Contents

Insurance-linked securities

Diversification play

Cat bond-lites, new exposures gain traction

Catastrophe bond-lite structures appear to be gaining traction as a way of reducing transaction costs. At the same time, demand for exposure to new perils and jurisdictions is rising as investors seek increased diversification.

Investors are calling for a reduction in the fixed cost of full-size catastrophe bonds to make them more competitive with collateralised reinsurance. Cat bonds typically cost US$600,000-US$700,000 to structure, so deals typically need to be at least US$200m-US$300m in size with terms of no less than 2-3 years to make them cost-effective for issuers.

Legal fees tend to account for two-thirds of the structuring fixed costs. Michael Stahel, partner and portfolio manager at LGT Insurance-Linked Strategies, argues that these fees could be reduced by developing industry standard cat bond master documentation, with an annex that outlines the risks specific to any given deal.

Many ILS investors don't require ratings, so reducing the reliance on rating agencies would be another way of lowering the cost. Equally, for smaller deals, a risk modeller often isn't necessary because sophisticated investors can undertake the risk analysis themselves.

"Taking all of these costs away leaves about US$100,000 in fixed fees. If arrangers can be pressurised into arranging a deal for US$75,000, then it would be possible to bring smaller transactions in less time - which is a much more appealing proposition. However, sponsors need to push for this to occur," Stahel suggests.

Conceptually, the insurers' Chief Risk Officer's Forum or catastrophe market data firm PERILS could act as an industry body to draw up such a cat bond master agreement. Since the latter organisation is owned by the industry and has access to the relevant data, the move would appear to be a natural progression for it. It is hoped that the implementation of Solvency 2 will trigger broader discussions on the topic.

In the meantime, segregated accounts companies (SACs) appear to be gaining traction as a basis for so-called cat bond-lite structures. For instance, the Tokio Tensai Platform provides an alternative to the traditional Rule 144A offering process by allowing clients to sponsor cat bonds through Shima Reinsurance, a Bermuda-domiciled Class III SAC (SCI 11 June).

Cadwalader, Wickersham & Taft partner Angus Duncan notes that SACs provide economies of scale for cedents to access the capital markets. "Transaction costs can also be reduced if cedents and investors agree that the transaction is not rated. For certain transactions, cedents may choose not to use a modelling agent, which can further reduce transaction costs."

He anticipates that appetite for cat bond-lite structures will increase due to the excess of demand for exposure to catastrophe risk products. Also expected to rise is the number of bilateral transactions involving the issuance of securities, the terms of which are negotiated between the investor and the cedent.

"Sponsors are increasingly able to demand flexibility in terms, due to increased demand for ILS products, and are seeking to achieve terms approaching the flexibility they are used to in the reinsurance markets. This environment may change, however, if spreads widen due to an event," Duncan observes.

Meanwhile, dedicated cat bond funds are driving demand for exposure to new risks and geographical locations. "They would typically be looking to diversify the risks within their portfolios, essentially creating mini-reinsurers," confirms Judy Klugman, md and head of ILS distribution at Swiss Re. "Generic large money managers, on the other hand, generally invest a smaller percentage of assets in ILS because they're diversifying across other asset classes. In the latter case, I advise them to allocate to whichever cat bond risk is cheapest for the return."

She adds that only a handful of issues are exposed to specific risks and/or states/jurisdictions and so these deals tend to trade tighter because of the desire for diversification. "There is only a finite amount of North East wind or Gulf-only wind exposure, so investors have to look more broadly at US wind for the majority of risk transfer trades."

Given that its trigger is linked solely to storm surge, First Mutual Transportation Assurance Company's (FMTAC) recent MetroCat Re series 2013-1 was widely touted as a diversification play for ILS investors (SCI 15 July). The transaction was also welcomed for being a state-specific bond, which - like April's Tar Heel Re series 2013-1 that is exposed to North Carolina risk - facilitates diversification.

Stahel says that FMTAC's motivation for issuing the deal was clear. "This is important: the last thing we want is to provide a counterparty with additional capacity to arb its portfolio. As an investor, it's much easier to support a transaction that is a solution for a specific need."

But he notes that his firm didn't qualify it as a diversifier. "Based on our analysis, the deal is highly correlated to many other catastrophe bonds because the New York metropolitan area is a key driver of North Eastern US ILS structures. We didn't believe the price was justified, but FMTAC got a good reception and was able to upsize the transaction."

Stahel says that LGT Insurance-Linked Strategies has built a reputation for running a diversified book. Whereas its competitors are mainly focused on US wind, the firm has only a 30%-40% allocation to the peril.

However, only the savvier investors typically buy into this argument. "US wind has higher returns because it presents a greater concentration of risk," Stahel observes. "Diversification is consequently a difficult argument to make, especially when a portfolio may show short-term volatility due to a greater number of smaller events occurring. For instance, the 2011 tsunami impacted our fund negatively at the time due to our exposure to Japanese earthquake risk, yet returns remained positive over the year as a result of the broad diversification."

In terms of new exposures coming onto the market, Stahel suggests that the most promising candidates at the moment are German insurance companies, with a focus on flood. "This year's flood events were devastating and follow a devastating flood in 2002. The severity of these events means that counterparties are now interested in buying protection."

He adds: "We'd be happy to support a company such as Allianz, for example, on an indemnity flood bond. This could almost be viewed as an ILW trade, providing there is enough data and it's a clean structure."

A UK flood bond for a large primary insurance firm also has potential. For instance, a Thames river flood would be a massive event and - given the low probability of occurrence but high cost - is a perfect match for a cat bond.

Indemnity bonds are also increasingly being accepted by investors, reflecting their growing sophistication. "Cat bond investors are growing more comfortable with the risk assessment and structural nuances of such transactions. This is good news for issuers because indemnity triggers reduce basis risk," Klugman comments.

Market signals appear to be positive for the remainder of the year. Stahel cites the successful placement of Nakama Re series 2013-1 - which is the first cat bond to roadshow in August - as an example.

"Roadshowing in August was an indication that the sponsor was confident about investor interest and wanted to be early to market," he concludes. "A good number of issuances are forecast for the rest of 2013: it is expected to be a record year in terms of absolute growth. But a question mark remains around event activity in September and October, which could affect sentiment."

CS

ABS

Mix of paper in busy ABS session

A US$110m bid-list of dealer floorplan bonds boosted auto ABS secondary supply yesterday. Credit card and utility ABS paper was also represented, as BWIC volume for the sector reached US$285m.

SCI's PriceABS data shows that the majority of the auto names were from 2012 and 2013 issuances. An exception to that was the HERTZ 2010-1A A2 tranche, which was talked at plus mid-60s.

Covers were recorded at 52 and 99.75 for AMOT 2013-1 A1 and AMOT 2013-2 A respectively, while FORDF 2012-1 A was covered at 17.8, a week after being talked in the mid-teens. The tranche was covered at over par in July and first appeared in the PriceABS archive on 29 May 2012, when it was talked in the low-30s.

Of the other Ford bonds out for the bid, FORDF 2013-1 A2 was covered at 42 and FORDO 2013-C A2 was talked at plus 17, a week after being covered at plus 12. Meanwhile, MBMOT 2012-BA A traded successfully during the session and GEDFT 2012-4 A was covered at 43, having been talked in the very low-40s on 8 August.

Half a dozen tranches from HAROT 2012 deals and the HAROT 2013-1 transaction circulated during the session, with talk between plus 10 and plus 19. HDMOT 2013-1 A2 was talked at plus 15, a week after being covered at plus 11.

Talk was also wider for AMCAR 2012-3 A2 and SDART 2012-5 A2, which were talked at plus 28 and at plus 30 respectively. The latter tranche was covered at 99.97 on 19 July and had been talked at plus high-30s to low-40s on 2 July.

Credit card paper was also available yesterday, meanwhile, including a trio of CHAIT bonds. CHAIT 2006-A8 A8 was talked in the low/mid-singles and CHAIT 2013-A2 A2 was talked at around 10, while CHAIT 2013-A6 A6 was talked in the mid/high-30s and covered at 39.

BACCT 2006-A8 A8 was talked in the mid-singles. The same tranche was talked at plus 4 in October last year, when it was also covered at plus 3.7.

CCCIT 2008-A6 A6 was another noteworthy name seen during the session. It was talked in the low/mid-teens, but had been talked in the mid- and high-teens on 22 July.

Finally, among the utility ABS names out for the bid were four AEP Texas Central Transition Funding tranches, as well as paper from CenterPoint Energy, Detroit Edison Securitization Funding, Oncor Electric Delivery Company and PSE&G Transition Funding. Talk for the securities ranged from plus 19 to plus 50.

The AEP tranches comprised AEPTC 2002-1 A5, AEPTC 2006-A A3, AEPTC 2006-A A4 and AEPTC 2012-1 A2, which were talked respectively at plus 23, 19, 41 and 50. Of those tranches, only AEPTC 2006-A A4 had not appeared in the PriceABS archive before.

The four CenterPoint tranches included CNP 2005-A A4 (which was talked at plus 34) and CNP 2012-1 A2 (which was talked at plus 50). The latter tranche was talked in the mid-30s at the start of the year.

