Contents

Structured Finance

Euro ABS market still active

The European ABS and RMBS secondary markets continue to witness strong BWIC supply. SCI's PriceABS data shows a number of covers from yesterday's session, while one trader reports that next week is also expected to be busy.

"There have been a lot of bid-lists lately and those are mainly coming from hedge funds rather than legacy accounts. What we are seeing is investors looking to lock in profits for the year," says the trader.

He continues: "Dealers are both selling and buying, as they look to build inventory for the end of the year. Dealers have generally had a good year, so they will not want to blow that, but they are already looking ahead and positioning for January."

The trader points to "a couple of big BWICs" due at the start of next week, although he suggests that activity will then quieten down before the week is out. While prime spreads are not expected to move and have been fairly stable for a couple of months, peripheral spreads continue to tighten.

Five-year UK credit card ABS triple-A spreads are at about 50bp, with price talk and covers captured by PriceABS from yesterday's session showing a number of auto tranches at or around par. For example, the TURBF 4 A tranche was talked at 100.16 on its first appearance in the PriceABS archive, while COMP 2011-2 A was covered at 100.715 and VCL was covered at 100.01.

Senior Italian RMBS is trading at around the low-200s and Spanish paper is slightly wider. Dutch RMBS is at about 80bp and UK five-year RMBS paper could be as tight as 50bp, while UK non-conforming is more like 125bp-150bp.

The trader expects the positive trends seen this year to continue into next year. "This has been a good year and I think people are looking forward to 2014," he says.

The trader continues: "There is still a relative dearth of strong technicals, but I think we are going to see more activity and further diversification in the new issue market. I am looking forward to it."

JL

CLOs

Euro bank boosts CLO supply

A plethora of 2005-, 2006- and 2007-vintage bonds circulated in the US CLO secondary market yesterday. Supply was boosted by a bid-list with over 80 cash CLO/CDO items totalling over US$800m in original face value, which is understood to have come from a European bank looking to free up balance sheet.

Prices observed by SCI's PriceABS data were universally high, although the session was dominated by talk without trading. A great many of the tranches captured by PriceABS had first appeared last week.

Among those was the ACACL 2006-2X A1 tranche, which was talked at 99 handle, around 99, at low-99 and at mid-99 - similar levels to where it was talked during Friday's session. The tranche first appeared in the PriceABS database on 3 December, when it was talked at 99.44.

DUANE 2006-3X A2B was talked between 96 handle and high-97 handle. It first appeared in the PriceABS archive last week, when it was talked at 98.06.

The GEML 2006-3X A2 tranche was another one to have debuted last week, when it was talked in the low/mid-90s. Yesterday it was talked in the mid-90s, at 96 and in the mid/high-90s.

It is a similar story for GLEAG 2005-1X B, which first appeared last week with price talk of 96.13. Yesterday it was talked between 95 area and mid-97 handle.

Among the many other names to have first appeared in the archive last week was HARCH 2007-1X B, which was talked yesterday at between 95 and low-97. Last week it was talked between 97 and 97.25.

The PRIM 2007-2X B tranche is another example, talked on its first appearance last week at 95.5 and yesterday between 91 and the mid-90s. There was also RGTTA 2007-1X A1L, which was talked last week at 99.13 and yesterday between 98 and 99 area.

Additionally, tranches that had not even appeared last week were out for the bid yesterday, such as ARECO 2007-1X A2. The bond appeared in the PriceABS archive for the first time and was talked at 93 handle. Another new arrival was SLVR 2006-2A A1, which was talked at around 98.

Other tranches have a longer track record in the archive, such as ACACL 2006-2X A2, which was talked between 95 and the mid/high-90s - having been talked at between 97 and the mid/high-90s on Friday. When the name first appeared in PriceABS on 23 January it was talked at 95.16.

Meanwhile, BLACK 2005-1X B was talked at 96 handle, around 97 and in the mid/high-90s. A month earlier the tranche was talked in the low/mid-90s, mid/high-90s and at 97 and was covered at 96.25.

BLACK 2006-1X AD was also out for the bid, talked at mid/high-95, 97 handle and in the mid/high-90s. It was covered in November 2012 at 95 handle and first appeared in PriceABS on 5 June 2012, with price talk in the low-90s.

BLACK 2006-1X B is another noteworthy name. It was talked at 90 handle, mid-93 handle and in the low/mid-90s and was last covered on 9 October at 91.51. Before that, it was covered at 91.25 on 21 February and in the mid-80s on 6 August 2012.

GALE 2007-3A A1 was talked at mid/high-98. The tranche was last covered on 15 July and first appeared in the PriceABS archive in May 2012.

GREYR 2005-1X A2L was talked at 99 handle, mid-99 and high-99. Price talk last week was between 99 and high-99 and the tranche was covered in November last year at 96 handle.

Finally, KATO 2007-10A A2B was circulating during the session, with talk at high-98 handle. It was covered at 97 handle on 12 July and was first captured by PriceABS on 12 September 2012, when it was talked at 96.3.

JL

CMBS

US CMBS inches wider

US CMBS spreads inched wider yesterday as bid-list supply came in at around US$200m. SCI's PriceABS data recorded several covers from the session, with a range of vintages from 2004 to 2013 represented.

Several odd-lots circulated during the session split between legacy names and CMBS 3.0 bonds, with legacy super seniors ending the day about 1bp wider, according to Trepp. The GSMS 2007-GG10 A4 bond finished the day at 172 over swaps.

LBUBS 2004-C7 G was covered at 226 yesterday, with price talk at swaps plus 265, in the mid/high-200s and at around 300. The tranche was previously covered on 28 February at 101.18.

2005 paper, such as BSCMS 2005-T18 D, was also available. That tranche was covered at 345, having been talked in the mid-300s, at swaps plus 375 and at around 400.

The GECMC 2005-C3 H tranche was covered at around 91, with price talk between the high-80s and low-90s. It only debuted in PriceABS in the prior session, when it was talked in the very low-90s and low-90s.

JPMCC 2006-LDP9 AJS was among the names from 2006 out for the bid, although it was recorded as a DNT. Price talk had been in the 90 area and the tranche was previously successfully traded on 17 July and 10 April, as well as on its first appearance in the archive last year when it was covered at 75.12.

MSC 2006-T21 B was covered at 233, with price talk in the low-200s, mid-200s and at swaps plus 250. The tranche was talked between around 105 and the mid-200s in September.

Moving on to the 2007 vintage, LBUBS 2007-C2 AM was covered at 270, in line with talk in the mid/high-200s. The tranche was covered at 287 on 23 October and at 339 on 25 July.

MSC 2007-T27 AJ was also covered, this time at 245. Price talk on the tranche had been between swaps plus 215 and the 240 area.

Another AJ tranche - CMLT 2008-LS1 AJ - provided 2008-vintage representation. Talk was in the mid-80s, although the tranche came back as a DNT, as it had done in October.

As for post-crisis paper, both MSBAM 2012-C6 A4 and WFRBS 2012-C6 A4 were covered at 90. The former was first picked up by PriceABS with a cover at 74 on 16 May, while the latter had been covered at 77 on 25 March.

Additionally, the WFRBS 2013-C11 B tranche was covered at 165. That tranche was covered at swaps plus 189 on 29 July and at 136 on 22 March.

A couple of FREMF tranches, including FREMF 2013-K33 B, were also out for the bid. That tranche had not appeared in the PriceABS archive before and was talked in the mid-200s.

JL

ABS

Even keel for ECP

The ABCP market has this year seen a rebalancing of issuance towards the ECP sector, which now accounts for roughly 50% of volume. With outstandings expected to increase slightly in 2014, the market appears to have successfully returned to its core function.

EMEA ABCP volume declined to approximately US$70bn as of September 2013, versus US$524bn in July 2007, according to Moody's figures. The number of conduits rated by the agency dropped from 68 to 30 during the same period. A similar magnitude of decline has been observed in the US ABCP market, but Moody's vp - senior analyst Alex Wickens says that this trend now appears to be bottoming out in both sectors.

Traditional multi-seller conduits accounted for the majority of EMEA ABCP issuance (73%) through end-3Q13. Hybrid conduits accounted for 20%, while repo conduits accounted for 7% and single-seller/securities arbitrage vehicles for less than 0.5%.

"The 17% reduction in ABCP outstandings from September 2012 to September 2013 was largely driven by single-seller conduits terminating," Wickens explains. "Most single-seller conduits have now disappeared, leaving the core multi-seller vehicles remaining."

He adds: "The regulatory landscape is a factor in the reduction of the single-seller vehicles; however, multi-seller conduits remain a strong alternative source of finance for core banking clients and sponsor banks recognise the value in using them. The vast majority of conduits are fully supported."

The majority of assets financed in the EMEA ABCP market are trade receivables and auto loans and lease receivables. Equipment lease, consumer loan and credit card receivables account for the remainder.

"Corporate receivables are well-suited to short-term financing. In some cases, conduits also serve as warehousing facilities before a term securitisation," observes Wickens.

The largest regional exposure for EMEA conduit seller additions during 2013 is multi-jurisdictional (accounting for 25% of issuance so far this year), followed by the US (17%), Italy (16%), Germany (12%) and the UK (10%). There was minimal additional exposure to countries with challenging economies.

Structured CP issuance - puttable/callable, extendible and repo instruments - is also rising as a response to regulatory developments and sponsors' desire for flexible liability management. "Investors tend to prefer short-term paper, but long-term paper suits issuers better and the difference in preference can be addressed by structured CP. Such instruments are mainly being issued into the US market, but appetite for the paper is growing in EMEA - although the need to educate the investor base about it remains," Wickens notes.

EMEA ABCP outstandings are expected to increase slightly in 2014 as new transaction volume outstrips those terminating. Few, if any, new multi-seller conduits are anticipated to launch. However, Moody's periodically fields enquiries about single-seller conduits, albeit they are different to the old-style securities arbitrage vehicles and are being utilised as a way for banks to finance specific large balance sheet originations.

"The feeling we get from sponsors is that, despite regulatory issues, they believe in the product and it remains a useful funding tool for them," Wickens concludes. "The market appears to have fundamentally returned to the core reasons for why ABCP conduits were structured in the first place. However, future developments in the sector remain highly dependent on bank rating actions, regulatory proposals (specifically changes to money market fund rules) and incentives for banks to continue in the ABCP business."

CS

Structured Finance

SCI Start the Week - 9 December

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

Pipeline
Over twice as many deals joined the pipeline last week as had done in the week before, although the pace remains slower than it was pre-Thanksgiving. In total, five new ABS, one ILS, two RMBS, five CMBS and two CLOs were announced.

The ABS new entrants comprised: US$447m Access to Loans for Learning Student Loan Corp 2013-I, US$183m CPS Auto Receivables Trust 2013-D, US$151.8m SoFi Professional Loan Program 2013-A and US$2.1bn Utility Debt Securitization Authority Series 2013T and Series 2013TE. The ILS was US$100m Loma Reinsurance Series 2013-1, while the RMBS were €4.35bn BBVA RMBS 12 and US$154.33m Nationstar Mortgage Loan Trust 2013-A.

The CMBS consisted of US$1.2bn Aventura Mall Trust 2013-AVM, US$295m CGWF Commercial Mortgage Trust 2013-RKWH, US$136.95m Resource Capital Corp CRE Notes 2013, US$760m SCGT 2013-SRP1 and US$230.09m Selkirk No.1 2013-1. Meanwhile, the CLOs were €360m Jubilee CLO 2013-XI and US$187.5m Hildene CLO I.

Pricings
It was a slightly quieter week for completed issuance. Last week saw three ABS, three CMBS and three CLOs price.

