Contents

CMBS

Legacy AMs, AJs attract attention

US CMBS BWIC volume reached around US$600m yesterday, with SCI's PriceABS data revealing a number of successful and unsuccessful trades from the session. Many of the names out for the bid were legacy AM, AJ and mezz bonds, with spreads generally widening.

"Overall, spreads on legacy super seniors edged wider by two or so basis points. The benchmark GSMS 2007-GG10 A4 bond finished the day at 155bp over swaps, 3bp wider on the day. Generally speaking, the market remains concerned over the possible end - or more accurately, the tapering - of bond purchases by the Federal Reserve, at times overlooking decent economic data in the process," notes Trepp.

Several of the AM tranches out for the bid yesterday failed to trade. For example, CSMC 2007-C5 AM was talked in the low-500s, GECMC 2007-C1 AM was talked in the high-400s and mid/high-400s, and MLMT 2007-C1 AM was also talked in the mid/high-400s. But all of the bonds were DNTs.

However, other names met with more success. The GSMS 2007-GG10 AM tranche traded during the session, with talk in the low/mid-500s. JPMCC 2007-LD11 AM also traded, with price talk on that tranche in the high-400s.

In the AJ space, meanwhile, BACM 2007-5 AJ was talked in the low-90s and low/mid-90s before being covered at 91 handle. WBCMT 2006-C27 AJ was covered at 92 handle, with talk around the 92 area. WBCMT 2006-C28 AJ and WBCMT 2006-C29 AJ were both also covered.

Among the CMBS 2.0 names that were out yesterday, the only recorded cover was for the GSMS 2012-TMSQ A bond, which traded in the session with talk at 135. The same tranche was covered at 147 at the start of last month and at 135 in June.

Other recently-issued GSMS tranches - such as GSMS 2013-G1 A2 and GSMS 2013-PEMB A - did not trade. Both tranches were talked at 155.

Another DNT from the session was JPMCC 2012-WLDN A, which had been talked at 140. That tranche was covered on 25 July at 149.

The afternoon also saw around US$80m of Freddie Mac K-series notes put out for the bid. PriceABS recorded a cover at 360 for FHMS K013 X3 and at 175 for FHMS K014 X1. The latter tranche was previously covered at 151 in February.

JL

RMBS

Non-agency leans on legacy list

US non-agency RMBS secondary supply shot up yesterday to around US$1.25bn on the back of a US$1.1bn legacy bid-list. SCI's PriceABS data shows tranches from as far back as 1996 out for the bid, with a couple of post-crisis bonds also circulating.

Several BWICs of a similar size have recently been attributed to the GSEs (SCI passim). As with those lists, expectations were high ahead of yesterday's session, with a variety of price guidance issued in advance.

The oldest vintage tranche captured by PriceABS yesterday was GT 1996-9 A6, which was talked at around par. Other tranches from the 1990s that circulated during the session include DELHE 99-3 A1F (which was talked in the high-90s and low-pars) and PBHET 99-3 A1 (which was talked in the mid/high-80s).

Price talk was in the low single-digits for several tranches, including ACE 2006-ASP4 M1 - which had been talked at less than one in August last year. In addition, tranches such as RALI 2003-QS20 AV and RFMSI 2006-S12 1AV were talked at zero handle.

It was a different story, however, for bonds such as VALT 2002-1 M1 (which was talked at around 109) and MALT 2003-2 (which was talked at around 105 and at 107 handle).

A handful of principal-only bonds were also available yesterday, such as the MASTR 2006-1 15PO tranche, which was talked in the mid/high-80s. MARS 2005-PO 3PO was also talked in the low-80s. MALT 2007-1 15PO was talked lower, in the low-60s.

In addition, a couple of post-crisis bonds were out for the bid yesterday. The MESC 2012-1W 1A3 tranche was talked in the 104 area, while the RBSSP 2009-13 9A2 tranche was talked in the high-80s.

JL

Structured Finance

More GSE RMBS sales anticipated

Quarterly statements released last week by Fannie Mae and Freddie Mac show that CMBS accounts for a disproportionate amount of sales from their legacy holdings so far, at 55%. While the RMBS portfolios are bigger at both GSEs, the proportion of sales coming from them has been smaller, at about 25% for Freddie Mac and 45% for Fannie Mae.

Barclays Capital analysts suggest that this is due to the scarcity of investment grade assets in the RMBS portfolios and is probably reflective of the GSEs' concerns around flooding the market with credit-sensitive RMBS bonds.

At end-2012, Fannie and Freddie held US$437bn and US$346bn respectively in their retained portfolios. Of this, the CMBS/RMBS split was US$20.6bn/US$32.2bn for Fannie and US$48bn/US$76.5bn for Freddie. Their scorecard sales target for this year is US$21.2bn and US$15.7bn respectively.

Fannie sold US$1.9bn UPB of CMBS and US$300m of other mortgage-related assets in Q2, as well as US$1.5bn of CMBS and US$2.9bn RMBS securities so far in Q3. Freddie has sold US$1.3bn CMBS, US$1bn RMBS and US$1bn of other securities in Q2, together with US$1.8bn CMBS and US$400m RMBS bonds so far this quarter.

The Barcap analysts estimate that Freddie needs to sell about US$10bn more to reach its target, while Fannie has slightly under US$15bn more to sell, for a total of about US$25bn. They suggest that, given Fannie and Freddie in aggregate have sold only about a third of their annual target to date, the GSEs will need to step up the pace of offerings in the last five months of the year if they are to achieve what was outlined in the scorecard.

"It is entirely possible that sales will become even more CMBS-heavy and that the GSEs will not have to dip into the below-investment grade RMBS by much to achieve their goals," the analysts observe. "However, if the GSEs aim to balance sales roughly half and half between RMBS and CMBS, that would imply more sales from the below-investment grade RMBS book - which could put some pressure on the more credit-sensitive parts of the sector."

They expect that even these bonds will be pass-throughs backed by cleaner conforming balance pools than some of the subprime bonds that currently trade in the market. "Overall, if the broader markets remain resilient and risk premiums stay contained, we would not expect much of an impact from these sales. However, if broader market risk premiums do not perform well, these potential sales could lead to even more volatility in the weaker credit sectors."

CS

Structured Finance

SCI Start the Week - 19 August

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

Pipeline
A variety of deals remained in the pipeline at the end of last week. These included two ABS, one RMBS, one CMBS and four CLOs.

The ABS comprised US$755.5m CNH Equipment 2013-C (an equipment deal originated by CNH Capital America) and US$800m Santander Drive Auto Receivables Trust 2013-A (an auto deal from Santander Consumer USA). The RMBS was US$434.17m Agate Bay Mortgage Trust 2013-1.

Deutsche Bank's US$485m COMM 2013-300P was the CMBS entrant, while the CLOs consisted of US$400m Battalion CLO IV, US$400m Galaxy XVI, US$190m GT Loan Financing I and US$500m Madison Park Funding XI.

Pricings
A further two ABS deals printed last week, along with one RMBS, four CMBS and three CLOs.

The ABS pricings were both auto deals - US$1bn Capital Auto Receivables Asset Trust 2013-3 and US$1.25bn Fifth Third Auto Trust 2013-1 - while the RMBS was A$3.2bn Medallion Trust Series 2013-2. The CMBS new issues were: US$325m BBCMS 2013-TYSN; US$1.57bn FREMF 2013-K31; US$1.2bn GSMS 2013-GCJ14; and US$1.79bn JPMBB 2013-C14.

Finally, US$400m NewStar Commercial Loan Funding 2013-1, US$531m Northstar 2013-1 and US$367m Vibrant CLO II rounded out the primary issuance.

Markets
US CMBS BWIC volume increased last week as investors looked to capitalise on the present liquidity in the market, with over US$600m of supply in mezzanine bonds alone. SCI's PriceABS data reveals a number of successful trades, as SCI reported on 15 August.

Wednesday's session typified many of the week's themes, with AM tranches such as GSMS 2007-GG10 AM and JPMCC 2007-LD11 AM both trading. The session also saw senior 2.0 bonds circulating: PriceABS recorded a cover for GSMS 2012-TMSQ A as well as DNTs for bonds such as JPMCC 2012-WLDN A.

Significant supply was also seen in the US RMBS secondary market. Tuesday's session saw US$1.2bn of non-agency bid-list volume, boosted by a CDO liquidation and large legacy list, as SCI reported on 14 August. Over three-quarters of the legacy list's 20 bonds traded.

It was a quieter week for US CLOs, with total BWIC volume coming in below US$200m, according to Bank of America Merrill Lynch analysts. Unlike the previous week, equity paper accounted for only a small proportion of line items.

"Secondary trading will likely remain slow during the final stretch of summer, but volatility risk remains elevated as we head into September when the FOMC may announce when, what and how much to taper. Until a clearer picture develops, we maintain the view that legacy mezzanine discount tranches provide the best opportunities," the analysts note.

The European CMBS market has also been quiet, although German multifamily paper has been more active than other sectors, according to one trader (SCI 16 August). He reports that there has been good buying and selling not only for senior paper, but also for mezzanine bonds in that part of the market.