DESF 2001-1 A6 was talked at plus 30, PEGTF 2001-1 A8 at plus 29 and RSBBC 2007-A A3 at plus 40. The Oncor tranches - ONCOR 2003-1 A4 and ONCOR 2004-1 A3 - were talked at plus 20 and at plus 23 respectively.

JL

Structured Finance

Week starts with WBS flurry

A number of UK whole business securitisation bonds were out for the bid yesterday. Some noteworthy credit tenant-linked CMBS were also seen in secondary, with SCI's PriceABS service recording covers ranging from 113 to 280 for the names.

Among the WBS bonds circulating in yesterday's session were a trio of pub names. The tightest cover among them was for Marston's MARSLN 5.1774 tranche, which was covered at 225.

The other pub names from the session were Mitchells & Butlers' MABLN 6.469 tranche and Punch Taverns' PUNTAV 6.82 tranche. The former was covered at 280, while the latter was covered at 250. The MABLN 0 34 tranche was covered earlier this month, while the first PUNTAV 0 tranche recorded in the PriceABS archive comes from September last year.

In addition, Dignity Finance's DIGFIN 8.151 bond was covered at 158 during the session. Freshwater Finance's FWFIN 5.182 tranche, meanwhile, was covered a little wider at 165.

As for the CMBS activity, the widest cover was recorded on British Land's BLNDLN 5.264 bond, which was covered at 200. A BL Superstores Finance tranche - BLSF 4.482 - was covered considerably tighter at 113.

There was a similar difference between two of Telereal's credit tenant-linked bonds. The TELSEC 5.3887 tranche was covered at 115, but the TELSEC 6.1645 tranche was covered at 190.

A couple of Tesco Property Finance bonds were also out for the bid. TSCOLN 6.0517 was covered at 179, while TSCOLN 5.8006 was covered at 189.

A final name of note is the BBCWC 5.1202 tranche. The White City Property Finance bond appeared in the PriceABS archive for the first time yesterday with a cover of 140.

JL

CLOs

Back to business for Euro CLOs

Secondary markets surged yesterday and the European CLO sector was no exception. Activity is picking up as the market moves into autumn, with a significant list circulating yesterday and another one planned for the start of next week.

"An ABS CDO BWIC came out yesterday, which was really interesting. Some of the bonds on that list were very well bid," says one trader.

He points to the €25m ZOO IV-X A1B tranche as an example. The bond was covered yesterday in the low-80s, with SCI's PriceABS data also showing talk in the low-70s and in the high-80s/90 area.

"We were looking at that ZOO tranche in June in the low/mid-70s, with the mid-70s really as an absolute maximum. The DM then was around 700 and now it is more like 400, maybe even less," says the trader.

He reports that dealers were offering leverage to clients for the bond. Such a move may have been influenced by the large size of the piece being offered.

More broadly the market still appears hungry for paper. The trader says that his firm recently traded a double-A rated bond at about 250 DM and notes that double-Bs have tightened from the 800 DM they were trading at a couple of weeks ago.

"Generally dealers have not wanted to bid on double-Bs recently and I think that is to do with capital requirements for lower-rated paper. That said, there is a double-B BWIC coming out on Monday with names like Avoca and Jubilee," says the trader.

He continues: "I really think it is going to go well. We will be bidding on it. There is not a lot of paper out there with a decent yield, so there is a lot of anticipation surrounding this list."

Developments in the primary market are also positive, with the trader pointing to a handful of upcoming deals. One of these is understood to be a US manager bringing its first European CLO.

"US CLOs are just so tight now that I think managers are seeing whether they can pick up some European assets instead. It is certainly an interesting move," says the trader.

He concludes: "I think after this week, though, we are going to see prices go up. There are more end clients getting involved in the market, so it is no longer so heavily dominated by the dealers."

JL

Structured Finance

SCI Start the Week - 16 September

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

Pipeline
Deals entered and left the pipeline in quick succession last week, with many new arrivals printing before the weekend. Several transactions remained as well, including five new ABS, two RMBS, five CMBS and three CLOs.

The ABS comprised: US$200m Dong Fang Container Finance series 2013-1; US$231.9m DriveTime 2013-2; US$446.85m GEEMT 2013-1; US$325m Leaf Commercial Capital 2013-1; and €750m VCL 18. The RMBS were Bluestep Mortgage Securities No.2 and US$308.6m Shellpoint Asset Funding Trust 2013-2.

The CMBS consisted of: US$425m Boca Hotel Portfolio Trust Series 2013-BOCA; US$985m CGCMT 2013-GC15; C$400m SCG 2013-CWP Hotel Issuer; US$185.5m VFC 2013-1; and US$1bn WFRBS 2013-C16.

Finally, the CLOs entering the pipeline were: St Paul's CLO III; US$832m Symphony CLO XII; and US$407m WhiteHorse VII.

Pricings
More transactions priced last week than have been seen in a long time. The prints included 13 ABS, three RMBS, four CLOs and a CMBS.

Seven of the ABS new issues were auto deals: US$550m Avis Budget Series 2013-2; US$500m Exeter Automobile Receivables Trust series 2013-2; US$1.3bn Ford Credit Floorplan Master Owner Trust A 2013-5; US$1.28bn Hyundai Auto Receivables Trust 2013-C; US$1.4bn M&T Bank Prime Auto Loans 2013-1; US$712m Toyota Auto Receivables 2013-B Owner Trust; and US$783m World Omni Lease Securitization 2013-A.

The other six ABS comprised: US$700m Citibank Credit Card Issuance Trust 2013-A6; €696m FCT Ginkgo Compartment Consumer Loans 2013-1; US$350m HLSS Servicer Advance Receivables Trust 2013-T6; A$278m Impala Trust 2013-1; US$996m SLM Student Loan Trust 2013-5; and US$300.9m Textainer Marine Containers III series 2013-1.

The RMBS prints were: RUB4.4bn Otkritie 1; £238m Paragon Mortgages 18; and €753m STORM 2013-IV. In the CMBS sector, the US$1.51bn FREMF 2013-K32 priced.

As for the CLOs, US$650m Acis 2013-2, US$517m Dryden XXX Senior Loan Fund, US$345m Garrison Funding 2013-2 and US$407m Neuberger Berman CLO XV all printed.

Markets
The US ABS secondary market took a slight dip early on but picked up in mid-week, as SCI reported on 12 September. Wednesday's session included a US$110m dealer floorplan bid-list as auto names led the pick-up in activity.

SCI's PriceABS data also shows a number of utility ABS names from the session, including a number of AEP Texas Central Transition Funding and CenterPoint Energy tranches. DESF 2001-1 A6 was also out and talked at plus 30, while a pair of ONCOR tranches were talked at plus 20 and plus 23.

US RMBS started the week particularly strongly, with US$1.3bn in BWIC volume recorded on Monday (SCI 10 September). More than US$800m of that was non-agency supply, with adjustable-rate bonds dominating, including tranches such as SAMI 2006-AR5 4A1 - which was talked in the mid-50s a year after having been in the high-40s - out for the bid.

Barclays Capital analysts note that US CMBS spreads were relatively unchanged last week. Generic 2007 dupers finished the week at swaps plus 120bp, while AJs were down by about half a point.

Close to US$500m of BWIC volume was recorded for the US CLO market, with pre-crisis triple-A and equity tranches prevalent, according to Bank of America Merrill Lynch strategists. Only a small number of tranches were reported to have not traded and CLO 1.0 spreads concluded the week unchanged.

Meanwhile, the European RMBS market saw some peripheral tightening. JPMorgan RMBS analysts note that there was tightening "in the more 'interesting' parts of the market this week, with peripheral spreads grinding inwards across the subset". Italian and Spanish seniors tightened by 10bp to 290bp and 320bp respectively.

Finally, the European CLO market surged towards the end of the week, with Thursday's session proving a busy one. One trader reports that a significant list towards the end of last week and another one planned for today grabbed investor attention (SCI 17 September).

From the Thursday list, the trader points to bonds such as the ZOO IV-X A1B tranche, which was covered in the low-80s. "We were looking at that ZOO tranche in June in the low/mid-70s, with the mid-70s really as an absolute maximum. The DM then was around 700 and now it is more like 400, maybe even less," says the trader.

Deal news
• The Federal Home Loan Bank of Chicago plans to issue securities guaranteed by Ginnie Mae and backed by mortgages originated by member financial institutions. The new conduit product - dubbed MPF Government MBS - is designed to provide mortgage lenders with a new option when creating mortgage products for their home-buying customers.
• The Bush Terminal loan - securitised in GCCFC 2007-GG11 and CGCMT 2008-C7 - has been modified again, after superstorm Sandy devastated the buildings. The loan received a US$190m/US$110m A/B split modification in April 2012 (see SCI's CMBS loan events database).
• Tropic CDO I - a 2003-vintage deal that declared an EOD in January - last month became the first bank Trups CDO to complete a liquidation, underlining recent price rises in the sector. A slew of further Trups CDO liquidations are unlikely, however, given insufficient market value coverage for the notes and the presence of large out-of-the-money interest rate swaps.
• An insolvency event has been declared for Alburn Real Estate Capital (REC 6), after the directors of the issuer determined "it is more likely than not" that the CMBS will be unable to pay its debts as they fall due. A number of other European CMBS deals are now expected to follow suit, with the aim of switching the waterfall to protect class A noteholders.
• Punch Taverns has disclosed that it is continuing its engagement with stakeholders, which now includes the ABI special committee of noteholders and its advisers. This suggests that class A bondholders could be actively involved and thus restructuring negotiations are likely being held on a more constructive basis (SCI passim).
• GCO Education Loan Funding Master Trust II has executed a fifth supplemental indenture, which will permit the series 2006-2 reset rate notes to be remarketed on the initial reset date (10 September) in US dollars in a principal amount not to exceed US$249.51m, with an interest rate not to exceed 65bp over one-month Libor. The notes are currently denominated in Canadian dollars and indexed to CDOR.

