News Analysis
RMBS
Rising opposition
Eminent domain success in doubt
Successful implementation of Richmond, California's eminent domain plan (SCI 31 July) and widespread adoption of similar exercises by other cities is said to be unlikely. Nevertheless, it has introduced more uncertainty to the non-agency RMBS market.
Less than a third of the 624 underwater mortgages targeted in Richmond's proposal are believed to be delinquent. The city has offered to buy the mortgages out of the RMBS trusts for 80% of their fair value.
Once the loans are acquired, the plan is to refinance these homeowners into new GNMA loans. If the loan holders do not comply, Richmond would use its power of eminent domain to seize the loans.
While the number of loans immediately impacted by these actions is small relative to the size of the non-agency RMBS market, Bank of America Merrill Lynch analysts note that it introduces more uncertainty, given the potential spill-over effects if successful. Moody's says that the move is credit negative for US RMBS because a successful execution of the programme would encourage other cities to adopt similar plans that would increase losses on RMBS.
However, to get to that point, the use of eminent domain to seize underwater mortgage loans will likely have to move through the court system to determine its legitimacy. The use of eminent domain is contentious and legally complex because servicers of RMBS trusts are not contractually and legally allowed to sell mortgage loans, due to REMIC laws and their pooling and servicing agreements.
"The bottom line is that this should end up going through exhaustive litigation before it is resolved," the BAML analysts observe. "Until there is some sort of final resolution from the courts, the use of eminent domain will continue to make waves in the market. In the near term, trusts which have exposures to the loans in question may be impacted to the extent servicers and/or trustees incur legal expenses, which may be passed onto the trusts - depending on each deal's PSA."
Affected bondholders appear to be coming together to mount opposition to the proposal. PIMCO and Blackrock, for instance, are members of a coalition of RMBS investors that has filed a law suit against the plan via Ropes & Gray.
The group is expected to argue that mortgages which are held outside the city are not within the city's legal jurisdiction to seize. Richmond also still needs city council approval before seizing mortgages.
A number of other questions also need to be addressed, according to RMBS analysts at Barclays Capital. First, is the legality of using eminent domain to seize mortgages in this manner: the precedents set on eminent domain cases seem to give broad powers to local governments.
Second, questions are likely to be raised in this case because the immediate monetary benefits are passed onto other private investors. A US Supreme Court decision in June 2005 (Kelo versus City of New London) appears to address that issue in favour of the local government, as long as it showed 'public use'.
"The courts may be asked to determine whether the benefit to a small number of borrowers outweighs the costs that are borne by all borrowers in the community, as well as potentially investors in these loans," the Barcap analysts observe. "If the benefits do not outweigh the costs, then the only beneficiary would be the investors buying these loans and Mortgage Resolution Partners. In such a case, the Kelo decision may not apply."
Finally, there is the question of just compensation. If compensation is offered at about 80 cents to a dollar on the home appraisal, courts will need to be convinced that this amount is adequate.
Since there is little trading in such underwater current loans, model-based estimates are likely to be used, which may vary widely depending on the assumptions used. Further, questions should be asked regarding whether the valuation is based on the loan and the borrower's ability to pay alone or on the value of the underlying home.
The plan is contingent on private equity investors buying the loans at market value, which may be difficult to determine in neighbourhoods with high foreclosure levels. "The loans have to be written down to values lower than the home prices to leave a meaningful equity for the existing owners to incentivise them to stay. The forced process of setting values and new loan balance between servicer, new investor, the borrower and city will by itself be very complex and full of controversies," notes Ron D'Vari, ceo of NewOak Capital.
In addition to expected litigation, there are other headwinds to the Richmond plan with respect to the GNMA take-out that is instrumental to their success. Incorporated into the House Financial Services Committee's recently proposed Protecting American Taxpayers and Homeowners (PATH) Act is a provision that would prohibit the GSEs and the FHA from guaranteeing or insuring mortgages originated in a county that has exercised eminent domain to seize mortgage loans in the past 10 years. The Defending American Taxpayers from Abusive Government Takings Act was also reintroduced by Representative John Campbell last month.
Meanwhile, rising home prices are undercutting the rationale for the programme, according to Moody's. Loan-to-values (LTVs) have been declining and home prices rising since 2012 in Richmond, as well as several other cities that are reportedly considering the plan. As home prices improve, borrowers will have less negative equity and be less likely to default.
Without eminent domain, Moody's notes that expected recovery on the effected loans will be greater. First, many borrowers with underwater loans who remained current until now would continue to make their payments and there would be no losses. Second, rising home prices will continue to reduce the likelihood that borrowers will default and, even if they do, will reduce ultimate losses.
"If only Richmond and a handful of other cities implement the plan, overall losses to RMBS will be small. In the event that the plan becomes widespread - which we do not expect - losses would be significant," the agency says.
D'Vari suggests that mortgage lenders and banks will most likely restrict or stop lending in cities pursuing eminent domain, pushing home prices even lower and exacerbating the very problem attempting to be solved. "One alternative to eminent domain for stopping foreclosures is to create special loan programmes to enable the underwater borrowers to approach their servicers with reasonable and more attractive pay-off proposals than can be achieved through foreclosure. Servicers are apt to consider borrower-initiated proposals in lieu of foreclosure if it leads to higher recovery. This should ultimately turn the negative cycle and even attract new buyers to the cities affected."
The Structured Finance Industry Group (SFIG) is finalising a position paper on the issue. The paper was initially drafted by members of SFIG's Residential Mortgage Committee, which then sought and received comments from a broad group of industry participants, including investors, servicers and trustees.
CS
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Market Reports
ABS
Diversity seen in secondary ABS
US ABS secondary trading remained active yesterday, with elevated supply observed in auto paper in particular. A rare bond from a tobacco-related litigation fee securitisation was also out for the bid.
A list of short WAL senior 2011-2012 vintage bonds provided the bulk of supply in the auto space during the session. Among the tranches appearing for the first time in SCI's PriceABS archive were BMWLT 2012-1 A4 (which was talked in the high-30s/40s) and FORDO 2011-B A4 (which was talked at 20 area). ALLYA 2011-5 A3 was talked at mid-20s, having been covered at plus 25 on 1 August.
Aircraft paper was also well represented yesterday. CSTLE 2003-1A B2 was talked in the low-100s (the same level as two days previously) and PALS 2001-1A C2 was talked in the very low-singles. EAST 2000-A A1 was talked in the mid/high-teens, having previously been talked at 20 area on 9 July.
Volume was lighter in the credit card ABS space, however. DCENT 2010-A2 A2 was talked in the low-20s (having been talked at 20 area on 22 July), while COMET 2005-A9 A was talked at 20 area (having last been covered at plus 13 on 25 October). CHAIT 2012-A3 A3 was talked in the mid-teens, a little lower than where it was talked on 22 July.
In terms of student loan ABS, a few seasoned mezzanine roundlots from the SLMA shelf were out for the bid. The SLMA 2002-A and 2003-A C tranches were talked in the mid-90s and high-30s respectively during the session, having been talked at the same levels two days previously.
A couple of short WAL equipment ABS bonds also did the rounds yesterday. GEDFT 2012-3 A and JDOT 2011-A A3 were talked at 40 and mid-teens respectively.
Finally, there was a rare outing for LSMFT 2001-3A A, which was talked in the low-100s. The Litigation Settlement Monetized Fee Trust bond was talked at the same level two days ago.
CS
Market Reports
RMBS
Large list leads RMBS surge
A CDO liquidation and large legacy bid-list helped boost US RMBS secondary supply yesterday, with around US$1.2bn of non-agency BWIC volume observed. Senior tranches dominated, while investors were mainly focused on subprime paper.
The legacy list is understood to have been met with good participation, with 16 of its 20 bonds trading. Many of the session's larger blocks came from this list and a few of those were entire tranches that had been held since origination, according to Interactive Data.
SCI's PriceABS data reveals prime names out for the bid such as WFMBS 2005-AR2 2A2, which was talked in the 100 area. The tranche was also talked at 100 last month and around 102 in June. It was covered on 10 October last year in the high-90s.
The Alt-A hybrid BALTA 2004-12 1A1 bond was also out for the bid, talked in the mid-90s. It was previously talked in the 90 area or very high-80s on 19 July.