Meanwhile, European RMBS interest has been focused on Spain, where senior bonds are the preference. Activity has been more limited than for CMBS, although PriceABS does show a cover in the 70 area for the GCPAS 5 A2 tranche, which out for the bid on Thursday.

Deal news
• 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.
• ATLANTICLUX Lebensversicherung has established a US$100m insurance-linked Sukuk programme dubbed Salam III. Proceeds will be used to finance upfront acquisition costs of new business.
• Markit iTraxx Series 20 is set to begin trading on 20 September. Based on current data and Series 19 inclusion rules, six constituent changes are expected in iTraxx Main and three in iTraxx Crossover. No changes are anticipated for the iTraxx Financials index.

Regulatory update
• The Australian Prudential Regulation Authority has provided further details 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.
• The CFTC has issued a final rule to exempt swaps entered into by qualified cooperatives from the clearing requirement, subject to certain conditions. It has also released final rules to implement enhanced risk management standards for systemically important derivatives clearing organisations (SIDCOs), as well as proposed rules to establish additional SIDCO standards.
• 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.
• 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).
• Criminal complaints against Javier Martin-Artajo and Julien Grout for their alleged participation in a conspiracy to hide the true extent of credit derivatives losses at JPMorgan have been unsealed by US Attorney General Eric Holder, Attorney for the Southern District of New York Preet Bharara and George Venizelos of the FBI. The US SEC has announced separate civil charges.
• President Obama has 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. The new loan rates are expected 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 Joint Forum has released a consultative report on the longevity risk transfer (LRT) markets. The paper aims to assist in setting appropriate policies and to help ensure effective supervision of related activities and risk.
• 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.

Deals added to the SCI Primary Issuance database last week:
ALM VII(R); ALM VII(R)-2; AmeriCredit Automobile Receivables Trust 2013-4; Cabela's Credit Card Master Note Trust series 2013-II; Citibank Credit Card Issuance Trust 2013-A5; CNH Wholesale Master Note Trust Series 2013-2; Enterprise Fleet Financing series 2013-2; Harvest CLO VII; Hayfin Ruby II Luxembourg SCA; Herbert Park CLO; Highbridge Loan Management 2013-2; Hyundai Auto Lease Securitization Trust 2013-B; JPMBB 2013-C14; MMAF Equipment Finance 2013-A; Octagon Investment Partners XVII; Palmer Square CLO 2013-2; Quadrivio RMBS 2013; SLM Student Loan Trust 2013-4; TACSEE Funding Co; WFRBS 2013-C15.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-4 & WBCMT 2006-C27; BACM 2006-6; BACM 2007-1, JPMCC 2007-LDP10 & GECMC 2007-C1; BALL 2010-HLTN; BSCMS 2006-PW11; COMM 2003-LB1A; CSFB 2001-CKN5; DECO 8-C2; ECLIP 2006-2; ECLIP 2006-3; EMC VI; EURO 25; GCCFC 2005-GG5; GCCFC 2006-GG7; GCCFC 2007-GG9; GECMC 2005-C4; GMACC 2003-C2; GMACC 2006-C1; GSMS 2006-GG6; GSMS 2007-GG10; GSMS 2011-GC3; GSMS 2011-GC5; GSMS 2012-GC6; JPMCC 2007-LDPX; JPMCC 2008-C2; LBUBS 2007-C1; LORDS 2; MLMT 2005-MCP1; MLMT 2007-C1 & BSCMS 2007-PW17; NEMUS 2006-2; THEAT 2007-1 & THEAT 2007-2; TITN 2005-CT1; TITN 2007-2; WBCMT 2005-C21; WBCMT 2006-C25; WFRBS 2011-C2; WTOW 2007-1.

Top stories to come in SCI:
European ABS supply/demand dynamics
Trends in US agency RMBS

CMBS

Freddie K-Cert A1s look attractive

Five-year average-life first pay FREMF issuance spreads have widened dramatically over the last three months. The latest A1 tranche priced at swaps plus 68bp, a level which makes the paper very competitive with CMBS 3.0 and PAC CMOs with similar durations.

Spreads for FREMF 2013-K27 when it came to the market in May were swaps plus 31bp for the A1 tranche and plus 49bp for the A2 tranche. In comparison, spreads for this month's FREMF 2013-K31 widened by 37bp and 16bp respectively.

FREMF A2 issuance spreads now stand at plus 65bp. The fact that they have widened less significantly than A1 spreads - and are now tighter than A1s - appears to be largely due to the recent steepening of the intermediate part of the yield curve.

"After the recent widening, first-pay K-Certificate issuance spreads are now roughly equal to those of five-year average-life CMBS 3.0 tranches," note FTN Financial CMBS strategists. "The five-year average-life tranche from the most recent conduit CMBS deal (WFRBS 2013-C15) priced last week at 70bp over swaps - or only 2bp wider than the issuance spread of FHMS K031 A1."

WFRBS 2013-C15 has a higher DSCR than the FREMF deal and a lower LTV, although the Freddie Mac guarantee accompanying K-Certificate A1 tranches makes them more attractive on a relative value basis, according to the FTN strategists. The A1s have a wider pay window than A2 tranches and are also first to receive any unscheduled principal repayments after a borrower default.

Although the serious delinquency rate of Freddie Mac multifamily loans is extremely low, investors do have the option of discount dollar-priced A1 tranches if the possibility of the early return of principal from involuntary prepayments is a concern. In that case, any return of principal earlier than expected would enhance the investor's return.

Spreads on discount dollar-priced K-Certificate A1 tranches also look attractive on a relative value basis versus the option-adjusted spread (OAS) of PAC CMOs with similar average lives. The strategists reckon the option cost for K-Certificates would likely be small due to their protection from voluntary prepayments and their low delinquency rate, although it is hard to calculate a precise OAS.

The relative outperformance of discount dollar-priced first-pay K-Certificates can be further seen by comparing the FREMF 2012-K21 A1 note to a similar-duration PAC CMO - FHR 4203 DE. "There is a slight give in terms of yield-to-maturity, [but] the K-Certificate picks over 40bp versus the OAS of the PAC and improves the convexity measure by over 20bp," note the strategists. "The K-Certificate 'wins' in almost every scenario."

JL

RMBS

Ambac supplemental payments discussed

The segregated account of Ambac Assurance is this month expected to begin making cash payments on certain policies in excess of 25% of permitted policy claims, following an order granted by the Circuit Court for Dane County, Wisconsin. The move is likely to reduce the amount of credit support within the affected RMBS transactions and result in higher write-downs for the other tranches in the deals.

The order authorises supplemental payments on 14 RMBS policies and certain other policies identified from time to time, where - absent such supplemental payments - cashflow (estimated to total US$310m) that would have been available to reimburse Ambac had it paid policy claims in full is being diverted to uninsured holders who would not have received it if claims had been paid in full. Payments can be made on a case-by-case basis in respect of all or a portion of any outstanding unpaid permitted policy claim, in one lump sum or in varying proportions. The purpose of making such supplemental payments is to maximise the cash reimbursements available to the segregated account, which should preserve its claims-paying resources and benefit all segregated account policyholders, the monoline says.

According to RMBS analysts at Bank of America Merrill Lynch, Ambac expects to apply each policy's supplemental payments first in satisfaction of an amount up to the outstanding unpaid permitted policy claim in respect of the current claim period (after payment of the 25% interim distribution). Thereafter, if any supplemental payments remain unapplied, they will be paid in reverse sequential order, such that the permitted policy claim relating to the oldest claim period still outstanding shall be satisfied first and so on until the supplemental payments have been applied in full.

The BAML analysts note that if Ambac starts being reimbursed with excess spread in the affected deals, it will reduce the amount of credit support within the transaction and result in higher write-downs for the other tranches in the deal. To look at the potential impact to the RMBS trusts, they examined HVMLT 2006-14, whose class 2A1C was wrapped by Ambac and has already been fully written off.

The deal currently has an outstanding unpaid claim amount of US$63.5m. If Ambac pays this amount through supplemental payments, it will be eligible to recover previous insured payments from excess spread, which could reach an estimated US$42m over time.

If the supplemental payment is not made and the status quo remains in place, the class 2A1B has a price of 27.3, assuming a 650 DM. If the payment is made, the price drops to 20.1 and its principal write-down increases from 72% of the tranche to 80%, the analysts observe. The class 2A1A ends up with a price drop of 3.4 points and sustains an additional four points of principal write-down.

Ambac last September began making interim cash payments equal to 25% of the permitted amount of each policy claim under its rehabilitation plan (SCI 12 June 2012). The plan originally contemplated the issuance of surplus notes to cover the remaining 75% of the permitted amount that is currently not being paid.

However, due to potential tax consequences, the rehabilitator is now considering recording the balance as an outstanding policy obligation that would be tracked and accrete at a rate of 5.1%. The rehabilitator is currently determining whether it will amend or modify the plan with respect to what form the outstanding RMBS claims will take.