The ABS new issues were €247.9m Atlantes Finance 6, €230m Bee First Finance Compartment Edelweiss 2013-1 and US$800m Nissan Auto Receivables 2013-C Owner Trust. The RMBS print was A$347m RESIMAC Bastille Trust 2013-1NC.

As for CMBS, pricings consisted of C$330.4m IMSCI Series 2013-4, US$190m STORE Capital 2013-3 and US$450m VNDO 2013-PENN. Finally, US$411m BlueMountain CLO 2013-4, US$363m Cathedral Lake CLO 2013 and €616m Richmond Park CLO were issued.

Markets
European CMBS secondary trading has slowed down as year-end approaches, according to analysts at Bank of America Merrill Lynch. The limited BWIC supply probably represents a degree of profit-taking and action by bad banks to meet year-end targets, they suggest.

The analysts add: "Most notes were from first- or second-pay tranches and were well bid at prices in the 90s. In general, we continue to see demand for investment grade rated front-pay notes and some mezzanine tranches. However, we saw some softening in senior and second-pay notes, with prices above 95 in some highly liquid, benchmark transactions that are widely owned by dealers."

Meanwhile, the European ABS and RMBS secondary markets continued to witness strong BWIC supply, as SCI reported on 6 December. Several bid-lists circulated during the week and more are expected to kick this week off.

"Dealers are both selling and buying, as they look to build inventory for the end of the year. Dealers have generally had a good year, so they will not want to blow that, but they are already looking ahead and positioning for January," notes one trader.

Secondary CLO activity picked up in both Europe and the US, reaching just over US$500m in the US. US CLO spreads ended the week unchanged and Bank of America Merrill Lynch analysts note there is a 80-line list due out today totalling over US$800m in original value.

US non-agency RMBS was one of the first markets to recover from its turkey hangover. SCI's PriceABS data captured US$225m in BWIC volume for the first session of the week (SCI 3 December), including a variety of Countrywide tranches.

Finally, US CMBS spreads widened marginally over the week as secondary volumes continued to decline, note Barclays Capital CMBS analysts. "TRACE data showed that about US$6bn of CMBS bonds changed hands this week, below the US$7bn average over the past six months," they say.

Deal news
• The removal of loans from two recent US CMBS could be an early warning sign of risk for bondholders. Recently a US$47.5m loan backed by Midwestern shopping centres was removed from GSMS 2013-GCJ16 after the deal priced. Additionally, the ninth largest loan in a mixed-use pool in Chicago was removed from MSBAM 2013-C13 just two days after its launch (SCI 26 November).
• Moody's has downgraded the global scale ratings of the senior FCC BIAT-CREDIMMO 1 and FCC BIAT-CREDIMMO 2 notes, as well as the global and national scale ratings of the junior FCC BIAT-CREDIMMO 2 notes. The agency has also affirmed the national scale ratings of the senior notes in both transactions and the global and national scale ratings of the junior notes in FCC BIAT-CREDIMMO 1.
• Fitch has downgraded the single-C rated B1c, C1c and D1c classes of Eurosail-UK 2007-5NP to D, following the restructuring of the transaction (SCI passim). In addition, it has placed the double-C rated A1a and A1c classes on rating watch positive.

Regulatory update
• ISDA, SIFMA, the Financial Markets Association and the Institute of International Bankers are suing the CFTC for defects in its cross-border rule. They allege that the CFTC failed to follow complete rulemaking procedures and their suit also challenges aspects of other CFTC Dodd-Frank swap rules and seeks broad relief, including that the cross-border guidance be vacated.
• Freddie Mac has entered into a settlement agreement with Bank of America concerning the GSE's claims related to representations and warranties on single-family loans it was sold. Under the terms of the agreement, Bank of America agreed to pay Freddie Mac a total of US$404m, less credits of US$13m for repurchases already made and for reconciling adjustments.

Deals added to the SCI New Issuance database last week:
1st Financial Credit Card Master Note Trust III series 2013-II; AA Bond Co (tap); BAMLL 2013-DSNY; China Dragon Trust series 2013-1R; China Funding Investment 2013-1; COMM 2013-RIAL4; CSMC Trust 2013-IVR5; Eagle Credit Card Trust series 2013-1; Fan Engine Securitization series 2013-1; Foncaixa PYMES 4 FTA ; Ford Auto Securitization Trust series 2013-R4; FREMF 2013-K35; Genesis Trust II series 2013-1; Glacier Credit Card Trust series 2013-1; Grain Spectrum Funding 2013-1; Hollis Receivables Term Trust II series 2013-1; Institutional Mortgage Securities Canada Inc series 2013-4; Kentucky Higher Education Student Loan Corp series 2013-2; Residential Reinsurance 2013-II; Sapphire V NZ series 2013-1 Trust; Securitisation of Catalogue Assets (UK)

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-3; BACM 2007-2; DECO 2007-E7; DECO 9-E3; EMC IV; EURO 25; EURO 28; FOX 1; GECMC 2003-C2 & GMACC 2003-C2; GRGER 2007-1; GSMS 2006-GG6; GSMS 2007-EOP; TITN 2006-3; TITN 2007-2; TITN 2007-CT1; WBCMT 2006-C28 & CWCI 2006-C1

Top stories to come in SCI:
Developments in solar ABS

Structured Finance

Top trades touted

Morgan Stanley suggests in its global securitised products outlook for 2014 that the market is on the verge of a major transition from being liquidity-driven to being growth-dependent. While the returns are more modest in this scenario than they have been in the past, strategists at the bank believe that alpha opportunities within the sector remain more significant, scalable and diverse than in many other fixed income segments.

The Morgan Stanley strategists highlight their top trades for 2014, which cover agency and non-agency US RMBS, US CMBS, CLOs and European ABS. First, they expect the mortgage basis to cheapen relative to 10-year US Treasuries. Consequently, investors are urged to begin next year defensively in the agency MBS space, overweighting the belly of the coupon stack and overweighting 15s/30s.

"The belly remains the most attractive in the stack, especially 4s, as the carry for the coupon is attractive and the valuation seems fair relative to other coupons. The increased risk in higher coupons raises the attractiveness of the 15-year sector as a way to defensively position for a back-up in rates and reduce duration," the strategists explain.

As for non-agency RMBS, they recommend legacy Alt-A seniors with exposure to VCPR optionality, as well as legacy option ARM seniors sheltered from sticky loss severities. As mortgage credit eases and housing prices rise, upside optionality is available in the form of increased voluntary prepayment rates.

With respect to US CMBS, the strategists recommend Tier 3 AM tranches, CMBS 2.0 triple-A to double-A bonds and Freddie K A2 bonds. They believe that wider-trading AM bonds offer attractive relative value, given compelling risk-adjusted returns.

Furthermore, the Morgan Stanley analysis suggests that senior CMBS 2.0 bonds currently appear more compelling to the bottom part of the capital structure, with last-cashflow triple-A bonds, AS bonds and double-A bonds 0.39, 0.41 and 0.75 standard deviations cheap to triple-B minus bonds. At the same time, the inclusion of post-2008 Fannie GEMS and Freddie Mac K bonds in the Barclays Aggregate indices and the implementation of the Liquidity Ratio may increase demand for these securities next year. Freddie K 10-year A2s are particularly recommended, given the steeping of the yield curve and tightening in swap spreads.

In terms of CLOs, the strategists note that CLO 2.0 equity is one of few remaining 10%-plus loss-adjusted return opportunities in fixed income. Additionally, European and US CLO triple-A rated tranches - both new issue and legacy - are said to offer a significant pick-up relative to comparably risk-remote tranches.

Finally, among the many opportunities in European ABS, the strategists recommend mezzanine UK non-conforming RMBS and Spanish SME CLOs and RMBS. For Spanish RMBS mezz, high coverage and front-ended payment windows are touted, while second- and third-pays in deleveraged transactions are recommended in the Spanish SME CLO sector.

Regarding mezz UK non-conforming RMBS, structural leverage is highlighted as a relatively safe way to play the UK housing recovery. "We expect more transactions to switch to pro-rata pay over the course of next year and believe that cures will be sustainable over the next two years," the strategists explain. "Call economics are also likely to improve if mortgage rates normalise further and house prices trend higher. Investors who are not constrained by ratings considerations can find more interesting double-digit yield opportunities in equity/residual tranches."

CS

Structured Finance

Volcker Rule concerns linger

The US Fed, the FDIC, the OCC, the CFTC and the SEC have issued final rules to implement section 619 of the Dodd-Frank Act, known as the Volcker Rule. While changes from the original proposal have broadly been welcomed by the securitisation industry, some lingering concerns remain.

The final rules prohibit insured depository institutions and companies affiliated with insured depository institutions from engaging in short-term proprietary trading of certain securities for their own account. They also impose limits on banking entities' investments in, and other relationships with, hedge funds or private equity funds.

The final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, insurance company activities and organising/offering hedge funds or private equity funds. They also clarify that certain activities are not prohibited, including acting as agent, broker or custodian.

SFIG has outlined what it describes as some "helpful changes" in the final rules. First, the definition of covered fund now excludes 14 different types of entities, including loan securitisations, qualifying ABCP conduits and qualifying covered bonds. As a result of these exclusions, the so-called 'Super 23A' issue - whereby the provision of interest rate derivatives, servicing advance facilities and liquidity facilities to securitisations would have been problematic - has been fixed.

Second, the exemption of wholly owned subsidiaries from the definition of covered fund also means that any securitisation issuer that issues only debt not constituting an 'ownership interest' to third parties will not be subject to any Volcker rule restrictions. This effectively closes the gap that had existed in the proposed rule with respect to intermediate SPEs that did not hold loans and thus could not rely on the loan securitisation exemption.

Third, a non-US fund that is not otherwise exempt from the Investment Company Act by virtue of section 3(c)(1) or 3(c)(7) and that is sponsored by a foreign bank, which is not controlled by a US banking entity, is entirely exempt from everything including Super 23A. "This is a great result for non-US securitisation issuers that would have a hard time converting to a Rule 3a-7 Investment Company Act exemption, due to the existence of a non-US trustee or a Regulation S offering outstanding," SFIG observes.

However, the association points out that some lingering or newly created concerns remain. For instance, the final rule has narrowed the definition of a loan so as to expressly exclude securities and derivatives.

In addition, a covered fund includes a commodity pool for which the commodity pool operator claimed an exemption under 17 CFR 4.7. Thus any CPOs that claimed an exemption as a precautionary measure prior to the December 2012 guidance may have inadvertently created an extra Volcker problem.

Also, the conditions for qualifying ABCP issuers will not be able to be satisfied by all ABCP issuers, according to SFIG. The conditions include: all securities issued must have tenors of 397 days or less; the issuer invests only in the same assets permissible for permitted loan securitisations and ABS acquired in an initial issuance from an issuer or underwriter; and a regulated liquidity provider provides full and unconditional liquidity coverage with respect to all of the outstanding securities issued by the issuer.

Finally, under the rules, a loan securitisation should exclude securities (bonds) unless obtained in a work-out/restructuring. But most CLOs currently permit a minority portion of the underlying portfolio to be bonds. Furthermore, there is no grandfathering for existing CLOs, so to the extent that a CLO does not meet the definition of loan securitisation, it would be a covered fund and subject to the ownership and transaction prohibitions.

The compliance requirements under the final rules vary based on the size of the banking entity and the scope of activities conducted. Banking entities with significant trading operations will be required to establish a detailed compliance programme and their ceo will be required to attest that the programme is reasonably designed to achieve compliance with the final rule. Independent testing and analysis of an institution's compliance programme will also be required.

The final rules reduce the burden on smaller, less-complex institutions by limiting their compliance and reporting requirements.

Banking organisations covered by section 619 will be required to fully conform their activities and investments by 21 July 2015.

CS

CMBS

CMBS surprises in store?