Option ARM paper also proved popular during the session, with WAMU 2005-AR8 2A1A one of many WAMU tranches circulating. The bond was talked in the mid-90s, while tranches such as WAMU 2005-AR12 2A1 and WAMU 2005-AR13 A1A3 were talked in the high-90s and mid/high-90s respectively. Tranches from the WAMU 2005-AR17 and 2007-OA5 deals were also out for the bid.
Among the subprime offerings seen yesterday was CXHE 2006-A M1, which was talked in the mid/high-60s. The same tranche was talked at around 70 a day earlier and had been talked in the low-70s back in May.
RASC 2006-KS8 A4 was also out for the bid and talked in the mid-50s. That tranche had been talked in the mid-40s and mid/high-40s on the day before and was also talked in the mid/high-40s on 20 June.
Some of the lowest talk in the session was reserved for another subprime tranche - BNCMT 2007-2 M1. The bond was talked in the mid-single digits, a little higher than the low-single digits talk it attracted last September.
JL
Market Reports
RMBS
Divergent price talk observed
US non-agency RMBS secondary supply was boosted by a large CDO liquidation yesterday. The bid-list was concentrated in 2005-vintage mezzanine bonds, which in turn showed a wide range of price talk.
For example, the Alt-A hybrid GPMF 2005-HY1 M1 bond was talked at low-30s and low/mid-40s during the session. The prime hybrid BAFC 2005-D B1 tranche was talked at mid-60s, before being covered at 78 handle, according to SCI's PriceABS archive.
A similar divergence in subprime paper was also observed: ACCR 2005-3 M3 was talked at low/mid-60s and low-70s. Elsewhere in the subprime space, the ABSHE 2005-HE6 M2 tranche was talked in the high-90s.
News
Structured Finance
SCI Start the Week - 12 August
A look at the major activity in structured finance over the past seven days
Pipeline
In a week in which many deals joined the pipeline and left soon after, CMBS accounted for the majority of those that remained. Three new ABS deals were also announced.
Two of those ABS (US$779m Capital Auto Receivables Asset Trust 2013-3 and US$1bn Fifth Third Auto Trust 2013-1) were auto transactions, while the other (US$563m Kentucky Higher Education Student Loan Corporation series 2013-2) was a FFELP student loan ABS.
The CMBS consisted of: US$325m BBCMS 2013-TYSN; US$1.57bn FREMF 2013-K31; US$1.2bn GSMS 2013-GCJ14; US$250m JPMCC 2013-ALC; US$91.8m JPMCC 2013-WT; and US$340m ORES Series 2013-LV2.
Pricings
There were considerably more ABS pricings, with a pair of RMBS and a CMBS also printing. In addition, eight CLOs were issued during the week.
Four of the ABS new issues were auto deals: US$877.67m AmeriCredit Automobile Receivables Trust 2013-4; US $367.3m CNH Wholesale Master Note Trust Series 2013-2; US$750m Enterprise Fleet Financing series 2013-2; and US$785.28m Hyundai Auto Lease Securitization Trust series 2013-B. The other ABS prints comprised: US$297.5m Cabela's Credit Card Master Note Trust series 2013-II; US$900m Citibank Credit Card Issuance Trust 2013-A5; US$732.29m MMAF Equipment Finance 2013-A; and US$747m SLM Student Loan Trust 2013-4.
The RMBS prints were A$500m-equivalent Pepper Prime 2013-1 Trust and €1.028bn Quadrivio RMBS 2013, while the CMBS was US$1.1bn WFRBS 2013-C15.
Much of the week's issuance was in the CLO space, with five US transactions and three European deals pricing. The US deals were: US$857m ALM VII(R); US$933m ALM VII(R)-2; US$414.05m Highbridge Loan Management 2013-2; US$414m Octagon XXII; and US$463.8m Palmer Square CLO 2013-2. Finally, the European CLOs comprised: €307m Harvest CLO VII; €372.42m Hayfin Ruby II; and €413.18m Herbert Park CLO 2013.
Markets
The US ABS secondary market was active last week, as SCI reported on Friday. Auto supply was particularly elevated towards the end of the week, while Thursday's session also saw a rare bond from a tobacco-related litigation fee securitisation out for the bid.
Much of the auto supply on Thursday came from a list of short WAL senior 2011-2012 vintage bonds. SCI's PriceABS data shows several tranches from that list, including ALLYA 2011-5 A3 and BMWLT 2012-1 A4. It also shows that the tobacco bond - LSMFT 2001-3A A - was talked in the low-100s.
It was also an active week for US RMBS, with non-agency trade volumes up to about US$7bn, according to Wells Fargo analysts. Price levels were up from half a point to a point and a half.
US CMBS spreads tightened and outperformed broader equity and credit markets. Generic 2007 dupers came in by 5bp to around swaps plus 102bp. "The basis in credit spreads between the 2007 and 2006 duper has compressed substantially and is now at about 20bp, close to its post-crisis tights," comment Barclays Capital CMBS analysts.
The US CLO secondary market, however, was quieter. Only around US$200m of BWIC volume was observed, with half of that concentrated in equity tranches. A healthy amount of the paper traded, but DNTs accounted for around 25% of supply.
Deal news
• All loans securitised in the Fleet Street Finance 3 CMBS are now in default, following the transfer into special servicing of the €49.4m Saxony loan. The deal is expected to suffer additional principal losses of €108m-€118m, with an increased proportion likely allocated to class B noteholders.
• Moody's discusses in its latest CLO Interest publication a number of novel features contained in KKR Financial CLO 2013-1 that are intended to comply with both current and forthcoming European risk-retention rules. The US deal is structured so that the originator of the assets retains the equity, which provides incentives for European investors to purchase the deal's notes.
• S&P has raised its rating on Munich Re's Queen Street V Re to double-B minus from single-B plus. The move follows the release of a reset report detailing the new attachment and exhaustion points for the catastrophe bond.
• Vertical Capital has replaced Strategos Capital Management as collateral manager on Kleros Preferred Funding. Moody's has confirmed that the move will not result in the withdrawal, reduction or other adverse action with respect to the ABS CDO's ratings.
Regulatory update
• Successful implementation of Richmond, California's eminent domain plan (SCI 31 July) and widespread adoption of similar exercises by other cities is said to be unlikely. Nevertheless, it has introduced more uncertainty to the non-agency RMBS market.
• The Loan Syndications and Trading Association has submitted a comment letter to the Fed, the OCC, the FDIC, the SEC, the FHA and the Department of Housing and Urban Development. The letter prominently features a new survey - polling 35 CLO managers that collectively manage US$228bn across 509 deals - conducted by the LSTA, which shows that new risk retention rules would dramatically shrink the CLO market.
• ISDA has released a new white paper entitled 'CCP Loss Allocation at the End of the Waterfall'. The move is in response to industry efforts to develop an effective recovery, continuity and resolution framework for central counterparties and reflects consensus views of the ISDA Risk and Margin Regulatory Implementation Committee.
• Even as the CFTC's swap execution facility (SEF) rules go into effect on 2 October, execution models are emerging that will help the buy-side preserve their existing workflow for swaps trading, according to TABB. The firm suggests that the CFTC's decision to reduce the RFQ requirement to two/three from five, in tandem with the voice trading provision, favours buy-side firms that want to keep trading swaps in size with a few trusted counterparties.
• The US SEC has charged UBS Securities with violating securities laws while structuring and marketing the ACA ABS 2007-2 CDO by failing to disclose that it retained millions of dollars in upfront cash it received in the course of acquiring collateral for the CDO. UBS agreed to pay nearly US$50m to settle the charges.
• The US SEC has charged Bank of America and two subsidiaries with defrauding investors in an RMBS by failing to disclose key risks and misrepresenting facts about the underlying mortgages (SCI 5 August). The SEC alleges that the bank failed to tell investors that more than 70% of the mortgages backing the offering - called BOAMS 2008-A - originated through the bank's wholesale channel of mortgage brokers unaffiliated with Bank of America entities.
• IntercontinentalExchange is set to launch a swap execution facility (SEF) - dubbed ICE Swap Trade - in 3Q13. So far, Citi, Morgan Stanley, SG and UBS have signed up to provide firm pricing for the platform.