CS

RMBS

FHFA settlement costs increasing?

UBS last month agreed to settle FHFA claims relating to misrepresented US RMBS sold to Fannie Mae and Freddie Mac for US$885m (SCI 23 July). The settlement amount appears to be relatively high, however, which could result in other banks currently in the FHFA's sights making additional litigation provisions.

The FHFA filed lawsuits two years ago against 18 banks, alleging that they misrepresented the quality of private-label mortgage securities (PLS) sold to the GSEs (SCI passim). Of those 18 banks, three - General Electric, Citi and now UBS - have so far settled, although a series of other cases remain outstanding.

The three lawsuits that have been settled so far represent 5% of the US$204.3bn in original par. Outstanding balances are now down to about US$63bn, with Bank of America, JPMorgan and RBS between them accounting for two-thirds of that figure.

UBS' US$885m payment resolved both FHFA lawsuits and other unasserted claims, including claims in connection with US$4.5bn original face value of UBS-sponsored RMBS and US$1.8bn in original face value of third-party RMBS. At 14% of the US$6.3bn of the original face value of the private-label securities, Fitch argues the settlement appears to be relatively high.

"The size of the UBS settlement may make it more likely that banks with larger exposures may decide to fight the charges in court. This is likely to be a drawn-out process, similar to other PLS litigation, which will perpetuate uncertainty of ultimate losses," the agency notes.

Interestingly, the size of the UBS settlement seems to be related to expected losses over the life of the securities cited in the FHFA's original complaint, rather than realised losses up to this point. The 21 securities cited in the complaint have a current aggregate balance of US$1.5bn, while life-to-date losses have been around US$100m.

While multiple factors influence a bank's ultimate exposure, the quality and performance of the underlying PLS will be significant. The weighted average ratings of the current outstanding securities vary between banks, but are all between triple-C and single-D for the banks that have not settled.

Aggregate loss rates for the underlying securities cited in the FHFA's 15 outstanding complaints vary from 0% for Barclays, HSBC and Société Générale to 6.5% for First Horizon National Corporation. The current balances vary from 17.9% to 41% of the original balance.

Although estimating potential litigation exposure is difficult, Fitch believes that improved and more consistent disclosure could help investors size the potential maximum exposure that banks face. Such additional information could include the performance of the underlying securities and maximum exposure estimates - which have been disclosed by HSBC - while the final size of the Citi and GE settlements would also be useful to know.

JL

RMBS

Agency prepays to decline sharply

US agency RMBS prepayment speeds are projected to decline sharply over the next two months as rising mortgage rates continue to dampen refinancing activities. At the same time, housing turnover - due mostly to existing home sales - is becoming a critical component of agency prepays for the first time in many years.

Historically, housing turnover has been negatively correlated with interest rates (as lower rates increase housing affordability) and positively correlated with home prices (as a strong housing market generally boosts existing home sales). In addition, a growing economy increases geographic mobility, which leads to faster housing turnover.

While the housing turnover rate is used as a baseline for speeds, discount prepayments are also affected by the curve's steepness, default rates, cash-out refinances and mortgage assumability. For example, if mortgage rates remain at their current levels or continue to increase, RMBS strategists at RBS expect long-term prepayments of 3s and 3.5s to reach 6-7 CPR - equal to the turnover rate in an environment where the housing recovery is firming up.

The path to reach that level will likely vary by vintage: 2012 discounts may prepay slower, while 2013 discounts could continue their seasoning ramp. In addition, GN MBS are likely to display higher turnover rates than their conforming counterparts due to their greater default rates, according to the RBS strategists.

In the near term, speeds on lower coupon cohorts - which slowed by 10% to 30% last month - are forecast to decrease by another 10% to 30% in both August and September. A more modest decline is anticipated in 5.5s and higher coupon speeds, as some servicers continue to ramp up HARP refinancing efforts.

As the environment shifts from being dominated by refinancing, other trends in the industry are likely to become more important, according to securitisation analysts at Deutsche Bank. Chief among these are a change in the product mix, easing credit standards and changes in competitive pressures.

During periods of falling interest rates, many borrowers shorten the maturity of their mortgages because the impact of higher monthly payments is blunted by lower rates. Conversely, in a rising rate scenario, borrowers favour 30-year maturities to help hold down monthly payments.

In the most recent cycle, 10- and 20-year mortgages increased in popularity. Thus, at a time when shorter duration is in demand, supply of shorter-maturity collateral will be reduced and should outperform 30-year collateral.

"One of the classic lender responses to rising rates and falling volume is loosening credit standards," the Deutsche Bank analysts observe. "The canary in the mortgage market that's sending a warning now is the 15-year purchase segment of the market, which is not contaminated by refinance activity. Since the trough in mortgage rates at the end of 2012, LTVs in this segment have risen 1.5%, credit scores have fallen by 20 points and debt-to-income ratios have risen more than 3%."

CS

ABS

Sterling ABS trader recruited

Lloyds has appointed Martin de Ville as fixed sterling ABS trader in London. He will join next month and report to head of structured credit trading Gary Hibbard.

De Ville was most recently at Cantor Fitzgerald, where he was responsible for building out the European ABS business. He has also worked at UBS as a senior ABS trader.

Structured Finance

Hong Kong SF lawyer appointed

Jones Day has added Donna Healy to its banking and finance practice in Hong Kong. She was formerly of counsel for Orrick's debt capital markets and structured finance groups.

Healy focuses her practice on structured finance, banking and debt capital markets. She also has experience of cross-border real estate financings in China and cross-border securitisation transactions in Korea.

Structured Finance

Industry vet joins PNC board

Andrew Feldstein has joined PNC Financial Services' board of directors. His appointment is intended to strengthen the board's risk management expertise.

Feldstein is co-founder, ceo and cio of BlueMountain Capital Management. He was previously head of structured credit at JPMorgan and has also worked at Sullivan & Cromwell.

Structured Finance

New role for risk management pro

Glenn Votek has been named as the new cfo at Annaly Capital Management, replacing the retiring Kathryn Fagan. He was previously the company's chief administrative officer.

Votek joined the firm earlier this year (SCI 21 May) and has particular expertise in risk management, capital raising, liability management and regulatory oversight. He has previously worked for CIT Group, Newcourt Credit Corp and AT&T Capital Corporation.

Structured Finance

Special situations fund abuse charges settled

Philip Falcone and his advisory firm Harbinger Capital Partners have agreed to an US$18m settlement with the US SEC. They have admitted wrongdoing and Falcone will be barred from the securities industry for at least five years.

The SEC filed enforcement actions in June 2012 alleging that Falcone improperly used US$113m borrowed from Harbinger's special situations fund to pay his personal taxes. He also secretly favoured certain customer redemption requests at the expense of other investors and conducted an improper 'short squeeze' in bonds issued by a manufacturing company.

Falcone must now pay US$6.5m in disgorgement, US$1m in prejudgement interest and a US$4m penalty. Harbinger must pay a US$6.5m penalty.

Structured Finance

FGIC emerges from rehabilitation

The Superintendent of Financial Services of the State of New York, in his capacity as the court-appointed rehabilitator of FGIC, has determined that the conditions to the monoline's plan of rehabilitation have been satisfied (SCI 2 October 2012). Accordingly, the plan has become effective and the rehabilitation proceeding is terminated.

Part of FGIC's rehabilitation plan is a novation agreement whereby covered public finance policies are transferred to National Public Finance Guarantee Corporation, which will assume the role of insurer under the policies. As a result of the novation agreement, Moody's has reviewed the affected securities and notes that their ratings are the higher of the rating of National Public (Baa1) or the published underlying rating.

Structured Finance

Law firm adds London partner

Ronan Mellon has joined DLA Piper in London as structured finance partner within the firm's finance and projects group. He was previously at White & Case, where he was a capital markets associate.

Mellon specialises in securitisations, CDOs, CLOs, covered bonds, derivatives and emerging markets bond issues. During his 10 years at White & Case he was seconded to Morgan Stanley, Goldman Sachs and BNP Paribas.

Structured Finance

Legal, banking vet joins Sutherland

Sutherland Asbill & Brennan has appointed Brian Barrett as capital markets partner in New York. He has more than 20 years of securities and derivatives market experience as a lawyer, inside counsel and banker.

Barrett was most recently at Goldman Sachs, where he worked in the global liquidity products group. He has also worked at HSBC, Merrill Lynch and Cleary Gottlieb Steen & Hamilton and has advised on a wide variety of securitisations, financings, derivatives and collateral management transactions. He has particular expertise in ILS, CDS and CDOs.

Structured Finance

Structured finance partner named

Squire Sanders has recruited Mark Thomas as partner in its financial services practice group in London. He was previously head of structured finance at Addleshaw Goddard. His practice focuses on advising on developing structured loan products, loan portfolio sales and acquisitions, restructuring - particularly relating to ABS and real estate finance transactions - and the provision of finance to banks and non-bank financial institutions.

