Contents

Structured Finance

Casting nets

Hunt for relative value puts range of options on the table

European primary issuance may have been patchy this year, but liquidity in the secondary market has generally increased. The hunt for relative value has become all the more pressing as spreads have tightened.

Regulatory initiatives such as Solvency II and CRD IV weigh on investors' minds, but until regulations come into force it is always possible that their provisions will change. A more pressing concern might be what would happen to pricing if liquidity fell away.

"Capital requirements mean people will have to hold more capital against ABS. My experience is that these rules often get pushed back and watered down, and there is a chance that may happen again," says Conor O'Toole, European securitisation director at Deutsche Bank.

He adds: "It is difficult to go long mezz with all these regulatory issues. Central banks have injected a lot of liquidity, but the question has to be what will happen when they stop doing that."

Daniel Leiter, executive director at Morgan Stanley, is also hopeful that the final form of the coming regulations will not be too punitive. He senses that the market is just now getting up and running again.

"After five years of volatility, securitisation finally works again. Hopefully regulators will appreciate its value and our market will work in a way that it makes sense for banks," says Leiter.

He continues: "Our focus this year is less on the size of our balance sheet and more on the velocity of the balance sheet. Its composition is much more senior-heavy than it was."

While regulatory restrictions remain the perennial problem for the market, canny investors continue to find innovative ways to seek out relative value. There are attractive opportunities in the core and periphery, across ABS, RMBS, CMBS and CLOs.

"European ABS is one of the cheapest markets out there. It can be hard to build a portfolio, but the peripheral market is offering 250bp-plus over Libor for what are essentially strong bonds," notes O'Toole.

RMBS is also very compelling for those investors who are able to buy into it. UK RMBS continues to provide opportunities, but there is also growing interest in certain peripheral bonds.

"RMBS suffers from harsher regulatory treatment for bank buyers versus other fixed income asset classes; this keeps the asset class cheap for asset managers, with liquidity no worse than for other fixed income asset classes," says Warwick Scoggins, head of European RMBS and consumer ABS trading at RBS.

Leiter sees value in some short duration RMBS, such as Granite, which is trading wider than prime. Meanwhile, one RMBS and ABS strategist recommends turning to the periphery in order to find optimal relative value.

The strategist says: "Spain is very interesting from a relative value standpoint because it really offers something for everyone. You can pick up relatively seasoned paper and it comes with the added advantage that Spanish RMBS offers call optionality for free."

Peripheral RMBS also brings regulatory risk though. The Personal Insolvency Arrangement (PIA) process in Ireland (SCI 15 August 2012), for example, could change that market dramatically, depending on take-up.

"PIA was not a consideration until last year, so these new regulations can come into force quickly. Likewise the repossession rules in Spain keep changing, so you are not protected and worst of all you are not paid for being unprotected," says the strategist. "That has to be a consideration."

The strategist also fancies Italian SME CLO bonds. However, he notes that it can be difficult to pick those bonds up at the right price. As with peripheral RMBS, it follows his preferred strategy of targeting "beaten up" deals with forced liquidations, which he believes offer the best value.

To truly find the best relative value, investors may have to widen their scope. Scoggins notes that there are attractive bonds in a range of asset classes, although some high yield pockets - such as CLO and RMBS equity - have rallied a lot and recent valuations are starting to look fully priced.

"The pockets of ABS we think represent the best value right now include shorter-duration investment grade credit with high coupons and decent cash carry. We specifically like UK non-conforming seniors, shorter-duration periphery RMBS seniors in the 250bp-300bp range, investment grade-rated CLO mezz and new issue investment grade-rated mezz across asset classes," he says.

Finally, O'Toole also extols the virtues of CMBS, but only from the core jurisdictions. He says: "It is a sector which provides pitfalls as well as opportunities. Specifically, I like the look of front-pay UK and German CMBS, which can give yields of 6%."

JL

ABS

Student list buoys ABS session

US ABS secondary trading was dominated yesterday by a large student loan list, during what was otherwise a quiet session. BWIC volume was just under US$100m, with aircraft ABS also accounting for a modest amount of paper.

The most recently issued student loan bond circulating yesterday was SLMA 2013-R1 A, which was talked in the low-200s, according to SCI's PriceABS data. In addition, several 2012 tranches were out for the bid, but the oldest was SLMA 2006-1 A4 - which talked around 30. It was last talked at 99.3 in November, when it was also covered at 99.2825.

Among the tranches seen yesterday were a couple of new additions to the PriceABS archive, including EDUSA 2012-2 A (which was talked in the 80 area) and EFSV 2010-1 A1 (which was talked in the 60s). EFSV2 2012-1 A1 was also out for the bid, talked at around 70.

The student loan list also included names such as SLCLT 2008-2 A2, SLMA 2012-E A2B and VSAC 2012-1 A. Those tranches were talked in the 30 area, the 130s and around 80 respectively.

In the aircraft ABS space, meanwhile, the ACST 2006-1A G1 tranche was talked at around 90 and traded yesterday - having been talked at around 93 and trading at high-92 in the final session of May. Another ACST tranche - ACST 2007-1A G1 - was talked in the low-90s and covered at 88.25.

AERLS 2007-1A G3 was both talked and covered in the mid-90s, after talk on 19 June had been in the mid-90s and at 95 handle, when it also traded. Also out for the bid was PALS 2001-1A A1, which was talked at around 40 and covered.

Finally, two JetBlue tranches were available. JBLU FLOAT 3/15/14 was talked in the mid/high-90s and covered at 97.71, while JBLU FLOAT 11/15/16 was talked at around 90 and covered at 89.878.

JL

Structured Finance

Subprime survives trading drop-off

It was a quiet start to the holiday week in the US as the market moves into the third quarter. Non-agency RMBS BWIC volumes remain muted at US$90m, with dealer offering levels largely unchanged.

Subprime RMBS supply held up better than other sectors yesterday. SCI's PriceABS data shows a number of subprime tranches for the session, although a number of bonds failed to trade.

CARR 2006-NC1 M2 was talked in the low/mid-20s, but did not trade. It was previously talked in the low/mid-20s on 28 June and was talked at around 20 on 21 May.

Also out for the bid was CWL 2006-2 M2, which was talked in the high-single digits but did not trade. The tranche was also a DNT back in November and its last successful cover was on 15 October, when it was covered in the low/mid-single digits.

The WFHET 2004-1 A3 tranche was talked in the 90 area, which is also where it was talked in June's final session. The tranche was talked in the low/mid-90s on 10 April and in the mid/high-80s in November last year.

The PPSI 2005-WCH1 M5 tranche did trade successfully during the session, with talk in the mid/high-50s. It was also talked in the mid/high-50s last week and in the mid/high-40s in April, having been talked in the mid-30s in March and in the mid-20s last year.

Away from the subprime sector, BWIC volume was limited. Some Alt-A tranches were circulating, such as MSM 2005-6AR 1A4, which was talked in the mid-80s - the same level it was previously talked on 28 June and last year on 1 August.

In addition, some prime hybrid paper was available, not least in the form of the WAMU 2005-AR12 1A6 bond, which was talked in the low-90s. WAMU 2005-AR12 1A4 was also out for the bid and talked in the mid-90s, while talk on WAMU 2004-AR12 X was in the mid/high-5s.

The US ABS sector was also very quiet, posting only US$72m of BWIC volume. That limited supply was dominated by student loan paper, with a limited number of auto bonds available and credit card ABS proving particularly scarce.

JL

CLOs

CLO bonds in search of buyers

SCI's PriceABS data shows more than three times as many US CLO tranches offered on BWICs that did not trade in yesterday's session as those that did. There was comparatively less activity in European CLOs, but again more tranches in this segment did not trade than did.

The US DNTs include names from a range of vintages, with tranches from 2005 up to 2008 and from 2011 right up to 2013. They also ran the length of the capital structure, from senior to subordinate bonds. Among the DNT tranches were BABSN 2005-2A SUB, RMPRT 2006-1A PS, GALE 2007-3A A1, ABERD 2008-1A B, ALM 2011-4A C, CIFC 2012-1A A1F and OZLMF 2013-3A A1.

However, several other tranches traded successfully during the session, again from a range of vintages. Most of these bonds were from the top of the capital structure, but HICDO 2007-1RA D and EATON 2007-10A C2 were both traded, as was VENTR 2013-13X D. A couple of B notes also traded, such as STCLO 2007-6X B and INGIM 2012-1A B, with the latter talked around 100 and covered at 99.77.

In addition, BLACK 2005-1A A1 was covered in the session and talked at 98.5. The tranche also traded earlier this month and was covered twice in May, including at its last known cover price of 99.561.

AMMC 2006-7A A was also covered yesterday. Talk last month had been at a low-99 handle, around 99, at 99.38 and in the high-90s. ARES 2007-12X A was covered too, with talk from high-98 to low-99. Another noteworthy name covered during the session is the recently-priced NMRK 2013-1A A1.

There were a few European DNTs, but CADOG 4X B1 (covered in the high-80s) and EUROC VI-X D (covered at 72.6) both traded.

JL

CMBS

Secondary CMBS market not shut yet

The quarter began quietly enough for the US CMBS sector, although secondary activity did pick up yesterday. SCI's PriceABS data shows a number of bonds out for the bid, with several covers and some strongly divergent price talk.

"The CMBS market enjoyed a modest lift on the coattails of US equities. Legacy super seniors ended [Monday] a basis point or two tighter. The benchmark GSMS 2007-GG10 A4 bond was the exception, ending the day at 158bp over swaps, 2bp wider to begin the second half of the year. Meanwhile, legacy AMs were being quoted about 5bp tighter," comments Trepp.

Tuesday's session saw several bonds trading, not least from BSCMS deals. BSCMS 2005-PWR8 A4 was covered at 89, for instance, after it was previously covered at 45 on 11 December. Its first recorded cover in the PriceABS archive was on 3 August at 62.

BSCMS 2004-PWR6 A6 was also covered in the session, at 74, having previously been covered on 5 February at 60. BSCMS 2006-PW11 A4 was covered at 94, having been covered at 42 in January. In addition, BSCMS 2006-T24 A3, BSCMS 2006-T24 A4 and BSCMS 2007-T26 A4 were all covered at 100.19, 95 and 85 respectively.