Deals added to the SCI database last week:
American Credit Acceptance Receivables Trust 2013-2; CarMax Auto Owner Trust 2013-3; CIFC Funding 2013-III; Citibank Credit Card Issuance Trust 2013-A3; Citibank Credit Card Issuance Trust 2013-A4; COMM 2013-CCRE10; Courtine RMBS 2013-I; FREMF 2013-K30; Geldilux TS 2013; Hilton Grand Vacations Trust 2013-A; HLSS Servicer Advance Receivables Trust Series 2013-T4; HLSS Servicer Advance Receivables Trust Series 2013-T5; MSBAM 2013-C11; MVW Owner Trust 2013-1; Northshore Re series 2013-1; NYCTL 2013-A Trust; RAIT 2013-FL1; Sound Point CLO III; STWD 2013-FV1; Thrones 2013-1; Wireless Capital Partners series 2013-1; Wireless Capital Partners series 2013-2.
Deals added to the SCI CMBS Loan Events database last week:
BACM 2007-5; BSCMS 2005-PWR8; BSCMS 2005-T20; COMM 2006-C7; CSMC 2007-C3; DECO 2007-E5; DECO 2007-E7; DECO 6-UK2; FLTST 3; GCCFC 2006-FL4A; GSMS 2005-GG4; JPMCC 2006-LDP8 & JPMCC 2006-LDP9; JPMCC 2006-LDP9; LBFRC 2007-LLF C5; MSC 2005-IQ9; TAURS 2006-2; TAURS 2007-1; TITN 2007-2; TITN 2007-3; TITN 2007-CT1; TMAN 5; TMAN 6; UBSC 2011-C1; UBSC 2012-C1; WBCMT 2006-C25; WBCMT 2006-C29; WBCMT 2007-C30; WINDM VIII; WINDM X; WINDM XII.
News
CMBS
Expected losses upped for FLTST 3
All loans securitised in the Fleet Street Finance 3 CMBS are now in default, following last week's transfer into special servicing of the €49.4m Saxony loan. Barclays Capital securitisation strategists expect the deal to suffer additional principal losses of €108m-€118m, with an increased proportion likely allocated to class B noteholders.
The final recovery for the Orange loan was last month determined to be €48.8m (see SCI's CMBS loan events database). Except for a final payment of €500,000, the net sales proceeds were already allocated to the transaction in July 2012, but the recovery determination resulted in a €18.2m loss allocation to classes E and D of the CMBS. Meanwhile, two property sales related to the Corleone loan resulted in a €20m principal reduction, allocated pro rata to the notes.
The Barcap strategists anticipate that losses and resolution on the Saxony loan won't occur until mid-2014. The nine properties securing the loan are let to Marseille Kliniken on a long lease and the reported market value as of January 2012 is €111.4m, resulting in a whole loan LTV of 62%. Resolution will likely consist of borrower-led property sales, with the aim of bringing the remaining leverage to a refinanceable level (40%-45% LYV).
As per the July 2013 IPD, Fleet Street Finance 3 was in modified pro rata pay mode. As a material senior loan default, the payment default of the Saxony loan should count against the sequential-pay trigger, according to the strategists.
Together with the defaulted Orange and Blue Star loans, the Saxony senior loan contributed 32% to the initial Fleet Street Finance 3 portfolio. However, the relevant sequential-pay trigger level is based on the defaulted loans' contribution to the initial principal outstanding of the whole loans.
By this measure, the three loans subject to a material senior loan default contributed only 22%, which is below the trigger level (30%). Hence, the strategists believe that the transaction will not switch to sequential-pay until the Corleone loan is subject to a material senior loan EOD.
If the CMBS was in sequential-pay mode, the predicted €108m-€118m loss would translate into an increased principal loss of 35%-55% for the class B notes. For class B noteholders in particular, the timing of the switch to sequential-pay is important.
"Based on current note balances, class B would receive 10% of Corleone loan property disposal proceeds," the strategists explain. "However, the class would lose subordination because classes C and D would combined receive 20% of such proceeds. All else equal, this would increase the principal loss severity for class B."
CS
Job Swaps
Structured Finance
Partner rejoins Aussie firm
Clayton Utz has appointed Sonia Goumenis as a partner in its Sydney securitisation practice. She has over 12 years' experience in securitisation transactions, acting for a range of participants and covering a broad swath of asset classes.
Goumenis began her career at Clayton Utz as a graduate, becoming a partner in January 2008. She returns to the firm from Allen & Overy.
Job Swaps
Structured Finance
Gleacher seeks advice on options
Gleacher & Company has retained Blackstone Advisory Partners to provide advisory services in connection with potential transactions and to work with the company to consider potential mergers, acquisitions or other business combinations. Gleacher earlier appointed a restructuring officer (SCI 5 June) and has shut down its RMBS and investment banking units.
Job Swaps
CLOs
Fixed income PM appointed
Jon Jonsson has joined Neuberger Berman as md. He is based in London and joins from JPMorgan, where he spent more than 15 years. Jonsson will serve as a portfolio manager on the firm's global fixed income team.
Job Swaps
CMBS
CMBS ratings probe opened
The US SEC is believed to have opened an investigation into the consistency of S&P's CMBS rating methodology. The move is said to be related to when the agency pulled assigned ratings on the US$1.5bn GSMST 2011-GC4 transaction just over two years ago, prompting Goldman Sachs and Citi to abandon their deal after it was placed with investors (SCI 28 July 2011). The ratings were withdrawn after S&P discovered potential discrepancies in the application of its methodology.
Job Swaps
Insurance-linked securities
ILS fund manager adds analyst
Ben Adolph has joined Leadenhall Capital Partners' underwriting team in London as senior non-life analyst. He will report to head of portfolio analysis Jillian Williams.
Adolph was previously at Antares, where he was property treaty deputy underwriter. Before that he worked in Brit's North American property treaty underwriting team.
Job Swaps
Risk Management
Market data provider expands CDS coverage
SuperDerivatives has added Fitch Solutions' CDS pricing service to its market data platform, DGX. Fitch's service covers up to 3,000 single name CDS contracts and its addition significantly boosts SuperDerivatives' platform.
Fitch Solutions' service uses independent pricing data from contributing market participants and provides CDS pricing intelligence that can be used for valuations, regulatory, accounting and risk management purposes. DGX provides a wide coverage of cash and derivatives products, with data, news and commentary from numerous sources.
Job Swaps
RMBS
SF vet joins REO-to-rental push
FeatherStone Investment Group has appointed Kevin Blaser as structuring and trading md. He will be in charge of all new securitisations of FeatherStone's REO-to-rental portfolio and secondary trading activities.
Blaser has over 20 years of structured finance experience and has previously worked for companies such as Shay Asset Management and KTI Enterprises. He will be based in Atlanta.
FeatherStone has also announced a new programme intended to provide liquidity to the REO-to-rental market. The new programme will allow investors to participate in both the immediate rental cashflow and the potential gains from the sale of the component properties in a deal, as opposed to current REO-to-rental deals which only pay investors coupon and principal payments derived from rents.
Job Swaps
RMBS
Strategy director named
Clayton Euro Risk has appointed Konstantine 'Gus' Pastras to the newly-created position of client development and strategy director, responsible for sales, client development and marketing activity. He will report to ceo Michael Bolton.
Pastras has spent the majority of his career in RMBS, most recently as vp of ABS & RMBS at DBRS. Before that, he worked at Fannie Mae, Fitch and Investec.
News Round-up
ABS
Risks ahead for container ABS?
US shipping container ABS issuance continues to increase, against a backdrop of improving collateral trends. However, Fitch suggests that lingering risks remain.
New container deals are on pace to equal and possibly even pass the high-water mark seen last year, with six transactions totalling US$1.7bn so far this year. This compares with nine transactions totalling US$2.5bn for all of 2012.
"The environment has been well-suited for new container ABS issuance as economic growth has trudged on and other industry funding sources have been constrained," says Fitch senior director Brad Sohl.
Performance thus far has been steady, with pre- and post-crisis container ABS transactions benefitting from higher utilisation rates. However, advance rates on new issues have generally risen to levels that Fitch believes may not provide adequate protection under a single-A stress.
This comes as container demand growth is expected to slow. Coupled with the yet-to-be-seen impact of shipping alliances on container demand, this means there are potential challenges to the container supply and demand balance on the horizon. At the same time, struggling shipping companies increase the risk of lessee defaults.
"Shipping company revenues are under heavy pressure by stubbornly low freight rates, which are elevating lessee default risks," explains Sohl. "Large scale lessee defaults would stress container ABS revenue and increase storage and recovery costs."
News Round-up
ABS
Retail card ABS sustainability discussed
Several news reports have speculated on the future financial stability of various US retailers over the past few months. This could have an impact on credit card securitisation trusts that contain receivables generated by co-branded or private-label cards associated with these retailers, S&P notes.