CDS

Credit trading pro brought in

Glen Gregorio has joined Citigroup's CDS team in New York as director for credit trading. He was most recently head of the high grade and crossover CDS trading desk at BNP Paribas and before that served as high yield credit trading vp at Deutsche Bank.

CDS

CIO group traders charged

Criminal complaints against Javier Martin-Artajo and Julien Grout for their alleged participation in a conspiracy to hide the true extent of credit derivatives losses at JPMorgan have been unsealed by US Attorney General Eric Holder, Attorney for the Southern District of New York Preet Bharara and George Venizelos of the FBI. The US SEC has announced separate civil charges.

Martin-Artajo was md and head of credit and equity trading for JPMorgan's chief investment office (CIO), while Grout was vp and a derivatives trader. The pair are accused of deliberately and repeatedly lying about the fair value of billions of dollars in CDS to cover up losses (see also 16 January).

Significant losses began to accumulate by March 2012. Martin-Artajo is accused of pressuring traders to manipulate values and Grout allegedly maintained a spreadsheet tracking the difference between the prices he should have recorded and those he actually did. Grout should have been using mid-market valuations for the derivatives portfolio.

Martin-Artajo and Grout are charged in one count of conspiracy, one count of falsifying records, one count of wire fraud and one count of causing false statements to be made in US SEC filings.

CLOs

Bank boosts CLO capabilities

CLO specialist Adrian Radulescu is joining Barclays' US credit structuring team. He will be based in New York and report to head of US ABS and credit structuring Jaime Aldama.

Radulescu most recently worked as a consultant for Credit Suisse in London. Before that he was at Lehman Brothers and SecondMarket in New York, following an earlier stint at Credit Suisse where he was head of the European leveraged finance CLO desk.

Radulescu has also worked for Donaldson, Lufkin & Jenrette, Deloitte & Touche and Trepp. He has over 14 years of experience in CLOs, structured products, derivatives and leveraged finance.

RMBS

FHFA's ResCap claims to proceed

The US District Court for the Southern District of New York last week ruled that the FHFA may proceed with its claims against affiliates of Residential Capital, despite Residential Capital's ongoing bankruptcy proceedings. The FHFA sued Residential Capital and numerous other defendants in 17 lawsuits filed two years ago, alleging generally that defendants misrepresented the quality of loans backing RMBS that they sold to Fannie Mae and Freddie Mac (SCI 5 September 2011).

Residential Capital in May 2012 sought to extend an automatic bankruptcy stay over 27 RMBS lawsuits against it and its affiliates, including several non-debtor entities, such as Ally Financial. In July 2012, US District Judge Denise Cote denied Residential Capital's request and permitted the FHFA to proceed with its claims against Residential Capital's affiliates.

On appeal, the Second Circuit found that the Bankruptcy Code's automatic stay provision may apply to non-debtors in some limited circumstances and remanded the action to the district court to supplement the record and determine whether the automatic stay applies to Residential Capital's non-debtor affiliates. On remand, Judge Cote concluded that the action against Residential Capital's non-debtor affiliates is unlikely to have an "immediate adverse economic consequence" for Residential Capital's estate and is not subject to the automatic stay, according to a recent Lowenstein Sandler memo.

RMBS

Manager adds non-agency specialist

Prosiris Capital Management has appointed Aashish Marfatia in New York to enhance its residential mortgage capabilities. He takes responsibility for non-agency residential mortgage trading and related investments.

Marfatia has over 10 years of experience in the mortgage and securitised product space. He was previously at Tilden Park, Perry Capital, Credit Suisse and Moody's, working in research and trading positions.

RMBS

Further IndyMac appeal filed

IndyMac Bancorp's former chief executive Michael Perry has made another filing in ongoing litigation in the US Ninth Circuit Court of Appeals. The appeal is from a District Court Decision in a case pitting the FDIC, IndyMac's Chapter 7 trustee, Perry and other former IndyMac executives against a group of insurers that includes XL Specialty Insurance Company, Arch Insurance Company, ACE American Insurance Company, Axis Insurance Company, Lloyds, Catlin Insurance Company, Zurich American Insurance Company, Twin City Fire Insurance Company and Continental Casualty Company.

The District Court determined that the insurers do not need to cover IndyMac's costs of defending and settling litigation brought by the US SEC for false representations regarding the firm's financial stability (SCI 14 February 2011). IndyMac was subsequently sued in several state and district courts for breaches of corporate fiduciary duties and violations of securities laws, including a class action securities lawsuit.

The firm had substantial directors and officers (D&O) insurance coverage. The D&O policies at issue provide that claims arising from "interrelated wrongful acts" are covered under only the first policy period in which the claims are made.

The insurers successfully argued to the District Court that IndyMac's claims related to the SEC litigation stem from the same interrelated circumstances that gave rise to the claims brought during the policy period of the class action. Because the policy periods are the same, the claims were found to be interrelated and IndyMac couldn't collect on the D&O coverage a second time.

A recent Structured Finance Industry Group memo notes that since the IndyMac D&O policies' language is similar to language found in many other policies, the District Court decision will likely be cited by insurers in other disputes to limit coverage where lawsuits were brought over multiple policy periods. This is because it provides a broad interpretation of what makes claims interrelated enough to be covered under only one policy period.

RMBS

Objection filed against FGIC settlement

A number of investors - collectively holding over US$714m of wrapped Residential Capital securities - have filed an objection against how certain policyholders will be treated after FGIC's settlement with ResCap debtors. They claim that 47 RMBS trusts that issued securities with a current face amount of US$4.9bn and hold over US$1n in FGIC policy claims will receive a one-time lump sum payment instead of receiving the payments outlined in the FGIC rehabilitation plan (SCI 2 October 2012).

The US$253.3m lump sum is said to be at most 21.3% of the discounted present value of estimated claims under the FGIC policies, significantly less than the 45% in total payments projected to be made over time under the rehabilitation plan, according to RMBS analysts at Bank of America Merrill Lynch. The investors argue that this goes against the rehabilitator's efforts to treat all policyholders the same.

Under the settlement agreement, the rehabilitator will receive a distribution under the proposed chapter 11 bankruptcy plan of the ResCap debtors that is expected to be approximately US$206.5m (SCI 20 May), with the rehabilitator then paying US$253.3m to the affected policyholders on account of FGIC policy claims, which amount to a minimum of US$1.189bn on a present value basis. As part of the agreement, other FGIC policyholders would no longer have to share recoveries with these affected policyholders.

While the investors aren't arguing against the rehabilitator's agreement to settle the litigation claims against ResCap or other aspects of the plan support agreement, they believe that the commutation part of the settlement agreement is not fair and equitable. In addition, they claim that the trustees do not have the authority under the relevant governing documents to agree to the commutation embedded in the settlement agreement.

ABS

Stable performance for timeshare ABS

S&P reports that the performance of collateral backing transactions in its US timeshare securitisation performance index remained stable in the first half of 2013. Total delinquencies declined overall and monthly defaults remained steady. Excess spread was also stable, but spiked in March after one deal was redeemed.

Total delinquencies declined from 4.2% in January to 3.92% in June, while monthly defaults hovered between 56bp and 64bp. Ownership upgrades steadily increased to 1.22bp in June from 77bp in January, and prepayments ranged from 49bp-66bp.

As of June, the 40 outstanding term transactions - backed by nearly US$4.13bn in timeshare loan receivables - that S&P rates had an aggregate outstanding issuance amount of approximately US$3.35bn. The agency rated two new deals with a total rated issuance amount of approximately US$343.1m in the first half. In comparison, during the first half of 2012, it rated four transactions with an aggregate issuance amount of approximately US$952m.

ABS

Tobacco ABS review completed

Fitch has completed its annual review of tobacco ABS ratings, accounting for the amount of Master Settlement Agreement (MSA) payment received by each trust in 2013. For 2013, the aggregate MSA payment was 21.56% higher than the amount in 2012, due to the non-participating manufacturer dispute settlement payment made by the tobacco companies to 20 settling states and territories.

This payment represents a one-time increase in the amount of the MSA payment and was stripped out of the amount allocated to each trust for Fitch's modelling purposes. Instead, the agency assumed that the settling states experienced the same rate of decline - approximately -0.03% - as the non-settling states. Since this settlement payment is cash positive, no downgrades will be taken on any bonds issued by settling states or counties.

Fitch notes that the full benefit of the settlement payment will be seen next year, at which point the ratings will be re-evaluated. The agency has taken 31 downgrades on bonds from non-settling states. Although the MSA payment was stable year-over-year, many of these downgrades result from having model-indicated grades that were below the current rating for two consecutive years.

Three ratings from Suffolk Tobacco Asset Securitization Corporation, Tobacco Settlement Asset-Backed Bonds Series 2008 are being upgraded, since the trust is now receiving a higher allocation of the county's MSA payment. The remaining 200 outstanding ratings are being affirmed.

Debt service reserve balances for Buckeye Tobacco Settlement Financing Authority 2007 (Ohio), Golden State Tobacco Securitization Corporation, United States Series 2007-1 and Nassau County Tobacco Settlement Corporation, Tobacco Settlement Asset-Backed Bonds Series 2006 continue to be below their required levels. As a result, Fitch does not give them the benefit of a rating one notch above the model-indicated grade.