Meanwhile, CGCMT 2006-C4 A3 was covered at 111, having been covered at 58 in November and 62 in October. GSMS 2012-GCJ7 A4 also traded during the session, with talk at 118. That tranche was being talked at plus 125 in July last year.

Another tranche that traded during the session was LBUBS 2007-C2 AM, with talk in the mid/high-300s, 400 area and mid/high-400s. Talk on 15 May had been in the high-200s and the previous cover was recorded at 293 on 25 April.

Finally, MLCFC 2007-8 AMA was talked in the high-400s, around 500 and around 550, before successfully trading. MLCFC 2007-7 AM, however, did not trade - albeit it was talked at around 600, in the low/mid-600s and in the high-600s. Talk on the latter bond ranged from the high-600s to the high-900s in December.

JL

Structured Finance

SCI Start the Week - 1 July

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

Pipeline
CLOs led the way last week, both in terms of new additions to the pipeline and deal prints. Six new CLOs were announced, as well as one ABS, one ILS, one RMBS and two CMBS.

The CLOs comprised: €310m Ares European CLO VI; US$350m NewStar CLF 2013-1; €306.2m Pinewood CLO 2013-1; US$352.75m Saranac CLO I; St Paul's CLO II; and US$362.7m Telos CLO 2013-4. The ABS was €400m Retail Automotive CP Germany 2013 and the ILS was US$125m Mona Lisa Re series 2013-2. The RMBS was Albion No.2, while the CMBS were US$1.3bn COMM 2013-CCRE9 and US961.2m JPMCC 2013-C13.

Pricings
The majority of new issuance was also made up of CLOs. In total, six CLOs priced, as did four ABS, three ILS, one RMBS and one CMBS.

The CLOs were: £660m Alchera 2013; US$413m Ares XXVII CLO; US$300m Gallatin CLO V 2013-1; US$465.5m Halcyon Loan Advisors 2013-2; US$418m LCM XIV Partnership; and US$511m OHA Loan Funding 2013-1. The ABS pricings consisted of: AA Bond Co; €714m Driver Eleven; US$460m Ford Floorplan Auto Securitization Trust Series 2013-F1; and US$304.72m Massachusetts Educational Financing Authority series 2013.

The ILS prints comprised: US$130m Ibis Re II 2013-1; US$75m Mythen Re series 2013-1; and US$75m Tramline Re II Series 2013-1. The RMBS was £200.2m Alba 2013-1, while the CMBS was US$1.5bn MSBAM 2013-C10.

Markets
Student loan paper dominated the US ABS secondary market at the end of the week, as SCI reported on 28 June. Total BWIC volume for Thursday's session was just under US$100m, with aircraft ABS accounting for a slice of that.

SCI's PriceABS data shows the SLMA 2013-R1 A tranche was talked in the low-200s on Thursday. There were also several 2012-vintage student loan tranches out for the bid, while in the aircraft space tranches such as AERLS 2007-1A G3 (talked and covered in the mid-90s) were available.

US RMBS non-agency BWIC supply was US$2bn for the week and trade volume was US$5.5bn, according to Wells Fargo RMBS analysts. "Liquidity seems to be improving, spurred by lessened fears of Fed tapering. Unlike last month, June remit reports did not bring any surprises in the form of forbearance/forgiveness updates," they comment.

Spreads also stabilised in the second half of the week in the US CMBS market. Barclays Capital CMBS analysts report that real money investors are beginning to re-approach some sub-sectors.

"Overall, 2006-07 vintage dupers and AMs finished the week at roughly the same levels as last Thursday's close. AJ/mezz tranches from those vintages, already down anywhere from 10 to 25 points from their local peak, tightened marginally - up a point from last week," they observe.

Meanwhile, many US CLO tranches failed to trade during Wednesday's session, as SCI reported on Thursday (SCI 27 June). There were three times as many DNTs as trades captured in the PriceABS archive.

The DNTs included names from a range of vintages, with tranches from 2005 up to 2008 and from 2011 right up to 2013. They also ran the length of the capital structure, from senior to subordinate bonds. Among the DNT tranches were BABSN 2005-2A SUB, RMPRT 2006-1A PS, GALE 2007-3A A1, ABERD 2008-1A B, ALM 2011-4A C, CIFC 2012-1A A1F and OZLMF 2013-3A A1.

Finally, Spanish ABS and RMBS paper appeared to be popular in the European secondary market, as SCI reported on 26 June. Among the many Spanish bonds out for the bid were SANFI 2006-1 D and BBVAC 2006-2 B, talked in the 50s and 90s respectively.

Deal news
• The Opera Finance (CMH) extraordinary resolutions, in connection with the Kennedy Wilson/Värde restructuring proposal, did not pass on 26 June (see SCI's CMBS loan events database). Revised proposals are now anticipated from both the preferred bidder (KW/Värde) and the junior lender (Northwood).
• Assured Guaranty and Flagstar Bank have entered into a settlement agreement concerning Assured Guaranty's litigation against the bank for breaches of reps and warranties. The settlement follows a New York District Court ruling earlier this year in Assured Guaranty's favour (SCI 12 February).
• The third auction of the year for Bristol CDO I is scheduled for 11 July. The auction call redemption amount was not met in the previous sales, which took place on 25 March and 11 January. An auction has also been scheduled for Buckingham CDO on 19 July.

Regulatory update
• The Basel Committee has published revised Basel 3 leverage ratio framework and disclosure requirements for consultation. The leverage ratio is designed to serve as a backstop to the risk-based capital measures by constraining the build-up of leverage in the banking system and providing an extra layer of protection against model risk and measurement error.
• More securitisation transactions are expected to launch in China, following new regulations promulgated under the specific asset management plan (SAMP) and the credit asset securitisation pilot scheme (CAS). However, challenges remain in data robustness, legal enforceability and transaction structure.
• The EIB and the European Commission have released a joint report detailing how the €10bn capital increase decided by Member States last year has been implemented. Entitled 'Increasing lending to the economy: implementing the EIB capital increase', the report also outlines new joint initiatives that aim to revive the structured credit markets to support SME lending.
• ISDA has published additional provisions relating to credit derivative transactions with a restricted delivery party where physical settlement applies. The additional provisions are for use where the settlement method is physical settlement and either party to the credit derivative transaction is restricted from holding a loan or there is a limit on the outstanding principal balance of a bond which it may hold.
• The Mortgage Bankers Association (MBA) has released a concept paper outlining steps to ensure mortgage lenders have the confidence to lend to the full range of qualified borrowers. Aligning the GSEs' underwriting standards and creating clear standards for representations and warranties is essential for a smooth transition to a sustainable secondary market operating with an explicit, limited government guarantee, the association says.

Deals added to the SCI database last week:
Alliance Laundry Equipment Receivables Trust 2013-A; BlueMountain CLO 2013-2 ; Capital Auto Receivables Asset Trust 2013-2; COMM 2013-THL; DECO 2013-CSPK; Flexi ABS Trust 2013-1; FREMF 2013-K28; FTA Santander Hipotecario 9; Hyundai Auto Receivables Trust 2013-B; Liberty Series 2013-1 SME; Nations Equipment Finance Funding I series 2013-1; Nelnet Student Loan Trust 2013-4; Private Driver 2013-2; PSPIB-RE Summit TD Canada Trust Tower; SLM Student Loan EDC Repackaging Trust 2013-M1; South Texas Higher Education Authority series 2013-1; TORRENS Series 2013-2 Trust RMBS; TruckLease Compartment No. 3

Deals added to the SCI CMBS Loan Events database last week:
CD 2005-CD1; CSFB 2004-C2; CWCI 2007-3; CWCI 2007-C2; DECO 2005-C1; ECLIP 2006-2; ECLIP 2006-3; ECLIP 2007-2; GCCFC 2006-GG7; GECMC 2006-C1; JPMCC 2004-C3; JPMCC 2005-CB13; JPMCC 2005-LDP5; JPMCC 2006-CIBC14; JPMCC 2011-FL1; LBUBS 2005-C5; LBUBS 2005-C7; LBUBS 2007-C2; MLCFC 2006-3; MSC 2004-IQ8; MSC 2007-T27; OPERA CMH; RIVOL 2006-1; TAURS 2006-2; TITN 2006-3; TITN 2007-1; TITN 2007-2; TITN 2007-CT1; TMAN 7; WBCMT 2004-C14; WBCMT 2006-C25; WBCMT 2006-C26; WINDM XIV

Top stories to come in SCI:
The future of the GSEs

CLOs

CLO BWIC participation broadening

Recent BWIC activity suggests that real money investors upped their share of secondary US CLO buying for the third consecutive year, from 52% in 2012 to 63% year-to-date in 2013, according to JPMorgan figures. Next come hedge funds, accounting for 27% of volume, followed by banks with 10%.

At the same time, decreased disparity is evident between real money (accounting for 47%) and hedge funds (39%) by number of trades. JPMorgan CDO analysts suggest that this is due to hedge funds' higher turnover and tendency to seek higher yielding low-rated/unrated tranches, usually with smaller notionals.

So far this year, bank participation represents a post-crisis low of the secondary CLO buyer base. The JPMorgan analysts cite a number of possible reasons for this.

First, there may be less supply in general, as senior notes are usually held by buy-and-hold investors. Second, regulatory developments such as Basel 3 and the SSFA penalise RWA for resecuritisations.

Year-to-date US CLO BWIC volume stands at US$14.8bn, representing about two-thirds of overall activity in the sector. By original rating, triple-A to single-A paper accounts for 58.7% of volume versus 41.3% for triple-B to equity.

The largest increases as a percentage of volume have been at the triple-B and double-B level, up by 5.5% and 8.2% respectively from 2012. Triple-A volume fell by 11.1%, while supply in the other tranches has remained largely flat year-on-year.

