no incentive to ensure that a borrower complies with the loan documents.

The agency evaluates the ability of the parent entity to effectively shield itself from recourse liability by divesting itself of assets. It adjusts credit support levels as necessary to account for the increased likelihood of a borrower's bad behaviour resulting from a sponsor's lack of incentive to prevent such behaviour.

CMBS

UNITE refi prepped

HSBC and Lloyds are in the market with a fixed-rate UK CMBS backed by student accommodation. The £380m UNITE (USAF) II transaction will fund the repayment of a UNITE subsidiary's debt, including the refinancing of the existing UNITE (USAF) CMBS notes.

Fitch and S&P have assigned a preliminary rating of single-A to the single tranche of notes. The loan is secured on an initial portfolio of 39 student accommodation buildings located in 15 towns and cities throughout England and Scotland.

At closing, a member of the obligor group will enter into a £25m five-year revolving credit facility with Lloyds TSB Bank. Lloyds, the issuer and HSBC Bank will share a common security package.

Between expected final and legal final maturity, S&P believes that the underlying collateral can be sold in a real estate work-out scenario to meet repayment by legal final maturity. However, its analysis considers that the presence of pari passu debt alongside the rated notes may result in a more complex recovery process in any work-out scenario, with potentially lower recovery proceeds.

CMBS

CMBS delinquencies inch up

The Trepp CMBS delinquency rate inched up by 4bp in May, one month after posting its lowest reading in more than two years. The delinquency rate for US commercial real estate loans in CMBS was 9.07% at the end of last month.

The resolution of distressed US CMBS loans was a major factor in driving the delinquency rate lower over the past few months. However, loan resolutions dropped sharply in May, with only US$858m in loans resolved, roughly 46% less than the amount resolved in April. The removal of these distressed loans from the delinquent assets bucket created 16bp of downward pressure on the delinquency number.

Furthermore, about US$266m in loans that were delinquent in April managed to pay off without a loss in May. Removing these loans from the delinquent category added an additional 5bp of downward pressure to the rate.

Loans that cured put 23bp of downward pressure on the May delinquency rate. This included a few eight-figure hotel loans that saw their delinquency status flip from non-performing past balloon maturity date to performing past balloon maturity. These loans helped to drive some of the improvement in the rate for the overall property type.

Putting upward pressure on the rate, meanwhile, were US$2.5bn in newly delinquent loans in May. New delinquencies were up significantly from April's US$1.6bn, totalling about 46bp. The May reading is more in line with the results for February and March of this year, making April's result that much more of an outlier, Trepp notes.

With the exception of loans backed by industrial properties, all major property types saw their delinquency rates fall in May. The bulk of the degradation of the industrial rate in May can be traced to the US$190m StratReal Industrial Portfolio I (see SCI's CMBA loan events database), whose inclusion led to a 77bp increase in the property type's rate.

Of the five major property types, hotel loans led the pack with a 65bp improvement. Two large notable loans that became delinquent in May were the US$716.5m DRA/Colonial Office Portfolio and the US$186m Four Seasons Aviara Resort.

CMBS

CMBS liquidation rate reverts

US CMBS liquidation volume fell back below US$1bn in May, according to Trepp, although loss severity moved up on a majority of losses in the greater than 2% category. May liquidations totalled US$849.2m, relative to the 12-month moving average of US$1.3bn.

The number of loans disposed with a loss in May came in at 82, down from 128 in April. The 82 loan liquidations resulted in US$408.9m in losses, translating to an average loss severity of 48.15%. May's reading was 2.35 percentage points higher than April's 45.8% and above the 12-month moving average of 42.54%.

Since January 2010, servicers have been liquidating at an average rate of US$1.16bn per month. The average size of liquidated loans in May was US$10.36m, lower than April's US$12.66m but in line with the 12-month average of US$10.18m.

CMBS

Pace of loan resolutions slows

The specially serviced US CMBS loan universe fell to US$64.2bn as of 31 March, according to Fitch. US$8bn in loans were transferred out of special servicing in the first quarter compared to US$12bn in 4Q12, while the volume transferring into special servicing in 1Q13 was roughly US$4bn.