ABS

FFELP SLABS issuance set to slow

US student loan ABS new issuance is on track to finish below last year's total issuance of US$30bn, S&P notes. In steep contrast, student loan originations through the Department of Education's (DOE's) Direct Loan programme have continued to grow quickly, further augmenting the total amount of outstanding student loan debt. However, student loans from the Direct Loan programme have not been used in securitisations.

The New York Fed reported that total student loan debt held by consumers had reached US$956bn during the autumn of 2012, after adding new annual disbursements of US$109bn. It also disclosed that the total outstanding balance of student loans owned by the federal government was US$516bn through October 2012 - nearly five times the 2008 amount of US$104bn.

Separately, the DOE reported that the Direct Loan programme's portion was approximately US$569.2bn and the terminated Federal Family Educational Loan Program (FFELP) accounted for US$429.5bn. Defaulted student loans totalled US$89.3bn of the US$998.7bn in federal student loans outstanding. Only 50% - or US$493.7bn - of the total federal loans outstanding were in repayment status.

Private student loans not originated through federal student loan programmes continue to constitute a small percentage of total student loan debt. The CFPB estimates there is US$165bn in private student loans outstanding.

Overall student loan ABS transaction volume stands at US$15.1bn so far this year, versus US$15.7bn during the same period in 2012. Despite being shuttered in 2010, loans originated under the FFELP programme are still the primary driver of student loan ABS issuance. By end-July, 22 FFELP deals totalling US$12.3bn (or 81% of issuance) had been issued, compared with 18 transactions totalling US$12bn last year.

FFELP securitised collateral has come from the unwinding of the Straight-A Funding conduit and refinanced pre-2008 auction-rate transactions. However, S&P expects the activity to slow during the remainder of 2013, as the loan supply from Straight-A Funding is nearly exhausted.

State agencies have also been active during 2013, as they were in 2012. Massachusetts Educational Finance Authority, New Jersey Higher Education Student Assistance Authority, Rhode Island Student Loan Authority and Vermont Student Assistance Corp have all issued bonds this year totalling US$587.6m (see SCI's primary issuance database).

But private student loan ABS volume has been sluggish, with six deals aggregating US$2.8bn (19%) at end-July, versus eight deals totalling US$3.7bn for the same period last year. Sallie Mae continues to be the largest securitiser of private student loans and has issued two deals so far this year for US$2.2bn, compared to four deals for US$3.2bn for the same period last year.

As the Straight-A Funding programme comes to a close, S&P expects student loan ABS volume to reach US$25bn this year and finish below the US$30bn of issuance in 2012. Remaining 2013 issuance is anticipated to comprise the balance of loans from the Straight-A Funding facility, auction-rate refinancings and private loans, with the roughly 80% FFELP/20% private split to continue.

So far, 2013 has yielded 168 S&P rating actions in the form of affirmations, upgrades and downgrades. Additionally, another 100 classes of notes have been placed on credit watch, predominately with negative implications.

The agency expects that all of the currently outstanding credit watch actions will be resolved before year-end. When coupled with its periodic surveillance reviews within the sector, total year-end rating actions are likely to be in line with 2010 levels, which amounted to roughly 700 actions.

"However, we expect downgrades to account for less (in percentage terms) than they have in previous years, and what downgrades are initiated will continue to be predominately performance-related. Over the coming years, we anticipate that as student loan collateral continues to season and the economic recovery maintains momentum, performance-related downgrades will begin to decline," S&P notes.

The agency currently has a stable outlook on the underlying collateral performance of FFELP student loan ABS, as well as a stable ratings outlook, given the US government's guarantee. But it anticipates a mixed performance for private student loan collateral during 2013: performance may vary by issuer, with some potentially experiencing escalating default rates and others stabilising as the job market for new college graduates improves modestly.

ABS

Tobacco bond cashflow errors corrected

Moody's says it will continue to maintain the ratings on the term bonds issued in tobacco settlement revenue securitisations under review with direction uncertain (SCI 23 January). But the agency has disclosed that since it placed the bonds under review, it has corrected certain errors in the cashflow models used in rating them. The corrections have a positive credit effect for most rated tranches.

The bonds will remain under review, however, because the positive credit effect of the model corrections is likely to be fully or partly offset by the negative effect of the recent settlement of the 10-year old NPM adjustment dispute between 22 states and tobacco manufacturers (SCI 16 May). The settlement agreement also indirectly impacts the securitisations sponsored by the states that chose not to settle by setting up a precedent that the recovery of the escrowed funds can be less than 100%.

Moody's notes that it will conclude the review upon full assessment of the effect of the settlement agreement.

ABS

Container ABS remains resilient

Container leasing ABS issuance has remained resilient this year, despite sluggish global economic and trade growth. S&P believes that issues rated single-A should be able to withstand substantial stress and still meet their financial obligations.

The agency rated six new container lease ABS transactions in the first half of 2013, roughly matching the record-setting pace of 2012. "Currently, we believe credit enhancement is sufficient for all of the outstanding transactions in this sector, given that container production and leasing companies have kept a lid on new container production, and the weak financial conditions of the shipping lines favour container leasing," says S&P credit analyst Weili Chen. "We believe container leasing will continue to enjoy supply and demand balance in the face of slow growth in world trade."

World trade and containerised shipping is expected to continue to face tepid demand in the near future. However, the container leasing business and related securitisations will continue to perform well, aided by disciplined new container production that seeks to balance supply and demand.

Structured Finance

Chinese securitisation challenges outlined

Securitisations in China continue to face key challenges in legal enforceability, data robustness and integrity, as well as underwriting and servicing standards, according to Fitch. The agency notes that true sale and bankruptcy remoteness are yet to be tested in Chinese securitisations under the specific asset management programme (SAMP).

Such transactions have weak legal structures since they rely on rules issued by the regulatory authority - Chinese Security Regulatory Commission. Because they are not enacted laws, it is possible that these rules may not be upheld in Chinese courts, Fitch suggests.

Lack of data robustness is also an impediment to the development of the Chinese securitisation market. There is sometimes an unavailability of a long history of portfolio data that is generally required in securitisations, due to the short history of both certain asset classes and detailed collection of data.

Fitch expects more companies to tap the securitisation market under both the SAMP and the credit asset securitisation scheme after new rules expanded the eligible originators, asset classes and investors. New originators are likely to have robust underwriting policies and vigorous monitoring, servicing, collection and reporting procedures in place to meet standards required in a securitisation. Standards for securitisation may be higher than those that Chinese companies would normally adopt, the agency observes.

Structured Finance

QE exit weighing on sentiment

Results from Fitch's 3Q13 European fixed income investor survey show that expectations on the timing of central banks' exit from QE, as well as policymakers' progress on eurozone banking union are at the front of investors' minds.

Overall, investors trust central banks to manage a smooth QE exit. While they see the risk of winding down monetary stimulus as a big challenge, most survey participants (73%) believe that central banks will tighten policy without threatening the economic recovery.

However, QE exit plans are causing investors concern about liquidity for emerging markets (EMs). A majority of investors (66%) expect such concerns to drive volatility in EM bond fund flows for the remainder of this year. About a fifth of respondents say that flows will decrease due to greater concerns over political risk.

Regarding progress towards full eurozone banking union, investors do not think it will reduce default risk for banks. Only 28% are optimistic that the regulation shift will reduce default risk, while the balance cite incomplete implementation (39%), the insufficiency of the proposed measures (6%) and the consequence of independent resolution being that banks are less likely to be supported (27%).

Nevertheless, investors are more positive towards banks in general. The sector is the most overweight of all corporate sectors in investor portfolios and the second most favoured marginal investment choice behind high yield.

Fitch's 3Q13 survey was conducted between 1 and 31 July. It represents the views of managers of an estimated €5.6trn of fixed income assets.

Structured Finance

Libor actions to remain a 'distraction'

The recent dismissal by the New York Federal District Court of antitrust and racketeering claims with regard to alleged Libor manipulation is credit positive for those banks that participate in Libor-setting panels, Moody's notes. However, the agency suggests that the banks remain vulnerable to fraud-based and other legal claims.

Litigation in the US based on securities fraud and other state law is ongoing and its potential impact is difficult to quantify at this point. Inter-dealer brokers have also recently come under investigation. While the Libor panel banks have capital capacity to absorb potential Libor-related regulatory charges and legal damages, inter-dealer brokers have more limited capital resources, according to Moody's.

"Regulatory investigations and actions have been proceeding at a brisk pace both in the US and abroad, and are expected to continue," comments Moody's svp Geoffrey Richards. "The level of regulatory scrutiny and visibility of the allegations is intense and will remain a source of management distraction."

Indeed, investigations are underway relating to a number of other benchmark rates that use processes similar to that for Libor, including those in Hong Kong and Singapore, as well as Euribor. In addition to the focus on past instances of alleged manipulation of Libor and other related benchmark rates, Moody's believes that regulators will continue to analyse and develop alternatives to the current rate setting mechanisms. These developments are anticipated to unfold over a number of years, given the absolute size and complexity of the markets and the range of instruments involved.