TRACE volume dropped from May to June - even with June new issue volume nearly US$3bn higher - which the analysts indicate might represent a secondary market characterised by DNTs (SCI 27 June). Average monthly trade volume in 2013 is 25% higher than in 2012, excluding the May-July 2012 outliers driven by the Maiden Lane liquidations.

"Given the CLO market's limited transparency, through the limited data available, the trend in 2013 shows a growing investor base and an active secondary market," the analysts conclude. "While the data seems to suggest more concentration in the secondary market among the different investor bases, when factoring in the primary market, the aggregate investor base tends to be more balanced. Additionally, with spreads having compressed quite substantially since the crisis - even with the recent widening taken into account - some hedge funds and distressed investors may have shied away from being active participants in the market, given the lower yields."

CS

CMBS

Revised Opera CMH proposals expected

The Opera Finance (CMH) extraordinary resolutions, in connection with the Kennedy Wilson/Värde restructuring proposal, did not pass yesterday (see SCI's CMBS loan events database). Revised proposals are now anticipated from both the preferred bidder (KW/Värde) and the junior lender (Northwood).

Extraordinary resolutions were passed by the class A and B noteholders, but were not passed by the class C or D noteholders. European ABS analysts at Barclays Capital indicate that the junior lender's last-minute counter bid contributed to the class C noteholders' rejection of the Kennedy Wilson/Värde proposal: classes C and D, in particular, are expected to benefit more from the Northwood proposal.

The special servicer, Eurohypo, now intends to canvass the views of noteholders regarding next steps before taking any further action. It had previously determined to sell the portfolio to Kennedy Wilson/Värde if the extraordinary resolution did not pass.

The Barcap analysts note in this case, given that the transaction documents do not clearly define how enforcement proceeds would be allocated to the notes, proceeds would not be allocated to the CMBS notes immediately but retained at issuer level. "In this event, the issuer would at some point run out of revenue proceeds to pay interest on the notes (including class A), resulting in a note event of default," they explain.

They add: "According to the special servicer, there could be a class A interest default within the next two quarters, depending on the level of Euribor and the amount of senior costs. Following a note event of default, senior noteholders could direct the trustee to accelerate the notes and distribute the cash on the issuer accounts sequentially, according to the post acceleration waterfall of the transaction."

Even after the publication of Northwood's counter bid, the special servicer published two transaction notices emphasising its determination to proceed with the sale to Kennedy Wilson/Värde. The reasons cited for this decision include: that it did not receive a notification from Northwood that it intended to submit a restructuring proposal; that 52% of class A noteholders and 34% of class B noteholders said that they would not support the Northwood proposal; and that Kennedy Wilson/Värde said that they would withdraw their bid if the special servicer engaged with Northwood on its restructuring proposal.

"We think that these statements were partially tactical, but they also imply that the special servicer is of the opinion that the Northwood proposal - which is likely an improved version of a formerly rejected 'best and final proposal' by the same party - runs against the spirit of the competitive process run by the special servicer," the analysts observe.

They suggest that revised proposals will be published in the coming weeks or months. "For example, Kennedy Wilson/Värde could increase their offer and/or change the allocation of enforcement proceeds. As another example, also depending on market conditions, Northwood could split the tender offer and restructuring elements of their proposal, in our view."

CS

CLOs

Benchmarking style

CLO analytics approaches discussed

Representatives from Moody's Analytics and ING Investment Management discussed how to leverage the latest analytics and data for CLO portfolio management, valuations and benchmarking during a live webinar, hosted by SCI in May (view the webinar here). Topics included manager style, differences between CLO 1.0 and 2.0 deals, and which data points to look out for. This Q&A article highlights some of the main talking points from the session.

Q: This year has so far been characterised by high levels of new issuance, suggesting that US CLO volumes will exceed most 2012 projections. Does this represent a return of the market to pre-crisis levels?
Marc Boatwright, svp, portfolio manager and team leader in the ING US Investment Management senior loan group: Market participants are certainly keeping track of new issuance levels. Volumes increased strongly before the financial crisis and so there is some concern that the market may be mimicking the past.

But it's important to understand the drivers of the prior CLO boom: it wasn't just the availability of cheap credit; it was driven by a surge in private equity transactions. Attractive financing was available for buyouts, due to fundamental economic growth in the country.

These days, the rise of CLOs is being driven by enormous investor appetite because the structures performed well through the downturn. However, the same large buyouts are not occurring, which means the supply of leveraged loans is more constrained. We're seeing a resurgence of the sector, but it's unlikely to return to its previous heights.

Luis Amador, senior director at Moody's Analytics: We're also seeing a resurgence in European CLOs, mid-market CLOs and project finance CLOs. Investment banks, commercial banks, credit hedge funds, loan funds and insurance and pension funds are all investing in the asset class. These entities are investing throughout the capital stack, whereas historically they may only have looked at senior bonds or at the mezzanine level and below.

Q: As at end-April, the largest portion of 2013 deals has been launched by repeat managers with over 10 deals, accounting for 51% of volume. First-time managers accounted for 26% of volume. How should investors differentiate between new managers or smaller repeat managers and larger managers?
Boatwright: Track record is crucial. New managers typically are led by teams that previously worked at firms with track records in the past.

Large managers can point to not only a certain style, but also a track record that demonstrates adherence to that style. Scale managers also tend to have other funds (not just CLOs) under management, which reduces the franchise risk - investors are buying into stability.

That isn't to say that there aren't compelling reasons to invest in smaller managers or first-time managers. What bothers me is that some people are increasingly investing in the structure of a deal, not the manager. They're investing in CLOs simply as a product.

At the triple-A level, it's possible to earn a bit more spread with new managers. But, as you move down the capital stack, it's important to have a handle on the specific style of the manager.

It may be that the manager has a unique edge; for example, in middle market loans. Whatever it may be, investors need to understand in their own minds what their investment drivers are and what a manager is really marketing.

Q: How significant are manager differences and which other exposures are important to monitor?
Boatwright: Individual manager performance pre-crisis looks similar to today's performance, but this doesn't account for collateral overlap. A low diversity score, for instance, is a good indicator of poor performance.

It's important to focus on how a portfolio would perform in a stress case. The reality is that a low diversity score and high concentration indicates that noteholders could suffer chunky hits in terms of defaults, with the potential to shut cashflows down.

I'd recommend analysing nuances in manager style over time and how it migrates. By looking at the data, it's possible to to identify trends that differentiate a manager across different portfolios.

Q: Which metrics can aid investors in determining whether a manager is debt-friendly or equity-friendly?
Amador: Whether a manager is perceived to be debt-friendly or equity-friendly is an interpretational issue. However, investors can look at factors such as disruptions in equity cashflows or fees as a guide. Another way of gauging manager performance is to analyse the standard deviation of cashflows over a given period.

Q: There are a variety of differences between CLO 1.0 and 2.0 structures. What are the key factors to consider in secondary market deals versus primary and as a debt holder versus equity holder?
Boatwright: The differences between CLO 1.0 and 2.0 structures are well-known: newer deals feature lower leverage, higher spreads, shorter average lives and mostly high quality first-lien collateral. Baskets are limited, so managers don't have as much flexibility to create alternative asset portfolios.

As a debt holder, the aim is to constrain the manager as much as possible regarding reinvestment and flexibility to move into alternative assets. Yet managers need enough flexibility to move into safer assets when necessary. If a manager is too constrained, a deal effectively becomes a static structure.

Amador: The focus on comparative analytics and benchmarking has increased. There is also increased emphasis on isolating 1.0 deals versus 2.0, with reporting and benchmarking being undertaken against their own separate universes.

Q: Covenant-lite percentage levels within CLOs are at an all-time high. Are there interpretational issues in the market when it comes to these instruments?
Boatwright: Much of the focus on the size of covenant-lite baskets in 2.0 deals is due to the concern they caused in 2006-2007. It's important for investors to recognise that leveraged loan managers have had to compete with high yield managers: offering cov-lite loans expands the access that high quality issuers have to public bond markets.

The definition of cov-lite in CLO indentures is nuanced. In order to manage the size of the basket, more scrutiny is emerging over what constitutes a cov-lite loan and ultimately which additional protections could be gained through other loan facilities of the issuer. For instance, we've seen the definition change to reference cross-default language to another facility or a facility that is pari passu to a bank loan.

I don't think trustees are tracking this at the moment, so it's up to individual managers to report and flag such activity. But it can dramatically reduce the number of cov-lite loans under the definition and create more room in the cove-lite basket.

Q: The volume of leveraged loan repricings is also at peak levels post-crisis, with first-quarter repricings totalling US$126.7bn. This is the highest quarterly total since 2007 and tops the US$73bn seen for all of last year. How is this impacting analytics frameworks?
Amador: Loan repricings are driven by cost of funds, so it's important from a valuations perspective to project costs of funds and interest rates. From a pure functionality standpoint, the ability to flag assets, look at the terms of individual loans and come up with assumptions on whether they have a higher potential to reprice is key. An additional wrinkle to be aware of is that CLO 2.0 deals often contain features that allow for tranche repricings.

The cost of funds environment is also driving managers to call their deals. At least 22 transactions were called in the first quarter by equity investors looking to invest in new CLOs.

Boatwright: Focusing on 2.0 deals, repricings have had the most dramatic impact on spread and floors. At the beginning of 2013, newer issue deals carried about a 440bp spread and 120bp floor for a 560 coupon; in April, this had declined to 400bp spread and 110bp floor. This is having a minimal impact on older vintages because they aren't invested in higher spread loans.

However, there is an impact on cash too, which many people don't tend to take into account in their modelling. The amount of cash drag on a portfolio has a significant impact on vintage deals because they comprise of older loans, which are being paid off or extended beyond the legal final.

Structures are also facing pressure on WAL tests. The net effect is that it's increasingly difficult to use cash quickly and efficiently for reinvestment. Settlement times are slowing down, so visibility around the real cash number is worsening.

Q: Leveraged loan defaults have experienced a slight up-tick in the US and a slight decrease in the UK. Is this a cause for concern and should it impact modelling assumptions?
Boatwright: The biggest impact of the up-tick is on 1.0 deals because most of the defaults are in connection with carry-over loans, where issuers have kicked the can down the road. It's a case of drilling down into the single names that are pretty well-known in the market.