Deutsche Bank CRE debt research analysts forecast that five scenarios could surprise the US CMBS market next year. These predictions are set against a backdrop of increased investor focus and improving performance across the sector, albeit with potentially disappointing absolute returns.

The first surprise is the return of multi-billion dollar conduit CMBS, with the number of loans in each deal moving closer to pre-crisis levels while average loan size does not decline much. The Deutsche Bank analysts suggest that such an increase will be the result of a number of factors: more originators, higher transaction volume, increasing amount of maturing loans and more leverage/proceeds.

The second surprise forecast by the analysts is that issuance will increase, but at a slower pace than expected. "The recovery in issuance over the last few years has been helped by WACs, which are significantly lower than historical averages, and a long-term trend of declining rates. If the yield curve steepens more than expected, US$100bn-plus of private label issuance will be a difficult goal to achieve," they note.

The agency CMBS market is also at risk, even more so given the pull-back from the GSEs. A decade ago the WAC between multifamily pools and private label conduits were roughly the same; this year, they are 100bp different, with agency loans being the lower of the two.

The third potential surprise is many more upgrades of legacy bonds. Rating migrations into investment grade have been few and far between, but have been more prevalent within investment grade.

"We expect to see more of both transitions in 2014. 2007 vintage LCFs and 2005 AMs had the largest number of ratings which moved in to either the double-A or triple-A category in 2013," the analysts observe.

Surprise number four is more surprises being in store for legacy loans in distress. More than three-dozen 2005-2008 vintage conduit deals have seen their special servicing rights transferred, mostly over the past year. The changes are expected to lead to more conflicts of interest and less predictability, given increased velocity of trading activity in the affected bonds and a general lack of information transparency in terms of tracking changes.

Deutsche Bank figures show that Midland has had the rights on more transactions taken away than any other special servicer by a large margin, with most of the rights going to either LNR or C-III. LNR, CW Capital and Berkadia have also had the servicing rights from at least two transactions transferred away.

The final surprise for 2014, as predicted by the analysts, is CRE CDOs/CLOs making a comeback. An increase in the amount of newly created subordinate debt will meet growing investor demand for CLO technology applied to CRE collateral, they suggest.

Only US$2.5bn of CRE CLOs have been issued since 2012 versus US$127.5bn of high yield CLOs. Upwards of US$5bn of CRE CDO transactions could be issued next year.

CS

RMBS

Further g-fee hike confirmed

The FHFA has directed Freddie Mac and Fannie Mae to raise guarantee fees as part of its ongoing drive to shrink the role of the GSEs in the market. The changes will move the effective annual g-fee for 30-year mortgages to around 62bp and decrease the likelihood of Mel Watt hiking fees when he takes over from Ed DeMarco as FHFA director.

G-fees are being changed in three ways. First, the base g-fee for all mortgages will increase by 10bp, but also the upfront g-fee grid is being updated to better reflect risk characteristics. The upfront 25bp adverse market fee is also being eliminated, except for in Connecticut, Florida, New Jersey and New York - where foreclosure carrying costs are more than two standard deviations greater than the national average.

The changes are expected to produce an overall average g-fee increase of around 11bp, with a 14bp increase on typical 30-year mortgages and a 4bp increase on 15-year mortgages. Increases of 10bp were previously announced in December 2011 and August 2012.

The changes help to further the FHFA's goal of progressing towards market-based prices, which might be expected if mortgage credit risk was borne solely by private capital. They are expected to encourage private capital into the market and reduce taxpayers' credit exposure.

"Elimination of the across-the-board adverse market fee (except as noted) provides recognition that the nationwide stress in housing markets has eased. The experience with mortgage defaults the past several years, however, has amply demonstrated that mortgage investors and guarantors have significantly greater costs carrying out foreclosures in the few states that stand far apart from the rest of the country," note Bank of America Merrill Lynch RMBS analysts.

Maintaining the 25bp adverse market fee in Connecticut, Florida, New Jersey and New York will make annual g-fees about 4bp-6bp more expensive than elsewhere. The fee is expected to be re-evaluated and refined at least annually.

For loans exchanged for RMBS, the price changes will be effective with settlements starting 1 April 2014. For loans sold for cash, the price changes will be effective with commitments starting 1 March 2014.

JL

Structured Finance

Credit fund tie-up announced

Franklin Square Capital Partners has partnered with GSO/Blackstone to launch the FS Global Credit Opportunities Fund, an unlisted closed-end fund that invests primarily in global credit. The fund seeks to generate an attractive total return - while also focusing on capital preservation - by investing in loans, bonds and other credit instruments of public and private companies, with a strong focus on the European and US markets.

FS Global Credit Opportunities Fund will employ an event-driven approach, focusing on companies that it believes are undervalued by the market. The fund intends to take advantage of dislocations that arise in the credit markets resulting from impending corporate events, such as mergers, acquisitions or corporate reorganisations.

FS Global Credit Opportunities Fund is sub-advised by GSO Capital Partners. Franklin Square and GSO/Blackstone have previously partnered on three other funds.

Structured Finance

US origination chief makes Japan move

Citi has appointed Gerald Keefe as corporate bank head in Japan, effective from the start of 2014. He will lead the division and join Citibank Japan's management committee as an executive officer, reporting locally to Kazuya Jono and globally to Michael Roberts.

Keefe was previously Citi's US head of securitised products origination. Before joining the bank in 2006 he was a partner in Dechert's structured finance practice. His successor in the US is yet to be named.

CLOs

Pricing data access for CLO platform

Vichara Technologies has integrated its V* CLO solution with Markit's pricing services. Mutual clients will be able to access Markit's pricing service within Vichara's platform and Markit will provide daily pricing feeds for leveraged loans, corporate bonds, CLOs and loan mapping services within the V* CLO framework.

The V* platform allows for forecasting, valuation and analysis of CLOs, CBOs, CDOs and other corporate-credit-linked securitisations. The association with Markit will enable better price discovery and further data transparency to improve investors' decision support, risk management, surveillance and accounting procedures.

CMBS

CMBS servicer names new ceo

Hatfield Philips International has appointed Blair Lewis as ceo, effective from next month. He has 17 years of experience in structured finance and joins from RBS.

Lewis was head of structuring and origination for Europe at RBS and also served as corporate director for global banking and markets. He previously worked at ABN Amro as well as in various positions at RBS and Société Générale and has significant experience in syndication and the origination of structured property mortgage loans and CMBS.

CMBS

CMBS pro becomes real estate head

Christian Janssen has joined Henderson Global Investors in London as head of real estate debt. He was previously co-head of commercial real estate lending at Renshaw Bay.

Janssen has also served as chairman of CREFC Europe and as head of CRE DCM for Europe at Jefferies. He has worked at Barclays Capital in London, Morgan Stanley in London and New York and First Boston, where he was based in New York.

RMBS

Record RMBS settlement agreed

Countrywide Financial Corporation has agreed to pay US$500m to investors who allege that they were misled by the company's sale of RMBS from 2005 to 2007. It is the largest RMBS class action settlement in history.

Robbins Geller Rudman & Dowd represented plaintiffs in the record-breaking case. The class action was launched two years ago (SCI 26 September 2011).

RMBS

ResCap objections resolved

Residential Capital expects to exit bankruptcy by 24 December, having resolved bondholder objections to its reorganisation plan. RMBS holders will be paid US$672.3m in rep and warranty recoveries as part of the plan. The RMBS trustees need to appoint a financial adviser to allocate this money among the RFC and GMAC trusts, with the recoveries likely to flow to bondholders in 2014.

ABS

Broadly stable outlook for US ABS

Moody's and Fitch have published their expectations for the US ABS market in 2014. While both rating agencies anticipate stable to positive credit card and auto performance, there is some disagreement on student loan ABS.

The exit of weaker card accounts from trusts during the recession and the improving wider economy will support the credit quality of the collateral backing credit card ABS, boosting performance in 2014. However, the decline in charge-offs is expected to level off and challenges persist for the sector as low short-term interest rates pressure operating margins and increased regulatory requirements make it difficult for banks to cut costs.

Moody's also warns that the improving economy could lead to banks loosening their credit card underwriting standards, which could negatively impact credit profiles. Standards are however higher than they were before the crisis and both credit card and auto ratings have proven resilient through several downturns.

Given the higher-quality collateral pools and structural enhancements in place, Fitch expects credit card and auto ABS ratings to maintain stability, despite any unforeseen macroeconomic pressures or performance deterioration. The picture for student loans is slightly different, where a downgrade of the US sovereign rating could cause an increase in rating volatility for FFELP student loan ABS.

Fitch has the vast majority of FFELP-backed transactions its covers on rating watch negative because of the link to the US sovereign rating. Its outlook for recent private label transactions is stable, but for legacy private label ABS the agency maintains a negative outlook.

Moody's outlook for both FFELP and private student loan ABS is stable. The agency expects loan performance for private student loan securitisations to improve and the outlook for FFELP securitisations has been bumped up to stable as the US government's fiscal position has improved.

As for new supply, Wells Fargo analysts project "lacklustre" consumer ABS issuance for the year of US$165bn - about equal to the expected total for 2013. Spreads are expected to tighten, but that movement is not being driven by market fundamentals.

ABS

Credit cards outperform expectations

US credit card ABS collateral again outperformed market expectations during the October collection period. The Fitch Prime 60+ Day Delinquency and Charge-off indices now stand at a record 1.25% and 2.98% respectively.

The Fitch Prime 60+ Day Delinquency Index now remains nearly 26.5% below November 2012 levels, while the Fitch Prime Charge-off Index level represents a month-on-month decline of 5% and an impressive 28.4% decline year-over-year (YOY). Prime charge-offs now stand 74% below their historical high of 11.52%, which was reached in September 2009.

Fitch's Prime Monthly Payment Rate (MPR) Index also ascended to a record high of 26.55% for October and remains up by 18% YOY. The Three-Month Average Excess Spread Index remained nearly flat MOM, declining by 23bp to 12.75%, yet remaining 17% above YOY levels.

Retail credit card indices faired less favourably in October, however. The Fitch Retail 60+ Day Delinquency Index increased for the fifth straight month to 2.67%, a 3% MOM gain.

A steady increase in late-stage delinquencies translated into losses as the Fitch Retail Charge-off Index increased by 9% in October to reach 6.24%. This index nevertheless remains nearly 2.5% lower than one year ago and 53.5% lower than its peak of 13.41% reached in March 2010.

The Fitch Retail MPR Index increased by 3.4% to 15.61% with this gain, while the Fitch Retail 3-month Average Excess Spread Index declined slightly to 17.81%. This metric remains 17% higher YOY, however.

ABS

CFPB oversight to spur servicer consolidation?

The seven largest student loan servicers have the capacity to weather the increased operating costs brought on by Consumer Financial Protection Bureau (CFPB) oversight, according to Fitch. The CFPB oversight applies to non-bank servicers of more than one million accounts.

The seven largest servicers of federal loan programmes are overseen by the US Department of Education. The CFPB's supervision will be distinct from the department's and include examinations to ensure that servicers follow all federal consumer financial laws.

In Fitch's view, the servicers' existing infrastructure will require only moderate changes, if any, to comply with additional CFPB oversight. Servicers may benefit from oversight as it could reduce the number of costly lawsuits based on deficiencies in compliance.

The bureau also may subject smaller servicers to supervision if it finds they pose a risk to consumers. Higher compliance costs and a threat of new regulations will likely create entry barriers for new entrants and force some existing players to exit the business, accelerating consolidation in the servicing industry.

Over the long run, Fitch believes that CFPB may provide guidance to servicers on prepayment strategies that could impact lenders' profits. The bureau solicited ideas for rules from borrowers and received several complaints regarding the procedure for prepayments, in which prepayments were spread evenly across all loans instead of being applied to the highest interest rate loans first.