Despite its expectation of a continued modest rebound in the US economy, the agency says that some retail segments - including niche non-apparel, restaurants and certain mid-tier department stores - still face greater challenges than others in their ability to draw in consumers. When rating and monitoring credit card ABS, S&P considers the future viability of a retailer because it believes that the closing of retailer's stores can reduce or eliminate the utility of the related credit cards. This would likely have an adverse impact on the size and performance of related trust assets.
The unique risks associated with a retail card securitisation affect assumptions for key performance variables, such as purchase rates, payment rates and loss rates. Generally, S&P considers lower purchase rate credit for private-label card programmes tied to a specific retailer, as it believes these cards will likely have less utility than co-branded cards - which can be used as general-purpose cards, even in the event of the closing of the related retailer's store.
Certain retailers are affiliated with banks established to issue retail cards associated with the retailer. Typically, these pools are not diversified, S&P says.
"In our opinion, if the retail store closes and the cards lose their utility, the strongest underlying obligors will likely pay off their outstanding receivables balances quickly and the pool would then be left with the least creditworthy obligors," it continues. "This outcome is more likely to occur for a retailer-affiliated bank, considering that one of the primary reasons retailers set up card programmes is to help increase sales. Therefore, following a retailer's closure - with sales generation no longer applicable - the retail-affiliated bank is most likely to cease issuing credit and possibly sell the outstanding receivables."
Because the agency contemplates a number of different factors in arriving at credit card ABS ratings, it notes that a change in the rating of a retailer - or a retailer's bankruptcy or closure - in and of itself often will not lead to a rating change.
News Round-up
ABS
Delamare drives card payment rate jump
The three-months rolling (3MA) charge-off and delinquency indices remained at the same level reached in the previous quarter, 4.5% and 1.8% respectively, according to Fitch's latest quarterly UK Credit Card Index. The 3MA payment rate index jumped to 20.3%, whereas the 3MA gross yield index decreased to 19.5% over the same period.
Fitch notes that these metrics are impacted by the inclusion of the Delamare master trust into the index calculation from May. The inclusion of Delamare - which contributes around 9% to the collateral balance backing the indices - influenced the payment rate and charge-off indices positively, due to its strong performance in these areas. However, the gross yield index is adversely impacted because the Delamare pool does not create as much yield as other UK trusts, partly due to high payment rates.
Fitch expects the annual UK unemployment rate for 2013 and 2014 to remain relatively stable, at 8 % and 7.9% respectively, before it drops to 7.4% in 2015. The agency has not revised its economic growth forecast for 2013 and 2014 for the UK, which stands at 0.8% and 1.8% respectively, before it is expected to reach 2% in 2015.
Based on these expectations, the agency believes that UK credit card performance will remain fairly stable, with only limited increases in delinquency and charge-off levels towards the end of 2013.
News Round-up
ABS
New student loan law to have mixed impact
President Obama last Friday signed into law the Bipartisan Student Loan Certainty Act of 2013, which pegs the interest rate on new federal student loans to a market rate fixed at loan origination. Moody's expects the new loan rates to have mixed effects on private student loan securitisations because the new rates will be credit positive for undergraduates, but credit negative for graduate students.
The legislation aims to lower borrowing costs for students this coming school year, but costs will climb as interest rates rise. It sets interest rates for new loans at the high yield of the 10-year Treasury note at the last auction before 1 June of each year, plus the spread depending on loan type, and includes lifetime caps to shield borrowers if interest rates significantly jump.
Undergraduates will pay a 3.86% fixed rate for Stafford loans this coming school year, far below the current 6.8% fixed rate, while graduate students will pay 5.41% for unsubsidised Stafford loans. Although undergraduate loan rates are unlikely to exceed 6.8% through 2018, Moody's projects that graduate student rates will quickly rise above 6.8%. The difference stems from the spread on the 10-year Treasury note being 3.6% for Stafford loans to graduate students but 2.05% for undergraduate students.
Lower loan rates for undergraduates will result in smaller monthly loan payments and lower lifetime costs. Based on Moody's 10-year Treasury note forecast, a typical incoming college freshman who takes out US$20,000 of Stafford loans over the next four years will pay roughly US$2,700 less over the life of the loans because monthly payments will be reduced by approximately US$22. Students who start school in 2015 will benefit less because their monthly payments will be cut by approximately US$6.
A typical incoming graduate student who takes out US$30,000 of unsubsidised Stafford loans over the next two years will pay roughly US$2,100 less over the life of the loans because monthly payments will be reduced by approximately US$17. However, a student who starts graduate school in 2015 will pay roughly US$2,800 more over the life of the loans, owing to an additional US$23 in monthly payments.
The majority of loans in the private loan securitisations Moody's rates are to undergraduates who will be better able to avoid default owing to a reduced debt burden. But only recent securitisations will benefit because they contain loans to undergraduates currently in school who are eligible for new, lower rate federal loans; loans to borrowers in school constitute 10%-50% of 2010-2013 securitisations the agency rates. Because students typically finance their education with both federal and private loans, lower federal loan payments will result in fewer private loan defaults.
However, the new rates will be credit negative for private loan securitisations if interest rates rise more than expected and if a considerable portion of the loans in the securitisations are to undergraduates who choose to attend graduate school.
News Round-up
Structured Finance
Special opportunities fund closed
Atalaya Capital Management has closed its fifth special opportunities fund to a new and existing primarily institutional investor base. Atalaya Fund V will seek to build upon the firm's prior success in opportunistically purchasing illiquid credit assets. Fund V may also invest in specialty finance opportunities and originate select primary private credit investments.
Atalaya exceeded its US$500m target and closed Fund V with a self-imposed hard-cap of US$575m. The commitments will be invested via a draw-down, private equity structure. Investors are primarily endowments, foundations and pension funds.
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Structured Finance
PPIP programme draws to an end
The current quarter marks the effective end of the PPIP programme, as all the funds have been wound down and all US Treasury debt and equity repaid. The last fund to sell its assets was Oaktree, which invested primarily in CMBS securities.
The Treasury had invested US$6.2bn in equity capital in the PPIP programme, along with US$12.4bn of debt. The equity returned close to 50% over the life of the funds, with the Treasury realising a net profit of US$3.8bn.
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Structured Finance
Securitised credit boosts hedge fund returns
Aggregate hedge fund returns rose by an average of 1.2% in July and have returned an average of 4.5% through the first seven months of 2013, according to the latest eVestment figures. Credit strategies resumed their path upwards during the month, with securitised credit funds leading the way once again.
Credit hedge funds focused on mortgage markets have fared relatively well during the recent treasury-induced MBS market declines, returning an average of 0.39% in July and 5.09% year to date. In comparison, the Barclays US MBS Index has fallen by 2.6%.
Funds with multi-sector securitisation exposure returned 0.33% in July and 6.02% year to date. Event-driven/distressed strategies returned 1.65% in July and 6.51% year to date.
At US$9.48bn, investor flows for fixed income/credit strategies remained strong in June, with a preference away from purely directional exposures. Relative performance is said to be a key reason for such strength, as institutional investors seek alternative exposures to their substantial traditional long-only bond fund allocations. Estimated assets under management in the sector stand at US$880.75bn.
Investor flows into MBS strategies accounted for US$1.62bn in June, with estimated assets under management now standing at $86.21bn. The comparative figures for distressed strategies are US$480m and US$228.49bn respectively.
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CDO
RFC issued on PF CDOs
Moody's has published a request for comment (RFC) on its proposed approach to rating CDOs backed by project finance and infrastructure assets (PF CDOs). Based on preliminary analysis, the agency expects the rating impact on existing transactions to be limited to a one-notch downgrade, which may affect one or two PF CDO transactions.
The proposed approach is in line with the main assumptions currently used by Moody's in its analysis of outstanding PF CDO transactions. The scope of the proposed changes is limited to the update and additional standardisation of correlation and recovery assumptions.
The analysis of a typical PF CDO is conducted in two stages: the assignment of public ratings or credit estimates to the assets in the CDO portfolio by the project and infrastructure finance team; the results are then used to review the structure at the level of the CDO issuing vehicle and assign ratings to the vehicle's liabilities. Moody's notes that the dual-phase profile of the underlying assets (construction and operation), the rating uplift in operation as well as asset-specific recovery rate assumptions and correlation frameworks are some of the most significant differentiating features of PF assets and PF CDO portfolios that distinguish them from corporate CDOs.