Amador: Against this backdrop, Moody's Analytics is focused on comparing the fundamental value of a deal versus its market value. It's a question of linking expected default frequencies to each loan to come up with a fundamental value.

Q: Data and its usage has changed dramatically since the financial crisis. Which data points are commonly used today and where are the remaining gaps?
Amador: Compared to ABS, trustees tend to report more information on CLOs, including for example the trades that managers are making. The difficulty is knowing what to do with all of this data.

Trustees typically report the seniority of an asset, its industry classification and lien status, as well as any triple-C bucket activity. Moody's Analytics then normalises the data and renders it usable.

We also create reports that track average purchase prices and sale prices, so clients can compare how one manager trades a loan versus another. In addition, they can analyse loan price distributions to gain greater insight into trading habits.

Boatwright: Given the ability to drill down into the performance of each underlying asset, it's incumbent on the industry to access that data as efficiently as possible and provide an effective means of reporting it. The industry is making important strides towards this goal.

Q: How significant is the impact of reinvestment and post-reinvestment language and assumptions to the performance of a deal?
Boatwright: Reinvestment language can have a significant impact on performance - especially for 1.0 transactions. The information isn't standardised, so it's a question of going through each indenture and interpreting it. There are many ways that reinvestment can be constrained, so it's incumbent upon investors to analyse the language carefully.

Reinvestment language is more standardised in 2.0 deals. But it's still possible to input unhelpful assumptions - for example, WAL caps - which could restrict reinvestment activity.

There also seems to be some misunderstanding about when a deal moves to post-reinvestment trading conditions: managers can continue to invest on a discretionary basis, providing they maintain their WAL tests. There is a disparity with deals that continue to invest for a long time, yet there isn't much collateral available to maintain the test - if there is, it has a low spread. These cases erode equity and shorten the life of the deal.

Q: Which advances have you seen when projecting reinvestment cashflows in CLOs?
Amador: We're seeing the use of more factors when setting up reinvestment models. Models tend to reinvest into loans and bonds with specific terms and conditions. Allowing for different types of assets over time has become more important, as well as looking at the price of an asset over time.

Q: Has the use of loan prices impacted the way you analyse transactions today?
Boatwright: Absolutely. Some loans may be being restructured and so a portion of the price is a function of the coupon. But residual value may not be reflected.

We're seeing a drive towards manager barbelling, whereby they add certain loans to the pool to make the arbitrage work or include discounted loans at the back of the ramp to meet target par.

Amador: Certainly the use of loan prices in metrics has increased. There has also been a shift in focus towards running market value OC, market value attachment and detachment points, thickness and collateral NAV metrics.

Q: How important is modelling single-name risk to the outcome of a deal?
Amador: Single-name analysis is extremely important. Moody's Analytics has developed modules that allow clients to flag individual names and keep track of their movements. If a client has an opinion on whether a loan is likely to default or pay-down, they can incorporate this opinion into the standard assumptions. 

Structured Finance

ICG beefs up in the US

Intermediate Capital Group has further expanded its North American debt platform by hiring four investment professionals, as it develops market-specific strategies in both private and liquid credit products. The new hires are Brian Spenner, Seth Katzenstein, Michael Sproul and Robert Kiesel.

Spenner joins ICG as an md, having previously worked at The Blackstone Group with Salvatore Gentile, head of ICG's North American operations. He has 19 years of investment experience and also formerly worked at SAC Capital, BancAmerica Securities and Nomura Securities.

Katzenstein also joins as an md and will serve as portfolio manager for syndicated loan products. He was previously md and portfolio manager at Black Diamond Capital Management and has also worked at GSC Group.

Sproul and Kiesel become principals at ICG, further expanding the firm's North American private debt origination and execution capabilities. Sproul was previously a member of Blackstone's corporate debt group, while Kiesel worked for HD Capital, Fifth Street Capital and ORIX Merchant Banking.

ICG's North American private debt investment platform now comprises eight investment professionals. The firm expects to hire further professionals to the business as it builds its syndicated loan and other liquid investment strategies.

Structured Finance

Knight acquisition approved

Knight Capital Group and GETCO Holding Company have approved a merger agreement between KCG Holdings, Knight Capital and GETCO. The combination of the two companies will create a securities firm with scale and depth across asset classes, product types and geographies.

The transaction is scheduled to close on 1 July and there will not be any material changes to Knight and GETCO's current client offerings and services. GETCO ceo Daniel Coleman will become head of KCG.

Structured Finance

Investment firm buys into equity specialist

Tikehau Group is set to become a 35% shareholder in Duke Street, in relation to which it will provide committed capital to accelerate the firm's deal-by-deal model. In partnership with Tikehau, Duke Street will have the capacity to underwrite any new deals in its target range.

The firms will look to build on each other's strengths to form a new operating model in private equity. Duke Street will use Tikehau's cash injection to launch a new fund focussed on controlling stake investments in the European mid-market.

Structured Finance

Asia managing partner poached

Michelle Taylor and her team have joined Jones Day's banking & finance group in Hong Kong. She was formerly Asia managing partner and China office leader with Orrick. Her practice focuses on structured finance, real estate finance, debt capital markets, general banking and securitisation, where she has almost 20 years of experience.

Structured Finance

Law firm makes Middle East expansion

Morgan Lewis is opening an office in Dubai and hiring structured finance lawyer Ayman Khaleq to provide local knowledge and Islamic finance expertise. He joins from Vinson & Elkins and will spend a short time in Morgan Lewis' London office until the Dubai office opens.

Khaleq has been appointed by the IMF as an expert in debt capital markets and also focuses his practice on structured finance. As well as providing guidance in debt capital markets and structured finance, the Dubai team will provide guidance on energy and infrastructure, private equity, Islamic finance, labour and employment, intellectual property and corporate strategy matters.

Structured Finance

Ares looks to expand in structured credit

Jeffrey Kramer has joined Ares Management's capital markets group as portfolio manager. He will lead a tactical expansion of Ares' structured credit business and take responsibility for the origination and management of investments under its asset-backed investing and lending strategy.

Kramer joins from Goldman Sachs' special situations group. He previously founded ReMark Capital Group in partnership with Goldman Sachs and has also served as a group head of the securitisation and structured credit unit of WestLB, within the structured finance and capital markets groups at Rothschild and Nomura and as a vp at Financial Security Assurance.

Structured Finance

Structured pro takes marketing role

Jisook Choi has joined Altum Capital in New York as a senior marketer focusing on capital raising. She was previously an executive director at UBS specialising in securitised and structured product sales and has also worked at Broadpoint Capital and in the CDO banking group at Bear Stearns.

Structured Finance

MBO for EM boutique

Emerging markets boutique Global Evolution has completed a management buyout from Saxo Bank, after three years of cooperation. The firm is now 80% owned by management and employees and 20% by Tactica, which initially funded its launch and continues to be a supportive financial partner.

The management at Global Evolution has for some time had a strong interest in regaining control of the company. Equally, Saxo Bank determined that it was best for its shareholders to focus on its core FX platform.

With offices in Denmark, Switzerland and the US, Global Evolution manages almost US$2bn in emerging and frontier market portfolios on behalf of a wide range of institutional and retail investors globally.

CDS

Law firm adds derivatives vet

Milbank, Tweed, Hadley & McCloy has appointed John Williams as partner in its New York office. He joins from Allen & Overy, where he led the US derivatives practice, and previously served as principal US counsel to ISDA for its big bang and small bang protocols.

Williams advises clients across the spectrum of derivatives products and on the cross-border implications of US derivatives regulations enacted in response to the financial crisis. He has particular recent experience dealing with the Volcker Rule sections of Dodd-Frank.

CDS

CDS antitrust violations alleged

The European Commission (EC) has informed a group of investment banks of its preliminary conclusion that they infringed EU antitrust rules by colluding to prevent exchanges from entering the credit derivatives business. If this is found to be the case then the companies in question could be fined 10% of their annual worldwide turnover.

The EC's statement of objections is addressed to Bank of America Merrill Lynch, Barclays, Bear Stearns, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley, RBS and UBS, as well as ISDA and Markit. The investigation opened two years ago (SCI 3 May 2011) and relates to attempts by Deutsche Börse and CME to enter the market between 2006 and 2009.

Deutsche Börse and CME approached ISDA and Markit to obtain necessary licenses for data and index benchmarks, but the EC alleges the banks controlling those bodies instructed them to license for OTC trading purposes only and not for exchange trading. Several banks are also alleged to have coordinated their choice of preferred clearing house in a further move to shut exchanges out in order to protect the revenues derived from acting as OTC market intermediaries.

CLOs

Manager adds Asia relations director

3i Debt Management has appointed Lisa Johnson as investor relations director in Asia, based in Singapore. Johnson previously held a similar role at Parker Global Strategies, where she was responsible for developing and maintaining strategic relationships with a variety of investors.

CMBS

Manager targets UK CRE lending

Standard Life Investments has appointed Neil Odom-Haslett as head of commercial real estate lending. He will join in August and report to David Paine, head of real estate investments.

Odom-Haslett will be based in London and lead Standard Life's entry into the CRE lending market in the UK. He will be responsible for all aspects of the lending platform, with an initial focus on good quality senior secured loans.

Odom-Haslett joins from Deutsche Pfandbriefbank where he was a senior negotiator for real estate restructuring in the UK, France and Spain and originator for UK and Nordic mezzanine and senior debt. Before that he worked at RBS and Eurohypo, in each role focusing on UK origination.

CMBS

CRE firm adds capital markets vet

Walker & Dunlop has added William Wein to its capital markets department. He joins as svp responsible for the day-to-day operations of the group and will be based in Chicago.

Wein joins from Marcus & Millichap Capital Corporation where he managed loan originators in the eastern and central US and also managed life company, bank and CMBS lender relationships. He has also worked at Bear Stearns and Cohen Financial.

CMBS

Madrid office marks European expansion

CR Investment Management has opened an office in Madrid, expanding its European footprint. Head of international activities Richard Fine is leading the process of building out the local team, which will focus on the management and restructuring of distressed assets and loans. Fine was promoted within CR to md earlier this month (SCI 25 June).