ABS

Negative outlook for WBS

Fitch says its outlook for UK pub and healthcare whole business securitisations is predominantly negative for 2014. This is driven by a fragile UK economic recovery, public spending austerity and regulatory pressures.

"Continuing decline in average real income, combined with public spending cuts mainly affecting healthcare funding as well as various regulatory pressures are all holding back the outlook of the WBS sector," says Stefan Baatz, senior director in Fitch's global infrastructure team.

The agency expects certain transactions to be more resilient. For example, performance of managed pubs has remained comparatively strong, with sales still up across the board. The traction driven by their food offering is expected to continue in 2014.

By contrast, tenanted pub companies' like-for-like profits are still declining on average at 2%. Tenanted pub companies could also be subject to increased profit-sharing with their tenants, impacting the pub companies' profitability. This was suggested by the Business, Innovation and Skills Committee ruling, which is expected to be addressed during the next parliamentary session in 1H14.

Care home operators also face tighter regulation. The Care Bill currently going through parliament proposes to establish the Care Quality Commission as the financial regulator of the care home sector, overseeing the finances of 50 to 60 of the largest care companies in England.

Furthermore, large private hospital operators are being scrutinised by the competition commission. Preliminary findings suggest that there is too much 'market power' in many local markets, leading to higher prices for patients.

Given the diversity within the universe of Fitch-rated WBS transactions, rating actions have not followed the same path across sub-sectors. However, the key trend is that healthcare ratings have increasingly been downgraded, driven by poor trading performance combined with refinancing pressures. Among pub securitisations - which had in the past been subject to the bulk of the downgrades - only one debt tranche was downgraded in 2013.

Structured Finance

Call to limit RWEM disclosure

DBRS has issued a comment letter regarding the proposal to incorporate existing Rule 17g-7 under the Securities Exchange Act of 1934 into new rule 17g-7(a)(1)(ii)(N). Current Rule 17g-7 requires each NRSRO to include in any report accompanying an ABS credit rating a description of all the representations, warranties and enforcement mechanisms (RWEMs) available to investors, regardless of what those RWEMs relate to and how they differ from the RWEMs in issuances of similar securities.

DBRS submits that the current version of 17g-7 is not working as intended from both the investor and NRSRO perspectives and should be revised in the course of the pending rulemaking. The agency suggests that the SEC has the opportunity now to examine how the existing rule is working in practice before re-codifying the current RWEM disclosure requirements.

In taking such an expansive approach towards RWEMs, the SEC rejected public comment suggesting that since the purpose of Section 943 was to improve transparency regarding underwriting in ABS transactions, the rule should be limited to RWEMs relating to the underlying pool assets and not include other aspects of the transaction. The Commission also dismissed concerns about the anticipated length of the disclosures and rejected the suggestion that NRSROs be allowed to provide the required disclosures by reference to a transaction's offering documents or other materials disclosed by the issuer or underwriter, rather than describing each RWEM separately in the rating report.

With regard to the other side of the equation - the RWEMs available in issuances of similar securities - the SEC declined to define the term "similar securities" or to permit comparisons to industry standards. Instead, the Commission directed each NRSRO to draw on its knowledge of industry standards and its experience with previously rated deals to make its own determination as to what constitutes a similar security for the purpose of the required comparisons.

The SEC suggested that an NRSRO could fulfil this obligation by establishing benchmarks for different types of securities based upon a review of previous issues and revising those benchmarks on an ongoing basis as necessary. The Commission has not provided any subsequent guidance on this issue, DBRS notes.

Compliance with Rule 17g-7 was required as of 26 September 2011. Before that date arrived, the SEC proposed to revamp the rule to incorporate a host of NRSRO requirements mandated by Title IX, Subtitle C of the Dodd-Frank Act.

In this regard, proposed new paragraph (a) of Rule 17g-7 sets forth up to a score of additional items NRSROs would be required to disclose with each credit rating, in accordance with Dodd-Frank Act Section 932(a)(8). The RWEM disclosures of existing Rule 17g-7 would then form just one of the required disclosures, identified as subsection (a)(1)(ii)(N) in the revised version of the rule.

Requiring disclosure of all RWEMs, coupled with requiring the publication of corresponding benchmarks in each report has led to overwhelming 17g-7 disclosures. Two hundred-page RWEM reports are not uncommon and one recent DBRS report topped 800 pages.

"Not only has this process proven enormously costly to the NRSROs, but it is of very little value to investors," the agency observes. "According to the feedback DBRS has received from its institutional clients and an analysis of usage data from our website, these voluminous reports are not being read. We understand that the staff of the SEC's Office of Credit Ratings has received similar feedback from the rule's intended beneficiaries."

Although the Commission has refrained from conducting a full cost-benefit analysis on rules mandated by the Dodd-Frank Act, DBRS respectfully submits that clear evidence of costs and benefits supplied by more than two years of Rule 17g-7's operation cannot be ignored. The agency further submits that the problems with the current rule could largely be addressed by limiting the scope of the RWEMs NRSROs are required to disclose and by modifying the means by which the benchmarks are identified to investors.

In particular, DBRS believes that the purpose of Section 943 can best be achieved by limiting the disclosure required by Rule 17g-7(a)(1)(ii)(N) to RWEMs that relate to the asset pool underlying the ABS transaction in question and which the issuer has disclosed in the prospectus, private placement memorandum or other offering document for that transaction.

Structured Finance

Strong results seen for MBS funds

Hedge fund returns rose by an average of 1.1% in November, boosting average year-to-date returns to 8.2%, according to the latest eVestment figures. On an annualised basis the industry is on pace to return 9% for the year, nearly 150bp ahead of 2012's 7.5% increase.

With a 0.35% return, credit strategies lagged the industry's average returns in November, weighed down primarily by smaller directional trading strategies. The ten best-performing credit funds last month have an average AUM of nearly US$1bn, while the bottom ten's AUM was less than half that size at US$342m.

However, MBS-focused funds posted very strong results in November (2.33%, boosting YTD returns to 10.48%), their best month of the year. "The group appears to be at an interesting point in its multi-year run of excellent performance and investor flows. Specifically, performance continues to be positive, albeit prior to November below its four-year average rate, while investor flows have been mixed in recent months," eVestment observes.

Distressed fund returns were up by 0.97% last month and now stand at 13.23% YTD.

Structured Finance

Bondholder communication tool launched

DealVector has launched InvestorLink, with the aim of streamlining communication in the structured credit markets. Created primarily for issuers, collateral managers and trustees, the service is designed to open a direct communication channel between deal administrators and noteholders.

Benefits of the service include: accelerated execution of amendments, waivers, consents and other voting events; improved liquidity and transparency; and differentiation for collateral managers as an investor-friendly provider of administrative services. InvestorLink allows deal administrators, investors, lawyers and other affiliated parties to create asset-specific micro-sites to communicate with noteholders about an upcoming event. An InvestorLink micro-site allows the author to describe the event and actions required, make pertinent documents available for download and create a customised URL for distribution through DTCC, Euroclear, Clearstream or other channels. Visitors to the InvestorLink site can correspond with the site's author through an identity-protected communication channel.

Issuers, collateral managers and trustees can also print InvestorLink URLs on monthly trustee reports, inviting holders to 'follow' their deals and thereby receive direct notification on future events.

Structured Finance

Greek country ceiling lifted

Fitch and Moody's have implemented positive rating actions on a number of Greek securitisations. The move follows an uplift in the Greek country ceiling by both agencies.

Moody's upgraded 16 notes and affirmed six notes in nine Greek transactions, after the agency raised its country ceiling on Greece to B3 from Caa2 and upgraded Greece's sovereign rating to Caa3 from C. The agency says that the move reflects a slightly lower redenomination risk and a lower likelihood of exit from the euro area.

Fitch upgraded 20 and affirmed eight tranches of nine transactions. Following the affirmation of the Greek sovereign at single-B minus, the agency upgraded the country ceiling for Greece to single-B plus from single-B.

It notes that the upgraded tranches have sufficient credit enhancement to absorb higher future defaults and losses at the country ceiling rating level. Many of the mortgage portfolios have paid down significantly, resulting in sequential note repayment and a build-up of CE, particularly for the senior tranches.

Structured Finance

Minimal Euro default rate underlined

Only 1.5% by original issuance volume of European structured finance notes outstanding in mid-2007 had defaulted by end-3Q13, according to S&P's latest quarterly transition study. The quarterly transition study analyses cumulative rating transitions and defaults from the beginning of the financial downturn - which is assumed to be mid-2007 - until end 3Q13, aggregating by issuance volume.

"The 12-month rolling European structured finance downgrade rate was 23% at the end of 3Q13, while the 12-month rolling default rate remained elevated at 0.43%," says S&P credit analyst Arnaud Checconi. "In addition, we estimate that more than 65% of European structured finance notes outstanding in mid-2007 have now redeemed in full."

S&P notes that the application of its European CMBS and SME CLO criteria, weak collateral performance in Spain and the knock-on effect of three large European bank downgrades were the main contributing factors behind the 12-month rolling downgrade rate of 23%. Consumer-related securitisations have outperformed those backed by corporate loans, with cumulative default rates since mid-2007 of 0.04% and 4.90% respectively. Higher-rated notes outperformed those ranked junior in the capital structure, with only 1.03% of ratings on triple-A issuance defaulting since mid-2007.

"We believe that the European recession may have found a bottom in 2Q13. However, we should discount a marked improvement in structured finance collateral performance as we expect subpar economic growth in most European countries for the coming two years (except for the UK and Germany) and only a gradual decline in unemployment, especially in the peripheral eurozone countries," S&P observes.

Structured Finance

Volcker Rule set to be finalised

The CFTC, FDIC and Federal Reserve Board are each set to discuss - and potentially approve - a final draft of the Volcker Rule next week. They will each meet separately on 10 December.

The US SEC and OCC must also approve the rule. The SEC is also expected to vote on the rule next week, while the OCC has a different finalisation process because it is not led by a board or commission, but lawyers at Schulte Roth & Zabel expected it to finalise the rule in conjunction with the other banking agencies.

Structured Finance

Euro credit quality to remain stable

The credit quality of European ABS and RMBS transactions will remain stable overall in 2014, says Moody's in its outlook report for the sector. Against the backdrop of stabilising macroeconomic drivers for most countries, affordability across Europe will be sustained by the low interest rate environment, prudent underwriting criteria and regulatory initiatives to boost credit supply.

While considerable risks remain, Moody's collateral performance outlook for the sector now seems less uncertain than it has been for some time, although performance dynamics will vary from country to country. For some countries, the effect of unemployment stabilising at high levels and growth rates at low levels - combined with the persistent effects of tightened credit supply - will continue to negatively affect the credit quality of the collateral backing ABS and RMBS, the agency notes.

Moody's has updated to positive its collateral performance outlook for the UK for credit card ABS, prime RMBS and buy-to-let RMBS, as it believes that UK transactions will continue to improve, aided by robust domestic recovery and low interest rates. The performance of German ABS and RMBS transactions, as well as RMBS deals in the Netherlands, remains stable at their current robust levels.

Although macroeconomic challenges remain for consumers, the Italian RMBS and consumer and auto ABS sectors have returned to stable outlooks aided by relatively sound economic indicators, proven resiliency and continued low household indebtedness compared to most European peers. Albeit for different reasons, Spanish ABS and RMBS and Irish RMBS are still under stress and will retain negative collateral outlooks for the next 12 to 18 months, Moody's says.

Moody's expects European ABS and RMBS issuance to remain low in 2014, at similar levels to 2013, but recover thereafter. Bank balance sheet deleveraging supported by greater banking sector liquidity and regulatory initiatives that provide cheaper alternatives to securitisation are weighing on volumes, the agency notes. However, spread compression across Europe is likely to lead to greater issuance from markets such as Italy, UK non-conforming RMBS or new markets, such as Russian RMBS.