The agency notes that eligibility criteria in recent transactions have continued to broaden the range of asset exposures in PF portfolios.
News Round-up
CDS
Index constituent changes predicted
Markit iTraxx Series 20 is set to begin trading on 20 September. Based on current data and Series 19 inclusion rules, JPMorgan credit derivative strategists expect six constituent changes in iTraxx Main and three in iTraxx Crossover. No changes are anticipated for the iTraxx Financials index.
The names likely to leave the iTraxx Main index are PostNL, Xstrata, Henkel, JTI UK, Technip and STmicroelectronics. Names likely to enter are Astrazeneca, Rexam, Anheuser Busch, Repsol, Swisscom and SABMiller.
The JPMorgan strategists note that Linde AG is currently the least liquid name in the industrials sector and could leave the index if volumes are low between now and the end of August. Additionally, Lanxess is a potential downgrade candidate, currently trading at BBB neg/Baa2/BBB. Deutsche Post is the most likely candidate to replace either name if they leave the index.
Names likely to leave the iTraxx Crossover index, meanwhile, are Codere, Grohe and Infineon. Infineon and Grohe are both expected to be excluded from Crossover Series 20 as they currently trade below the cut-off of 2x iTraxx Non-Financials (currently standing at 179bp).
Codere is likely to be excluded as it currently trades wider than the 50 points plus 500bp limit for Crossover names. A credit event in Codere prior to the September roll would also exclude it from the index; the cut-off date for this is one day prior to the launch of the new index.
The names likely to replace the outgoing entities are PostNL and two supplementary list names. The 12-month window period to consider debt issuance for the Crossover supplementary list ends on 30 August.
Inclusion rules for Series 20 have yet to be finalised by Markit. Consequently, the strategists warn that differences in the final constituents may arise.
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CLOs
Greater flexibility for new CLO managers
The CLO market has become more receptive to new managers, evident in the ability of some to issue multiple CLO 2.0 transactions, as well as the relaxation of reinvestment restrictions in their deals. However, Moody's notes in its latest CLO Interest report that some of the more recent entrants do not have investment professionals with substantial CLO or leveraged loan experience, heightening the risk of potential governance and operational issues.
Moody's expects the trend of managers having greater flexibility to adjust CLO portfolios to continue. The agency cites as an example the lengthening of the typical reinvestment period to four years for new managers, which is the same as the average reinvestment period for experienced CLO managers. A three-year reinvestment period was more common for deals by new managers last year, as senior investors sought to reduce potential extension risk by demanding an earlier return of their principal investments.
In addition, more of the recent new-manager CLOs permit the purchase of additional assets after the end of the reinvestment period, just like experienced-manager CLOs. Most of the new-manager CLOs issued through 3Q12 prohibit reinvesting after the reinvestment period, unless noteholders explicitly provide consent. Nevertheless, the purchase of additional assets is still a subject of heavy negotiation between the manager and investors (see also SCI 30 April).
Investors continue to demand excess returns or additional protection in new-manager CLOs, however. In most cases, liability spreads are higher than in experienced-manager CLOs.
CLO investors, especially experienced senior investors, also continue to seek protection from negative tail events. For example, in a few new-manager CLOs, the majority holder of the senior notes can remove the manager if: the deal triggers a key person provision; overcollateralisation ratios decline below specific thresholds; the rating on the senior CLO tranche falls below a certain level; or the manager loses investment professionals or its assets under management drop below certain thresholds. In some cases, an affiliate of the senior noteholder also has the right to step in as the designated replacement manager upon removal of the manager, with the additional incentive of collecting a subordinated fee at the onset of the deal.
Most of the new managers issuing deals through 3Q12 hired personnel with extensive leveraged loan experience through investment vehicles such as loan funds and managed accounts. Many had also recruited key investment professionals, sometimes entire teams, from other CLO management firms.
But some of the more recent entrants do not have investment professionals with substantial experience managing a CLO portfolio. When a new manager's key investment professionals have limited track records for both CLOs and leveraged loans, Moody's says it might decline to rate its CLO.
Governance is another issue. For example, the agency raised concerns about the adequacy of the valuation procedures and controls of KCAP Financial in relation to the KCAP Senior Funding I deal, following the SEC's findings that the firm committed violations related to valuation of investments and internal controls during the financial crisis (SCI 29 November 2012). In this case, however, Moody's concluded that the structural controls in the CLO documentation mitigated this risk because the manager will submit to the CLO trustee copies of bids or valuations from third parties that it used to determine the market value of assets.
Moody's assigned ratings to deals by six managers new to the CLO 2.0 market in the first half of 2013, bringing the number of new managers to 18 and the number of deals under their management to 32. Since 4Q12, a number of entities actively investing in CLO tranches have forayed into CLO management - including Anchorage Capital Management, DFG Investment Advisers and Palmer Square Capital Management. A number of other CLO investors are also expected to venture into the CLO management business in the coming months.
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CLOs
Vintage impacts CLO equity returns
Equity returns for US CLOs have been strong over the past year, but vintage significantly affects performance. Given current trends, 2007-vintage CLOs are expected to see the highest average cumulative equity distributions.
The most significant drivers of CLO equity performance during a period of low leveraged loan default rates are the timing of the CLO's origination and the extent to which a CLO has paid down its senior notes following the end of its reinvestment period, according to S&P. To gauge the prevailing trends in equity returns, the agency studied the distributions to equity holders of the US cashflow CLOs that it rates.
The study focused on the quarterly note payment reports for rated CLOs for 2012 through the first half of 2013. Specifically, S&P looked at the payments made from excess interest proceeds, as well as principal proceeds distributed to equity after the rated classes of notes had been paid in full.
For CLO 1.0 transactions, equity distributions are strong but tapering off as the transactions exit their reinvestment periods and the notes pay down, driving up the cost of funding. Conversely, CLO 2.0 transactions' equity distributions have remained stable, though some vintages have higher equity returns than others.
At 96.5%, the proportion of outstanding US cashflow CLOs making equity distributions increased in the first half of 2013 to higher levels than were seen before the financial crisis. This suggests that there is limited room for additional gains and it is unlikely that the ratio will reach 100% in the near future.
Most of the transactions still not making equity distributions at this point have subordinate notes rated in the triple-C category or lower, indicating some stress in the transaction. Some of these deals have rated notes that are deferring on their interest payments and have not made a payment to equity for several quarters. Because these deals might also be failing their coverage tests, equity noteholders have limited incentive or ability to exercise their option to redeem the notes in whole.
Unsurprisingly, there is also a marked difference in senior note spreads between transactions issued pre- and post-crisis. CLOs originated in 2006 have on average the lowest senior tranche funding costs of any vintage, with a weighted average spread across their triple-A rated tranches of just 28.5bp. This compares with a weighted average triple-A spread of 184.4bp for CLOs originated in 2010.
Many of the transactions issued in the years before the credit crisis were able to enjoy low funding costs through and after the crisis, while maintaining the ability to reinvest into assets that yielded a higher return. In contrast, the liability costs of CLOs issued after the credit crisis have been more calibrated to current asset spreads. Therefore, they have delivered equity returns that are solid but lower than those of many of the pre-crisis CLOs that had cash and the ability to deploy it during the credit crisis and since.
As of 2Q13, the equity holders of CLOs originated in 2005, 2006 and 2007 have received the highest level of cumulative equity payments for active deals. The 2003 and 2004 vintage CLOs lag behind, despite having a longer payment history.
"We believe this is largely because of the effect of market conditions as the transactions exited their reinvestment periods," S&P notes. "Most of the transactions issued prior to 2005 exited their reinvestment periods by 2010 and had limited ability to reinvest in loans that yielded higher returns from 2010 through 2012. By contrast, CLOs originated in 2005 and later were able to deploy cash in higher spread loans and increase their portfolio weighted average spreads significantly during this time."
Also as of 2Q13, 2007 vintage transactions reached cumulative equity payment levels that were similar to those of the 2005 and 2006 vintage transactions, despite having had less time to make payments. The 2007 vintage transactions have the highest average equity return, given the low average cost of funds and higher proportion of reinvesting deals.
As of 30 June, the proportion of outstanding CLOs that have exited their reinvestment periods had reached a new high of 44%. Over 200 US CLOs have paid down their senior notes by at least 25%.