CMBS

New CREFC chief to take charge

CREFC Europe has named Peter Cosmetatos as ceo, effective from late September. He has more than 15 years of experience in the property finance business, having held senior-level tax, legal and policy positions.

Cosmetatos joins CREFC after five years as finance policy director at the British Property Federation, where he was involved in the regulation and policy challenges arising from the real estate debt overhang. He previously worked as a tax associate at Wragge & Co and at Freshfields Bruckhaus Deringer.

Risk Management

Broker adds derivatives indices head

ICAP has named Jan de Smedt as global head of indices, based in London. He will report to Kevin Taylor, head of information services, and focus on increasing the number of ICAP indices linked to exchange traded products, mutual funds and derivative products.

Before ICAP de Smedt worked at S&P Dow Jones Indices, where he was senior director for licensing and sales in the client coverage group. He has also worked at Refco Alternative Investments, Liability Solutions, Threadneedle Asset Management, Gollyhott Trading, TDR and Cooper Neff.

RMBS

Corporate real estate vp added

Lauren Hedvat has joined Goldman Sachs in New York as corporate real estate transactions vp, reporting to Michelle Gill. She was previously at Barclays Capital and before that worked as an analyst at Deutsche Bank and in the MBS banking group at Lehman Brothers.

RMBS

ResCap reorganisation approved

The plan support agreement (PSA) entered into by Ally Financial, Residential Capital and ResCap's major creditors was approved last week by Judge Martin Glenn in the US Bankruptcy Court. The Chapter 11 plan provides broad releases for Ally from mortgage-related issues.

Consistent with the terms of the PSA, ResCap paid Ally approximately US$1.13bn on 13 June to satisfy Ally's substantial claims against ResCap on account of its secured credit facilities provided to ResCap. Ally has agreed to contribute US$1.95bn in cash to the ResCap estate, as well as the first US$150m from insurance proceeds Ally is pursuing related to insurable losses, in exchange for broad releases under the plan from potential mortgage-related claims against Ally related to ResCap's businesses. Ally will make the payment to ResCap on the effective date of the plan, which is expected to occur in the fourth quarter of this year.

Despite court approval, interested parties can still object to the reorganisation plan during the confirmation hearings. Several parties - including Ambac, Monarch, Stonehill and Assured Guaranty - are understood to have submitted objections to the terms of the PSA or reserved the right to object to the PSA prior to the court's approval.

ABS

Auto delinquencies hit 10-year low

US prime auto ABS 60+ delinquencies stood at 0.29% in May, according to Fitch's latest index results - the lowest level seen in the last 10 years and unchanged month-over-month (MOM). The rate in May was also 24% improved year-over-year (YOY).

Prime annualised net losses (ANL) posted a strong 30% drop in May over April, down to 0.17%. This rate was the second lowest level ever recorded and 5.6% below that of May 2012. The record low for the index was 0.14% recorded in June 2012.

Prime cumulative net losses continued to linger around the 0.3% mark and were at 0.29% in May - virtually unchanged versus April. The index has been in this range now for eight consecutive months, Fitch notes.

Subprime 60-plus delinquencies increased in May to 2.75%, up by 2.6% MOM and 5.8% YOY. Subprime ANL declined to 3.84% in May, down by 6.3% MOM, but were up by about 2% YOY.

ABS

Minimal impact expected from FDSL hike

As of 1 July, interest rates on federal direct subsidised loans (FDSL) for US college students will double to 6.8%. Although the increase is being portrayed as harmful to students who would be driven further into debt, Moody's expects the overall effect on student loan securitisations to be minimal.

The agency notes in its latest Credit Outlook publication that the rate increase is only slightly credit negative for both private and FFELP student loan ABS because although higher monthly payments boost default rates among borrowers, the new rates only affect borrowers who take out new FDSL loans. Most student loan deals the agency rates have a small proportion of borrowers who are still in college.

Higher rates have a greater effect on private student loan ABS than on FFELP securitisations because the former contain a higher proportion of loans to students currently in college, which makes them eligible for new federal loans. Loans to borrowers who are currently in college constitute 10%-50% of 2008-2013 private loan securitisations Moody's rates. The effect is smaller for FFELP loan securitisations it rates because fewer than 5% of loans in these deals are to borrowers currently in college.

Lawmakers could still deal retroactively with the loan issue when they return from the 4 July recess. One proposal, unveiled last Wednesday by a bipartisan group of senators, sets the rate for newly issued loans at a fixed rate at loan origination based on the yield on the 10-year Treasury bill plus 1.85 percentage points for both subsidised and unsubsidised Stafford loans. This proposal is similar to the plan included in the Obama administration's 2014 budget plan, Moody's reports.

ABS

Improving economy bolsters SLABS performance

Outstanding student loans approached nearly US$1trn at the end of last year, becoming the second largest source of US consumer debt after mortgage loans. Nevertheless, student loan ABS performance is primed for a brighter outlook due to the improving economy.

"Student loan ABS performance is highly correlated with the economy when it comes time for students to begin paying their college debt back," says Fitch md Michael Dean. "Graduating students are entering an improving job market, which positions both federal and private student loan ABS programmes for stronger performance."

Soaring unemployment during the credit crisis saw delinquencies and defaults jump for both federal and private loans. While FFELP-backed ABS still benefits from government support, it may be their historically more volatile counterpart that helps to drive improving performance overall.

Post-crisis private student loan ABS are coming to market with higher credit enhancement and tighter underwriting on the underlying loans. It is also important to note that ABS accounts for a relatively small percentage of the student loan market overall.

"Less than 25% of the nearly US$1trn in outstanding student loans is securitised and funded through the ABS market," explains Fitch senior director Tracy Wan. "Additionally, many private student loan lenders are pulling out of the market, the less competition of which will help to preserve strong underwriting standards."

Meanwhile, Fitch suggests that the rate hike for new subsidised Stafford loans may lower prepayment risk. The higher rate is likely to dissuade borrowers from taking out extra direct loans to pay off their FFELP loans if they have both.

The Senate is set to consider a bill to extend the current rate of 3.4% for another year when it returns from its recess. A separate bipartisan proposal introduced in the Senate would offer fixed rates (at a spread over Treasuries) for the life of the loan. The House of Representatives approved legislation in May to float new federal student loans interest rate with the 10-year Treasury note. Both proposals would also be subject to an interest rate cap. Any subsequent agreement could be applied retroactively to loans originated on or after 1 July 2013.

"These market-based approaches, especially the one proposed in Senate, would provide a lower interest rate for newly originated student loans than existing loans under the FFELP programme," Fitch says. "If passed, they may incentivise borrowers with both FFELP and direct loans to pay down their existing loans and shift balances to lower interest direct loans. This could result in a modest increase in prepayment in some FFELP ABS trusts."

Structured Finance

Basel 3 final rule approved

The US Fed has approved a final rule to implement the Basel 3 regulatory capital reforms and certain changes required by the Dodd-Frank Act. The final rule establishes an integrated regulatory capital framework that addresses shortcomings in capital requirements - particularly for larger, internationally active banking organisations - that became apparent during the recent financial crisis, while minimising the burden on smaller, less complex financial institutions.

Under the final rule, minimum requirements will increase for both the quantity and quality of capital held by banking organisations. Consistent with the international Basel framework, the rule includes a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5% and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets that will apply to all supervised financial institutions.

The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organisations. In addition, for the largest, most internationally active banking organisations, the final rule includes a new minimum supplementary leverage ratio that takes into account off-balance sheet exposures.

On the quality of capital side, the final rule emphasises common equity tier 1 capital and implements strict eligibility criteria for regulatory capital instruments. In addition, it improves the methodology for calculating risk-weighted assets to enhance risk sensitivity.

US banking agencies are said to have reviewed the comments received on the proposal and made a number of changes in the final rule, in particular to address concerns about regulatory burden on community banks. For example, the final rule is significantly different from the proposal in terms of risk weighting for residential mortgages and the regulatory capital treatment of certain unrealised gains and losses and trust preferred securities for community banking organisations.

The phase-in period for smaller, less complex banking organisations will not begin until January 2015, while the phase-in period for larger institutions begins in January 2014. Savings and loan holding companies with significant commercial or insurance underwriting activities will not be subject to the final rule at this time, however. The Fed says it will take additional time to evaluate the appropriate regulatory capital framework for these entities.

The final rule is coordinated with the FDIC and the OCC, which continue to review this matter. The FDIC says it will consider the matter as an interim final rule on 9 July, while the OCC expects to review and consider the matter as a final rule by then.

Structured Finance

Chinese securitisation 'underdeveloped'

Fitch believes that the Chinese securitisation market is underdeveloped, reflected in the small programme size of the third round of the credit asset securitisation (CAS) pilot programme launched in May 2012 at RMB50bn (US$8.2bn). The programme limit - accounting for less than 0.1% of the commercial banking system's assets in the country - is insufficient to fulfil the needs of Chinese banks, according to the agency.

Chinese securitisation issuance is expected to progress at a cautious pace as the Chinese government seeks to ensure that the market is adequately developed and the risks of the instrument are fully addressed. While the government is said to recognise that Chinese banks can benefit from securitisations in terms of credit risk, asset liability management and alternative funding, it also emphasises that the development of securitisation should be consistent with macro control policy objectives.

Notably, securitisations under the CAS schemes need approval from the China Banking Regulatory Commission (CBRC). Therefore it is unlikely that the development of the securitisation market will outpace current government mandates.

Six domestic securitisation transactions with a total issuance size of RMB23bn have been launched since May 2012. CLOs backed by large corporate loans originated by Chinese banks are the main asset types under the CAS. 85% of the issuances since May 2012 were CLOs, with the remaining 15% being auto loan ABS.

Fitch notes that significant obligor concentration risk exists in Chinese CLOs, which are typically backed by less than 60 loans from less than 35 obligors. The top-five obligor concentrations typically accounted for over 30% of the portfolio balance at closing.