"The pace of CMBS loans resolving slowed noticeably last quarter, but on a positive note, so did the pace of transfers," comments Fitch md Stephanie Petosa.

However, the amount of time a CMBS loan is staying in special servicing is increasing. The average number of months in special servicing for unsold real estate-owned (REO) loans is 31.4 months.

"Loans that spend more time in special servicing often have the highest loss severity," observes Petosa.

CMBS

Special servicing trends examined

Major changes in the US commercial mortgage special servicing business have occurred over the past five years. In particular, S&P notes that the increase of defaulted loans has raised the relative value of special servicing to CMBS bond valuation and performance.

Special servicers have responded to the increase in special servicing volume in various ways, including: hiring experienced work-out personnel, often with industry experience going back to Resolution Trust Corp; increasing specialisation of staff to focus on property type, geographic locations and pre/post foreclosure activities; investing in or upgrading servicing and asset management systems; and implementing creative work-out/disposition strategies. The fees associated with commercial property transactions and control of the fate of the underlying real estate made the business more relevant than it traditionally is during good times, when default rates are low.

The delinquency rate for the S&P-rated universe of US rose from approximately 1.1%, as of 31 December 2008 to 9.62% in December 2012. Loans associated with Fannie Mae and Freddie Mac, insurance companies and on-balance sheet loans showed a significantly lower delinquency rate throughout the period, however.

Breaking down the delinquency rate by property type, the relative underperformance of lodging over the past five years is clear. The short-term nature of lodging occupancy and rental rates helps explain the collateral type's quick performance drop compared with a loan with office collateral, where leases are of a longer term and for which performance typically lags the broader economy.

By breaking out hold times for US CMBS loans where the collateral property was foreclosed and the REO property liquidated by property type, multifamily collateral was consistently foreclosed upon and resolved more quickly than any other asset type during the past five years, according to S&P. "We believe this may partly be attributable to the decreasing homeownership rate over the period, resulting in increases in demand for apartments, and the better financing terms available through Fannie Mae and Freddie Mac for multifamily properties compared to all other property types."

The unpaid principal balance (UPB) and number of loans in special servicing trended up from year-end 2008 through year-end 2009. S&P suggests that the slight decline in UPB between 2009 and 2010 was associated with multifamily properties clearing the market, while the increase in problem loans and REO was associated with smaller loan balances and properties. In general, 2010 to 2012 marked the beginnings of overall improvements and declining special servicing business.

Based on the current trend of increased new US CMBS issuance and the greater availability of low-interest financing, the number of commercial mortgage loans and outstanding principal balances in special servicing will likely continue to fall and potentially at a faster rate. An example of this trend is the increasing popularity of auctions as a price discovery and clearing mechanism for loans and REO properties.

Another factor that S&P believes will continue to contribute to this decline is an improved willingness on the part of some borrowers to cover operating shortfalls for properties experiencing short-term cashflow issues, with a goal of holding on to the properties as fundamentals and values improve. Accordingly, the number of US commercial properties becoming delinquent and entering special servicing should continue to decline until 2015.

Between 2015 and 2017, a large number of loans become due and - depending on refinancing abilities - the volume entering special servicing may again increase. Special servicers may retain staff and redeploy them to other areas, in anticipation of higher activity beginning in 2015.

CMBS

CRE hedging guidelines issued

CREFC Europe has released 'Guidelines for interest rate hedging in European CRE finance transactions'.

The association established a hedging working group last year to study and report on interest rate hedging practices used in European CRE finance transactions. The group's objective was the formulation of practice guidelines that could be useful to market participants as liquidity returns to the CRE finance market and the supply of interest rate hedges is reduced. It focused on: the need for interest rate hedging in CRE finance transactions; the structural alternatives typically available to achieve such hedging; the relevant considerations in structuring interest rate hedging in CRE finance transactions; and certain practical guidelines that could potentially be relevant to market participants in structuring future transactions.

The hedging working group was chaired by Mark Battistoni of Chatham Financial and co-chaired by Sidley Austin's Partha Pal.