Regulatory update
• The concept of a unified conventional TBA deliverable for the GSEs has gained traction recently. Such a move could mark a first step towards unifying the GSEs themselves, which is one of many GSE reform options under discussion.
• Richmond, California city council voted 4-3 on 11 September to continue exploring Mortgage Resolution Partners' (MRP) proposal to use the City's power of eminent domain to seize underwater mortgages (SCI passim). SIFMA responded by stating it continues to believe that the move is unconstitutional and "would do much more harm than good" in the local Richmond community and across the country.
• Wells Fargo and Deutsche Bank's lawsuit, on behalf of bondholders affected by Richmond's eminent domain proposal, was heard in Federal Court on 12 September (SCI 13 August). US District Judge Charles Breyer stated that the request to block the plan was "not ripe".
• The re-proposed US risk retention rules (SCI 29 August) have been welcomed by CMBS market participants for eliminating the premium capture cash reserve account (PCCRA) provision. How risk retention for large loan and single-borrower deals should be satisfied remains unclear, however.
• The Russian government is reviewing a proposed legislative change that would allow banks to securitise a broad range of assets, including SME loans, consumer loans, credit cards and auto loans. The move is viewed as being credit positive for Russian originators.
• The ECB has enhanced the loan-level reporting requirements for RMBS and SME ABS that are used as collateral in Eurosystem monetary policy operations but are unable to satisfy the previously announced implementation timeline. The enhancements aim to ensure a smooth transition to full compliance while ensuring a level playing field between RMBS and SME ABS at different stages of the compliance process.
• The French government is proposing to create a National Credit Registry (NCR) that captures individual consumer loan indebtedness. The creation of such a registry is said to be credit positive for most French auto ABS, consumer ABS and RMBS, as it will improve the ability of lenders to assess borrower affordability.
• A number of CDO issuers - including Phoenix Light SF, Blue Heron Funding and Kleros Preferred Funding V - have filed a lawsuit in New York state court against Credit Suisse in connection with the purchase of over US$362m in RMBS. According to the complaint, the bank made numerous misrepresentations and omissions regarding the quality of loans underlying the RMBS.
• Barclays Bank will pay US$36.1m to settle allegations that it financed, purchased and securitised residential loans that were presumptively unfair under Massachusetts law. Similar actions against Morgan Stanley, Goldman Sachs and RBS have already achieved over US$214m in settlements.
• ISDA has published a DFP2 to EMIR Top Up Agreement, which seeks to allow for EMIR-compliant documentation for parties that have adhered to the Dodd-Frank March Protocol (DFP2) and do not wish to adhere to the EMIR Protocol in addition to this. The document extends DFP2 to cover EMIR compliance 'add-ons'. The association has provided an explanatory memo to assist in the consideration of the Agreement.
• The 2013 ISDA Arbitration Guide has been released, providing the first comprehensive set of ISDA model arbitration provisions for use worldwide. The document offers guidance on the use of an arbitration clause with the 1992 and 2002 versions of the ISDA Master Agreement and includes a range of model arbitration clauses covering a number of institutions and seats of arbitration around the globe.

Deals added to the SCI database last week:
Agate Bay Mortgage Trust 2013-1; Atlas IX Capital series 2013-1; BBCMS 2013-TYSN; Bilkreditt 4; COMM 2013-300P; CSMC Trust 2013-7; DBRR 2013-EZ3; Driver France FCT Compartiment 2013-1; Flexi ABS Trust 2013-2; InSite Wireless Group 2013-1; JPMCC 2013-ALC; Monnet Finance (private placement); Nakama Re series 2013-1; Newcastle Permanent Funding Trust No. 1 series 2013-1R; Progress 2013-1 Trust ; PUMA Series 2013-1; Sequoia Mortgage Trust 2013-11; VOLT 2013-NPL1

Deals added to the SCI CMBS Loan Events database last week:
BACM 2003-1; BACM 2006-2; BACM 2007-2; BACM 2008-1; BSCMS 2006-PW13; CD 2007-CD4; CGCMT 2005-C3; COMM 2003-LNB1; CSFB 2004-C5; DECO 2007-E5; EPC 3; FLTST 3; GCCFC 2007-GG11 & CGCMT 2008-C7; GCCFC 2007-GG9; GMACC 2004-C2; GSMS 2007-GG10; JPMCC 2007-CB20; MLCFC 2007-8; REC 6; TAURS 2006-1; TITN 2007-1; WBCMT 2006-C24; WFRBS 2011-C3

Top stories to come in SCI:
European ABS supply/demand trends
Innovation in the ILS sector

CLOs

Loan financing shortfall possible

JPMorgan CDO analysts estimate that US$304bn US and €81bn European CLOs remain outstanding, representing a global CLO market of US$416bn. They forecast that by 2016 or 2017 the CLO 1.0 market could shrink by half to around US$72bn, with triple-As paying down entirely by 2021.

The JPMorgan sample comprises 1,086 US CLOs (US$486bn face value) and 276 European arbitrage CLOs (€120bn face value) issued from 2000 to the present. In aggregate, 2006 and 2007 vintages account for US$145bn or 47% of this universe.

With six- to seven-year reinvestment periods, nearly all legacy (pre-2008 vintage) CLOs will exit their reinvestment periods by 2014 and begin to amortise. A number of these transactions are likely to be called before maturity in the next couple of years, depending on funding costs.

Meanwhile, all of the US$130bn CLO 2.0 deals issued thus far will exit their shorter reinvestment periods (3-4 years) during 2016 to 2017 and amortise. On top of this, US risk retention requirements are slated to begin by 2016 and will likely curtail issuance thereon.

"Even if we assume US$75bn US CLO issuance for each year of 2014 and 2015 before risk retention, the entire US CLO market will be around US$200bn by 2020. As CLOs have historically been the largest constituent in the US high yield loan market (US$666bn current outstanding), this may create a shortfall for leveraged corporate financing, unless the other loan investor types grow substantially over the next few years," the JPMorgan analysts observe.

Based on recent bond factor changes, it appears that both US and European 2007 vintage CLOs passed a tipping point this year, with triple-A factors dropping from 93% or 96% to 84% or 87% currently. At the same time, vintage triple-As are being paid down by 25%-30% a year in the US and 10%-15% in Europe. This is roughly at half the rate of the annualised 54% loan prepayment rate in US and 28% in European loans.

US loan repayments have tapered recently, exhibiting a 7.6% rate in the last three months versus 17.5% in Q1. The opposite is true for Europe, with a relatively low 4.25% in Q1 versus 12% over the last three months.

"While the shrinking legacy CLO market has positive market technical implications of contraction upside for certain bonds and cash returned to investors, it is also a cautionary tale of declining credit capacity," the analysts conclude.

CS

RMBS

Co-op redemption concerns emerge

The fortunes of the Co-operative Bank's outstanding Leek and Silk Road deals are more closely tied to the originator's financial health than most UK RMBS, due to noteholder put options inserted after the lender failed to call the transactions (SCI 14 April 2011). Investors are concerned that the bank may not be able to fund the note redemptions, given the need to raise £1.5bn of additional capital (SCI 18 June).

JPMorgan RMBS analysts calculate that £2.24bn of Leek notes are outstanding, across Leek 17, 18 and 19 - of which £1.6bn are senior notes. In March 2011 the bank failed to call the outstanding bonds of these transactions on their original step-up dates. Instead, class A noteholders accepted restructuring proposals in which an 'investor redemption option' was inserted five years after the original call dates.

As such, redemption of the Leek notes will be funded through the issuance of variable funding notes - in this case J VFNs - by the Co-operative Bank. Therefore scheduled principal redemption is dependant on the bank being able to fund the required J VFNs.

These J VFNs cannot be transferred from the bank to a new holder any time prior to the investor redemption date. Despite some investor concerns that non-payment of the VFN would not count as an event of default and so the puts would be worthless, the JPMorgan analysts note that this is not the case.

They explain: "The failure of the Co-operative Bank to fund its obligations under the VFN, which results in failure to redeem the relevant class of notes in the RMBS, is not an event of default of the transaction itself. That does not, however, mean that there are not consequences for the Co-operative Bank by failing to fund the VFNs."

For example, the bank must fund the VFN in an amount equal to the maturity redemption amount of the relevant notes, which is the note balance minus any debits to the tranche's principal deficiency ledger. This contractually obliges the bank to further fund the VFNs, reckon the analysts, otherwise the trustee could seek redress through the courts.

Should insolvency proceedings be commenced against the Co-operative Bank prior to the investor redemption date, then - as the J VFN holder - it must procure a payment to the issuer or trustee of liquidated damages in an amount equal to either zero or the principal amount outstanding of the notes, whichever is the greater. This would occur "minus the firm clean bid quotation for the price, which a third party would pay on a delivery versus payment basis to buy such notes".