The agency observes that the average credit enhancement of the top-rated tranche, which is provided by subordination, was 18% for the CLOs issued since May 2012 and is insufficient to cover the top five obligors' default if recoveries are lower than expected. The concentration can introduce volatility to the portfolio performance, it adds.

The third CAS pilot programme mandates the expansion of the investor base to include insurance companies, securities investment funds, enterprise pension funds and the national social security fund. This is a substantial step for the Chinese securitisation market as it helps to diversify banks' credit risk to other channels. However, the short track record and the inherent illiquid nature of securitisation products may limit the interest of the investors: Chinese banks still remain the major investors in securitised instruments under the CAS.

Structured Finance

Data, legal challenges remain for Chinese ABS

More securitisation transactions are expected to launch in China, following new regulations promulgated under the specific asset management plan (SAMP) and the credit asset securitisation pilot scheme (CAS). However, challenges remain in data robustness, legal enforceability and transaction structure, according to Fitch.

"Due to the rapid and continuous growth of China's economy in the past 30 years, asset delinquency and default data, as well as property price data, do not cover a full economic cycle," the agency explains. "Therefore, it is difficult to arrive at fair assumptions for asset default and recovery rates. Incomplete or a short history of data further makes credit analysis of Chinese securitisations difficult."

Bankruptcy-remoteness of the originator from project assets of SAMP ABS remains unclear, Fitch adds. This stems from an absence of comprehensive rules on how to effectively transfer the asset title for various eligible asset types under the SAMP framework. The agency believes it is difficult to rate transactions significantly above the rating of the originator as a result of the lack of clarity in bankruptcy-remoteness.

Meanwhile, there is no substitution or revolving mechanism present in the structure of prevailing CAS transactions. Because of the short tenor of SME loans, such securitisations are quickly paid off, resulting in the weighted-average life of the transaction being less than one year.

This results in the need to originate a new transaction and incur the associated costs, making it difficult for banks to use securitisation as a capital management tool, Fitch suggests. The governing CAS rules are silent on the revolving arrangement and all issued transactions thus far under the CAS pilot scheme are static.

By contrast, updated rules for SAMP deals released in March 2013 explicitly allow the revolving structure. The principal repayments of the project assets can be used to purchase new project assets from the originator, as long as the eligible criteria, purchase volume and mitigants of liquidity risk have been addressed in the transaction documents. Fitch believes SAMP's framework is more attractive to originators whose assets have short tenors, such as credit card, consumer or SME loans.

Structured Finance

SME ABS proposals put forward

The EIB and the European Commission have released a joint report detailing how the €10bn capital increase decided by Member States last year has been implemented. Entitled 'Increasing lending to the economy: implementing the EIB capital increase', the report also outlines new joint initiatives that aim to revive the structured credit markets to support SME lending.

Collaboration by the EIB and EC under the joint initiatives is directed at covering two dimensions: sufficient funding for the banking sector directed specifically to SME lending; and credit enhancement of existing or new SME loan pools, in order to reduce distorted credit margins. The two institutions are exploring a joint risk-sharing mechanism to be developed under the new Multiannunal Financial Framework by blending EU budget resources (COSME and Horizon 2020) and European Structural and Investment Fund (ESIF) resources with the lending capacity of the EIB, EIF and national promotional banks.

Three broad options are being put forward with respect to joint instruments under this initiative. First is a joint SME guarantee instrument combined with a joint securitisation instrument for new loans.

Under this instrument, funds would be pooled from COSME, Horizon 2020 and the ESIF funds and combined with the resources of the EIB and EIF to provide a combination of: guarantees for new SME lending by financial intermediaries to SMEs under a joint guarantee instrument; and guarantees for portfolios of new SME loans for the purposes of securitisation. Such portfolios would need to be built up by the banks in a specified time period (2-3 years) with a view to being securitised.

Under this option, which blends 75% of guarantees with 25% of securitisation, €10bn from ESIF and €420m from COSME and Horizon 2020 would be allocated to generate lending to SMEs of an estimated €55bn-€58bn (a leverage ratio of roughly 1:5), benefiting 580,000 SMEs. This option does not require changes in the draft Common Procedures Regulation (CPR).

The second option is a joint securitisation instrument allowing for securitisation of both new and existing SME loan portfolios. Under this instrument, public funds would be combined for the securitisation of portfolios of SME loans. There would be requirements for the financial intermediary to finance new loans to SMEs proportional to the amount covered by the joint instrument.

Under this option, €10bn from the ESIF and €420m from COSME and Horizon 2020 would be allocated to generate lending to SMEs of an estimated €65bn (a leverage ratio of roughly 1:6), benefiting around 650,000 SMEs. In this case, a limited change to the draft CPR would be necessary to extend eligibility of SME loans to include existing loans and review eligibility of working capital.

The third option is a joint securitisation instrument allowing for securitisation of new and existing SME loan portfolios and risk pooling. While being similar to Option 2, this option would include the possibility to pool risks and would extend eligibility criteria to include existing SMEs loans and review eligibility of working capital, while ensuring that the on-lending intermediary would generate new loans to SMEs to a value several times higher than the amount set aside by the Member State.

The pooling of risks allows for better portfolio diversification, according to the report, resulting in higher leverage than under the previous options. Moreover, it provides immediate capital relief and liquidity to banks.

Under this option, €10bn from the ESIF and €420m from COSME and Horizon 2020 would be allocated to generate lending to SMEs for an estimated amount of €100bn (a leverage ratio of roughly 1:10), benefiting around one million SMEs. This option would require the same changes to the draft CPR as in Option 2.

The EIB says it will work with the Commission in the development of the proposed joint instrument. Leverage will depend on the final choices made by Member States and on the take-up by private sector financial institutions, it adds.

European securitisation analysts at Barclays Capital reckon that the promotion of SME ABS will ultimately consist of direct (partial) loan and portfolio guarantees and ABS bond guarantees (wraps). The advantage of the latter is that the bonds would not fall under the definition of 'securitisation' in European bank and insurance regulation, because they are guaranteed by an eligible institution.

"As a result, the punitive regulatory requirements and capital charges currently in place or proposed would not apply, reducing the spread required by regulated investors further. The shortcoming of such an approach would be that credit risk is not transferred to the capital markets - which is one of the objectives mentioned in the EC 'green paper' - but to an EU institution," they observe.

Structured Finance

PFI CLOs on the cards?

The UK government last week hosted an information session for prospective bidders to provide the senior financing - dubbed the aggregator - for about 90% of the cost of its Priority School Building Programme (PSBP) under the Project Finance 2 initiative. One of the funding options being considered draws on PFI CLO technology.

Under the PSBP, the aggregator will be required to finance five batches of school projects, each with an average of nine schools. Each of the batches will be bid on separately and, in addition to providing technical/operational expertise, batchco contractors are expected to fund about 8% of the project, with the remaining 2% of the equity to be funded by the government. Each batch will require between £100m and £150m of senior debt, plus batch equity.

According to Barclays Capital European securitisation analysts, the rationale for running the tendering of the funding separately to the operational/technical bid is to reduce bidding costs, enable a faster bidding process and - by bundling the batches together - improve financing efficiencies at the aggregator level. The aggregator has the flexibility to pursue the most cost-effective funding option - short-/long-term bank finance, public bonds, privately placed bonds and EIB funding.

The Barcap analysts note that one of the potential options considered by the government looks like a tranched PFI CLO, where the five loans to each batch are tranched into a senior and junior bond. The government is expected to further refine the securitisation option, given the penal regulatory backdrop for such instruments.

The aggregator could also be structured to avoid being treated as a securitisation. "However, this would reduce the size of the issuance to levels from each batchco to below benchmark size between £100m and £150m, and so the aggregator would pay a liquidity premium. If the aggregator were to tranche the loans to the batchcos which are then on-sold by the aggregator, this might not be viewed as a securitisation, as in the case of the recent AA Bond Co issuance," the analysts observe.

CDO

ABS CDO on the block again

The third auction of the year for Bristol CDO I is scheduled for 11 July. The auction call redemption amount was not met in the previous sales, which took place on 25 March and 11 January.

CDO

ABS CDO auction due

An auction has been scheduled for Buckingham CDO on 19 July. The collateral shall only be sold if the proceeds reach the total senior redemption amount.

Separately, the Ambassador Structured Finance CDO was successfully liquidated on 4 June (SCI 28 May). Proceeds from the sale of the collateral will be distributed on 3 July.

CDO

CDO auctions scheduled

Auctions for Belle Haven ABS CDO, Longport Funding II and Libertas Preferred Funding I are scheduled for 22 July. The collateral will only be sold if the proceeds reach the auction call redemption amount.

Meanwhile, the proceeds from the auction of Mercury CDO II on 13 June have been distributed to noteholders. In contrast, the auction call redemption amount for RFC CDO I was once again not met during the most recent auction for the deal on 28 June (SCI 11 June).

CDO

Further CDO sale due

The second auction of the year for Trainer Wortham First Republic CBO IV has been scheduled for 23 July. The collateral will only be sold if the sale proceeds are greater than or equal to the auction call redemption amount.

CDS

CDS touted as early-warning signal

CDS spreads and other short-term market-based indicators have become more valuable market gauges for corporate treasuries, which have seen a notable change in their own responsibilities post-crisis, according to Fitch Solutions. While credit ratings and fundamental financial data are integral in gauging the long-term outlook of a company's health, the real-time movement of CDS spreads can serve as a valuable early-warning signal for corporate treasurers.

"Sudden changes in CDS movement would enable corporate treasuries to quickly identify and mitigate changes in their company's credit risk exposure to bank counterparts, suppliers and customers," explains Fitch director Diana Allmendinger.

The firm cites as examples Dell and JC Penney. After out-performing their peers during the first half of 2012, Dell's CDS spreads began to widen considerably in the middle of last year, with spreads coming out more drastically upon news of a potential leveraged buyout. A similar trajectory was evident with JC Penney last year.

"CDS movement in recent months appears to indicate that corporate and financial credit risk is realigning," adds Allmendinger.