About 70% of the deals that fully paid down their rated notes since 2012 did so via an optional redemption, in which the majority of the equity holders voted to sell the portfolio assets and use the proceeds to pay off the rated notes. For these deals, the residual portfolio was sold for principal cash to pay off the liability balances of the notes and any outstanding fees or expenses. The residual principal cash is typically paid to the equity note holders on the final payment date.
Barring a sharp, largely unexpected decline in collateral performance, the agency expects the overwhelming majority of outstanding CLOs to continue making equity distributions. More of the 2006, 2007 and 2010 vintage CLOs are anticipated to begin amortising their senior notes from principal proceeds, with the weighted average cost of liabilities consequently increasing.
In addition, the pace of optional redemptions of vintage transactions will likely continue, as equity holders estimate they will realise greater value through early redemption than by taking diminished periodic payments and waiting for residual principal. S&P also expects that equity holders across CLO vintages will see lower returns if Libor rates increase, mainly due to the decreasing impact of the Libor floor cushion.
News Round-up
CMBS
ORIX sales drive fall in CMBS late-pays
US CMBS late-pays fell by 40bp last month to 6.78% from 7.18% in June, the largest drop since the end of the recession, according to Fitch's latest monthly index results for the sector. Leading the fall were ORIX asset sales from LBUBS 2007-C2, which alone accounted for US$759m of dispositions (SCI 18 July). The delinquency rate is now 2.23 percentage points below its July 2011 peak of 9.01%.
The ORIX sales reported in July totalled 21 assets with a stated loan balance of US$773m, including two loans (totalling US$14m) that were not reported as delinquent prior to disposition. The dispositions resulted in US$462m in net proceeds after liquidation expenses and roughly US$310m (or 9% of the original pool size) in realised losses to the LBUBS 2007-C2 trust.
Topping the list of dispositions by loan size were the Bethany Maryland Portfolio II, One Alliance Center and Duke Cleveland East Suburban Portfolio (see SCI's CMBS loan events database). These three loans comprised US$483m in stated loan balance and accounted for US$173m in trust losses.
The US$2bn in resolutions last month far outpaced the US$561m in new additions to the index. Additionally, Fitch-rated new issuance volume of US$5.8bn edged out US$5.6bn in portfolio run-off, causing a slight increase in the index denominator.
CMBS loans becoming delinquent also continued to diminish in size, Fitch notes. The average loan size of new entrants in July was just US$8.5m, with only four loans over US$25m entering the index. The largest addition was a US$37m loan on The Mall at Steamtown in Scranton, securitised in LBUBS 2003-C5.
The ORIX sales helped drive down delinquency rates for all major property types last month. Delinquencies on office loans, a recent underperformer, stood out by falling by nearly 60bp month-over-month.
Forty-three office loans totalling nearly US$900m were resolved or disposed of in July, led by the US$165m One Alliance Center and US$133m Duke Cleveland East Suburban Portfolio. That volume is nearly double the US$460m (across 34 loans) of office resolutions in June.
Retail and hotels fell by 37bp and 31bp respectively. Delinquencies on industrial and multifamily loans fell by roughly 20bp each.
Current and previous delinquency rates are: 9.56% for industrial (from 9.77% in June); 8.04% for hotel (from 8.35%); 7.59% for office (from 8.18%); 7.41% for multifamily (from 7.59%); and 6.37% for retail (from 6.74%).
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CMBS
Hotel price appreciation analysed
US major market hotel prices have risen by 19.2% over the last two quarters, more than double the 7.9% rise in non-major market hotel prices, according to the latest Moody's/RCA Commercial Property Price Indices (CPPI). Apartment prices increased by 0.7%, while core commercial prices were up by 2.6%. The national all-property composite index increased by 2.1% in June.
Major market hotel prices are 11.3% below their level in March 2008, when national hotel prices peaked, while non-major market hotel prices are 34.3% below peak. The hotel series - added to the Moody's/RCA CPPI for the first time this month - will track national, major-market and non-major market hotel price trends every quarter, following the same 'repeat sales' methodology Moody's uses for other property types. The hotel series, however, commences in December 2004 because of data limitations for prior years and will not be rolled up into the Moody's/RCA national all-property index, which starts in December 2000.
The national all-property composite has increased by 38.8% since its January 2010 trough and is now 16.4% below its December 2007 peak. A version of the national index that excludes distressed sales is within 3.9% of its peak.
"Although both versions have appreciated approximately 40% since the trough, the decline in the series excluding distressed sales following the financial crisis was slower," comments Moody's director of commercial real estate research Tad Philipp.
Non-major market CBD office prices were the most affected by distressed transactions, while major market apartment prices were the least affected. Non-major market CBD office prices are 25.9% below peak, but would be 6.9% below peak were distressed transactions excluded. Major market apartment prices are 11.8% above their peak, but are 13.6% above the peak if distressed transactions are excluded.
Among the other findings from this month's Moody's/RCA report is that the roughly 100bp rate increase in the 10-year Treasury which started in early May has had little impact on commercial property prices through June because prices for many of the transactions that closed in June were negotiated before the full rate increase set in. Moody's expects to see additional 10-year Treasury rate increases totalling approximately 200bp over the next few years, with the timing depending largely on the pace of the economic recovery.
Price growth is moderating in several sectors that are approaching pre-crisis peak levels and accelerating in several sectors that are further below the peak, resulting from the continued movement of capital to markets and property types in which higher returns and risks are to be found. For example, over the last three months, non-major market prices have risen by 5.6% (outpacing the 0.7% rise in major market prices) and suburban office prices have risen by 4.9% (outpacing the 1.3% contraction in central business district (CBD) office prices).
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CMBS
US CRE 'performing strongly'
All commercial real estate sectors performed strongly in 2Q13 and are expected to continue doing so, according Moody's latest US CMBS and CRE CDO surveillance review.
"Despite some muted economic indicators, commercial real estate property markets benefitted from a limited amount of construction, as well as positive absorption," comments Michael Gerdes, md and head of Moody's US CMBS & CRE CDO surveillance. "With favourable fundamentals, transaction volumes remained healthy."
As in the previous quarter, multifamily and hotel markets continued to perform strongly in Q2, although the pace of improvement is expected to slow. Revenue per available room (RevPAR) in the latter market rose by 5% from 2Q12, with luxury hotels up by 6% and urban hotels up 6.1%. The most improved market performers were San Francisco/San Mateo, California and Oahu, Hawaii.
Meanwhile, the multifamily vacancy rate dropped by 20bp to 4.6% during the quarter. Six markets currently have vacancy rates lower than 3%, among them are Minneapolis, Miami and Oakland, California. Effective rent growth rose by an annualised rate of 3.1%, which is solid but slower than in 2012, Moody's notes.
The recovery of the office and retail sectors has been more muted. However, the performance of these sectors is anticipated to improve in tandem with employment and economic growth.
Moody's base expected loss for conduit/fusion CMBS transactions is 9.06%, down from 9.07% in 1Q13 because of lower delinquencies and overall better asset performance. Moody's Commercial Mortgage Metrics (CMM) weighted average base expected loss stands at 7.6%, down from 8.3%.
The share of delinquent loans declined to 9.9% from 10.2% in the first quarter, while the share of loans in special servicing declined to 11.5% from 11.8%. Base expected losses will decline slightly as delinquencies continue to decline and loss recoveries improve in tandem with improving market fundamentals.
The overall share of specially serviced (SS) loans decreased by 76bp to 10.28%, from 11.04% in the first quarter. The share of SS loans contracted by 244bp from the April 2011 peak of 12.72%, in large part because non-performing, five-year SS loans from 2006 and 2007 are being worked out at a faster pace than new loans have entered special servicing.
Lenders modified 59 CMBS loans amounting to US$1.9bn during the quarter. Monthly volume averaged 20 loans and US$641.6m.
Moody's central economic scenario remains the same: its macroeconomic board outlook forecast is for US GDP growth of about 2% this year because of fiscal policy and public spending cuts. With housing starts and employment still growing and consumer sentiment improving, US growth of 2%-3% and a decline in the unemployment rate to 6.5%-7.5% is anticipated in 2014.
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Insurance-linked securities
Private cat bond listed
Kane has launched an independent private catastrophe bond platform called Kane SAC Limited. The inaugural issuance under the programme - the US$9.52m series 1-2013 notes - has been listed on the Bermuda Stock Exchange (BSX), marking the first-ever listing on the stock exchange of a series of notes issued by a segregated accounts company.