CDO

Marginal decline for CRE CDO delinquencies

The overall delinquency rate for CRE CDOs fell marginally to 11.7% from 11.8% last month, according to Fitch's latest index results for the sector. Only three new delinquent assets were reported in July, while six assets were removed from the index.

New delinquencies included two recently matured balloon loans and one security with a new interest shortfall. The removed assets included five assets disposed of at losses and one security that is no longer suffering from interest shortfalls.

CDO managers reported approximately US$66m in realised principal losses in July from asset disposals. The average loss on these assets - which include both loans and securities - was approximately 34%.

The largest single loss was related to the discounted sale of a B-note secured by a one million square-foot Chicago office property. The loan was restructured and extended last year after a maturity default.

The next largest reported loss in the month was related to the discounted pay-off at 27% of par of a defaulted whole loan secured by a retail centre located in Cleveland, Ohio. The property defaulted in 2010 after losing its grocery anchor.

A total of 28 CRE CDOs rated by Fitch reported delinquencies ranging from 0.3% to 80.3% last month. In total, 41% of rated CRE CDOs were failing at least one overcollateralisation test in July.

CDO

Further decrease in Trups CDO defaults

Combined US bank Trups CDO defaults and deferrals further decreased to end July at 27.6%, from 27.8% at the end of June, according to Fitch.

Seven banks representing approximately US$62m of collateral cured and resumed their interest payments on their Trups last month. No new defaults or deferrals were reported.

Year-to-date there have been nine new deferrals and defaults, compared to 34 over a comparable period last year. Cures continue to trend higher, with 44 cures YTD compared to 28 last year.

The total number of bank issuers outstanding across Fitch-rated US Trups CDOs stood at 1,434 at the end of July. Of this total, 220 bank issuers are in default and 293 in deferral.

CDO

RFC issued on CSO update

Moody's is seeking comments from market participants on proposed changes to its rating approach for corporate synthetic CDOs (CSOs). If implemented, these changes will raise the minimum credit enhancement levels for a given rating category and will have a generally negative impact on outstanding CSO ratings.

The proposed changes include: lowering the average recovery rate assumptions for all types of debt other than subordinated bonds; increasing the number of asset correlation states with varying probabilities of occurrence; and adjusting default probabilities to match historical corporate performance and to mitigate risk of portfolio adverse selection. These changes introduce additional negative scenarios in Moody's rating considerations and enable a more robust credit assessment, the agency says.

Moody's is also proposing to remove the 30% macro default probability stress for corporate credits it applied to CSOs in 2009. The net result of these changes is a more conservative view of rated notes in this sector.

Credit performance in the sector has been poor, due to high default rates and low recoveries, leading to substantially higher losses to investors. "Two key drivers of poor performance were higher credit correlation within certain industries and the adverse selection of credits referenced in these transactions," says Jian Hu, a Moody's md. "For example, there was a significant concentration of referenced debt in CSOs from troubled financial institutions."

While Moody's does not anticipate new issuance in this specific asset class in the foreseeable future, it is proposing these methodology changes to ensure that risk factors present in the last generation of deals are appropriately accounted for in its ratings of outstanding transactions and any new proposed structures. "Having completed a study of historical corporate default and recovery data from 1920 to 2011 for our revised CLO methodology, we are applying what we learned from that study to other asset classes backed by higher rated corporate credits," adds Hu.

The agency anticipates that these changes will result in lower model outputs corresponding to half a notch on average for senior tranches of oustanding CSOs, 2.5 notches on average for mezzanine tranches and one notch on average for junior tranches.

Market participants are requested to provide feedback by 13 September. Moody's will finalise the changes to its modelling assumptions for CSOs after taking responses into account, following which it will publish its revised methodology and place on review the ratings of the affected CSOs.

CDS

Petrobras CDS hit four-year wides

Market concerns over Petroleo Brasileiro's ability to carry out its future investment plan have sent the company's credit default swaps (CDS) to their widest levels in four years, according to Fitch Solutions.

Petrobras' CDS have widened by 89% year-over-year. At 300bp, credit protection on the oil company's debt stands at levels not seen since April 2009. The likely reason for worsening market sentiment is that the company may need to issue more debt to help finance its five-year investment plan worth roughly US$237bn.

Fitch's CDS Implied Rating (CDS IR) for Petrobras moved one notch lower to double-B plus - two notches below its IDR - three months ago. If CDS continue trending at current levels, the CDS IR is likely to move lower again, the firm says. CDS liquidity for Petrobras has increased substantially as well, moving up from trading in the 21st global percentile to the sixth.

CLOs

RFC issued on multi-country CLOs

Moody's has published a request for comment on its proposed approach to assessing country risk in multi-country CLOs. Under the proposal, for a given size of exposure to countries with a local currency country risk ceiling (LCC) of A1 and lower, the rating agency would provide tables that indicate a portfolio par value haircut for tranches with target ratings higher than the relevant LCC. Haircuts would then be deducted from the CLO collateral par amount to reflect the incremental country risk.

Moody's proposal primarily impacts CLOs with exposure in some of the euro-area countries. Euro-area assets represent the largest exposures in CLOs to non-Aaa country ceiling jurisdictions and also introduce potentially higher correlation among these assets with respect to correlated country ceiling events.

The RFC does not cover emerging market CDOs, which present different sets of analytic issues - in particular on correlation - and are covered by a different methodology.

Moody's does not expect any ratings impact across the capital structure from its proposed approach on CLOs with less than 20% exposure to euro-area countries with an LCC of lower than A1. For CLOs with more than a 20% exposure to these countries, the impact on existing ratings will be slightly negative but generally by no more than one notch.

CMBS

Higher CRE prices sought in Japan

Moody's says that higher property prices in Japan - resulting from the government's policies of emphasising GDP expansion and higher inflation - would facilitate the refinancing of CMBS loans to repay investors and improve recovery rates for defaulted loans. Although normalised interest rates that would be higher than today's rates are a negative for refinancing, the agency believes that refinancing risk for the underlying loans of CMBS deals is unlikely to increase substantially from current levels because of higher property prices.

In addition, a weakening Japanese Yen - associated with monetary easing - would increase the numbers of overseas visitors to the country, which would in turn be credit positive for CMBS backed by hotels. As demand rises, hotels would be able to raise room rates above the inflation rate. Hotels in Kyoto, Tokyo and Osaka are the biggest beneficiaries because of their popularity with tourist and business travellers in the case of the latter two cities.

Higher property prices would also make J-REITs more attractive to equity investors, allowing the property trusts to expand their portfolios by tapping the equity markets to fund purchases. J-REITs sponsored by major developers would benefit the most due to their ability to purchase new buildings below market prices.

If the country's revitalisation strategy does not generate sustainable growth, a third decade of economic stagnation will perpetuate challenges facing the CMBS and J-REITS markets, Moody's observes. Both markets remain heavily reliant on bank funding and if the real estate market remains lack-lustre, bank lenders remain reluctant to refinance loans in those markets. As a result, loans with relatively high loan-to-value (LTV) ratios will continue to default and losses on CMBS junior notes with initial ratings of A or lower will continue to increase, the agency concludes.

CMBS

US CMBS downgrades declining

Fitch notes a stabilisation of trends in outstanding and newly issued US CMBS versus 1Q13. The majority of outstanding Fitch-rated investment grade classes maintained stable rating outlooks, while second-quarter downgrades declined over those in the first quarter.

"CMBS downgrades will continue to decline due to fewer loans transferring to special servicing and fewer delinquencies," comments Fitch md Mary MacNeill. Most second-quarter downgrades affected classes already rated speculative grade or distressed.

New issuance metrics were stable quarter-over-quarter but have worsened since last year. This is due to higher Fitch stressed LTVs, more interest-only (IO) loans and more loans having or allowing additional debt.

"The increase in IO loans from a year ago makes average debt service coverage ratios look better," says Fitch md Huxley Somerville. "However, the loans are poorer in quality and the Fitch LTV, which is up from a year ago, should also be considered." The agency says it has increased its triple-A credit enhancement requirements as additional debt and IO loans have become more commonplace.

Mortgage rates in new issue CMBS remained stable quarter-over-quarter. However, Fitch expects the early summer up-tick in rates to appear in third-quarter new issuance.

CMBS

CMBS credit degradation warning

Historically low interest rates, improving real estate fundamentals and commercial real estate's role as a natural hedge against inflation have driven an increase in US CMBS issuance by 30% or more year-over-year since the depths of the financial crisis. But increased origination volume has meant that some slippage in credit standards has occurred, which has been observed across 2013 vintage deals, Kroll Bond Rating Agency reports.

More recently, some market constituents have expressed concerns that a rising rate environment will contribute to credit degradation, particularly if lenders and borrowers are unwilling to accept loans with lower leverage points to offset the impact of rising debt service caused by higher coupon loans. KBRA has consequently released a report on credit standards in recent CMBS transactions.