Structured Finance

Divergent Euro rating outlook

Fitch's rating outlook for European structured finance (SF) transactions is geographically split. Almost 70% of ratings in the core European countries are predominantly stable, with the remainder related to transactions from the eurozone periphery, which are predominantly negative.

The negative outlooks for the eurozone periphery reflect a combination of declining asset performance, uncertainty over timing and extent of recoveries, policy uncertainty and sovereign credit considerations, Fitch notes. In contrast, expectations of GDP growth in France, Germany and the UK - together with flat or improving unemployment levels - support the mainly stable asset performance and rating outlooks in these core European countries. Despite increasing unemployment and further house price declines in the country, ratings on senior notes of Dutch RMBS transactions also remain stable.

Nearly all triple-A rated European SF transactions have stable outlooks. For seasoned ratings, this is usually due to high credit enhancement levels accumulated following sequential amortisation.

In consumer ABS transactions, the underlying loans have generally been originated post-crisis and as a result are tightly underwritten. Consumer ABS deals also have short maturities with rapidly deleveraging structures, which supports the stable outlook for notes across the capital structure.

Meanwhile, credit markets are improving for higher-quality commercial real estate and leveraged loan assets. However, borrowers with weak credit profiles and loans backed by inferior quality real estate will likely continue to struggle to repay, leading to more loan extensions and defaults.

CDO

Broadly stable outlook for CDOs

Moody's expects the credit quality of most existing US SF CDOs to be stable in 2014, but to improve for CLO-squared transactions because of CLO tranche amortisations and optional redemptions. Structural features in US cashflow SF CDOs are also generally credit positive for the senior-most tranches.

The credit quality of existing European SF CDOs will depend on the extent of deleveraging and the outlook for the predominant collateral in each transaction, the agency notes. Senior tranches in cashflow CDOs will continue to benefit from amortisation, while junior tranches will be sensitive to any deteriorating credit quality and lower diversification. Synthetic transactions with large exposures to collateral originated from weak European economies will continue to perform poorly, according to Moody's.

Meanwhile, the credit quality of existing bank-only and bank/insurance Trups CDOs is anticipated to improve in 2014, owing to improvement in the credit quality of underlying collateral and the deleveraging of senior notes from redemptions of bank Trups collateral and diversions of excess spread. Based on Moody's stable outlook for most of the insurance sectors, the agency does not expect the credit quality of insurance Trups CDOs to change from 2013. Insurance Trups CDOs will also continue to benefit from the deleveraging of senior notes.

The largely stable credit outlooks for investment grade credits and low default rate projections for speculative grade credits should also support the stable performance of existing CSOs in 2014. Nevertheless, the average gap between market-implied ratings (MIRs) and fundamental ratings for speculative grade reference entities has widened slightly in recent months, which could dampen CSO performance - particularly for portfolios referencing mainly speculative grade credits. The duration of CSOs continues to shorten, which is credit positive, however.

Finally, the credit quality of new market tax credit (NMTC) transactions issued with credit enhancement in 2014 is expected to be similar to that of NMTC transactions issued last year and reflect the quality of their credit support. "The credit quality of new NMTC transactions issued without credit enhancement will depend solely on the issuer's compliance with NMTC programme requirements," Moody's says. "As in 2013, NMTC transactions will represent the majority of tax-credit-generating structured note issuance in 2014. The credit quality of seasoned NMTC and certified capital company (CAPCO) transactions will be stable at a strong level."

CDS

JCP CDS outperform retail index

Five-year J.C. Penney credit default swap spreads have tightened by 31% and are currently quoted at 1,149bp, after reaching a high of 1,665bp on 25 October, according to Fitch Solutions. The move outperformed a 5% firming for the broader North America Retail CDS Index over the same time period.

The tightening reflects the 0.9% improvement in comparative store sales in October, marking the first positive comp report since December 2011. JCP said that trends are expected to improve into the fourth quarter, supported by a 10% comp increase in November. The company also expects that gross margin should improve from third-quarter depressed levels of 29.5%.

A widening of over 700bp from September to October had reflected market concerns about the need for additional liquidity over the next 6-12 months. This follows an US$800m equity infusion to offset a significant cash burn during the first three quarters and weak prospects for top line and gross margin improvement.

However, Fitch notes that JCP credit protection continues to price at distressed levels, given the significant execution risk and concerns regarding the heightened promotions needed to drive sales. The CDS maturity curve remains partially inverted, but the six-month CDS is no longer the most expensive tenor. This is now the three-year tenor, currently trading 32bp above the five-year CDS.

CDS liquidity for JCP remains high but has decreased slightly, from trading in the second global percentile rank to the fifth.

Beyond 2013, Fitch estimates that the company will have to generate a minimum of US$650m-US$675m in EBITDA to fund ongoing capex of US$300m and cash interest expense of US$360m-US$375m. This would require JCP to return sales of approximately US$13bn (up 10% from 2013 projected levels of approximately US$12bn) and realise gross margins in the 39%-40% range, assuming a relatively flat cost structure. This appears to be highly ambitious, given the significant execution risk.

CDS

Cross-border rule challenged in court

ISDA, SIFMA, the Financial Markets Association and the Institute of International Bankers are suing the CFTC for defects in its cross-border rule. They allege that the CFTC failed to follow complete rulemaking procedures and their suit also challenges aspects of other CFTC Dodd-Frank swap rules and seeks broad relief, including that the cross-border guidance be vacated.

The associations say that the CFTC unlawfully circumvented the requirements of both the Administrative Procedure Act and Commodity Exchange Act by characterising its own cross-border regulations as guidance. They further allege the rulemaking process was flawed and that the CFTC failed to conduct any cost-benefit analysis, as required by law.

Further, the CFTC is accused of imposing a series of rules that are contrary to the spirit and the letter of international cooperation, potentially harming global markets. The confusion caused by the CFTC's cross-border rule and its lack of coordination with the US SEC or foreign regulatory bodies has caused non-US counterparties to become increasingly reluctant to transact with US-based dealers, corporations or other end-users, say the associations.

CDS

OGX price settled

The final price of OGX PETROLEO E GAS PARTICIPACOES SA CDS was determined to be 9 at yesterday's auction. Twelve dealers submitted initial markets, physical settlement requests and limit orders to settle credit derivatives trades across the market referencing the name.

CLOs

Stable performance forecast for CLOs

US CLO issuance surpassed US$66bn through October 2013 and loan fund inflows were above US$56bn, increasing the visible demand for leveraged loans by US$122bn, according to Fitch. The agency notes that issuers of more than 81% of loans held in Fitch-rated CLOs maintain stable rating outlooks, indicating an expectation of stable rating performance over the next one to two years.

Negative and positive rating outlooks for issuers of underlying loans account for 9.3% and 8.6% respectively. At least 90% of issuers from each of the business services, energy, broadcast/media, industrial/manufacturing and chemicals industries have a stable rating outlook. Issuers from these five industries account for 31.6% of CLO portfolios.

More than 25% of issuers from the banking/finance and lodging/restaurants industries have a positive rating outlook, while these two industries account for roughly 6.6% of outstanding CLO holdings. More than 33% of issuers from the aerospace/defence and pharmaceuticals industries have a negative rating outlook, although they represent less than 5% of outstanding CLO holdings.

The sharp expansion in loan demand has led to some favourable terms for loan issuers, Fitch observes, as evidenced by the increase in covenant-lite loan issuance in 2013. "While this increase in covenant-lite loan issuance can be a sign of an overheated credit market, other metrics seem to indicate the current loan market is maintaining discipline," the agency says. "The majority of the 2013 loan issuance has consisted of refinancing activities, with new money issuance representing about one-third of the issuance volume. Similarly, leverage levels have begun to rise but remain within historical norms."

Fitch expects CLO managers to continue to build par coverage, as measured by the overcollateralisation (OC) cushion and overall increase in the aggregate principal balance over the target par amount. An increase in the robust demand for secondary loan paper and primary loan issuance would have a dampening effect on CLO managers' ability to build par for their new CLOs, Fitch suggests. But CLO managers with a strong position in the loan market would be able to benefit from better access to loan supply.

Since January 2013, managers have increased par coverage, measured by an average increase in senior OC ratio cushions of 0.6% and junior OC ratio cushions of 0.4%. Additionally, managers of CLOs issued in 2012 have been able to build principal balance cushions to target par amounts by an average of 0.5% since closing.

The weighted average spread (WAS) for CLOs declined from an average of 4.7% in January to 4.4% at the end of October. Fitch expects spread compression on underlying loans to continue resulting in reduced WAS levels for CLOs. Modest spread compression will not result in a meaningful impact to Fitch's ratings on CLOs, but significant spread compression may place pressure on CLO managers' ability to maintain passing collateral quality tests, the agency notes.

CLOs

Mezz SME CLO credit risk highlighted

German mezzanine CLOs face greater credit risk than refinancing risk, Fitch suggests. Defaults during the lifetime of the underlying loans appear to be exceeding defaults at scheduled loan maturity.

Of the10 Fitch-rated German mezzanine CLOs issued between 2004 and 2007, seven have reached scheduled maturity, making an initial assessment of the relative impact of credit and refinancing risk possible. In all cases, loan defaults prior to scheduled maturity are larger than those caused by failure to refinance at scheduled maturity.

The agency notes that both credit and refinancing defaults have a negative impact on portfolio cashflows, which in turn negatively affect redemption amounts. But the credit and refinancing default amounts materially differ across transactions, due to the limited granularity and different credit profiles of the pools, as well as the different level of involvement of the respective portfolio managers.

The transactions' default rates range between 12% and 36% as a percentage of the initial pool balance, primarily reflecting the low credit quality of the underlying borrowers. The poor asset performance has triggered a number of downgrades of the notes - the senior notes initially rated triple-A were subsequently downgraded to speculative grade.

The underlying loans also had bullet maturities after at least five years, embedding refinancing risk in the transactions. If an SME fails to repay a bullet loan from its own funds or arrange refinancing, then a principal deficiency occurs to the particular mezzanine CLO securitisation. Whether the principal deficiency can be cleared following the scheduled maturity date depends on the achieved recoveries, which are low because of the junior and unsecured nature of the debt.

Fitch believes that stressed sales of loan agreements shortly before scheduled maturity are driven by refinancing considerations, since portfolio managers and involved companies usually start taking measures in anticipation of the upcoming loan maturity around one year before the scheduled maturity. Portfolio managers often attempt to reduce the uncertainty by selling the companies' loan agreements to third parties. However, while such stressed sales generate funds, the proceeds are usually far below the outstanding loan obligations.

The rated notes in two of the deals - Preps 2004-2 and Force 2005-1 - were fully repaid on the respective scheduled maturity date, suggesting that the majority of the underlying companies successfully managed to refinance their debt. In Preps 2004-2, refinancing defaults amounted to 9.1% compared with credit defaults (12.7%).

In the case of Force 2005-1, refinancing defaults amounted to only 1.4% as compared with credit defaults of 18%. Despite the fairly high amount of principal deficiencies, these two CLOs managed to repay the rated notes on the respective scheduled maturity date due to a fairly high amount of credit enhancement and excess spread.

Another securitisation where the rated notes have already been fully redeemed is Preps 2005-1. In this transaction, the asset portfolio funds were not sufficient to redeem all the rated notes on the transaction's scheduled maturity date.

However, subsequent recoveries contributed to their full redemption ahead of the legal final maturity date. At scheduled maturity, credit defaults (23.6%) materially exceeded refinancing defaults (6.7%).

Four of the deals - Preps 2005-2, Preps 2006-1, StaGe and Prime 2006-1 - did not see full repayment on their respective scheduled maturity date. Credit defaults amounted respectively to 33.6%, 24%, 24.5% and 24.4%, while refinancing defaults were all significantly lower, amounting to 7.2%, 18.5%, 14.2% and 3.1%.