Fitch's CDS indices of North American financials and non-financial corporates have been pricing within 10% of each other since mid-February and within 2% as of 1 May. This is in stark contrast to just after the financial markets unravelled late in 2007, when CDS spreads on non-financial corporate institutions in North America were pricing nearly three times wider than swaps referencing financial firms.

CMBS

CMBS delinquency rate plummets

At 8.65%, the Trepp CMBS delinquency rate last month posted its lowest reading in almost three years. The 42bp drop in the delinquency rate was the second biggest one-month improvement since Trepp began publishing the monthly rate in autumn 2009. Four of the five major property types saw their delinquency rates fall in June.

Loan resolutions totalled US$1.25bn during the month, up sharply from May's total of about US$858m. The removal of these distressed loans from the delinquent assets bucket last month created 23bp of downward pressure on the delinquency number.

At the same time, there were about US$1.25bn in newly delinquent loans in June, which measured approximately half the total posted in May. This put upward pressure of 23bp on the delinquency rate.

Loans that cured totalled US$2.3bn, putting downward pressure of 42bp on the delinquent loan reading. One noteworthy loan that cured is the US$716.5m DRA/Colonial Office Portfolio, which was reported as 30-days delinquent in May (see SCI's CMBS loan events database).

Following a modification, the loan was listed as current again, as of June. That status change alone created 13bp of improvement in the delinquency rate.

CMBS

IRP update due

The Commercial Real Estate Finance Council is releasing CREFC IRP version 7.0, with an effective date of 1 October 2013. The latest version of the CMBS reporting template comprises a number of changes. These include: an updated CREFC overview narrative; an updated change matrix for CREFC IRP v.7.0; and updated data dictionary for CREFC IRP v.7.0 term changes; IRP new fields/field deletions to capture additional data and remove unnecessary fields; new disclosure templates; a new best practices section; and a CREFC intellectual property royalty license fee.

CMBS

CRE fund lists

ALPS Advisors and Principal Real Estate Investors have completed an IPO on the New York Stock Exchange for the Principal Real Estate Income Fund. The closed-end fund raised approximately US$126m in proceeds in the offering of 6.3 million common shares at US$20 per share.

The offering seeks to benefit from the recovery in commercial real estate markets by investing in higher-yielding debt and equity investments. It will invest at least 80% of its total assets in commercial real estate-related securities, primarily consisting of CMBS and other US and non-US real estate-related securities, such as REITs. Under normal circumstances, the fund will invest between 40% and 70% of its total assets in CMBS and will invest between 30% and 60% in other real estate-related securities.

CMBS

CMBS loan re-defaults eyed

So far this year, 43 loans over US$20m have transferred to a special servicer, representing a steep drop through the same period in 2012 (94) and 2011 (103). Of that amount, six loans over US$100m transferred to special servicing during first-half 2013 compared to 16 in 1H12, according to Fitch.

One trend that the agency says it is watching closely is the incidence of loans that re-default after exiting special servicing, often following a modification. While some re-defaulted CMBS loans simply need more time to secure refinancing, others are still suffering performance issues.

Of the 43 recent transfers, eight loans have transferred to a special servicer for a second time. Of that amount, four were for hotel properties, two were retail and the other two were office.

In the near term, Fitch expects that new transfers to special servicing will continue to decline, with occasional spikes in activity from CMBS loan re-defaults.

Insurance-linked securities

Record windstorm cat bond prints

Swiss Re Capital Markets has priced Green Fields II Capital Series 2013-1, which at €280m is the largest European windstorm catastrophe bond ever issued and the largest euro-denominated deal to date. The deal's single tranche priced at three-month Euribor plus 252bp and has been rated at double-B by S&P.

The transaction is the first issuance from Groupama's newly-established Green Fields II shelf programme. It covers French windstorm losses for three and a half years, collateralising a counterparty contract providing per-occurrence protection on a PERILS index basis.

Risk Management

Counterparty risk approaches examined

Quantifi and InteDelta have published a whitepaper entitled 'Measurement and Management of Counterparty Risk'. The report highlights that the accurate measurement and effective management of potential future exposure (PFE) and credit value adjustment (CVA) are critical for managing counterparty credit risk.

A range of new regulatory requirements is changing the way in which institutions view risk. This affects not only risk quantification, but also the whole commercial model of an institution, according to the paper.

New regulations or risk measures can affect the commercial attractiveness of an institution's existing product range or client profile, for example. The ability to calculate CVA and exposure metrics on an entire portfolio, incorporating all relevant risk factors and the dynamics between them, also creates substantial analytical and technological challenges.

Topics explored in the whitepaper include: the importance of defining a bank's approach when setting limits and monitoring exposure, taking into account the frequency of review and the process for ensuring limits are properly recorded; and the adoption of a 'top-down' approach to risk management and establishing active CVA functions as market best practices.

Risk Management

Data centre enhanced

Morningstar has been selected to provide financial data, technology and design for the re-launch of FINRA's Market Data Center. With an emphasis on bond market information, including price information from TRACE, the data centre aims to provide retail investors with unprecedented transparency to the corporate bond market.

The revamped platform now offers expansive market data, including intra-day pricing and fundamental data for US fixed income securities, as well as FINRA Investor Education materials and tools. "FINRA is pleased to work with Morningstar to give retail investors new resources and features to help them make better-informed investing decisions. TRACE has been vital to bringing transparency to the bond market and our updated Market Data Center will make it easier for investors to use and understand this and other information," comments FINRA vp Ola Persson.

Risk Management

Derivatives-related consultation begins

The Basel Committee has released two consultative papers on the treatment of derivatives-related transactions under the capital adequacy framework.

'The non-internal model method for capitalising counterparty credit risk exposures' paper outlines a proposal to improve the methodology for assessing the counterparty credit risk associated with derivative transactions. The proposal would, when finalised, replace the capital framework's existing methods - the Current Exposure Method (CEM) and the Standardised Method.

The method seeks to improve the risk sensitivity of the CEM by differentiating between margined and un-margined trades. The proposed non-internal model method updates supervisory factors to reflect the level of volatilities observed over the recent stress period and provides a more meaningful recognition of netting benefits.

'Capital treatment of bank exposures to central counterparties', meanwhile, sets out proposals for calculating regulatory capital for bank exposures to central counterparties (CCPs). This proposal has been developed in close cooperation with the CPSS and IOSCO. It is designed to replace an interim treatment for bank exposures to CCPs issued by the Basel Committee in July 2012.

Comments on the proposals should be submitted by 27 September 2013.

Risk Management

Call for harmonised bank disclosures

In reviewing first-time application of the Financial Stability Board Enhanced Disclosure Task Force's (EDTF) recommendations by a sample of major banks in their 2012 financial reports, S&P notes that many have started to incorporate some of the guidelines in key risk areas, such as liquidity and funding, capital adequacy and credit risk. But the agency also found that bank disclosures still have a long way to go to fully deliver on two fundamental principles - comparability and relevance to investors - of the seven the EDTF endorsed.

"We consider these principles as fundamental for benchmarking banks and the exercise of market discipline," S&P credit analyst Bernard de Longevialle says.

The agency believes that wider, more consistent and harmonised application of the recommendations is needed to further enhance investor confidence and the operation of market discipline over banks. In its view, more active involvement by regulators would help to ensure the broader and better application that is necessary. Yet the lack of comparability and relevance is likely to persist, unless the EDTF also becomes more prescriptive and extensive about the use of standardised templates for key disclosures, according to S&P.

The EDTF last October set out 32 disclosure recommendations aimed at improving clarity, timeliness, usefulness and comparability of bank disclosures. The recommendations encompass risk management strategies, capital adequacy, risk-weighted assets, liquidity, funding, market risk and credit risk. They are underpinned by seven fundamental disclosure principles: that disclosures should be clear, balanced and understandable; comprehensive; relevant; consistent over time; reflective of how banks manage risks; comparable; and timely.

A disclosure gap is among the elements that S&P believes currently weighs on market sentiment and market perception of banks' financial strength. The move towards more effective resolution regimes - including higher likelihood of investor bail-in in case of crisis - will further increase the need for enhanced disclosure, the agency suggests.

"Better, not just more, reporting by banks could help to bridge the disclosure gap," says S&P credit analyst Osman Sattar. "Disclosures that are fully in line with the EDTF's recommendations and principles would represent a significant milestone towards better reporting."

The agency reviewed disclosure recommendations for nine of the 13 major banks that are participants in the task force.

RMBS

Servicer sustainability questioned

The sale of over US$500bn in unpaid principal balance (UPB) of mortgage servicing rights (MSRs) to non-bank servicers from banks has been publicly reported, according to an analysis by Fitch. However, the agency expects the sustainability of growth for non-bank servicers in the longer term to be constrained by the declining size of the subprime market, reflecting the lack of new originations since 2007.

"We believe larger subprime servicing specialists will eventually be driven towards increased origination activity as the housing market improves and the balance of distressed loan MSRs diminishes in a more benign market environment. In the process, balance sheet risk for these servicers is expected to modestly increase," it says.

Many non-bank mortgage servicers have significant levels of private equity ownership, whose investment strategies typically seek to achieve cost efficiencies through increased scale and/or capitalise on slowing mortgage refinancing in a rising rate environment, which increases the value and revenue potential of the MSRs acquired. Private equity involvement raises questions about the firms' investment horizons and capital extraction plans with respect to owned mortgage servicers, Fitch notes.

The agency believes the growth and outsized scale of larger non-bank servicers may pose challenges to a potential orderly transfer of servicing, should it become necessary. In high stress, low probability scenarios used to analyse the ratings of high investment grade structured finance bonds, a potential large portfolio transfer of servicing may have negative rating implications for these bonds.

A growing number of new, smaller servicers have also entered the market, which may over time mitigate risk associated with a concentrated servicer landscape. Fitch believes there is currently available capacity and sufficient expertise by certain smaller non-prime servicing specialists to make portfolio acquisitions from smaller banks seeking to divest of their servicing portfolios in the near to medium term.

RMBS

Minimal negative equity seen in Aussie RMBS

Prepayments and higher house prices have helped stop loan-to-value (LTV) ratios in the Australian mortgage market rising, Fitch reports. The agency's analysis of more than A$180bn of outstanding mortgages in 141 Australian RMBS deals indicates that just 0.5% of these mortgages are in negative equity, after taking into account revaluations due to property indexation.