How the bank will fund the required redemptions is unclear. It will have to use any liquidity resources available, which may include relying upon official sector sources, such as the Bank of England's discount window facility.

The Co-operative Bank may also be able to refinance the existing deals into new secured debt transactions, but that depends on market conditions at the time. A one-off payment to class A noteholders in each Leek transaction will also have to be paid at the extended maturity date through another VFN (L VFN).

Although gilts mean the Leek seniors will not have to worry about extension, the analysts do not expect the bonds to be fully redeemed through repayments and gilt balances by the revised scheduled maturity dates. "Simplistically, by reducing current senior note notionals by taking CPRs of 5% for both Leek 17 and 18, and 3% for Leek 19, and by compounding these annual rates for 2.75, 3.25 and 3.75 years respectively until scheduled maturity ... we see 'put reliance' at scheduled maturity for all three transactions' seniors," they observe.

Investors in Silk Road One, meanwhile, are in a similar position to the Leek investors. The deal includes an investor redemption option back to the bank, funded by a VFN instrument (D VFN), and they can seek liquidated damages if the bank ceases to be a going concern. There is no such investor redemption option for Silk Road Two and Three.

JL

CMBS

Intermediary initiative

Nassar Hussain, managing partner at Brookland Partners, answers SCI's questions

Q: How and when did Brookland Partners become involved in the CMBS market?
A: Brookland Partners has been lead financial adviser on over 25 CMBS transactions totalling in excess of €22bn since our launch in 2009. We act as financial adviser to government agencies, financial institutions, private equity firms, property companies and the vast majority of all the European commercial real estate loan servicers.

The team's combined experience in real estate totals 65 years and spans a number of jurisdictions, including the UK, France, Germany, Benelux, Spain, Switzerland, Scandinavia and the Middle East. As well as restructurings and work-outs, we advise on the sale and acquisition of real estate-backed debt in all its forms, equity and debt raising, loan origination and real estate investment and asset management.

Among the more notable restructurings we've been involved with, Karstadt is a highlight because of its various complexities and numerous stakeholders. The underlying operating business was insolvent and the capital structure included multiple junior debt tranches, as well as broadly distributed CMBS tranches.

As the business employed thousands of people and went through a sale during the restructuring process, it was a politically sensitive transaction. Part of the agreed restructuring was a managed sell-down of the department stores and this aspect has been successful, with a large part of the CMBS now having been repaid.

Four Seasons Healthcare is another highlight. After two difficult restructurings, the business was sold to Terra Firma and refinanced in the high yield market. The CMBS and the outstanding junior debt were fully repaid.

The Plantation Place restructuring grabbed the headlines when the proposed soft restructuring was blocked by a strategic investor interested in acquiring the building. We persuaded a large number of noteholders and the junior lender to notify the market that they would not support an enforcement or scheme of arrangement type structure. This provided the equity holders with sufficient time to sell their interest to a counterparty that recapitalised the transaction and the loan was refinanced by new owners, again resulting in a full recovery for all noteholders (see SCI's CMBS loan events database).

GRAND was the benchmark CMBS in Europe due to its size and the restructuring was notable for its complexity and use of an innovative scheme of arrangement. GRAND has now fully repaid, partially through IPO proceeds and a corporate loan.

The Tahiti CMBS secured on a UK hotel portfolio was restructured in 2010 and was recently refinanced in the banking market, again resulting in a full recovery. On CityPoint, there has been a structured enforcement where the transaction is in receivership, but the asset is being repositioned with a capex investment before it is expected to be sold.

In the rare cases when restructurings have failed, activist investors have usually been involved, who have not supported the restructuring. Nevertheless, the use of schemes of arrangement and structured enforcements have assisted in negating their impact.

Q: What are your key areas of focus today?
A: We recently established Brookland Financial, a new intermediary platform to connect parties in the real estate debt markets and assist in the structuring and execution of loans and CMBS transactions (SCI 10 July). There has been a significant shift in the availability of senior debt since January, as sentiment has turned increasingly positive. At the same time, CRE debt funds are becoming more successful in raising capital and asset managers now have far more capital to deploy.

Different investor types - including insurers, pension funds, hedge funds and sovereign wealth funds - are investing directly in real estate or through funds or sometimes doing both, tapping different maturities and parts of the capital structure. Each lender has a different approach, depending on risk appetite and jurisdiction. Some only look at specific assets and/or sponsors.

The European CMBS markets have also made a come-back this year, surprising many participants in the market. About €6bn of CMBS has already been placed this year; in fact, we saw more issuance in the first half of 2013 than over the last three years combined. The launch of CREFC's CMBS 2.0 Principles also assisted in trying to deal with some of the historical structuring issues faced by the CMBS markets.

The lending market, however, remains highly fragmented - so it's difficult for borrowers to source an optimum solution. In the past banks dominated the market, accounting for almost 90% of all CRE debt in Europe. Bank CRE teams are now thinner and often need assistance in originating loans and underwriting the more difficult assets.

Over the years, we've been asked to raise debt and have done so as an ancillary service. Historically we have been too busy with restructuring work to focus fully on this area - until now.

We believe that the significant capital coming into the sector, coupled with the lack of expertise and fragmented nature of the market has created an interesting opportunity for us to act as an intermediary and leading adviser in this sector. The aim is to provide borrowers with optimum debt terms from a compatible lender and then assist in structuring and executing the loan or CMBS transaction.

We have access to over 120 lenders and always create competitive tension when sourcing debt terms. If a borrower doesn't wish to use our services, we can also offer a loan through our loan origination arrangements with five diverse lenders.

Q: How do you differentiate yourself from your competitors?
A: The major differentiating factor between us and other advisers is our background in deploying capital. As a team, we have originated, structured, acquired, securitised or distributed over €60bn of real estate debt.

While at Merrill Lynch, I also advised various other lenders on their real estate debt platforms, including NM Rothschild and Capmark. Combine this with our experience in the last four years in restructuring some of the most complex real estate debt transactions and you will see that we have a very rounded and complete understanding of real estate debt from all perspectives.

As a team, we are very solution-oriented and want to achieve the right result for our clients. We work incredibly hard analysing deals but also understanding the motivations of all stakeholders and building numerous market relationships. While accountancy firms are generally good at giving advice in key areas such as insolvency, they don't always have access or relationships with the investor base and other stakeholders that is required to get a transaction across the line.

We have significant experience in underwriting and executing loans and CMBS transactions. We can pre-empt structural issues and suggest solutions and also draft documentation to provide additional protection, should the transaction run into credit issues.

In particular, valuable lessons have been learnt in respect of French safeguard and German insolvency issues. In addition, there is an increased focus on financial covenants, the security structure, entrenched rights of different parties, valuation rights and the identity of who the debt can be assigned to.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: As a small but growing business, it is essential for us to evolve not as the market changes but to have the foresight to evolve before the changes occur. This means adapting our focus, resources and skill-sets to suit the changing needs of our clients.

It is also important not to cover the market too broadly. We know what we are good at and we stick to these product areas.

As a small firm, we have won a significant amount of business away from large global investment banks, but this is only because of our sector expertise, our client dedication, independence, business results and business culture. Our motto is trust and expertise in everything we do.

Q: What major developments do you need/expect from the market in the future?
A: While real estate debt will remain dislocated for the next 18 months, bank disintermediation provides significant opportunities in raising and deploying new debt. There has historically been a shortage in the provision of senior debt, but successful capital raising by funds, the emergence of the new lenders and the re-emergence of CMBS has created liquidity and resulted in a material increase in deal flow in the space.

Participants are attracted by the risk/return opportunity: real estate debt pricing still offers good relative value compared to other forms of debt, such as high yield or infrastructure debt. Spread compression, however, has already started and will continue throughout this year.

Lenders are beginning to look at the broader risk spectrum, with capital being made available for secondary properties, where there is some void risk and for specialist sectors such as hospitality, healthcare and development. In recent months institutions and entrepreneurial investors have returned to the secondary sector in a significant way and the lenders are starting to follow. As most real estate is secondary, this will substantially increase the demand for debt.

The return of the European CMBS market has also helped sentiment. While US investors are also attracted by the yield on offer, the European CMBS market is still dominated by a small group of investors that can buy in significant volume. Historically, the CMBS investor base in Europe was much broader and more diverse.

The new investor base has far more control on how deals are structured and in many cases are making reverse enquiries.

Recently PIMCO and Marathon provided a bridge loan to Toys R Us to refinance the Vanwall CMBS. They securitised this exposure via the Debussy deal and retained the majority of their exposure at closing. This transaction showed how CMBS can offer more leverage than is available in the banking market.

DECO 2013-CSPK also only attracted a limited number of investors. However, Taurus 2013 (GMF1) was broadly distributed - believed to be at least 40 investors across the capital stack - benefitting from cross-over RMBS investors.

The profitability of the Taurus CMBS deal also woke the investment banking market up, with a number of investment banks now rebuilding their CMBS teams. There are likely to be a number of single-borrower CMBS transactions in the coming months of prime or near-prime commercial assets or multi-family assets. CMBS backed by secondary assets or conduit transactions involving pools of loans are unlikely until next year.