Following Federal Reserve Chairman Ben Bernanke's taper talk in May, the average 10-year US Treasury yield has increase by 64bp in absolute terms (or 29%) through 16 August. The rise in Treasury yields has, in turn, pushed spreads wider by roughly 70bp-100bp compared to prevailing mortgage rates for generic fixed rate loans to the high-4%/low-5% range.

The focus on rates has increased the competitiveness of balance sheet lenders and life insurance companies, KBRA observes. Unlike conduit programmes, these lenders originate loans benchmarked to the 10-year US Treasury yield, providing an approximately 16bp advantage over CMBS.

"Although this could prompt a decline in conduit originations, we believe that any decrease in production will be short-lived, given the high volume of maturing loans in the coming years - absent an unanticipated market dislocation," the agency notes.

The more likely scenario is that credit quality may be negatively affected by increased competition and a gradual rise in interest rates as the Fed reduces quantitative easing. To the extent that lenders do not reduce leverage levels to compensate for increased debt service burdens, debt service coverage will decline. While there will be some natural deleveraging associated with amortisation, rising rates and declining coverage may ultimately contribute to higher defaults and losses.

KBRA recently evaluated the impact of rising rates on six conduits that it rated this year, where the loans were rate-locked primarily in 2Q13, before the impact of the rate increase took effect. The transactions had an average cut-off balance of US$1.4bn and comprised of 447 loans secured by 677 properties that had a weighted average coupon (WAC) of 4.17%.

To isolate the impact of higher interest rates, the agency increased the coupon rate of each of the underlying loans by 75bp and 150bp. This had a material impact on each deal's weighed average Kroll Debt Service Coverage (KDSC), as well as the average deleveraging that occurred in each pool due to amortisation, which decreased by approximately 10% and 19% respectively in each scenario.

The impact of the rate rise varied somewhat across the sampled transactions depending on their individual characteristics, including the level of unadjusted coupons and the degree to which partial term and full term IO loans were present in the pool.

The ultimate impact of higher rates on credit quality in the CMBS sector remains to be seen, as lenders will ultimately adapt to increasing interest rates by changing their origination parameters in a number of respects. This could entail reducing in-trust leverage, increasing IO periods, changing loan terms and potentially offering additional debt outside the trust, according to KBRA.

Insurance-linked securities

Longevity risk consultation launched

The Joint Forum has released a consultative report on the longevity risk transfer (LRT) markets. The paper aims to assist in setting appropriate policies and to help ensure effective supervision of related activities and risk.

Estimates of the total global amount of annuity- and pension-related longevity risk exposure range from US$15trn to US$25trn. At the same time, pension funds are increasingly looking for ways to hedge or transfer this exposure.

The report makes a number of recommendations to policymakers and supervisors. First, supervisors should communicate and cooperate on LRT internationally and cross-sectorally in order to reduce the potential for regulatory arbitrage. They should also seek to ensure that holders of longevity risk under their supervision have the appropriate knowledge, skills, expertise and information to manage it.

Policymakers should review their explicit and implicit policies with regard to where longevity risk should reside to inform their policy towards LRT markets. They should also be aware that social policies may have consequences on both longevity risk management practices and the functioning of LRT markets.

In addition, policymakers should review rules and regulations pertaining to the measurement, management and disclosure of longevity risk with the objective of establishing or maintaining appropriately high qualitative and quantitative standards, including provisions and capital requirements for expected and unexpected increases in life expectancy. They should also consider ensuring that institutions taking on longevity risk - including pension fund sponsors - are able to withstand unexpected, as well as expected, increases in life expectancy.

Policymakers are urged to closely monitor the LRT taking place between corporates, banks, (re)insurers and the financial markets, including the amount and nature of the longevity risk transferred and the interconnectedness this gives rise to. In particular, supervisors should take into account that longevity swaps may expose the banking sector to longevity tail risk, possibly leading to risk transfer chain breakdowns.

Finally, policymakers should support and foster the compilation and dissemination of more granular and up-to-date longevity and mortality data that are relevant for the valuations of pension and life insurance liabilities.

Comments on the report should be submitted by 18 October.

Risk Management

Additional clearing rules released

The CFTC has issued a final rule to exempt swaps entered into by qualified cooperatives from the clearing requirement, subject to certain conditions. It has also released final rules to implement enhanced risk management standards for systemically important derivatives clearing organisations (SIDCOs), as well as proposed rules to establish additional SIDCO standards.

A qualifying cooperative is permitted to elect to not clear a swap providing its members are either non-financial entities or other cooperatives whose members are non-financial entities. In addition, the swap must be entered into in connection with originating loans to cooperative members or hedging or mitigating commercial risk related to loans to, or swaps with, members.

The final rule requires the reporting counterparty to report the election of the cooperative exemption, as well as certain other information, to a swap data repository (SDR). Because the final rule will not be effective for 30 days after publication in the Federal Register, concurrent with the issuance of the final rule the Commission has issued a time-limited, no-action letter granting relief from required clearing for certain swaps entered into by qualifying cooperatives that expires on the effective date of the final rule.

Meanwhile, the final SIDCO rules are designed to be fully consistent with the Principles for Financial Market Infrastructures, thereby enabling them to continue to be qualifying central counterparties (QCCPs) for purposes of international bank capital standards. The final rules: increase financial resources requirements for SIDCOs that are involved in activities with a more complex risk profile or that are systemically important in multiple jurisdictions; prohibit the inclusion by SIDCOs of assessments when calculating their available default resources; and enhance system safeguards for SIDCOs for business continuity and disaster recovery. They also implement special enforcement authority over SIDCOs granted to the CFTC under the Dodd-Frank Act.

Finally, the proposed SIDCO rules include substantive requirements relating to governance, financial resources, system safeguards, special default rules and procedures for uncovered losses or shortfalls, risk management, additional disclosure requirements, efficiency and recovery and wind-down procedures. In addition, because of the potential advantages afforded to QCCPs, the proposed rules include procedures by which derivatives clearing organisations other than SIDCOs may elect to become subject to these additional standards.

Risk Management

MarkitSERV volumes jump

Over 600,000 trades have been submitted to clearinghouses by MarkitSERV in the period between 11 March, when the CFTC made clearing of certain OTC derivatives mandatory, and the end of July. In the first half of 2013, the volume of trades submitted for clearing using MarkitSERV increased by 48% from the same period in 2012 and included more than 120,000 client trades on behalf of approximately 280 firms. Over 300 buy-side firms have become new subscribers to the service so far this year in order to comply with CFTC mandates.

Since 2004, when MarkitSERV connected to its first clearinghouse, more than five million OTC derivatives trades have been submitted for clearing via the platform. Today, the service links more than 2,500 buy-side firms, 100 dealers and 70 execution venues to 13 clearinghouses worldwide. Its newest clearing connection is to LCH.Clearnet (SwapClear US), which launched in June.

Risk Management

Regulatory comparison principles released

ISDA has outlined a set of principles designed to help achieve a more harmonised framework of international derivatives regulations. The principles are intended to guide the development of frameworks and processes for inter-jurisdictional recognition of derivatives regulation through a principles-based substituted compliance methodology.

In its Methodology for Regulatory Comparisons, ISDA suggests that an effective framework should be grounded in the declarations issued by the G20 following the Pittsburgh and Cannes meetings. The five G20 goals include: clearing of standardised derivatives; exchange/electronic trading, where appropriate; reporting to trade repositories; higher capital requirements for non-cleared trades; and margin requirements for non-cleared trades.

In order to minimise burdens on regulators, maintain global markets and avoid market fragmentation, regional and national regulators should evaluate the other's regimes to allow for a principles-based approach to cross-border compliance, according to the methodology. For purposes of substitute compliance or equivalence, comparisons of one jurisdiction's requirements to another's may use a variety of analytical methods, all of which must start with identification of a set of common principles that elaborate on the G20 regulatory goals.

Ultimate decisions regarding comparability require not only a bilateral dialogue between regulators, but also a transparent process. Regulators should therefore consult and cooperate with each other before implementing their derivatives regulations.

RMBS

RMBS ratings reviewed

S&P has completed a review of over 60,000 ratings across more than 5,500 US RMBS. The transactions are backed by pre-2009 collateral and primarily reflect criteria changes that occurred in August 2012 and March 2013.

Between August 2012 and July 2013, S&P downgraded 15,100, upgraded 1,532 and affirmed 43,611 tranches. The agency focused on first-lien, re-REMIC and second-lien transactions to examine performance trends stemming from various factors, including how its ratings were affected by recent criteria updates.

The updated criteria had the biggest impact on ratings from prime transactions. S&P lowered ratings on 39% of prime classes, compared with 20% for Alternative-A, 19.5% for subprime and 11.5% for negative amortisation (Neg-am).

"In essence, the larger impact for prime was driven by the ratings stability metrics we applied in conjunction with the lower absolute levels of subordination and our tail risk analysis," says S&P credit analyst Terry Osterweil.