CMBS

CMBS loss severities dip

The weighted average loss severity for all loans backing US CMBS that liquidated at a loss was 40.7% in 1Q13, down from 40.8% in the previous quarter, Moody's reports. Excluding liquidated loans with losses of less than 2%, the figure is 52.9%, down from 53.1% the previous quarter. Loans with losses of less than 2% account for 23.5% of the sample size by balance and 19.8% by number.

For liquidated loans in the 2004 to 2007 vintages, maturity defaults had a weighted average loss severity of 11.4%, compared to 52.5% for term defaults. Excluding loans with losses of less than 2%, maturity defaults had a weighted average loss severity of 35.5%, compared to 55.5% for term defaults.

Loans backed by retail properties had the highest weighted average loss severity (47.2%), while loans backed by self-storage properties had the lowest (33.3%).

The three vintages with the highest loss severities are 2006 (at 49.3%), 2008 (46.8%) and 2003 (43.3%). As of March 2013, these vintages constituted 29.2% of CMBS collateral and 32.8% of delinquent loans.

"We expect aggregate conduit losses - inclusive of realised losses - of 8% of the total balance at issuance for the 2005 vintage, 11.3% for the 2006 vintage and 13.5% for the 2007 vintage, with most of the losses yet to be realised," comments Moody's vp and senior credit officer Keith Banhazl. "The aggregate realised loss for these three vintages is currently 2.7%."

From 1 April 2012 to 15 March 2013, liquidations amounted to US$15.7bn of debt, up slightly from the US$15.5bn during the same period the previous year. 1548 loans liquidated (with a weighted average loss severity of 41.2%), compared to 1,764 loans (with a weighted average loss severity of 44%) over the same period the previous year.

"The balance of liquidations will continue to grow, although we expect monthly fluctuations because of uncertainty surrounding the outcome of certain large commercial real estate loans, which would skew liquidation volumes," adds Banhazl.

Of the 10 metropolitan statistical areas with the highest dollar losses, New York had the lowest percentage severity (22.5%) and Detroit had the highest (61%).

Total cumulative realised losses for all liquidated loans rose in 1Q13 to 2.6% from 2.5% in the previous quarter. For all liquidated loans, the 2000 CMBS vintage had the highest cumulative loss rate (4.4%, the same as the previous quarter), while the 2001 CMBS vintage had the second-highest cumulative loss rate (3.9%).

"Cumulative loss rates will continue to rise because of the significant share of recent vintage loans currently in special servicing," Banhazl suggests.

CMBS

Opera pre-pack proposal unveiled

Further details of the Kennedy Wilson/ Värde Partners Europe restructuring proposal for the Opera Finance (CMH) CMBS have been disclosed ahead of a noteholder meeting on 26 June. The proposal involves the acquisition of all the properties for cash in a pre-pack enforcement sale undertaken by a receiver (see SCI's CMBS loan events database).

The KW/Värde proposal provides for the purchase of the properties by newly incorporated SPVs for an aggregate cash purchase price of €306m. Of this cash, €242.9m is allocated to the class A noteholders, €50m to the class Bs, €10m to the class Cs and €3.1m to the class Ds.

However, due to a proposed apportionment of rental proceeds received during the current rental quarter between the vendor and purchaser, the total cash available will not be sufficient to make these pre-allocated redemption payments in full after the application of senior items in the waterfall per the pre-enforcement income priority of payments. The special servicer estimates that the shortfall will be €4m. The class A notes will be unaffected by the shortfall, while 43.75% of the shortfall will be allocated to the class Bs and Cs and 12.5% to the class Ds.

In order to redeem the notes in this way, conditions five (interest) and six (redemption) of the documentation will need to be amended. Such amendments constitute a basic terms modification and therefore need to be approved by an extraordinary resolution of each class of notes.

Following the appointment of a receiver (anticipated to be Ernst & Young) to maximise recoveries under the senior loan, it is anticipated that options in respect of the relevant shares in three of the propcos would be exercised. The portfolio sale agreement is expected to be completed by 15 July 2013.

In the event that the extraordinary resolution is not passed, the special servicer will enforce the loan security and appoint the proposed receivers to sell the properties.

Risk Management

Clearing costs highlighted

Sapient Global Markets has published an in-depth study on how new central clearing mandates will impact investment performance for buy-side firms. The research demonstrates significant drag on portfolio returns in the new regulatory environment: the drop in return ranges from between 0.20%-0.62% for cleared hedges, up to almost 1% for traditional uncleared bilateral OTC trades.