Due to the material total defaults exceeding credit enhancement, the junior rated notes were not fully repaid at the respective scheduled maturity date. Their current ratings are single-C (for all but StaGe) or double-C (StaGe), implying that a default is inevitable at the respective legal final maturity.

Force Two and Preps 2007-1 will reach their scheduled maturities in January 2014 and March 2014 respectively. To date, credit defaults total 22.6% and 38.9% of the respective initial pool balance.

Stressed sales to date are 1.4% and 8.1% respectively. However, additional companies may fail to repay their debt at the scheduled maturity or further loans may be sold at haircut, further increasing the amount of refinancing defaults.

CLOs

Strong credit quality forecast for global CLOs

Moody's expects the credit quality of new CLOs in the US, Europe and Asia-Pacific to be strong in 2014. The agency says that the CLO 2.0 template will underpin strong performance in US balance sheet and SME transactions in particular.

Increased subordination across the two segments is anticipated to offset the negative effects of newly issued loans of lower average credit quality. New SME transactions will also benefit from substantial credit enhancement and structural provisions that protect debtholders from unexpected risks, while many existing BSL and SME CLOs will benefit from amortisation.

"The primary risks to our outlook stem from the shift in the loan market toward riskier borrowers," says Yvonne Fu, a Moody's md. "The proportion of B3-rated issuers among speculative grade borrowers has grown this year and is likely to continue growing in 2014. Nevertheless, new US CLO structures will be sound and the assets backing them will perform well, which will offset the negative effects of newly issued loans of lower average credit quality."

Existing CLOs - particularly CLO 1.0 deals - will benefit from amortisation as loan collateral prepays and structures delever. "Amortisation favours senior tranches, but negatively affects the quality of remaining collateral because better quality credits tend to prepay, leaving lower quality credits," says Jian Hu, a Moody's md. "So, even though junior classes also benefit from increased overcollateralisation, their credit quality is more vulnerable to deterioration."

Optional redemptions are another positive trend, Moody's notes. However, existing CLOs - particularly CLO 1.0 deals - could be subject to the risk that a portfolio's weighted average life could lengthen. Declining loan spreads would also be credit negative for existing CLOs.

Issuance volume next year for both BSL and SME CLOs in the US will likely be similar to 2013 levels. The primary constraints on growth are the scarcity of triple-A investors and pressure on excess spread. However, the amortisation and the redemption of older deals, together with market innovations should support primary activity.

The credit quality of new European BSL CLOs, meanwhile, is expected to be similar to that of deals issued in 2013. European CLO 2.0 structures will remain more conservative than typical European CLO 1.0 structures, with shorter reinvestment periods and higher levels of equity subordination. Additionally, new loans will likely be subject to stricter lending criteria by originators, who will also target enhanced performance stability.

Amortisation will drive the performance of most existing CLOs, although the effects on senior and junior tranches will vary. The exposure to borrowers based in the lower-rated peripheral euro-area countries is generally limited to 10% of the eligible portfolio, Moody's says.

The agency adds that, despite the resumption of new issuance in 2013, the outlook for primary European BSL CLO issuance in 2014 is rather uncertain. The main drivers of new issuance will be the availability of collateral and the impact of new regulations taking effect in 2014.

"Issuance of balance sheet CLOs will again be low because of the gap between investors' yield targets and originators' cost constraints, as well as the constrained capacity and willingness of European commercial banks to extend new corporate loans. Furthermore, origination will likely be restricted to a diminishing number of safe-haven domiciles in northern Europe, given the impact of the sovereign crisis on peripheral European nations," it explains.

Regarding existing SME CLOs in Japan, such transactions are anticipated to benefit from banks' supportive lending attitude to SMEs, which continue to amortise. However, new issuance is likely to be minimal in 2014.

Finally, balance sheet CLOs in Asia ex-Japan will continue to perform solidly - even though the credit quality of loans in some regions will deteriorate - because: portfolios are diversified by country and industry; loan replacement criteria safeguard portfolio credit quality; and the projected default rate remains low, supported by continued growth in GDP in major emerging market countries. Issuance in 2014 is expected to be low, however, because of an increase in regulatory costs. Regulators have increased the capital charges on investors holding structured finance securities, which will reduce the benefit of decreasing charges for originators.

CMBS

Smaller balance loan transfers rise

Fitch reports that smaller balance US CMBS loans are increasingly transferring to special servicing. So far this year, 647 loans in the agency's rated universe transferred to special servicing - approximately 100 more than for the same period last year, but by dollar volume the number has declined considerably (US$15.8bn YTD November 2012 versus US$7.5bn in 2013).

Most transfers to special servicing year-to-date 2013 have primarily been in the US$10m and below range (accounting for 467 loans at US$1.8bn), while only 16 loans with balances over US$75m transferred to special servicing this year (US$2.2bn). By this time last year, Fitch observed 39 transfers exceeding US$75m (US$8bn total).

By property type, office and retail represented the greatest volume in both years. However, more multifamily loans transferred in 2013 at 104 compared to 83 loans in 2012, but by balance the 2013 transfers totalled only US$576m compared to US$1.4bn for the same time last year.

For the other major property types, a comparison of loans transferring YTD November 2013 compared to YTD November 2012 shows: 194 loans at US$2.9bn for office in 2013 versus 191 loans at US$5.8bn in 2012; 189 loans at US$2.1bn for retail in 2013 versus 148 loans at US$2.7bn in 2012; and 47 loans at US$1.2bn for hotel in 2013 versus 56 loans at US$3.4bn 2012.

CMBS

Defeasance activity accelerating

US CMBS defeasance activity accelerated to US$10.1bn by end-November - a 140% jump over the same period a year ago, according to Commercial Real Estate Finance Council (CREFC). The association suggests that this is due to multiple factors, including concern about increased rate volatility, the ongoing stabilisation of property values and the coming expectation of loan maturities.

Many borrowers appear to be concerned about Treasury bond rates dropping, causing the price of bonds to rise and, with them, the cost of defeasance. As financings increasingly become available and markets continue to normalise, more defeasance activity can be expected, especially as loans mature in greater numbers.

"We are still in a period of economic transition," comments CREFC president and ceo Stephen Renna. "And the industry still has to face the issue of expected loan maturities. The up-tick we're tracking in defeasance activity is clearly a sign of that movement and, provided interest rates stay low, we expect 2014 to exceed current levels of activity."

CMBS

CRE CDOs tipped for growth

US CMBS financing will expand on 2013 levels, according to Fitch's 2014 Outlook report for the sector.

The agency notes that mortgage interest rates have increased rapidly from their early 2013 lows and, while the outlook on interest rates is largely benign in 2014, the expectation is that they will continue to rise slowly. That may impact the ability of a new 2014 loan to refinance all of a maturing first mortgage. Fitch consequently believes that this will result in an increased use of mezzanine financing and more floating-rate debt transactions, perhaps through whole-loan CRE CDO structures.

Underwriting will be of continued focus in 2014. All Fitch metrics, save debt service coverage ratios (DSCRs), worsened in 2013.

DSCRs improved due to the decline in interest rates and the increase in interest-only (IO) loans. But DSCRs are expected to worsen in 2014 as interest rates tick up. IO loans comprised 49% of the pool on average through end-September, compared with 33% in 2012.

Fitch LTV averaged 100% though 3Q13 versus an average of 97% in 2012. As LTV moves past 100%, the Fitch default curve steepens and CE rises more quickly than the corresponding increase in LTV. Average CE at the triple-A level through 3Q13 was 100bp higher than the 2012 average.

However, the increase was muted by the decrease in DSCR and the increase in loan count, which provided diversification benefits. If DSCR starts to decline and LTV continues to rise, the uptick in CE will be more substantial, Fitch warns.

Property quality will also be closely watched next year, the agency notes. It says there has been a tendency recently for poorer quality properties and loan structures to make it into preliminary pools. There is also a concern that pools are being filled with small-balance, low-quality properties that improve diversification but reduce property quality.

Ratings on investment grade CMBS bonds should be mostly stable in 2014 because potential declines in performance and value have already been built into their analysis, Fitch says. However, it points to continued risk from idiosyncratic factors that in the past have caused substantial declines in value. The effects of these declines in value will be felt most acutely in concentrated pools.

"Most investment grade bonds should be immune to a downgrade from these risks," the agency observes. "Select senior bonds are at risk from interest shortfalls and are already or will be capped at single-A. Non-investment grade bonds will continue to bear the brunt of ratings changes."

CMBS

Multifamily CMBS origination trending up

Kroll Bond Rating Agency expects the US multifamily CMBS sector to continue benefitting from household formation and low homeownership. As long as multifamily fundamentals continue to outperform the rest of the commercial real estate market, both investors and lenders will feel comfortable expanding their allocations to the sector, the agency suggests.

On the lending front, this trend has been evident in CMBS conduit, commercial bank and life company originations all posting strong double-digit increases this year. Conduit originations are up by 44% year-to-date, according to KBRA, outpacing both commercial banks and life insurers - which posted increases of 22% and 19% over the same period.

The agency anticipates that growth in conduit originations will outpace alternative sources as the GSEs reduce production - particularly given the increasing number of borrowers that face CMBS loan maturities in the coming years. Acquisition financing will likely also be a source of growth for the sector, given property sales volumes, which have increased by more than 67% year-over-year through October.

"Conduits are well positioned to participate in this growth, provided the spread environment doesn't impede conduit lenders' ability to offer attractive financing rates," KBRA notes. "Multifamily fundamentals will also inevitably play a role in overall financing volumes and, while it isn't clear the sector's outsized performance will continue, housing and demographic trends suggest the sector will remain relatively strong over the next couple of years."

The agency anticipates that the percentage of multifamily product in CMBS will trend upwards throughout next year. "When 2015 rolls around, we may even see the proportion of multifamily in CMBS approach or exceed levels last seen in the mid-2000s, when it represented on average 18% of the CMBS universe, with some recent deals in the conduit universe starting to trend closer to 20%."

CMBS

Pay-off percentage hits highs

The percentage of US CMBS loans paying off on their balloon date hit 81.3% in November, the second highest rate since Trepp began tracking the number in August 2008. The highest reading was 84.9% in December 2008.

The November pay-off percentage is well above the 12-month moving average of 66.1%. By loan count as opposed to balance, 79.1% of loans paid off last month, with the 12-month rolling average on this basis now at 68.5%.

CMBS

CMBS loss severities dip

The weighted average loss severity for all loans backing US CMBS that liquidated at a loss was 41% in 3Q13, down from 41.5% in the previous quarter, according to Moody's. The weighted average loss severity for all liquidated loans excluding those with losses of less than 2% was 52.7%, down from 53.5% in the previous quarter. Loans with losses of less than 2% account for 22.7% of the sample size by balance and 19.8% by count.

There were three liquidations with both a high dollar loss and a high percentage loss in the third quarter. The Promenade Shops at Dos Lagos loan liquidated with a US$135.4m loss for a loss severity of 109.2% (see SCI's CMBS loan events database), Silver City Galleria liquidated with a US$108.2m loss for a severity of 91.2% and the Duke Cleveland East Suburban Portfolio liquidated with a US$77.5m loss for a severity of 58.2%. The Promenade Shops at Dos Lagos represents the highest dollar loss recorded, while Silver City Galleria is the fifth highest and Duke Cleveland East Suburban Portfolio the tenth.

Loans backed by retail properties had the highest weighted average loss severity (48.8%) and loans backed by self-storage properties had the lowest (33%). The vintages with the highest loss severities are 2008 (52.6%), 2006 (49.1%) and 2007 (40.9%). As of September 2013, these vintages constituted 54.4% of CMBS collateral and 76.5% of delinquent loans.