CS

ABS

Trade finance leader brought in

JPMorgan has appointed Kah Chye Tan as md and global head of trade finance securitisation, based in London. It is a new role at the firm which will see Tan work directly with the global trade and markets teams.

Tan was previously at Barclays, where he was corporate banking vice chairman, having earlier served as global head of trade and working capital. Before joining the bank he worked at Standard Chartered, Deutsche Bank, JPMorgan and Citibank in Europe and Asia.

Structured Finance

Bank boosts SF efforts

United Bank & Trust has promoted Jeff Billig to structured finance evp. He was previously svp in business banking, responsible for growing United's commercial loan portfolio. Before joining United, Billig was at First National Bank and Bank of Ann Arbor.

Structured Finance

CDO issuers file suit

A number of CDO issuers - including Phoenix Light SF, Blue Heron Funding and Kleros Preferred Funding V - have filed a lawsuit in New York state court against Credit Suisse in connection with the purchase of over US$362m in RMBS. According to the complaint, the bank made numerous misrepresentations and omissions regarding the quality of loans underlying the RMBS.

Plaintiffs further allege that Credit Suisse failed to disclose that, at the same time the bank was selling the RMBS to the plaintiffs, the bank was privately betting that the same and similar securities would soon default at significant rates. A Lowenstein Sandler client memo notes that the plaintiffs are suing for fraud, aiding and abetting fraud, negligent misrepresentation and rescission.

Structured Finance

Lincoln adds CDS, fixed income pair

Lincoln Financial Group has added Andrew Yorks and Scott Pelkola to its team in newly-created positions. Yorks joins as svp and head of markets and investment strategy, while Pelkola becomes svp and head of fixed income.

Yorks will lead Lincoln's overall markets and investment strategy. The credit derivatives specialist was previously cio at Four Wood Capital Advisors and has also worked at Stratum Capital Advisors and BlackRock, where he was in the portfolio management group overseeing bonds, loans and CDS.

Pelkola will oversee fixed income investment strategy. He was previously a portfolio manager at MetLife and at Washington Mutual and has worked in investment management roles at General Electric and Nortwestern Mutual Life Insurance.

Structured Finance

Australian legal team poached

Squire Sanders has hired a team of lawyers in Sydney from DibbsBarker, to be led by Tom Lennox, who joins as partner. Lennox specialises in structured finance and has particular experience in aviation and real estate.

Kate Prior and Abigail Sardinia also join in Sydney, having spent six years at DibbsBarker. They each have experience in asset finance and project finance.

Structured Finance

Asia hedge fund appoints ceo

Greg Donohugh has joined Double Haven Capital in Hong Kong as ceo and will lead strategy and capital raising efforts at the company. He was previously at Wells Fargo, where he led regional fixed income and capital markets operations in Asia.

Prior to Wells Fargo, Donohugh was svp at Lehman Brothers where he worked in global real estate and structured finance, with a focus on distressed debt. Before that, he was an md at Bear Stearns, where he was head of fixed income for Asia.

CLOs

Polygon appoints business head

Polygon Global Partners has added Douglas Ross to its team in New York. He joins as North America head of business development and will market Polygon's hedge fund products, including CLOs.

Ross joins from Field Street Capital Management, where he also held a senior business development role. Before that he worked at Normandy Hill Capital and Tiger Management.

CLOs

Hedge fund adds CLO pro

Joe Matteo has joined Credit Value Partners in New York. The CLO specialist was previously at Par-Four Investment Management and began his career at Merrill Lynch.

CMBS

Real estate group builds sales team

Carlton Group has formed an international investment sales team to provide investment sales services to clients worldwide. The group will focus on Manhattan and major cities throughout the US and Europe, with a focus on assignments of US$100m or more.

Carlton chairman Howard Michaels will lead the team with Carlton Hospitality president John Bralower and Javier Beltran, who runs Carlton's Iberian franchise. All three are experienced in structured debt and equity offerings and they will be joined by Mads Loewe, Clement Guy, Brian LeBlanc, Robert Mudry, Jeff Kosow, Chase Chehade, Andrew Manton and Chad Roberson.

RMBS

NCUA's misrepresentation suit to proceed

The Kansas District Court last week allowed the NCUA to proceed with its claims against a number of financial institutions in connection with the sale of RMBS to credit unions. The NCUA alleges that the originators of the loans underlying the RMBS systematically abandoned the stated underwriting guidelines, resulting in securities that were riskier than defendants disclosed.

A Lowenstein Sandler client memo notes that the defendants moved to dismiss the action on the basis that they could not be liable for repeating misrepresentations by borrowers on the underlying loans. In rejecting that argument and denying defendants' motion to dismiss, US District Judge John Lungstrum relied on a related case against Credit Suisse, in which the court found that the strict liability standard of the Securities Act of 1933 allows for a claim based on a defendant's passing along misstatements by third parties.

RMBS

RMBS reshuffle targets trading focus

Amherst Securities is changing its focus to concentrate more on facilitating day-to-day trading. To that end, Lidan Yang and Brian Landy will report directly to the non-agency and agency MBS desks, respectively, replacing departing head of RMBS strategy Laurie Goodman.

Yang and Landy will be responsible for producing material for internal and external distribution with a greater focus on issues, market colour, risks and opportunities which can produce trades. Amherst ceo Sean Dobson will take on the additional responsibility of directing Amherst's macro-orientated property-related strategy to provide insight into RMBS and CMBS.

Goodman is set to become head of the Housing Finance Policy Center at the Urban Institute think tank. She will remain at Amherst as a special advisor to the board.

ABS

FFELP SLABS value touted

FFELP student loan ABS spreads have generally lagged the tightening witnessed in other US consumer ABS sectors since early July and remain substantially wider than they were a year previously. Wells Fargo structured product analysts suggest that the asset class offers good relative value for its wider spreads and income potential, especially given one-month Libor is likely to stay low.

FFELP student loan ABS spreads have tightened by 5bp-7bp since the early August highs. The Wells Fargo analysts believe that the sector has a bias towards tighter spreads over time, even though the pace may be somewhat slow. Their short-run relative value indicator model suggests that spreads have become more fairly valued in recent weeks, but the spread differential to credit card ABS still looks attractive for a five-year average life.

Concerns about the split rating (AAA/AA+) on some bonds and the potential for additional downgrades seem to have receded. However, the analysts note that there a number of other factors that could influence FFELP demand, including the federal budget negotiations and debt ceiling debate.

"Increased market volatility could affect student loan spreads to a greater degree than other ABS if the process drags on," they observe. "In addition, we have been hearing some investor objections to adding to FFELP ABS positions based on policy concerns. Uncertainty surrounding the scope of any student loan programme changes and their effect on borrower behaviour seem to be affecting some investment decisions, in our view."

ABS

Punch restructuring progressing?

Punch Taverns has disclosed that it is continuing its engagement with stakeholders, which now includes the ABI special committee of noteholders and its advisers. Barclays Capital European securitisation analysts suggest that this means class A bondholders could be actively involved and thus restructuring negotiations are likely being held on a more constructive basis (SCI passim).

"We continue to take a positive view on the Punch A class A, M and B bonds, which - in our view - offer relative and absolute value, with expected yields of circa 6.5%, 9% and 17% respectively," they note.

The Barcap analysts forecast two main catalysts for the class B bonds to perform strongly over the next 12 months: stabilisation in Punch operating performance and completion of a consensual restructuring. "The company considers that a consensual restructuring can be launched in the second half of 2013," they explain. "While the restructuring could easily slip into next year, we think completion of a consensual restructuring is now probable within 12 months. As we expect operating performance in core to stabilise and completion of a restructuring, we think the Punch A class B bonds look good value."

ABS

New law set to unlock Russian ABS

The Russian government is reviewing a proposed legislative change that would allow banks to securitise a broad range of assets, including SME loans, consumer loans, credit cards and auto loans. Moody's notes in its latest Credit Insight publication that the move is credit positive for Russian originators, as it will: allow the domestic issuance of Russian-law governed non-mortgage ABS; facilitate Russian originators' access to increased and diversified funding sources; and establish the foundation for a secondary market for securitised products.

The legislation aims to allow issuers to, for the first time, register special financial companies in Russia for the sole purpose of issuing ABS. The companies will be similar to SPVs in Europe and the US.

The new law will also increase confidence in the securitisation market as it will provide more clarity as to tax treatment, asset segregation and bankruptcy remoteness. For example, it will guarantee the true sale of securitised receivables, ascertain the rights of bondholders and clarify the legal status of the purchaser, as well as allow for traditional credit enhancement mechanisms.

After an initial set-up period, Moody's expects that the new law will drive transaction costs down. Also, domestic transactions will reduce settlement risk as well as true sale risk, since there will be less uncertainty as to when a sale is permitted by local law.

In contrast, the current system relies heavily on complicated common law principles, which do not provide a sufficiently robust legal framework to generate growth in non-RMBS transactions.

ABS

Private student loan defaults drop

Moody's reports that its private student loan default rate index dropped to 3.6% in 2Q13, the first time it has dipped below 4% since 2007. The agency expects the index to continue falling year over year in 2013, but remain above pre-recession rates.