The report, entitled 'Cost of clearing: a buy-side investigation', compares the overall portfolio performance of a typical fixed income fund using four different hedging instruments over a fixed historical period: uncleared swaps subject to pre-2008 margin requirements; uncleared swaps subject to the Basel Committee/IOSCO guidelines for margining (effective after 2015); swaps cleared through LCH.Clearnet SwapClear; and Eris Standard swap futures (cleared through CME).

"Because of the significant impact on performance these results demonstrate, as well as the 10 June timeline set by regulators, it is apparent that portfolio managers must examine their own hedging strategy based on expected cost of clearing with a renewed urgency," comments Ben Larah, manager, Sapient Global Markets. "Once the post-Dodd-Frank and BCBS/IOSCO recommended treatment for uncleared derivatives takes effect, using standardised and centrally cleared instruments will be the cheapest available option."

On 10 June 'Category 2 Entities' - including securitisation vehicles, insurers, investment funds and non-swap dealer financial institutions - must begin mandatory clearing. In order to comply with the regulations, firms need to make informed decisions about how to invest and where to clear.

The results of the study show that cumulative portfolio returns are highest when hedging is performed using uncleared swaps in a pre-2008 environment and lowest when hedging is performed using uncleared swaps in a Basel/IOSCO recommended environment. Once the Basel/IOSCO recommendations take effect, the use of customised uncleared swaps will jump from being the cheapest way to the most expensive way to hedge.

Risk Management

FpML coverage enhanced

ISDA has published the Recommendation for Financial products Markup Language (FpML) version 5.5. One area of expanded coverage relates to the European reporting requirements detailed by ESMA in its technical standards published last autumn, including coverage of listed derivatives as mandated by EMIR. Further functionality has been included to support the reporting of complex and bespoke products in different jurisdictions, as well as for clearing functionality, where credit limit check messages have been added to support clearing certainty workflows.

Work has started on version 5.6, with a goal to cover requirements in jurisdictions where reporting to trade repositories is expected to go live towards the end of 2013 and in early 2014, including several Asian jurisdictions. While the FpML Standards Committee focuses on the coverage of the regulatory reporting requirements in different jurisdictions, work continues on further standardisation and product representation for different asset classes. The emphasis on clearing and electronic execution workflow is likely to increase further as well, ISDA notes.

RMBS

Buy-back targets mezz bonds

UCI has launched a fixed price tender offer for 11 Spanish RMBS tranches from across the UCI 10 to UCI 17 deals. The bank is offering to purchase up to €300m of the €3.4bn currently outstanding across the bonds.

This is the seventh tender for UCI bonds, with the first being in August 2009 and the last in November 2010. European securitisation analysts at Barclays Capital estimate that €2.2bn of bonds have been repurchased over the previous six tenders, with the latest one being the first instance when non-senior bonds (class B and C notes) are offered for tender.

Tender purchase prices range from 83-89 for class A notes, 76-77 for class A2s, 62-67 for class Bs and 50-55 for class Cs. The Barcap analysts note that these prices offer a slight premium to current secondary market levels, though there is limited price transparency, particularly down the capital structure.

"For the non-senior bonds offered for tender for the first time, and given that three of these non-senior bonds are currently rated below investment grade, we expect investors will be glad to reduce their exposure," they observe.

SCI's PriceABS archive shows that the UCI 15 A tranche was talked at low/mid-70s yesterday, up from 61, where it was last covered on 25 September.

The tender offer expires on 6 June, with results expected the following day.

RMBS

HAMP gets two-year extension

The Making Home Affordable Program has been extended from 31 December 2013 to 31 December 2015. The new deadline was determined in coordination with the FHFA to align with extended deadlines for the Home Affordable Refinance Program (HARP) and the Streamlined Modification Initiative for homeowners with loans owned or guaranteed by the GSEs.

Since its launch in March 2009, about 1.6 million actions have been taken through the programme to provide relief to homeowners and nearly 1.3 million homeowners have been helped directly by the programme. As of March 2013, more than 1.1 million homeowners have received a permanent modification of their mortgage through HAMP, with median savings of US$546 every month - or 38% of their previous payment.