"We expect aggregate conduit losses, inclusive of realised losses, on deals we rate of 7.9% of the total balance at issuance for the 2005 vintage, 11.8% for the 2006 vintage and 13.9% for the 2007 vintage, with most of the losses yet to be realised," comments Moody's vp and senior credit officer Keith Banhazl. "The aggregate realised loss for these three vintages is currently 3.2%."

Of the 10 metropolitan statistical areas (MSAs) with the highest dollar losses, New York had the lowest severity (23.6%) and Detroit had the highest (61%).

Total cumulative realised losses for all liquidated loans rose in the second quarter to 2.8% from 2.7% in the prior quarter. For all liquidated loans, the 2008 CMBS vintage had the highest cumulative loss rate - 5.4% - in the third quarter, up from 4% in the previous quarter. The 2000 CMBS vintage had the second-highest cumulative loss rate - 4.6% - the same as in the prior quarter.

CMBS

Euro CMBS performance to stabilise

Weak European CMBS performance is set to stabilise in 2014 on improving market fundamentals, says Moody's. The rating agency's outlook on the sector also predicts bolstered commercial real estate values, although significant losses are expected on legacy deals over the next five years.

Secondary property values are expected to stabilise and loans backed by prime properties should perform strongly in 2014. However, weaker secondary and tertiary property prices will continue to fall.

Moody's believes the outlook for CRE property values in the UK and Germany will improve. They are being propped up by strong capital inflows, improving tenant demand, more positive sentiment towards the sector and an easing of the constrained lending environment.

Legacy loans will continue to challenge the sector, with most pre-2008 securitised properties highly leveraged. Therefore, despite the continuing improvement in CRE fundamentals, Moody's expects around 60% of the €5.5bn CMBS loans in transactions it rates maturing next year will not repay, adding to the €17.7.bn of loans currently being worked out. The agency estimates that loan-level losses will total around €9bn.

CMBS

Major market recovery boosts CRE prices

The recovery in major markets boosted the recovery in national commercial real estate prices to within 11% of the December 2007 peak, according to the latest Moody's/RCA CPPI report. Major markets recouped roughly 95% of their peak-to-trough decline, while national prices have recovered almost 75% of their peak-to-trough decline. Non-major markets recouped around 56% of their losses.

The national all-property composite index increased by 1.1% in October. The apartment component of the national all-property composite index (which constitutes roughly 28% of the composite) increased by 1.2% in October, while the core commercial component (roughly 72% of the composite) increased by 1%.

"Of the core commercial sectors, the industrial sector has lagged the most in its recovery, with prices increasing over the last 12 months at roughly half the rate of the other three components of the commercial sector," says Moody's director of commercial real estate research Tad Philipp. Prices in the industrial sector increased by 6.3% over the last 12 months, compared with at least 12% for the retail, CBD office and suburban office sectors.

Metro area apartment price changes varied greatly in comparison with changes in net operating income (NOI). From 4Q07 to 4Q12, the increases in apartment prices in Seattle exceeded apartment NOI growth by 10 percentage points. Apartment price changes in San Francisco, Orlando, New York and a composite of three Texas metros were within five percentage points of their NOI changes.

"The outlier was South Florida, where the impact of condo conversions and the housing crisis caused prices to lag NOI growth by 36 percentage points," adds Philipp. "Eleven other metro areas or metro composites also saw price growth substantially lag NOI growth."

CMBS

CMBS outlook 'moderately positive'

While the US CMBS market has benefited from low interest rates, better access to capital and the recovery in property fundamentals, S&P warns that several economic risks remain. The rating agency predicts GDP growth of 2.6% and has a moderately positive 12-month outlook for CMBS.

Average credit metrics such as LTV ratios, percentage of interest-only loans and deal diversity have been fairly stable for 3Q13 deals on a quarter-over-quarter basis, but are riskier than last year's deals, says S&P. It believes "that slipping loan standards will eventually translate to higher loss rates" for 2013-vintage conduit deals.

New issuance does greatly benefit vintage CMBS transactions, however, as shown by the significant uptick in maturing loan payoffs. Concerns regarding maturing 2007-vintage loans appear to have ebbed and S&P says that under its downside economic assumptions, existing triple-A ratings would likely remain unchanged.

Insurance-linked securities

ILS growth, diversification to continue

The aggregate amount of outstanding catastrophe bonds will be approximately US$19.8bn at year-end, which is the largest since the market's inception. Moody's expects this market growth to continue as cat bond peril coverage widens across geographies and risk types.

Demand has outstripped even the surging supply. While there has been US$6.54bn of new issuance so far this year, pricing continues to decline, as is evidenced by the contraction from an average spread premium to expected loss multiple of 4.1x in the first quarter of the year to 3.2x in this quarter.

With robust demand expected to continue into next year, issuance will also continue to broaden geographically. Cat bond sponsors have had success securitising risks beyond the typical risk zones in the US, Europe and Japan and Moody's expects that the widening geographic base can further fuel the cat bond market's growth.

A Turkey earthquake cat bond raised US$400m (SCI 5 August), while there was also an unusually large US$300m Japanese earthquake bond. Mexico storm and hurricane coverage along with European windstorm coverage helped increase peril diversification of cat bond issuance.

Entities such as New York's Metropolitan Transportation Authority and the Turkish Insurance Pool entered the market in 2013, helping to grow the issuer base well beyond private insurance firms. The ability of corporations and public entities to directly access capital markets for insurance coverage is decreasing the number of risks that could otherwise be assumed by reinsurers, which is credit negative for them as they compete against this new and often lower-cost capacity across a widening range of business lines.

Reinsurers accounted for 43% of origination in 2011 and 39% in 2012 but only 19% this year. The dollar volume of cat bond issuers from reinsurers has decreased by 64% since 2011 and this year it was half of that issued by public, state-run and non-insurers.

While reinsurers' use of cat bonds for retrocessional protection has declined, they have been busy establishing alternative asset management arms and setting up sidecars. Validus Re has sponsored three sidecars in recent years, with US$500m PaCRe the largest, while Renaissance Re has also invested in three managed joint ventures.

Montpelier Re capitalised asset management platform Blue Capital Management last year to offer catastrophe reinsurance-linked investment products to institutional and retail investors. Its sidecar Blue Water Re began operations last year and its new catastrophe reinsurer Blue Capital Reinsurance Holdings recently floated.

Aspen Re established an ILS division this year (SCI 17 April) and also set up a sidecar (SCI 3 December). XL Group also provided money alongside Stone Point Capital to form an ILS investment manager (SCI 26 July).

There have been other transactions too, such as Transatlantic Holdings acquiring a minority stake in Pillar Capital Management. Moody's believes that the share of alternative capital in the reinsurance sector will continue to grow, pressuring reinsurers to further adapt to a changing economic environment.

Insurance-linked securities

Innovative longevity deal minted

SCOR Global Life has entered into an innovative longevity transaction with Aegon. The transaction covers underlying longevity reserves in the Netherlands of €1.4bn and has a maturity of 20 years, with a commutation covering exposures that run for longer than 20 years.

RMS provided the medically-based model of longevity risk that underpins the structure of the transaction. At the 20-year maturity, the final payment is based on modelled scenarios that project mortality another 50 years into the future - allowing Aegon to hedge 70 years of longevity risk with a 20-year instrument. RMS also provided scenario-based modelling results to investors to allow them to gain intuition into the risk of the transaction.

"Models make markets," comments Peter Nakada, head of RMS LifeRisks. "This feels very much like the early days of the catastrophe bond market, except that the potential size of the longevity market is at least five times larger than the market for natural catastrophe risk. We believe that it is a watershed deal that will pave the way for many more similar transactions in the future."

SCOR is taking a 50% share in reinsuring the residual trend risk, with other reinsurers and third-party investors assuming the remainder. Société Générale acted as intermediary on the deal.

The transaction is the second undertaken by Aegon to reduce longevity risk in its pension business in the Netherlands, following a longevity hedge on €12bn of reserves completed in January 2012. The firm says it will explore further opportunities to manage its Dutch longevity risk efficiently.

Risk Management

SIMM proposed

ISDA has proposed a standard initial margin model (SIMM) to facilitate the introduction of final BCBS-IOSCO guidelines in respect of margin requirements for non-centrally cleared derivatives. The association says that a common methodology would have several key benefits to the market, such as permitting timely and transparent dispute resolution and allowing consistent regulatory governance and oversight.

In order to realise these benefits, agreement between market participants and global regulators on several key assumptions will be required, according to ISDA. The association notes that these assumptions are: general structure of margin calculations; requirement for margin to meet a 99% confidence level of cover over a 10-day standard margin period of risk; model validation, supervisory coordination and governance; use of portfolio risk sensitivities ('Greeks'), rather than full revaluations; and explicit inclusion of collateral haircut calculations within the portfolio SIMM calculation.

ISDA has identified key criteria that a candidate SIMM model should satisfy: non-procyclicality; ease of replication; transparency; quick to calculate; extensible; predictability; costs; governance; and margin appropriateness. The association notes that margin calculations can be thought of as proceeding in two steps.

In the first, market scenario shocks for each risk factor are applied to the portfolio and changes in portfolio valuations are recorded. In the second step, an aggregation function of those recorded valuation changes is applied. Sufficient collateral has been provided if the collateral value exceeds the SIMM calculation for the total sensitivities.

Risk Management

SEF connectivity offered

Calypso Technology has extended its OTC clearing solution to support swap execution facility (SEF) connectivity. As a first step in providing clients with access to SEFs, the firm is interfacing with Tradeweb's TW SEF to offer an out-of-the-box request-for-quote (RFQ) and order book integration solution. The platform supports straight-through processing for interest rate swap and credit derivatives clearing workflows and prevents double entry of trade details.

RMBS

Supply up ahead of IABF sale

Sales from the ING Illiquid Assets Back-up Facility are set to begin with a US$5.1bn list scheduled to trade tomorrow (11 December). The list consists of 316 RMBS bonds that are predominantly backed by 2006 and 2007 option ARM collateral.

The assets could trade either on a CUSIP level or as an AON, which may allow for broader client participation. RMBS analysts at Bank of America Lynch suggest that the bonds will be particularly attractive to hedge funds and insurance companies.

"Given the lack of opportunities non-agency investors will have to source bonds with this kind of size moving forward, we think the bonds will trade well," they note.

The BAML analysts point out that a high concentration of the deals could receive proceeds from legal settlements, which should boost the value of certain bonds. For instance, Chase services 29.2% of the assets and BAML 13.2% of them, while 22.8% and 15.7% of the bonds are from WaMu and Countrywide shelves respectively.

Talk circulating ahead of the sale boosted SCI's PriceABS coverage to 690 RMBS line items today. The service captured a number of relatively rare names out for the bid, including WAMU 2007-OA6 CA1B and CWALT 2007-OA7 A2B, which were talked at low-singles and mid-20s respectively yesterday.

RMBS

Servicing deficiencies remain

The latest report from Joseph Smith, a court-appointed monitor of the US$25bn national mortgage settlement, indicates that certain deficiencies remain outstanding in meeting the settlement terms in servicing delinquent mortgage loans. Yet the report also notes that progress is being made to address the issues.

The monitor used 26 metrics and 304 distinct standards to establish compliance. However, broader servicing standards being set by various regulators are still evolving, based on feedback from borrower complaints, attorney generals and consumer advocates.

A recent NewOak memo suggests that notification to borrowers of incomplete modification documents within five days seems still to be a challenge to some servicers. On a positive note, the monitor's report indicates that none of the large banks have been improperly foreclosing on a mortgage or denying modifications, although there may have been errors along the way.