Kane SAC is a Bermuda exempted company registered as a Class 3 insurer and as a Class C insurer under the Insurance Act 1978 and as a segregated accounts company registered under the Segregated Accounts Companies Act 2000. Robert Eastham, md Kane (Bermuda) Limited, says: "Our decision to list the notes on the BSX was due to investor demand and means that they are now available in a tradable format, which we feel will significantly heighten their overall value to the investment community. Moving forward, we see this platform playing a key role in facilitating the flow of smaller transactions into the collateralised reinsurance sector. Our goal is to reduce both time to market and structuring costs by providing a very standardised and efficient means for investors to access the reinsurance markets."
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Insurance-linked securities
Insurance-linked Sukuk debuts
ATLANTICLUX Lebensversicherung (ATL) has established a US$100m insurance-linked Sukuk programme dubbed Salam III. Proceeds will be used to finance upfront acquisition costs of new business.
Salam III is a limited, non-cellular company incorporated in Guernsey that will enter into a swap agreement with Salam III A IC, an incorporated cell of Salam ATL Re ICC. The cell is 100% owned by AON Services.
Salam III A IC acts as a transformer vehicle and will enter into a reinsurance contract with ATL. Through this reinsurance contract, ATL cedes 90% of the remaining mortality risk to Salam III A IC and part of the lapse risk from a designated block of new business policies.
A retrocession contract has been set up between Salam III A IC and Partner Reinsurance Europe for all mortality risk in the designated portfolio, which leaves Salam III A IC retaining only lapse risk that is then transferred by the swap agreement to Salam III.
Each tranche of the Salam III programme has a final payment date five years after its issuance. Fitch has assigned an expected rating of triple-B minus to the proposed first US$20m issuance under the programme.
The Sukuk's rating is the same as ATL's long-term issuer default rating because, despite having some structured elements, Fitch has treated it as effectively having the same credit characteristics as a senior unsecured corporate obligation of ATL. This is due to its partly recourse nature and what the agency views as a lack of bankruptcy-remoteness in the structure.
ATL acts as ultimate obligor in the programme, which is sponsored by its parent company FWU. Fitch notes that the programme increases the diversification of ATL's financing of acquisition costs, which is currently dominated by a factoring agreement with FWU.
However, when the programme's total of US$100m is issued, ATL's total financing commitments to total available capital ratio will increase to 2.4x from 0.8x. Although this is a relatively high ratio, it does not currently affect ATL's ratings, as the programme will be paid back through acquisition fees included in the insurance premiums of the designated block of new business policies and ATL's contractual agreements with its distribution partners, which Fitch says significantly reduce the insurer's credit risk arising from lapses.
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Risk Management
APRA releases CLF guidance
The Australian Prudential Regulation Authority has provided further detail on its approach to the implementation of the Basel 3 liquidity framework and, in particular, on the operation of the committed liquidity facility (CLF). Due to the relatively short supply of Australian dollar high-quality liquid assets (HQLA), the Reserve Bank of Australia (RBA) will allow 'scenario analysis' ADIs to establish a secured CLF sufficient to cover any shortfall between the ADI's holdings of HQLA and the requirement to hold such assets under the LCR.
APRA has consequently detailed the main steps in the process of determining the appropriate size of the CLF for each scenario analysis ADI. ADIs will be required to apply for inclusion of a CLF for LCR calculation purposes on an annual basis, after demonstrating that they have taken all reasonable steps towards meeting their LCR requirements through their own balance sheet management before relying on the CLF. They will also have to meet relevant qualitative and quantitative liquidity requirements, including having in place a statement of the Board's tolerance for liquidity risk, an appropriately robust liquidity transfer pricing mechanism and appropriate remuneration arrangements for those executives responsible for the ADI's funding plan and liquidity management.
The CLF will be available to address Australian dollar liquidity needs only, with the size of the CLF for each ADI limited to a specified percentage of that ADI's Australian dollar net cash outflow target as agreed by APRA, plus an allowance for an appropriately sized buffer.
APRA is undertaking a trial exercise with all scenario analysis ADIs in 2013. It will release further details on the CLF process once it has completed this exercise.
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Risk Management
On-boarding underway for trueEX
Credit Suisse and UBS have completed full certification and testing on the trueEX exchange and are set to offer client access to trueEX pricing. The banks will provide markets and routing of client flows on the most liquid interest rate swaps, as well as the standard coupon standard maturity (SCSM) swaps that are ISDA MAC (market agreed coupon) compliant. In addition, the banks will offer buy‐side clients seamless electronic access to consolidated liquidity and the PTC (portfolio terminations and compactions) platform on trueEX.
The PTC platform is provided through the trueEX SEF for the automated termination, compaction, backloading, portfolio rebalancing and allocation of interest rate swaps in a cleared and regulated environment. The trueEX SEF application was filed with the CFTC on 15 July and is currently in pending temporary registration status.
An additional six IRS market makers are at an advanced stage of legal on‐boarding, testing and certification in preparation to go live on the platform.
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Risk Management
CCP loss allocation discussed
ISDA has released a new white paper entitled 'CCP Loss Allocation at the End of the Waterfall'. The move is in response to industry efforts to develop an effective recovery, continuity and resolution framework for central counterparties and reflects consensus views of the ISDA Risk and Margin Regulatory Implementation Committee.
CCPs are required to establish robust recovery, continuity and resolution mechanisms in relation to two situations: at the 'end of the default waterfall', when all financial safeguards available to a CCP to cover losses arising from a clearing member (CM) default are exhausted; and where there are non-default losses (NDL) that exceed a clearinghouse's financial resources above the minimum regulatory capital requirements.
For default losses, the paper advocates variation margin gains haircutting (VMGH) as a robust recovery and continuity mechanism, which will operate as part of the default waterfall following the exhaustion of all other layers of the default waterfall. VMGH allows the CCP to distribute remaining losses by recourse to pro rata unpaid gains at the beneficial owner level, according to ISDA. The CCP would impose a haircut on cumulative variation margin (VM) gains on the portfolio of trades of each beneficial owner that have accumulated over the days since the commencement of the default management process.
The idea is that the sum of clearing participants' cumulative VM gains since CM default would always be sufficient to cover the defaulter's mark-to-market losses in the same period. In the remote circumstance that the CCP's waterfall of resources were insufficient to cover mark-to-market losses and the transfer cost implied in a portfolio auction process - or where the CCP were not able to determine a market clearing price for that portfolio - in the absence of a voluntary position taking and/or loss absorption, counterparty netting considerations dictate a full tear-up of all of the CCP's contracts in the product line that has exhausted its waterfall and has reached 100% haircut of VM gains.
It is imperative that the CCP specify the termination process in the rule book at the end of the waterfall as a prerequisite for regulatory and accounting netting, the report notes. Further, if clearing participants know the alternative is a full tear-up, service closure will provide an additional incentive for all to participate in any reasonable voluntary process. There should be no forced allocation, invoicing back, partial non-voluntary tear-up or any other CCP actions that threaten netting.
Where the CCP's default management is seen to be effective in managing down the risk and transferring the defaulter's hedged positions, resolution authorities should not be entitled to interfere with the CCP's loss allocation provisions. ISDA suggests that three processes be implemented in order to mitigate moral hazard.
First, any clearing participant's loss allocation in the form of VMGH creates a proportionate share in the CCP's claim against the defaulted CM's estate. Second, the default waterfall mitigate moral hazard by requiring the CCP to put additional significant portions of its capital at risk senior to CM contributions, but before the exercise of VMGH. Finally, that potentially all clearing participants that bear losses from rebalancing the CCP through VMGH loss distribution be given the opportunity to receive new shares or some form of senior convertible debt instrument as consideration for the losses absorbed.
News Round-up
Risk Management
Final TR report issued
CPSS and IOSCO have published a report entitled 'Authorities' access to trade repository data'. The report aims to provide guidance to trade repositories (TRs) and authorities on the principles that should guide authorities' access to data held in TRs for typical and non-typical data requests.
For a broad range of authorities and international financial institutions, it is essential to be able to access the data needed to fulfil their respective mandates while maintaining the confidentiality of the data pursuant to the laws of relevant jurisdictions, the two organisations say. The report describes the expected data access needs of authorities using a functional approach, complemented by an illustrative data access mapping that aligns each function to the minimum level of access authorities would typically require in support of their mandates and responsibilities. It also sets out possible approaches to addressing procedural and legal constraints to data access, as well as confidentiality concerns.
The report was first issued for public consultation in April (SCI 12 April). This final version has been revised in light of the comments received during that consultation.