Data from the OCC shows that the median savings for homeowners in HAMP is higher than the median savings for homeowners in private industry modifications, which has helped homeowners in HAMP sustain their mortgage payments at higher rates. As a result, HAMP modifications continue to exhibit lower delinquency and re-default rates than industry modifications.

RMBS

Bluestone clerical error rectified

The principal balance of mortgages assigned at closing for the Bluestone 2005, Bluestone 2006 and Bluestone 2007 RMBS was overstated by the unintentional inclusion of fees and interest arrears following a clerical error. This has resulted in under-collateralisation of the notes by £208,821, £1.33m and £4.36m respectively.

As a form of rectification, the seller Redstone has repaid these balances to each of the Bluestone issuers. These amounts will be available on the upcoming June payment date for principal redemption of the notes in each transaction. Following the one-off additional payment to noteholders, reconciliation between the assets and liabilities of the transactions should be complete.

Consequently, Fitch says that no rating action is warranted.

RMBS

MILAN introduced in Mexico

Moody's has updated its approach to rating Mexican RMBS. The adoption of the new methodology won't result in any changes to existing ratings, however.

Under the new approach, MILAN becomes a key element of Moody's loan- and portfolio-level evaluation for Mexican RMBS. The approach combines the MILAN collateral analysis model with a cashflow model.

Moody's primarily calibrated MILAN for Mexico by considering the historical performance of mortgages securitised in the country and by benchmarking the Mexican residential real estate market to other jurisdictions that also use MILAN.

RMBS

Delayed write-downs hit RMBS

More than US$1bn of losses have been retroactively recognised on 170 US RMBS. The result of mortgage modifications, Moody's notes in its latest Credit Outlook publication that the losses are credit negative for the impacted transactions.

According to Ocwen Loan Servicing, which began servicing the transactions in December, the transactions incurred the losses because of principal forbearance modifications the previous servicer (Homeward Residential) undertook before July 2012. In 50 transactions, the losses exceeded US$10m each; in 13 of the 50, those losses exceeded US$30m each. In another 57, losses were US$1m-US$10m apiece. Subprime mortgage loans back the majority of the affected transactions.

The delay in recognising losses allowed mezzanine bonds to continue receiving interest payments, thereby reducing excess spread available to amortise more senior bonds, Moody's observes. The sudden write-down also affects some senior bonds whose payment priorities are now more likely to change earlier than previously expected.

Ocwen believes the situation is a one-time occurrence and does not expect additional losses in these transactions resulting from old forbearance modifications.

RMBS

ULC proposal criticised

The American Securitization Forum has submitted a comment letter in response to the Uniform Law Commission's (ULC) draft residential real estate mortgage foreclosure process and protections. The ULC is proposing to reverse the holder in due course doctrine, which currently provides that a mortgage assignee that paid value for a loan in good faith and that lacked notice of certain claims and defenses to payment that the borrower has against the original lender takes the loan free of those claims and defenses; the assignee remains subject to real defenses, such as duress.

This change would likely significantly increase foreclosure timelines for mortgage loans transferred to subsequent holders, the association warns. ASF's letter highlights the importance of maintaining established holder in due course protections in order to support liquidity and efficiency in the secondary market, which depends on confidence among investors that mortgage loans will be enforceable in accordance with their terms, without unnecessary impairment due to potential and unquantifiable assignee liability.

The ULC met in April concerning the holder in due course proposal and is currently working on revising the draft law. At its upcoming meeting in July, the ULC again plans to specifically discuss the holder in due course and assignee liability protections.

RMBS

Margining service enhanced

BNY Mellon has enhanced its DM Edge product by expanding its bilateral margining capabilities to include forward-settling MBS, as recommended to help reduce counterparty and systemic risk by the Fed's Treasury Market Practices Group (TMPG). The aim is to help MBS trading counterparties reduce the credit risk inherent in forward transactions by exchanging collateral as protection against loss in the event of default. The TMPG recommends that exposures from forward-settling transactions be margined beginning early this month and substantially completed by the end of the year (SCI 16 April).