Ratings on re-REMIC transactions were more stable, resulting in the affirmation of 90.6% of ratings. For second-lien transactions associated with the updated US second-lien RMBS surveillance criteria, S&P lowered 17.21% of ratings, raised 9.79% and affirmed 73%. In part, the upgrades reflect the updated criteria's extended default and loss horizon, which correspondingly increased the projected excess interest available as credit support to these classes.

RMBS

Forbearance-related downgrades hit

S&P has lowered its ratings on 31 classes from 19 US RMBS and removed 26 of them from credit watch with negative implications. At the same time, the agency affirmed the ratings on 319 classes from 66 transactions and removed 99 of them from credit watch negative.

The rating actions follow the announcement by Ocwen Loan Servicing that US$1.4bn of previously undisclosed losses on certain loans were realised in the May 2013 remittance period (SCI passim). All of the transactions in this review were issued between 2001-2007 and are backed by a mix of adjustable- and fixed-rate prime jumbo, subprime, Alternative-A, document-deficient, re-performing and Neg-Am loans secured primarily by first liens on one- to four-family residential properties.

Among the transactions reviewed, the amount of losses tied to forbearance modifications as a proportion of the original collateral balance varied from as low as 0.08% (in MESA Trust 2001-5) to 3.71% (Soundview Home Loan Trust 2007-OPT1). In cases where the number of loans placed in forbearance was low, S&P's lifetime projected losses stayed virtually unchanged, despite loss reclassifications.

In other cases where the number of loans placed in forbearance resulted in an upward adjustment to the lifetime projected losses, downgrades stemmed primarily from deteriorating credit support caused by increased delinquencies. In general, transactions reporting the highest amounts of forbearance losses already had speculative-grade ratings.

RMBS

Mexican loan modifications due

Mexican servicers Patrimonio and Tertius are set to apply a number of loan modification proposals (LMP) to certain securitised mortgages. The LMP comprise Apoyo con Quita, Programa Finiquito/Venta de Derechos Litigiosos, Reduccion Permanente de Mensualidad con Quita and Dacion en Pago con Incentivo Economico.

The servicers' collection policies already include these loan modification products. They are to be applied under a recovery maximisation principle and will be offered individually rather than as part of a broader programme.

The affected loans back rated RMBS from the BRHSCCB, BONHITO, CREYCCB, MXMACCB, MXMACFW, PATRICB and Su Casita Trust shelves. Fitch confirms that such LMP would not cause a downgrade or withdrawal of the current ratings of these deals. However, the agency states that further rating actions cannot be ruled out after applying the LMP, based on the credit performance of each transaction.

RMBS

RFC cashflow errors corrected

Moody's has confirmed the ratings of 13 tranches and upgraded the ratings of five tranches across seven RMBS from Residential Funding Corporation's RAMP and RASC shelves. The rating actions reflect the recent performance of the underlying pools, as well as Moody's updated expected losses on the pools. They also reflect corrected errors in the Structured Finance Workstation (SFW) cashflow models previously used by the agency in rating these transactions.

The cashflow models used in previous rating actions for the affected transactions incorrectly applied separate interest and principal waterfalls. In the impacted deals, all collected principal and interest is commingled into one payment waterfall to pay all interest due on the bonds first and then pay principal.

RMBS

Serviceability test utility underscored

Meaningful serviceability tests are becoming an even more important way for Australian mortgage originators to maintain the high quality of their portfolios as interest rates reach historic lows, Fitch reports. The agency says that current low interest rates, coupled with high house prices and household leverage could expose borrowers to future payment shocks when interest rates rise.

"It is therefore important that residential mortgage lenders factor into tests rates that are closer to historical averages, so that borrowers - particularly first-time borrowers - are able to service their loan obligations, should interest rates return to average historical levels or higher," it explains.

At loan origination, lenders typically stress borrowers' serviceability using a buffer of 1.5 to 2.0 percentage points higher than existing rates. Most lenders also use a minimum lending rate in their borrower serviceability calculations to help guard against payment shocks; thus, Fitch says that while this is not an area of major concern, it does need to be monitored.

A minimum lending rate can capture the risk that rates return to average historical levels that are higher than the stress rate with the addition of a buffer. This has been demonstrated in previous periods of low interest rates in Australia.

Average residential mortgage standard variable interest rates (SVR) at the large banks that provide the bulk of Australian mortgage lending are currently 6.1%, with borrowers usually able to get discounts of 0.5 to 1.0 percentage point. SVRs have been as high as 9.6% as recently as September 2008.

RMBS

MSR challenges ahead

Movement of non-agency RMBS away from banks and into the hands of non-bank servicers continued apace in the second quarter. Additional large mortgage servicing right (MSR) transfers are scheduled to be completed in the last half of 2013, as banks offload defaulted/high-risk loans, Fitch reports.

For example, in addition to its acquisition of the Homeward Residential and GMAC Mortgage portfolios, Ocwen announced its intention to acquire MSRs from IndyMac Mortgage Services and from Greenpoint Mortgage Funding (SCI 24 July). With the acquisition of Homeward Residential and GMAC Mortgage completed, Ocwen not only materially increased its volume of subprime loans, but added both prime and Alt-A products to its portfolio mix. By end-Q2, the firm was servicing 47% of all non-agency RMBS subprime loans.

Meanwhile, Nationstar continues on-boarding its sizeable MSR acquisition from Bank of America (SCI 13 August).

The second quarter also saw servicer-related loss volatility, as several servicers and master servicers adjusted principal forbearance loss reporting (SCI 5 July). Both Ocwen and Nationstar passed through roughly US$1bn in principal forbearance-related losses during the quarter as part of their acquisitions of portfolios.

This has led to concerns regarding servicer and master servicer reporting and the timing of loss recognition. Fitch believes this reporting issue will continue to drive further loss adjustments in the third quarter.

Overall, delinquencies and foreclosures continue to decrease. However, residential mortgage servicers are still faced with issues regarding management of foreclosure and delinquency timelines.

There continues to be a marked difference in the time to resolve delinquent loans between bank and non-bank servicers due to many factors, including regulations and staffing levels. Fitch believes that it will be challenging for non-bank servicers to maintain shorter timelines as additional highly delinquent loans move from the banks' portfolios to the non-bank servicers' portfolios.

RMBS

Ginnie prepays spike on buy-outs

Prepayment speeds on 2009 and newer Ginnie Mae pools accelerated unexpectedly last month after Bank of America bought out delinquent loans. Unlike other large servicers that buy out loans consistently every month, Bank of America buy-outs occur more haphazardly and in bigger blocks, Deutsche Bank securitisation analysts explain.

Last month's buy-outs pushed 90-day delinquency rates in Ginnie Mae I 30-year bonds down from around 5% to 4%. The largest share of delinquent loans is present in 2009 and newer pools. Even with the latest round of buy-outs, there are three times more 90-day delinquent loans in 2009 and newer vintages than the older ones.

RMBS

Mortgage insurance recommendations released

The Joint Forum has released its final report on 'Mortgage insurance: market structure, underwriting cycle and policy implications'. The report examines the interaction of mortgage insurers with mortgage originators and underwriters.

The report includes a set of recommendations directed at policymakers and supervisors that aim to reduce the likelihood of mortgage insurance stress and failure in tail events. One of the recommendations is that policymakers should consider requiring mortgage originators and mortgage insurers to align their interests and maintain strong underwriting standards. Further, supervisors should be alert to - and correct for - deterioration in underwriting standards stemming from behavioural incentives influencing mortgage originators and mortgage insurers.

Supervisors should also require mortgage insurers to build long-term capital buffers and reserves during the troughs of the underwriting cycle to cover claims during its peaks. In addition, they should be aware of and take action to prevent cross-sectoral arbitrage, which could arise from differences in the accounting between insurers' technical reserves and banks' loan loss provisions, as well as from differences in the capital requirements for credit risk between banks and insurers.

Finally, supervisors should apply the FSB Principles for Sound Residential Mortgage Underwriting Practices to mortgage insurers, noting that proper supervisory implementation necessitates both insurance and banking expertise.

RMBS

Eminent domain impact examined

Fitch says that the potential use of eminent domain by communities in California would negatively affect private label US RMBS and future lending in those regions (SCI 8 August). If those communities are successful, similar plans might be replicated in other communities, thereby broadening the impact of the scheme. The agency also believes that these programmes could further weigh on investor confidence and appetite for private-label MBS going forward.

Fitch expects action on the plans to be slow and legally challenged. PIMCO, BlackRock and DoubleLine Capital have already filed lawsuits against the city of Richmond and Mortgage Resolution Partners, seeking an injunction (SCI 13 August).

In addition to pushing losses forward on performing loans, the use of eminent domain could have other unintended consequences, including increasing mortgage interest rates and decreasing credit availability in affected areas. For example, the FHFA has said it may direct the GSEs to stop their activities in towns that use eminent domain to seize mortgages.

Eminent domain provides a mechanism for local, county or state governments to seize mortgages at discounted values, potentially resulting in losses for the holders of those seized. Several of these plans focus on borrowers who are current on their existing mortgage obligations.