News Round-up
Risk Management
Japanese clearing compliance polled
Calypso Technology has announced the results of a survey on OTC clearing conducted at a recent conference it hosted in Tokyo. The survey revealed that 80% of respondents are working on achieving operationally readiness for OTC clearing in Japan; 20% are already operationally ready, even though it is not mandated.
It is expected that OTC client clearing will be mandated within 2014 in Japan. Over half of the operationally-ready firms are actively searching for a new system to help them with operational compliance.
In addition, over 50% of respondents revealed concerns that collateral management/collateral optimisation will impact their business profitability once OTC client clearing becomes a reality. Conference attendees were also polled on how they would select clearing brokers.
The majority (61%) of respondents highlighted that breadth of services was the most important attribute when selecting a CCP partner. In terms of the most valuable clearing services, operational support around connectivity (46%) and risk and margin management (22%) topped the list.
News Round-up
RMBS
Chinese slow-down weighs on Aussie RMBS
S&P has released a number of reports detailing the potential effects of China's slow-down on Australia. China's GDP growth rate dipped to 7.8% in 2012 from 9.2% the previous year.
For this year, S&P expects China's GDP growth will likely slow to 7.3% and remain at that pace in 2014. As a result, the agency has updated its three economic scenarios - base, downside and hard downside - and assessed the impact of the scenarios on Australian issuers and issues.
Although having a low probability of 5%, a hard downside scenario could mean China's real GDP growth declining steeply to 5% in 2014. This could tip Australia's economy into a mild recession, affecting in particular the credit profiles of the country's weaker miners, banks, housing market and lenders' mortgage insurers.
S&P believes the credit profiles of Australia's major miners and highly-rated tranches of RMBS are well placed to withstand this downturn. Other Australian issuers and issues, however, would come under pressure.
Property prices could plummet if commodity prices plunge in a hard downside scenario. Such a severe downturn could see banks' stand-alone credit profiles decline by a notch or more, while LMIs could see their credit ratings drop into the triple-B category from the double-A category. The latter would, in turn, adversely affect subordinated RMBS.
News Round-up
RMBS
Ratings withdrawn on 'lack of interest'
S&P has withdrawn its ratings on 2,905 tranches from 193 US RMBS, citing "a lack of market interest in the securities". Previously rated D, the affected classes of notes were issued between 1999 and 2007 and are backed by a mix of adjustable- and fixed-rate loans secured primarily by first liens on one- to four-family residential properties.
Many of the classes are part of transactions that have taken a substantial amount of realised losses, including some where their outstanding balance is currently zero. Further, S&P says it does not expect some of the bonds to receive any payments in the future.
When analysing US RMBS collateral pools to determine their relative credit quality and the potential impact on rated securities, the agency says the degree of remaining losses stems from its outlook regarding the behaviour of such loans in conjunction with expected economic conditions. Overall S&P's outlook for RMBS is stable, albeit fundamentals hinge on factors such as the ultimate fate of modified loans, the propensity of servicers to advance on delinquent loans and liquidation timelines.
News Round-up
RMBS
Eminent domain challenges outlined
Further details have emerged about the legal challenges brought by investors against Richmond, California's eminent domain plan (SCI 8 August). Three trustees - Wells Fargo, Deutsche Bank and Bank of New York Mellon - have filed two separate lawsuits in the US District Court of Northern California to block the city from seizing mortgages under the plan.
According to Barclays Capital RMBS analysts, the key points raised in the complaint are: the takings are not for public use; the takings do not provide just compensation; and the takings violate other laws. The trustees allege in their complaints that the plan benefits only MRP, its investors and a select group of homeowners but not the public at large.
They further argue that the general public will be hurt by resultant higher borrowing costs and the associated adverse implications for home prices. The justification of preventing blight from foreclosed homes does not stand because most of the loans being bought out are current loans and do not face immediate foreclosure.
The complaints argue that the plan does not account for the payment history of the affected borrowers and that the value of a performing loan is much higher than the 80% on appraisal that is being offered. The trustees note that the plan is to flip these mortgages into new higher LTV mortgages that are sold into other securitisations at more than the value paid to the trust, which is against the just compensation requirement. Furthermore, they argue that there are instances where defaulted mortgages have recently traded at above 80% of underlying home value and as a result this cannot be just compensation for predominantly current loans.
In addition, the complaints mention several other laws that are said to be being violated by the seizure programme. For example, the complaints allege that because the loans reside in trusts outside the boundaries of Richmond, the seizure is extraterritorial and therefore unlawful under various federal state and local laws.
The investors are seeking declaratory judgements against the use of eminent domain in this fashion and also injunctive relief restraining the city from implementing the seizures as planned. The plaintiffs argue that California's 'quick-take' laws allow the city to seize mortgages without giving the investors much time to block it.
Additionally, since Mortgage Resolution Partners has indemnified the city for any liabilities arising from the programme and MRP's financial position is unknown, compensating trustees afterward may not be possible and the trustees may be left without recourse for losses suffered. They argue that these reasons justify asking for immediate relief, even before any takings have happened.
News Round-up
RMBS
Clarity emerging on BofA MSR transfer
Moody's has released a list of 26 non-agency RMBS trusts - backed by US$4.1bn of collateral - that will be affected by the transfer of the first chunk of MSRs from Bank of America to Nationstar, scheduled for early September (SCI 8 January). The sale will be concentrated in prime/Alt-A deals belonging to the BOAA, BOAMS and HVMLT shelves, with a small number of option ARM and subprime deals also included.
RMBS strategists at JPMorgan point out that no Countrywide shelves are included, given that these deals are still being considered under the US$8.5bn investor settlement. They estimate that about 21% of the total loan balance is 60-plus days delinquent.
Typically, Nationstar has lower advance rates than other servicers, but a faster resolution of delinquent inventory. Recently liquidated prime/Alt-A Nationstar-serviced loans spent about 25 months in the pipeline, compared to over 30 months for those serviced by BofA, according to the JPMorgan strategists.
Advance rates have been about 10 points higher than the Nationstar average for the transferred deals, indicating that advancing could decline in the next 6-12 months. On the other hand, Nationstar liquidation timelines have recently been higher than those of the impacted deals, by as much as seven months. If these trends persist, timelines could drift higher in lockstep with Nationstar's aggregate timelines.
News Round-up
RMBS
Down payment assistance to impact turnover?
SIFMA is considering whether to allow mortgage loans with a new subordinate financing product, FirstREX, to be delivered into the TBA market. US federal home loan banks have already agreed to accept pools with this type of down payment as collateral, while the FHFA has recommended that the GSEs also accept the product.
FirstREX is an equity-sharing product that buys out a part of the borrower's equity in exchange for a share of the gain in home price, which can be used as a form of down payment assistance. Barclays Capital RMBS analysts note that the programme effectively reduces a borrower's prepayment sensitivity to house price appreciation: as per the terms of the product, the equity investor is owed 40% of any gain or loss in the value of the home. In other words, the borrower does not realise 40% of the HPA on the house and is exposed to only 60% of the HPA that has actually occurred.
As such, the product has significant implications for turnover speeds. In a discount environment in which investors are looking for HPA-driven home sales activity to support turnover, the relative immunity of FirstREX borrowers to HPA is likely to be perceived as an unwanted characteristic, according to the Barcap analysts.
News Round-up
RMBS
RMBS loss criteria updated
Fitch has updated its criteria for estimating losses on US mortgage pools for RMBS, as part of its annual criteria review. While the basic framework remains unchanged, the model has been expanded to analyse both agency and non-agency collateral.
In addition, Fitch has introduced three new variables that influence default expectations: number of borrowers, origination channel and liquid reserves. The rating agency has also made enhancements to certain loss severity assumptions and adapted its sustainable home price forecasting methodology to better react to market shifts.
The implementation of the updated criteria is expected to result in modestly lower loss assumptions on newly issued prime jumbo MBS pools with strong credit attributes. Fitch expects that less than 5% of all legacy ratings will be affected by the model enhancements, although the rating impact will vary by sector and vintage.
On average, the updated model criteria is expected to have a largely neutral impact on legacy prime jumbo ratings, while the impact on Alt-A and subprime ratings is expected to be modestly positive. Additionally, although legacy prime jumbo mortgage loss projections are not expected to change materially, the ratings on prime jumbo classes issued prior to 2005 are expected to be more sensitive to the model changes due to the higher number of remaining investment grade ratings and the lower credit enhancement levels.
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