RMBS

Ability-to-repay rule amended

The Consumer Financial Protection Bureau (CFPB) has amended its ability-to-repay rule for small creditors, community development lenders and housing stabilisation programmes (SCI 11 January). It has also revised the rules on how to calculate loan origination compensation for certain purposes.

"Our ability-to-repay rule was crafted to promote responsible lending practices," comments CFPB director Richard Cordray. "[These] amendments embody our efforts to make reasonable changes to the rule in order to foster access to responsible credit for consumers."

The amendments: exempt certain non-profit and community-based lenders that work to help low- and moderate-income consumers obtain affordable housing; facilitate lending by small creditors by extending qualified mortgage status to certain loans; and caps points and fees charged by lenders offering qualified mortgages. The amendments will take effect with the ability-to-repay rule on 10 January 2014.

Separately, the CFPB has delayed the effective date of a Dodd-Frank provision that prohibited creditors from financing credit insurance premiums in connection with certain mortgage loans. The rule would have taken effect on 1 June, but was postponed while the CFPB sought clarification over how the prohibition applies to credit insurance products with certain periodic payment features. The prohibition will also now take effect on 10 January 2014.

Risk Management

Counterparty credit risk uncovered - part three

Terri Duhon, managing partner at B&B Structured Finance and author of 'How the Trading Floor Really Works', discusses wrong-way counterparty credit risk

Most of the chatter about counterparty credit risk is around OTC derivatives. Exchange-traded derivatives (ETP) have counterparty credit risk as well, but the overall size of the market (around 10% of the derivative market place), the average maturity of the product (less than one year), the type of product (mostly futures and options) and the daily margining requirements mean that those risks are dwarfed by the OTC market.

When we then examine where the risk lies in the OTC market, we find that the majority of the risk comes from the swaps market (primarily credit and rates) because of both the outstanding size and the long maturities of those products. The first in this series of articles (SCI May 3) examined the counterparty credit risk in a vanilla interest rate swap. The second in this series (SCI May 17) examined the same for credit default swaps. This article will now look at cross-currency swaps (including FX forwards), which are a subset of the interest rate swap market. Importantly, cross-currency swaps have some key differences to same currency swaps, one of which causes "wrong-way" risk.

Wrong-way risk is the term for the counterparty credit risk that results when the creditworthiness of the counterparty is adversely correlated to the mark-to-market of the derivative. In the second article in this series we introduced the risk of the counterparty being correlated to the reference entity in the CDS trade.

In CDS, wrong-way risk refers to the risk of a high default correlation between the seller of CDS protection and the reference entity resulting in the buyer of protection having a high potential future exposure right when the counterparty defaults. Because we generally assume that there is some positive default correlation between all counterparties and all reference entities when we trade CDS, to some extent all CDS trades could fall under the term wrong-way risk from the protection buyer's perspective.

As default correlation is unobservable (as discussed in the second article), the correlation assumption is just that - an assumption. It is an even bigger assumption to say that any one combination of counterparty and reference entity are that much more correlated than any other. Intuitively, it makes sense that dealers are more concerned about buying protection from JPMorgan on Goldman Sachs than on BMW, but putting an exact number on that is the challenge.

The more common association with wrong-way risk is with respect to cross-currency swaps. This includes all swaps that have an exchange of principal in different currencies at maturity.

When we examined credit default swaps in the second article, we identified three main differences between IRS and CDS counterparty credit risk: the symmetric (IRS) versus asymmetric (CDS) graph of potential future exposure; the difference in the potential future exposure as a percentage of the notional of the trade; and the correlation between the credit risk of the counterparty and the market risk of the trade which exists in CDS but not IRS. When we look at cross-currency swaps in contrast with IRS, only the last two differences apply as the potential future exposure for cross-currency swaps is also symmetric.

The difference in the potential future exposure as a percentage of the notional is what causes cross-currency swaps to have a disproportionate amount of risk, particularly compared to IRS. The correlation between the credit risk of the counterparty and the market risk of the trade, which exists in some cases, is what causes wrong-way risk.