"The legacy servicing infrastructures tend to be patched together from independently developed modules. This makes flawless implementation of elaborate standards across large delinquent mortgage pools inherently a very hard task. Hence, the servicing industry's effort to comply with new and evolving mortgage servicing standards is still a work in progress and entails design and implementation of new overlay modules and processes," NewOak notes.

RMBS

Forward-settling MBS supported

Northern Trust has enhanced its collateral management system to include forward-settling MBS in response to new margin recommendations. Offered as a component of the firm's investment operations outsourcing for asset managers, the service supports two-way variation margin recommended as of 31 December by the Treasury Market Practices Group (TMPG).

The forward-settling nature of most agency MBS transactions exposes trading parties to counterparty credit risk between trade and settlement. In order to prudently manage counterparty exposures, TMPG recommends that asset managers not be allowed to trade forward-settling MBS unless they have credit agreements in place with counterparties or can display progress to that end.

RMBS

Newark eyes eminent domain

Newark City Council has formally voted to start legal research towards using eminent domain to seize underwater mortgages. Newark accounts for 268 first lien loans in RMBS trusts that are underwater but current, according to Barclays Capital figures.

The UPB of these loans is US$80m and they are expected to take a US$24m loss if they are written down to 80% LTV. "The losses will be higher if delinquent loans are also included," Barcap RMBS analysts suggest. "But, given the structure of the eminent domain proposal, it is unlikely that a large number of these will be condemned. Exposure to Newark is not particularly concentrated in some deals, with the GSR 2007-OA2 having the most at 0.38%."

RMBS

RMBS call dates extended

The Langton Securities series 2010-1, 2010-2 and 2011-2 RMBS have been restructured. The restructuring involved extending the call dates and margin step-up dates on six rated notes (2010-1 A5 and A9, 2010-2 A3, and 2011-1 A1, A2 and A7) and two unrated notes (2010-1 Z1 and Z2). The margins paid on the cross-currency swaps for the two euro-denominated notes - 2010-2 A3 and 2011-1 A1 - have also been reduced slightly.

Following the restructuring, credit enhancement for the class A notes is unchanged at 20.23% for series 2010-1, 20.22% for the series 2010-2 and 20.5% for the series 2011-1, provided by the subordination of the unrated class Z notes, as well as fully funded issuer reserve funds for each issue outstanding. The class A notes also benefit from a proportionate share of the funding reserve fund of £20.45m.

Fitch observes that although arrears have shown an increasing trend over the past year, the percentage of loans that are in arrears by three months or more remains low, at 1.83% of the current outstanding collateral balance. The agency notes that there is no rating impact on Langton Master Trust's outstanding notes (rated triple-A) from the restructuring.

RMBS

Tunisian RMBS downgraded

Moody's has downgraded the global scale ratings of the senior FCC BIAT-CREDIMMO 1 and FCC BIAT-CREDIMMO 2 notes, as well as the global and national scale ratings of the junior FCC BIAT-CREDIMMO 2 notes. The agency has also affirmed the national scale ratings of the senior notes in both transactions and the global and national scale ratings of the junior notes in FCC BIAT-CREDIMMO 1.

The rating actions are prompted by the lowering of the Tunisian country risk ceiling from Baa2 to Baa3. The move also reflects increased counterparty risk, following the downgrade of Banque Internationale Arabe de Tunisie (BIAT) to Ba3 from Ba2 due to weakened financial strength. The bank acts in various roles in the transactions, including servicer, cash manager, collection account bank and issuer account bank.

The sovereign ceiling downgrade primarily reflects the weakening of the Tunisian government's credit profile, as captured by Moody's recent downgrade of Tunisia's government bond rating by one notch to Ba3 from Ba2 and the lowering to Baa3 of the local currency country ceiling.

RMBS

RMBS credit quality to vary

New issue private-label US RMBS credit quality implications will vary next year, according to Moody's. The agency expects new transactions in 2014 to be of lower credit quality because originators will likely have trouble maintaining volume in loan pools as refinancing activity decreases.

This will lead originators to relax underwriting standards, resulting in further deterioration of the credit quality of the collateral backing the pools. Furthermore, the shape of investor protections for new transactions remains in flux, with issuers continuing to explore different representation and warranty (R&W) frameworks.

"Institutional investors and RMBS issuers have not yet reached a consensus on the appropriate balance of liability and protection," says Kruti Muni, Moody's svp and manager. "Investors will have to decide which R&W framework will provide a level of credit protection they deem acceptable."

In addition, the creation of the qualified mortgage (QM) class will make it more expensive to originate non-qualified mortgage loans because of the risk of borrower legal challenges, whose costs and penalties RMBS trusts would bear. "Because of the added risk, lenders will charge more to non-QM borrowers and the loans will be more expensive to hold in a trust," cautions Muni.

Losses on pools with non-QM loans will increase as borrowers challenge foreclosures, causing trusts to incur legal fees, lengthen foreclosure timelines and potentially pay penalties if the borrowers succeed. Conversely, the collateral strength of outstanding RMBS will be stronger because the remaining borrowers in the pools will have stronger credit profiles, thus boosting the performance of those deals.

"Improving loan-to-values indicate the credit strength of the remaining borrowers in the pools and faster liquidation timelines weed out borrowers with weaker credit profiles," notes Moody's associate md Debash Chatterjee. "Liquidating the backlog of severely aged properties in a portfolio will also lead to a decline in pool losses toward the end of 2014."

The portfolios of non-bank servicers - such as Ocwen, Nationstar and Green Tree - continue to grow, fuelled by large banks shedding their most seriously delinquent loans. Despite the added servicing capacity, completed foreclosure timelines will continue to rise because of the large number of complicated and unworkable foreclosure cases remaining in servicers' backlogs.

"However, timelines for new foreclosures will improve as judicial states clear their foreclosure pipelines," says Chatterjee.

RMBS

RFC issued on non-QM approach

Kroll Bond Rating Agency is proposing to extend its existing methodologies for rating RMBS to address additional risks for pools backed by non-Qualified Mortgage loans. The agency has released for comment a methodology relating to non-QM loans that are prime credit quality mortgage loans.

The key components of KBRA's non-QM rating methodology consist of: loan originator and servicer reviews; loan file reviews; loan analysis and RMBS modelling; non-QM risk assessment; evaluation of securitisation structure; and surveillance. The document focuses specifically on risks associated with non-QM loans and the additional analysis contemplated for pools backed by these mortgages.

KBRA notes that there is little historical data demonstrating how the new non-QM risk factor might affect mortgage performance. The agency's proposed non-QM methodology consequently relies on its fundamental analysis of mortgage risk, augmented by stressed assumptions regarding a borrower's propensity to engage in litigation against an originator and potential losses resulting from a successful borrower claim. These assumptions are derived primarily from limited data on litigation-related mortgage loss.

While KBRA says it would also consider rating RMBS backed by non-prime non-QM loans, this collateral could pose additional considerations not directly addressed in the new methodology. If presented with non-prime non-QM loans, the agency would analyse the loan attributes that resulted in non-QM status and whether such attributes - when associated with less affluent and perhaps less sophisticated borrowers - posed a heightened risk of successful challenges under the QM rule.

Comments on the proposed methodology should be submitted before 31 January.

RMBS

Steady RMBS performance predicted

Fitch's 2014 outlook for US RMBS is stable, with home price growth and stable macro conditions expected to support steady performance across most vintages. Post-crisis transaction performance remains exceptionally strong with no downgrades to date and this trend is expected to continue into next year.

Past rating actions, combined with improving credit trends and positive momentum in the housing market, are expected to drive ratings stability in pre-crisis transactions in 2014. Prime pre-2005 vintage collateral will remain an outlier, however, due to collateral adverse selection and growing tail risk.

Collateral improvement has been uneven across vintages, Fitch observes. The mortgage pools issued during the peak issuance years of 2006 and 2007 have experienced significant improvement, while the remaining pools issued prior to 2005 have generally shown little or no improvement.

"Since ratings in RMBS issued in 2006 and 2007 are predominantly distressed, the improved mortgage pool performance has generally resulted in improved recoveries on defaulted bonds, rather than positive rating changes," the agency notes. "The adverse selection of the remaining borrowers within prime RMBS pools issued prior to 2005 pushed delinquency rates up to new highs in 2013 for those transactions. Rising delinquency - combined with pro-rata structures vulnerable to tail risk - continues to result in negative rating pressure within pre-2005 vintage prime RMBS and accounts for the largest portion of RMBS classes on negative rating outlook."

Outside of prime pre-2005 RMBS, Fitch expects ratings to generally remain stable in 2013 for bonds currently rated single-B or above. Bonds with distressed ratings below triple-C are expected to default in the future and will experience downgrades as the timing of the default becomes imminent. The number of upgrades will likely remain limited but could increase in classes that benefit from sequential payment priorities and relatively short remaining lives.

Performance on post-crisis RMBS remains outstanding: serious delinquencies remain at or near zero for Fitch-rated transactions issued since 2010; there have been no downgrades; and credit enhancement continues to build. The agency expects strong performance trends to continue in 2014 and, given stellar performance to date and heavy deleveraging, transactions from 2011 may become eligible for upgrade consideration next year.

Fitch does not anticipate material changes in underwriting conditions in 2014, with new issue RMBS largely backed by high-quality jumbo collateral. However, rising mortgage rates could drive a decline in refinance volume, which could result in some incremental credit expansion with a slight deterioration in pool FICO and CLTV attributes.

The agency believes that the vast majority of new issue RMBS in 2014 will be backed by QM loans as lenders and aggregators continue to adjust guidelines and operational controls to demonstrate compliance with the new rule. The agency also expects pools of non-QM loans to come to market, although this will likely be limited to established lenders/issuers that can demonstrate a low risk of challenge and liability exposure to the trust.

RMBS

Higher loss severities for non-QM RMBS

US RMBS backed by non-qualified mortgages will incur higher loss severities on defaulted loans than those backed by qualified mortgages. Non-QM loans will therefore increase risk in new RMBS.

Moody's notes that the higher loss severities will be driven by the higher legal costs and penalties for non-QM securitisations, where a defaulted borrower can more easily sue a securitisation trust on the grounds that the loan violated the Ability-to-Repay (ATR) rule under the Dodd-Frank Act. Some QM loans will also be subject to a greater risk of penalty than others.

Conversely, the presumption that QM loans satisfy the ATR rule means they will be less susceptible to borrower challenges. Of the two types of QM loans - those with a rebuttal presumption and those with a safe harbour status - it will be those with safe harbour which are less likely to incur penalties.

Borrowers of safe harbour loans will only have grounds to challenge the ATR determination if they can successfully challenge the loan's QM status. This will be difficult for a borrower because of the specificity of most QM requirements.

Rebuttal presumption QM loans will be more likely to draw legal challenges so there is the risk of higher loss severities. However, they will still be subject to less risk of challenges and penalties than non-QM loans because the burden of proof will still lie with the borrower rather than the lender.

The degree to which RMBS will need additional credit enhancement to account for the increased risk of losses will depend on the strength of originator compliance practices and the trust mechanisms protecting against lawsuits. The ATR rules are open to interpretation so compliance processes will vary, while strong representations and warranties will help to lessen the risk of losses.

RMBS

IABF unwind to begin

The Dutch government intends to start a competitive auction process to sell the non-agency RMBS underlying the ING Illiquid Assets Back-up Facility (IABF). BlackRock Securities will be responsible for the execution of the sale of the securities on behalf of the Dutch State Treasury Agency (DSTA).

The IABF was created almost five years ago (SCI 28 January 2009) as one of the government's measures to preserve financial stability in the banking sector. An agreement to unwind it was reached a month ago (SCI 4 November).

The decision to begin selling off the portfolio is based on the continued improvement in the US housing market and a high level of interest from investors in non-agency RMBS. The DSTA expects to be able to divest the assets within a 12-month period but there is no fixed deadline for completion of the sale of the portfolio.