The index analysis shows that 70% of properties have increased in price, pushing the weighted average LTV across all mortgages down to 57.2% of the indexed property value, from 63.3% of the original property valuation. Loan-by-loan data also show that just 6.6% of loans have a current un-indexed LTV of over 90%, with the figure dropping to 5.2% on a current indexed basis. Without allowing for indexation and prepayments, the figure would be closer to 10%.

The regions that suffered the largest house price declines from their peak to 31 March 2013 are: East Gold Coast (-19.7%), Ipswich City (-10%) and Logan City (-9.6%) in Queensland; Boroondara City (-8.9%) and Southern Melbourne (-8.5%) in Victoria; and Hobart (-8.2%). Borrowers in these regions are more vulnerable to negative equity, Fitch notes.

However, where prices have fallen, there is usually sufficient equity either from the initial purchase deposit or borrowers making repayments ahead of schedule. As a result, only a very small proportion of households have suffered negative equity against their property.

Fitch assessed indexed loan-level revaluations in the Australian residential mortgage market ahead of the expected introduction of property price indexation into its Australian RMBS analysis later this year. "We used the indices for units and houses in 76 Fitch-defined regions - based largely on the Australian Bureau of Statistics subdivisions - that we plan to use in our RMBS analysis. The indices are provided by RP Data/Rismark and will be updated quarterly," the agency explains.

RMBS

Reconciliation transfer concerns raised

Some US RMBS servicers are shifting custodial account reconciliation items to their internal corporate general ledger accounts, a practice that raises significant concerns about transparency, according to Moody's in its latest ResiLandscape publication. Although RMBS documentation does not prohibit such transfers, the agency says that the practice could mask significant operational issues that will ultimately require write-downs on securitisations.

Because internal general ledger accounts are not part of the servicer's SEC Regulation AB review and testing, the attestation available to the public will not include the disclosure of reconciliation transfers. Moody's points to reports from American Home and NationStar that have showed aged items which were outstanding for long periods without being corrected.

"Reconciling the principal and interest custodial funds that banks hold in trust for RMBS securities is vital for mortgage servicers because doing so can help detect operational deficiencies, such as modification-related errors and servicer-reporting challenges early on," the agency notes. "A sound reconciliation process can also help prevent undue exposure to the risk of write-offs for investors in situations in which a servicer cannot reconcile outstanding cash items. Many operational mistakes tend to show up in these reconciliations, through overages or shortages in the custodial accounts."

The practice of moving reconciliation items to a corporate account instead of resolving them quickly can create a number of problems, including the fact that interested parties will be unable to identify potential RMBS remittance or recovery items due to or from the trust. An RMBS trust could incur additional losses if the servicer cannot resolve trust-related reconciliation items or deems them unrecoverable. By maintaining these items in a corporate general ledger account, the servicer could write them off as losses to the trust without prior warning or disclosure.

RMBS

Patrimonio modifications eyed

The loan modification programme that Patrimonio plans to implement in connection with eleven Mexican RMBS could have mixed results, according to Moody's, depending on the transaction and the assumptions used in the analysis. The agency says it will monitor the implementation and results of the programme as information becomes available.

The final assessment of the impact will depend on the loss severity assumed for defaulted loans and the re-default rate of modified loans. Moody's is currently reviewing the severity of loss assumptions on six of the affected deals: MXMACCB 05U, MXMACCB 06U, BRHSCCB 05U, BRHCCB08U, 08-2U and 08-3U, and PATRICB 06U and PATRICB 07U. The agency notes the considerable uncertainty regarding re-defaults and loan severities, given the limited amount of data available.

In principle, a loan modification programme could have a credit positive impact on a transaction because it could turn highly delinquent loans (most of which are 360+ days delinquent) into performing cash-flowing collateral. However, such programmes could lead to a higher severity of loss, depending on how the servicer implements the programme and how the modified loans perform.

In order to analyse whether the impact on the transaction is credit-positive, negative or neutral, Moody's estimated the loss severity that could result from implementing the programme on the affected deals and compared it to the loss severity assumed currently. The following factors were considered: a re-default rate of 55%, which indicates the percentage of loans that re-default after being modified; the loss severity currently assumed for each transaction; and a maximum principal forgiveness of 30% of the loan's outstanding balance, which is the maximum the servicer can provide a borrower.

The agency is in the process of evaluating its current loss severity assumptions for Mexican RMBS due to rising concerns about the potential for a higher loss severity on defaulted loans.

Modifications will take one of the following forms: a discount on past due amount, with the possibility of forgiving a portion of this amount; permanent reduction of the monthly instalment; total liquidation, which entails a discount to the outstanding balance if the loan is paid in full; or deed-in-lieu, with economic incentive. For both the first and second modification type, the servicer can forgive principal only if the borrower remains current after modification of the loan during four years for the first case and permanently for the second case.

RMBS

REIT reliance on repo highlighted

Fitch has published a report focusing on mortgage REITs that invest primarily in fixed rate agency MBS. Entitled 'Shadow Banking Mortgages: Agency mREITs and Repos', the study highlights the sector's reliance on repo borrowing and the potential ripple effects on mortgage markets if repo lenders were to tighten financing terms and availability.

The report notes that fixed-rate agency mREIT sector has grown to about US$340bn, as of 1Q13, from about US$80bn as of end-2009. Repos represent roughly 90% of agency mREIT liabilities, with about one-third having maturities of less than one month.

Dealer banks intermediate agency mREIT funding by borrowing at a lower repo rate (20bp) and haircut (2%) within the triparty market and, in turn, providing repo lending to mREITs at about 50bp and a 5% haircut, as of 1Q 2013. Although agency MBS is a sizable market, the report warns that a marginal amount of forced selling could affect mortgage markets - particularly given recent New York Fed research indicating that a dealer or investor liquidation of US$4bn in one day could affect MBS pricing.

Agency 30-year fixed-rate mortgage (FRM) rates jumped by as much as 1.2% last month, reaching above the 4.5% mark, following the Fed's taper talk. Movements of this magnitude over such a short time span are unprecedented.

RMBS

Strong performance for post-crisis GSE loans

US mortgage loans recently acquired by Fannie Mae and Freddie Mac will outperform historical levels, according to Fitch. The agency has completed an analysis of historical data to help investors evaluate upcoming credit-sensitive securitisation proposals from the GSEs.

With plans of engaging in credit risk transfer transactions in the works, the GSEs have publicly released for the first time historical mortgage loan-level credit performance data. The risk-sharing transactions are expected to allow the GSEs to sell credit risk to the private market and to gradually reduce their dominant role in housing finance.

Fitch's analysis uncovered several notable credit trends, most obviously an improvement in credit quality in recent vintages. "Similar to what we've observed in the private market, post-crisis GSE originated loans have recorded strong performance to date," confirms Fitch md Rui Pereira. "The recent performance reflects both better credit quality and improved underwriting controls."

In its report, the agency compares GSE performance to non-agency prime jumbo collateral. It also offers indicative default expectations for a hypothetical pool of newly originated agency loans.

RMBS

Nationstar forbearance revisions expected

Nationstar intends to revise the reporting of principal forbearance modifications, resulting in approximately US$1bn in losses for RMBS collateralised with loans it services, with the revision likely to occur in the July distribution. Fitch expects the impact to be concentrated in classes currently rated double-C or below and currently does not anticipate significant rating changes as a result of the revision.

The revised losses affect loans acquired in 2012 from Aurora Bank FSB and its wholly owned subsidiary Aurora Loan Services. Nationstar has indicated that it currently does not anticipate future revisions on loans recently acquired from Bank of America, or on any loans unrelated to the Aurora acquisition.

Fitch expects to formally review the Nationstar transactions after the loss revisions are reported at the end of July. The revised loss amount is roughly 1.5% of the total balance of the mortgage pools affected.

The agency conducted a survey of all rated mortgage servicers to determine whether additional loss revisions are pending, but - other than Nationstar - no servicer reported a significant amount of HAMP principal forbearance yet to be realised as a loss. Several servicers reported significant non-HAMP forbearance amounts that had yet to be realised.

However, in each case the servicer indicated there was no intention to revise the reporting on these loans. Consequently, Fitch does not expect any additional large revisions for realised losses tied to principal forbearance.

RMBS

Mixed outlook for legacy RMBS

US RMBS issued between 2005-2008 will continue to benefit from rising home prices, but many risks remain that will limit how much their performance improves, according to Moody's. The agency expects losses tied to loan servicing issues to significantly offset the benefits from borrowers being more incentivised to keep up their mortgage payments as they watch the values of their properties rise.

Additional risks to the performance of securitisations include rising interest rates - which decrease the credit protection from excess spread in a transaction - and structural weaknesses in some transactions that expose their bonds to declining credit enhancement when few loans remain in the loan pool. Moody's expects the combination of positive and negative factors to result in it evaluating some bonds for upgrades and others for downgrades.

"Given the complexity of many RMBS structures, some bonds will benefit from the overall improvement in loan performance, while others will be more affected by the downside risks," says Moody's analyst Jiwon Park.

Servicing issues that could offset the benefits of improving mortgage performance include loss mitigation decisions that produce inefficient workouts on delinquent loans, looming write-down's from unrecognised forbearance modification losses and cashflow disruptions from future servicing transfers. "Although the mortgage servicers have been clearing their pipelines of delinquent loans, both by loan modifications and stepping up short sales, they continue to face numerous challenges," says Moody's vp Peter McNally. "These include dealing with the long timelines for foreclosure, which will press losses upwards, and the need to liquidate a high number of loans in serious delinquency."

Rising interest rates will reduce the credit protection from excess spread in transactions that have modified loans with low fixed rates, but pay out floating rate bond coupons. Modified loans make up about 30% of the loans outstanding backing 2005-2008 vintage subprime RMBS.

The rate of new defaults is expected to decline in 2005-2008 RMBS loan pools because of improving loan-to-values for borrowers that have not defaulted on their loans as home prices climb higher.