While wrong-way risk exists to some extent in all CDS from the protection buyer's perspective and in some cross-currency swaps, in CDS the driver of the wrong-way risk is the correlation between the counterparty's and the reference entity's creditworthiness, whereas in cross-currency swaps the driver of the wrong-way risk is the correlation between the counterparty's creditworthiness and FX spot rates.

As in the case of IRS, cross-currency swaps have symmetric potential future exposure graphs. From a pure market risk perspective, the magnitude of the potential future exposure is the same regardless of which side of the trade the dealer is on.

As relative interest rates in the two currencies and the FX spot rate are the drivers of the mark-to-market, we say that these can go up or down with equal probability. Because there are two drivers of the mark-to-market, it is possible that they move in a way that cancels the other's impact; however, we focus on the scenarios where they amplify each other.

While the potential future exposure graph for a cross-currency swap is symmetric, the shape does not follow that of a vanilla same-currency interest rate swap. The driver of the different shape is the fact that cross-currency swaps have a principal exchange at maturity.

The notionals to be exchanged at maturity are fixed at the inception of the cross-currency swap and based on the FX spot rate at the time. Over the life of the trade, the magnitude of that final set of cashflows far outweighs any other cashflows that might exist in the swap. (FX forwards don't have any other cashflows, but most cross-currency swaps have some combination of fixed and floating legs. We ignore any initial exchange of principal, as that is generally done on day one and thus doesn't come into the potential future exposure calculation.) The two key determinants of the mark-to-market of that final set of cashflows are relative interest rates in the two currencies and the FX spot rate.

Over the life of the trade, one may dominate the other. At the maturity, the only determinant remaining is the FX spot rate on the day of exchange.

A simplified way to think about the potential future exposure is to think about how far the FX spot rate can move from the rate agreed at trade inception. Again, this is a function of the volatility that we assume and the confidence level that we want to analyse (e.g. 95% or 99%).

Based on how volatile the currency is, it can appreciate or depreciate as long as the trade is outstanding. The picture shown below demonstrates this assumption.

For example, imagine that a Mexican corporate has executed a five-year FX forward where the dealer has to pay Mexican pesos in five years and will receive US dollars in exchange. There are no other cashflows. Over five years, if the US dollar appreciates compared to the initial FX spot rate, the dealer has a positive mark-to-market; but if the US dollar depreciates, the dealer has a negative mark-to-market.

We all know that a weak currency is often considered positive for that country's economy. But a currency that is deteriorating rapidly can be a sign of a very weak economy and, in extreme cases, one that is in distress. The wrong-way risk in the Mexican peso example above is that when the US dollar has appreciated significantly against the Mexican peso, there is an increased probability that the counterparty will have deteriorated from a credit risk perspective.

The dealer has a positive mark-to-market when the US dollar appreciates and thus is more exposed to the credit risk of the counterparty exactly when the counterparty has a higher probability of default. However, if the dealer were paying US dollars in five years in exchange for Mexican pesos, this risk from a counterparty credit perspective would not exist. While the counterparty would still have a higher probability of default when the US dollar appreciates, that would be a negative mark-to-market for the dealer.

Hence the concept of wrong-way risk being directional. It is the risk derived from a trade that done in a particular direction generates higher counterparty credit risk than when done in the other direction.

Similar to the CDS counterparty credit risk, these correlations are assumptions that we make. However, if we take a more extreme example, we can see a more direct relationship. Instead of a Mexican corporate, let's assume that the counterparty is the government of Mexico.

The relationship in this case is more direct because the government of Mexico has the power to manipulate its currency in a number of ways in order to stimulate its economy. In the extreme, we could call this moral hazard risk, but it is unlikely that any swap between a government and a dealer will drive the exchange rate policy in that country.

These three articles have given us the tools to understand and manage the counterparty credit risk of the majority of OTC derivatives. The key is to start with the potential future exposure profiles which represent the market risk element of IRS, CDS or cross-currency swaps.

Then we consider the credit risk of the counterparty and any possible adverse correlation between the counterparty and the mark-to-market. At that point we can figure out the best way to manage the risk.

Despite increased levels of general knowledge in this space, we are still debating and discussing the best risk management practices around counterparty credit risk. The fourth and final article in this series will address the management of this risk including loss reserves (i.e. CVA).