"The default rate index will continue to fall in 2013, but will remain higher than average pre-recession levels of 2.5% because of the continuing high rate of unemployment," comments Moody's avp-analyst Stephanie Fustar. "Even though the unemployment rate for young college graduates has improved, higher student loan debt and lower earnings than pre-recession levels will limit borrowers' ability to repay loans."

The default rate index stood at 4.2% in 2Q12 and has now fallen to less than half of the 7.9% peak in third-quarter 2009. Meanwhile, the 90-plus delinquency rate for 2Q13 was 2.1%, down from 2.4% in 2Q12.

"Ninety-plus delinquencies will continue to decline slowly, continuing their downward trend since peaking in mid-2009," says Fustar.

ABS

Timeshare delinquencies hit post-2007 lows

Quarterly US timeshare ABS delinquencies have fallen to the lowest level since 2007, according to Fitch's latest index results for the sector. Total delinquencies for 2Q13 were 3.05%, down from 3.27% in 1Q13 and 3.29% in 2Q12.

Defaults for 2Q13 remained consistent with 1Q13, finishing at 0.72%. However, they are down from the 0.82% observed at the same time last year.

Nevertheless, defaults remain elevated from pre-recessionary levels. Some of the recent improvement is attributed to slight shifts in the composition of the index, Fitch notes. Transactions from issuers with lower historical delinquency and default rates were added in 2012.

ABS

FADE issuance limit upped

Fitch has confirmed that Fondo de Titulizacion del Deficit del Sistema Electrico's (FADE) ratings - currently triple-B - will not be affected by the latest modifications included in the programme documents. This follows the Royal Decree 9/2013 approved in July by the Spanish Government.

The agency has analysed the documents provided by FADE's management company (Titulizacion de Activos SGFT) and believes that the modifications included are rating neutral to the Fitch-rated outstanding series 1, 2, 3, 4, 5, 10, 13 14 16 and 17 FADE bonds. The main modifications are the recognition of an additional €4.1bn tariff deficit credit rights generated in 2012 that could be securitised and the extension of the programme's issuance limit to €26bn from €22bn.

With these latest modifications, all FADE series remain fully guaranteed by the Spanish government. Consequently, the ratings are credit-linked to the long-term issuer default rating (IDR) of Spain and any change in the sovereign IDR or in the terms of the guarantee are likely to lead to a change in the rating of the FADE bonds.

FADE is now able to issue different series of bonds up to its current programme limit, while its current outstanding volume of securities stands at €20.77bn.

ABS

Fixed-, floating-rate income compared

US fixed-rate ABS should provide significantly more income than floating-rate bonds, unless the Fed tightens policy sooner or more aggressively than expected, according to Wells Fargo ABS strategists. In addition, fixed-rate bonds may offer better total return potential as they roll down the steeper yield curve.

The three-year swap rate has risen from about 0.5% at year-end 2012 to just above 1%, following the Fed's taper talk. However, money market rates remain anchored near zero and are unlikely to rise in the near future.

Further, the one-month Libor/three-year swap rate difference has reached its highest level since July 2011 at plus 83bp. "The steeper yield curve makes fixed-rate ABS more attractive than floaters, in our view," the Wells Fargo strategists observe. "A widening yield difference of plus 42bp from two-year swaps to three-year swaps also indicates that three-year average life ABS would offer better relative value."

To illustrate the current advantage of fixed-rate bonds, they evaluated the potential interest income generated by the recently issued FORDF 2013-5 floorplan ABS. The transaction comprises a fixed-rate and a floating-rate senior tranche with a 2.99-year average life.

The analysis compares the expected fixed-rate coupon to the interest income generated by the Libor floater using three interest rate paths - fixed at the current rate, the forward curve and an 'aggressive' Fed tightening beginning in 2015. The difference in income between the fixed-rate bond and the floater in the first scenario was US$255,000 less interest to the floater. The shortfall in interest to the floater in the latter two scenarios was US$10,263 and US$118,833 respectively.

The strategists consequently suggest that money market interest rates would need to rise earlier and faster than most market expectations would indicate in order to match the interest generated by fixed-rate bonds.

ABS

ABCP issuance drops on RPI offload

EMEA ABCP issuance fell by 16% to US$72bn in 2Q13, after levelling out in the previous quarter, Moody's reports. The decline was driven almost entirely by the winding down of three single-seller programmes: Atlantis One Funding Corporation, Atlantis Two Funding Corporation and Royal Park Investments (RPI) (SCI 29 April). All three conduits decreased their USCP issuance dramatically as part of the wind-down process, leading to overall USCP issuance dropping by 26% to US$37.8bn during the quarter.

Moody's also observed a US$900m contraction in French Billets de Tresorerie (BT) issuance. Four out of five conduits issuing BT decreased their BT issuance, while increasing ECP issuance. However, total ECP issuance only showed a small increase of US$200m as a result of a reduction in other conduits, including a US$400m drop in RPI's ECP issuance.

USCP issuance remained the main funding source for EMEA conduits in 2Q13, although its market share dropped to 53% from 59% in 1Q13. Meanwhile, the share of ECP increased to 41% from 34% in the previous quarter.

As the Atlantis and RPI programmes are single-sellers, the share of single-seller conduits dropped in 2Q13 to 8% from 26% in the previous quarter. At the same time, the share of all remaining conduit types increased, with multi-seller conduits accounting for nearly two-thirds of the total outstanding ABCP, compared with 52% in 1Q13.

Structured Finance

FAB vehicle debuts

Spanish bad bank SAREB last month completed its first sale of an REO portfolio, dubbed project Bull. The transaction was structured as a Fondo de Activos Bancarios (FAB), a new vehicle that is a hybrid between asset securitisation funds and collective investment vehicles.

The portfolio comprises 939 residential units and 750 parking and storage units, valued at €100m. It was awarded to HIG Capital affiliate Bayside Capital.

The debut FAB will operate as a joint venture, with SAREB holding 49% and HIG Capital holding the remainder. Jones Day notes in a recent client memo that such vehicles have been specifically created to attract investors, based on their tax benefits and flexibility, in order to facilitate dispositions of assets by the bad bank.

FABs are governed by the provisions of Law 9/2012, governing the restructuring and resolution of financial institutions, and Royal Decree 1559/2012 that governs asset management companies. The vehicles are taxed at 1% corporate tax, while investor returns will not be subject to withholding tax under certain conditions, if the investor is a non-resident with no permanent establishment in Spain.

FABs may issue securities as a structured product for placement with professional investors, subject to stock exchange legislation, if structurers believe there is potential in the market. However, at present, SAREB is not expected to make such public offers.

The bad bank plans to release new portfolios using these investment vehicles in open and competitive processes. Next on the block is project Teide, involving the sale of a portfolio comprised of 36 finished residential buildings, six developments in progress and four plots of land.

Structured Finance

Swap risk remedies discussed

Providing collateral with significant cushion remains an important remedy to counterparty ineligibility in a structured finance cross-currency swap, according to Fitch. The agency adds that only allowing replacement as a remedy with little or no collateral posting beforehand exposes noteholders to extra risks.

"Without collateral providing ample support, both structured finance and covered bond issuers can accumulate significant exposure to cross-currency swap counterparties that may exceed the level of credit protection available to even the most senior notes," says Grant England, senior director in Fitch's structured finance team. "An unmitigated default of the counterparty can lead to losses being allocated to all noteholders."

The agency believes that a combination of documented collateral posting and replacement obligations is the most effective way to mitigate the large counterparty exposures that can arise in cross-currency swaps. Fitch has observed proposals that focus on earlier replacement obligations, with lower or no collateral posting commitments before replacement. It says that these proposals do not adhere to its rating criteria: in practice, downgraded counterparties invariably elect to post collateral in the first instance, given that replacement can take significant time.

By excluding options to post collateral, the issuer becomes exposed to 'jump-to-default' risk, when it is impossible to replace the swap on a timely basis and either no or limited collateral has been posted in the interim. Such limited timeframes and options also constrain the ability of counterparties to novate swaps in an orderly fashion. In turn, this increases the likelihood of future documentation changes from counterparties who, contrary to upfront documentation, seek to post collateral post-downgrade.

Fitch says it has received comment from some market participants that its 'volatility cushions' for cross-currency swaps are high in comparison with some other rating agencies' criteria. Volatility cushions allow for added collateral to be posted beyond marking a position to market to stem potential movements in the swap value during the time required to secure a replacement counterparty.

While the appropriate size of volatility cushions is subjective, small volatility cushions offer very limited protection to issuers and noteholders. This is especially true under potentially prolonged replacement timing assumptions.

Structured Finance

NCR proposals 'credit positive'

The French government is proposing to create a National Credit Registry (NCR) that captures individual consumer loan indebtedness. Moody's notes in its latest Credit Insight publication that the creation of such a registry is credit positive for most French auto ABS, consumer ABS and RMBS, as it will improve the ability of lenders to assess borrower affordability.

The agency suggests that loan portfolio performance will also improve, if the NCR achieves its stated aim of reducing individual over-indebtedness, which has increased significantly over the past five years. Over the 2009-2012 period, 190,617 files per year on average were eligible for over-indebtedness procedures, which represents a 22% increase compared to the 2004-2008 period.

As of March 2013, the outstanding amount of financial debt going through over-indebtedness procedures stood at €1.47bn and comprises mostly consumer debt (63% of the total amount) and mortgage loans (35%). Although this rising trend in over-indebtedness is a political concern, Moody's notes that it remains marginal from a lender's perspective, as it currently represents less than 1% of the consumer loan amount outstanding.

The agency says that a number of limitations on the current NCR proposal could delay or reduce its positive effects. As the NCR will only include debts contracted after the law application date, it will take some years to gain a correct picture of individuals' indebtedness related to consumer loans. In addition, the proposed law will not allow a full reflection of the indebtedness of individuals because of the exclusion from the NCR of mortgage loans and overdraft facilities that are due and payable within three months.

To date, the French credit bureau has only contained negative data on borrowers who are already in default. Regarding data on existing indebtedness, French lenders can only rely on information provided by the borrower and are therefore exposed to the risk of omission or fraud. Going forward, consumer lenders will be obliged to: declare new loans and any default under those loans, thereby making the information available in the NCR; and check the registry prior to granting a new consumer loan.

The NCR, as currently proposed in France, will be comparable to similar registries already implemented in other European Countries.

Structured Finance

Market value criteria updated

S&P has published its revised methodology and assumptions for rating market value securities. These criteria apply to leveraged closed-end funds regulated in the US under the Investment Company Act of 1940, diversified market value CDOs and certain extendible ABCP programmes.

The criteria are being updated to determine the price depreciation applicable to financial assets backing rated notes. Haircuts will vary based on several factors, including the rating assigned to the notes, asset and programme/fund-specific considerations and the estimated worst historical price declines associated with each financial asset backing the rated market value notes.

The market value of each eligible asset is reduced by the associated haircut to determine the stressed value for each asset in a portfolio at the corresponding stress level. The maximum amount of rated debt for a given stress scenario will equal the sum of the stressed market values of all the eligible securities in the portfolio.

The criteria also outline instances where a ratings cap will be imposed to reflect risks that are inconsistent with highly rated securities. The caps are based on whether the transaction documents address certain provisions and whether the manager has provided specific representations limiting the transaction's exposure to certain asset types.

S&P says it may downgrade more than 25% of the currently triple-A rated leveraged closed-end fund transactions, but with 95% of the total outstanding ratings remaining single-A or higher. The agency anticipates lower ratings by an average of six notches on affected MV CDOs, including on the senior tranche ratings, with about half remaining investment grade. The criteria's more adverse impact on the ratings on MV CDOs reflects the generally lower credit quality of the assets in these transactions than in the leveraged fund transactions.

To provide transparency and facilitate the criteria's implementation for market participants, S&P has introduced an analytical tool - Market Value Evaluator - that encompasses the criteria's quantitative portions. The tool is designed to calculate the liquidation value of a pool of assets owned by a market value securities transaction at different levels of certainty commensurate with its ratings.

CDO

Trups defaults, deferrals remain stable

The number of combined defaults and deferrals for US bank Trups CDOs remained stable at 27.7% at the end of August, according to Fitch's latest index results for the sector. One deferring bank, representing US$10m of collateral, cured during the month and subsequently redeemed as the result of an acquisition.

Only one new bank, representing US$10m of collateral in one CDO, defaulted during the month. There were no new deferrals.

Year-to-date, there have been 10 new deferrals and defaults, compared to 36 over a comparable period last year. Cures continue to trend higher, with 44 cures year-to-date, compared to 29 last year.

Across 79 Trups CDOs, 221 bank issuers have defaulted and remain in the portfolio, representing approximately US$6.4bn. Additionally, 291 issuers are currently deferring interest payments on US$4bn of collateral. This compares to 358 deferring issuers totalling US$5.3bn of collateral at this time a year ago.

CDO

ABS CDO on the block

An auction is slated for RFC CDO I on 30 September. The collateral will only be sold if the proceeds are greater than the redemption amount.

CDS

Acquisition weighs on Neiman CDS

Credit default swaps (CDS) on The Neiman Marcus Group have widened by 80% over the past month, significantly underperforming the Fitch North America Retail CDS Index, which moved just 1% wider over the same time period. While credit protection on The Neiman Marcus Group's debt had been pricing at double-B levels for much of the past year given its strong operating performance, its CDS spreads climbed to single-B levels on the announcement that it is to be acquired by new sponsors, Fitch Solutions notes.

Fitch Ratings placed Neiman Marcus's and The Neiman Marcus Group's single-B issuer default ratings on rating watch negative on 11 September. The rating action reflects the agency's expectation for higher leverage following a definitive agreement by Ares Management and Canada Pension Plan Investment Board to acquire Neiman for a purchase price of US$6bn.

The transaction value equates to 9.5x of Neiman's latest 12 months (LTM) EBITDA of US$630m as of 27 April. The current sponsors, Texas Pacific Group and Warburg Pincus, purchased Neiman in October 2005 for US$5.1bn (or 9.7x fiscal 2005 EBITDA of US$528m).

The transaction is expected to close in 4Q13, subject to regulatory approval. A portion of the purchase price will be used to repay all amounts outstanding under Neiman's existing credit facilities (US$2.6bn).

No detail has been provided on the financing of the transaction. Assuming 20%-30% of equity contribution, the total transaction value could be financed with US$1.2bn-US$1.85bn of new sponsors' equity and US$4.3bn-US$5bn of debt.

This compares to US$2.7bn of debt outstanding currently. Therefore, pro forma adjusted debt/LTM EBITDA is expected to be in the 7x-8x range, versus 4.8x currently.

CDS

High CDS liquidity reported for Nokia

The credit default swap (CDS) market seems to be reacting favourably to Microsoft's plans to acquire Nokia, according to the latest case study from Fitch Solutions. Following the US$7.2bn acquisition announcement on 3 September, CDS spreads on Nokia have tightened by 59%, while Microsoft remains largely illiquid.

The cost of credit protection on Nokia's debt is now at double-B plus levels, Fitch notes. But CDS liquidity on the name remains high: it is trading in the third global percentile, with more CDS liquidity than 97% of Fitch's CDS pricing universe. The firm suggests that this signals still-high market uncertainty over future pricing.

CDS

Verizon CDS hit three-year wides

Verizon Communications' proposed deal with Vodafone Group has sent the company's credit default swap (CDS) spreads to their widest level since 2010, according to the latest case study from Fitch Solutions. Verizon CDS have widened by 38% over the past month alone.

"Verizon's plans to acquire Vodafone's US group - thereby increasing the company's leverage, as well as higher debt levels - are likely contributing to the growing market concern," says Fitch director Diana Allmendinger. CDS levels are indicating that the market is now pricing Verizon at triple-B plus levels.

CDS liquidity for Verizon has been increasing steadily since February, signalling higher market uncertainty. Verizon has vaulted from trading in the 31st global percentile to the fifth.

"Verizon CDS are now trading with more liquidity than 95% of our pricing universe," adds Allmendinger.

CMBS

Apartment prices take off

Apartments in New York and San Francisco are the hottest property sector in major markets, each having topped its previous peak by more than 20%, according to the latest Moody's/RCA CPPI report. Conversely, core commercial properties in Los Angeles and Chicago lag well behind, more than 20% below their respective peaks.

Los Angeles and Chicago commercial prices have each recovered less than half the 40%-plus price declines they experienced post-crisis. Apartment prices nationally increased by 0.4% in July. The national all-property composite index increased by 1.5% in July, driven by a 2% increase in its core commercial component.

"July was one of the rare months in which core commercial prices outpaced those of apartments," comments Moody's director of commercial real estate research Tad Philipp. "Since the December 2009 trough, apartments have experienced just short of double the pace of appreciation for commercial - 63% to 35%."

In core commercial, retail showed the best performance, up by 7.6% over the last three-month period and up by 17.1% over the last twelve-month period. Commercial properties in New York, Boston and Washington, DC are experiencing the longest recovery at 14 quarters, with cumulative price appreciation of 57% in New York, 52% in Boston and 30% in Washington, DC from their post-crisis troughs.

CMBS

Further dip forecast for CMBS late-pays

US CMBS late-pays fell by 10bp in August to 6.68% from 6.78% a month earlier, according to Fitch's latest index results for the sector. The agency notes that the delinquency rate is poised for another dip once an impending modification of the US$678m Skyline Portfolio loan is finalised (see SCI's CMBS loan events database).

The Skyline Portfolio is securitised in three CMBS transactions - BACM 2007-1, JPMCC 2007-LDP10 and GECMC 2007-C1 - and represents nearly 13% of BACM 2007-1. The loan transferred to special servicing in March 2012 due to imminent default. The sponsor, Vornado, cited the Defense Base Realignment and Closure (BRAC) statute as contributing to recent and upcoming vacancies at the properties.

In addition, Vornado indicated that significant capital may be required to re-tenant the properties. The pari passu loans have been under a forbearance agreement since November 2012.

According to the special servicer, CWCapital Asset Management, modified terms have been agreed upon with the borrower and they are now working toward documenting and closing the modification. Resolution of the Skyline loan will contribute to a 12bp drop in Fitch's CMBS delinquency rate. Skyline is currently the second largest delinquent loan in Fitch's index, behind only Stuy Town.

In August, resolutions of US$1bn outpaced new additions to the index of US$559m. Additionally, Fitch-rated new issuance volume of US$3.8bn fell short of US$4.5bn in portfolio run-off, causing a slight decrease in the index denominator. The month saw limited new additions to the index, with the largest being the US$42m Grand Marc at Riverside (GECMC 2006-C1) in Riverside, California.

Delinquency rates for all major property types fell last month, led by the hotel sector. Hotels saw a 36bp improvement month over month, driven by the resolution of the US$103m loan on The Shore Club in Miami Beach (securitised in JPMCC 2005-CIBC13). The borrower redeemed a foreclosure judgment on 25 June and paid off the loan in full in early July.

Current and previous delinquency rates are: 9.41% for industrial (from 9.56% in July); 7.68% for hotel (from 8.04%); 7.56% for office (from 7.59%); 7.3% for multifamily (from 7.41%); and 6.23% for retail (from 6.37%).

CMBS

Innkeepers paid down

September remittances indicate that the US$656m Innkeepers portfolio - securitised in LBUBS 2007-C6 and LBUBS 2007-C7 - has paid down. The move was widely expected, given that the asset has been open for prepayment since its December 2011 modification and owner Cerberus was shopping for a new loan in June (see SCI's CMBS loan events database).

The large principal cashflows paid off the A2 note and half of the penultimate last-cashflow A3 note in LBUBS 2007-C6, as well as 20% of the last-cashflow A3 bond of LBUBS 2007-C7, according to Barclays Capital CMBS analysts. AJ subordination was increased to 14.8% from 12.9% in the former and to 8.9% from 7.9% in the latter deal.

A US$4.95m workout fee was charged by the special servicer in relation to the pay-down, resulting in large interest shortfalls in both trusts. The shortfalls in LBUBS 2007-C6 rose all the way to the AM tranche, which received less than half its scheduled cashflow. In LBUBS 2007-C7, shortfalls rose to the AJ tranche, which received only 10% of its scheduled interest.

"We expect the shortfalls to be recovered in the coming months as scheduled interest cashflows make up for this one-time charge," the Barcap analysts observe. "Note that the loan was still carrying US$15m of ASERs that had accrued prior to the modification. However, these were not paid back in the pay-down, as this delinquent interest had, in effect, been forgiven as part of the modification."

Insurance-linked securities

Insurance private debt strategy offered

Twelve Capital has launched an insurance private debt strategy, which aims to provide small and medium-sized insurers with an additional source of regulatory capital while generating attractive risk-adjusted returns for the firm's investor base. This will take the form of bilateral loans or private placement bonds, benefitting from Twelve Capital's existing expertise in collateralised reinsurance and insurance fixed income. As banks seek to strengthen their balance sheets and cut back on lending activities due to stricter capital requirements, small and medium-sized insurers are finding it more difficult to obtain solvency financing.

Risk Management

Economic capital solution strengthened

Moody's Analytics has released RiskFrontier 3.4, the latest version of its portfolio management and economic capital solution. A new risk measure has been added to the service that combines regulatory and economic capital into a single metric.

The model in RiskFrontier treats regulatory capital charges as a binding constraint that reduces profitability, and produces a series of unified metrics that quantify their impact. These metrics allow institutions to rank-order the instruments in their portfolio, as well as new deals, while simultaneously accounting for economic risks and regulatory charges.

The latest version of the solution also introduces Risk Driver Analysis, which provides transparency into variables that have the greatest impact on a portfolio's risk.

Risk Management

EU repository registration delayed

ESMA has updated its EMIR implementation timetable. The key change relates to the registration of the first trade repositories (TRs), which was not expected to occur until 24 September.

ESMA now doesn't anticipate making registration decisions before 7 November. Consequently, trade repository reporting is not expected to start before February 2014. The change in the timetable is related to a combination of factors, including issues faced by applicants in ensuring the completeness of their applications, the authority says.

Separately, CCP authorisations are unlikely to occur before 15 October.

Risk Management

Model integration issues persist

Principia Partners has released the findings of a survey focusing on ABS, MBS and CDO investors' use of cashflow and waterfall models. The results show that while the growing commoditisation of issuer reporting, collateral performance and loan level data has benefitted the modelling of cashflows, it is not enough to lighten the burden investors carry when building and managing cashflow and waterfall models.

Respondents to the 2Q13 survey comprised 100 structured finance investors from 62 organisations. The results confirm that most investors are juggling several different modelling methods and/or providers and, as a consequence, integration issues are commonplace. For example, over 50% of investors are using more than one method for obtaining or modelling cashflows and - for those using commercially available models - over 66% are using two or more providers.

Respondents expressed frustration with the amount of integration they face and the criticality of ensuring the accuracy of the models they use. This finding aligns with the degree of consolidation and the investment in expanding asset coverage by commercial waterfall model providers.

Unlike the reported use of waterfall models, the survey also shows that only 35% of investors rely on commercial prepayment and loss models. However, the greater access to current and historical loan level data in the US makes a notable difference: US investors reported using commercial models almost twice as often as European investors (45% in the US versus 25% in Europe).

RMBS

Dutch NHI plan weighed

The Dutch government is set to purchase - via the National Mortgage Institute (NHI) - up to €50bn of RMBS backed by NHG mortgages from banks over the next five years (SCI 4 April). The NHI will issue bonds guaranteed by the government to finance these purchases.

Fitch suggests that the initiative is unlikely to materially reduce overall funding costs or regulatory capital requirements for participating banks. However, the agency says the scheme should enlarge the banks' investor bases by increasing the funding provided by Dutch pension funds - which has so far been limited - and potentially adding other sovereign and state-agency investors.

One reason for the substantial 'funding gap' (customer deposits being smaller than customer loan books) at Dutch banks is because a large proportion of households' assets are held as pension savings. The new initiative would help the banks access more retail deposits indirectly in the form of pension savings through the NHI structure. This would be a greater benefit to mid-sized and smaller banks, which typically have fewer wholesale funding options.

However, Dutch banks would overall remain reliant on wholesale funding markets. Loan-to-deposit ratios of the domestic operations of the largest banks are between 130% and 150%, despite Dutch retail savings increasing by an impressive 45% between end-2006 and June 2013. The ratios would not change with the new scheme, so the banks would still be vulnerable to changes in investor sentiment, according to Fitch.

The agency further notes that benefits from the cheaper state-backed funding is likely to be offset by the cost of the guarantee, while banks will also need to retain first-loss tranches to ensure they bear some of the risk.

RMBS

Mexican reform 'credit negative' for RMBS

The Mexican Congress is expected to pass a new fiscal reform bill that could take effect next year. The bill aims to increase tax revenues for the federal government, but is credit negative for outstanding Mexican RMBS because it would lead to higher delinquencies and higher losses, according to Moody's latest Credit Outlook.

The bill calls for: a new 16% tax on mortgage loan interest payments; a hike in income tax to 32% from 30% on individuals who earn more than MXN500,000 annually; the elimination of tax exemptions for tuition fees and services such as school transportation; and a significant cut to the limit to tax deductions for individuals. The increased taxes diminish borrowers' disposable income and negatively affect their ability to make mortgage repayments.

Low-income borrowers are particularly sensitive to changes in household disposable income and unemployment. Mortgage loans to low-income borrowers back approximately 75% of total outstanding Mexican RMBS and include a significant share of loans from Infonavit and FOVISSSTE, as well as non-bank financial institutions (sofomes).

The bill also calls for an unemployment insurance programme, which Moody's notes could mitigate the negative effect on RMBS performance. However, the eligibility criteria for the programme are not yet defined.

In addition, the bill would reduce the REO turnover rates in existing RMBS deals, which would result in higher losses. The new 16% tax on the sale of new or used houses would translate into higher home prices and thus slow home sales, affecting mainly RMBS deals backed by sofomes. Unlike other Mexican RMBS, these deals contain large percentages of delinquent loans on homes that will eventually have to go into foreclosure, the proceeds of which would be remitted to the deals.

RMBS

Richmond continues with MRP plan

Richmond, California city council yesterday voted 4-3 to continue exploring Mortgage Resolution Partners' (MRP) proposal to use the City's power of eminent domain to seize underwater mortgages (SCI passim). SIFMA responded by stating it continues to believe that the move is unconstitutional and "would do much more harm than good" in the local Richmond community and across the country.

The association adds that the city is "moving towards a massive potential liability, for which it cannot be fully indemnified", putting its residents and taxpayers at significant risk.

Divisions reportedly remain among the members of the city council regarding the MRP proposal, however. A five-member super-majority is believed to be necessary for the council to proceed further with the plan.

RMBS

Richmond lawsuit 'not ripe'

Wells Fargo and Deutsche Bank's lawsuit, on behalf of bondholders affected by Richmond's eminent domain proposal, was heard in Federal Court yesterday. The trustees are seeking preliminary and permanent injunctions against the city from implementing its seizure programme (SCI 13 August).

US District Judge Charles Breyer stated the request to block the plan was "not ripe". SIFMA responded by stating: "It is important to understand that no decision has been made on the merits of this case. Judge Breyer ruled that the case is not ripe, which is a ruling made on timing."

The association adds that the ruling does not mean Richmond's plan is legal and that it fully expects the litigation to succeed on merit once the issue is ripe. A formal ruling is expected on 16 September, likely either dismissing the case or putting it on hold pending further action by Richmond in its implementation.