Contents

ABS

Autos fuel ABS activity

European ABS secondary activity was dominated by auto tranches yesterday. SCI's PriceABS data shows a strong range of auto names out for the bid, as well as a couple of credit card tranches, with the majority covered at or around par.

Among these was the BILK 3 A1 tranche, which was covered at 100.171. The tranche was covered at 100.168 just two days earlier and first appeared in the PriceABS archive on 4 February, when it was covered at 100.12.

Another Bilkreditt tranche - BILK 4 A - was also out for the bid. Covers for that tranche were recorded at both 100.171 - as with BILK 3 A1 - and at 100.18. The bond had also been previously covered on 10 December.

Meanwhile, BUMP 2011-2 A was covered at 100.61, having been covered two days earlier at 100.638. The tranche was covered half a dozen times between late June and November and first appeared in the PriceABS archive in the middle of last year, when it was covered at 100.55.

The BUMP 2012-5 A2 tranche was also out for the bid and covered at 100.48. It was talked and covered the day before at 100.5 and its first recorded cover was at 100.29 on 16 July 2012.

CAR 2012-F1F A was covered at 100.308, having last been covered at 100.25 on 31 October. Another French auto name - COMP 2011-2 A - was also circulating and covered at 100.715.

In addition, ECAR 2012-1 A was covered at 100.69, having been covered at 100.708 on 14 November. ECAR 2013-1 A, meanwhile, was covered at 99.99.

The auto supply did not stop there, with GLDR 2010-A A covered at 100.23 and HIGHW 2012-1 A covered at 100.38. There were also covers for names such as MOTOR 12X A2, RNBAG 2012-1 A and TURBF 3 A.

Rounding out non-US activity, on its first appearance in the PriceABS archive, the Australian bond DAOT 1 A was recorded as a DNT.

While the bulk of yesterday's supply came from auto ABS, a couple of 2004-vintage credit card tranches were also circulating. COUK 2004-1 A was covered at 99.971 (having been covered last month at 99.941) and COUK 2004-2 A was covered at 99.89 (having been covered on 21 November at 99.815).

JL

RMBS

RMBS supply spikes

US non-agency RMBS volume yesterday was up day-over-day, boosted strongly by the liquidation of the US$5.1bn ING bid-list (SCI 10 December). The Dutch government is understood to have sold the assets to five dealers.

As expected, most of the supply consisted of block-sized senior option ARM bonds. But fixed-rate supply also picked up, with a mix of senior current paying Alt-A bonds out for the bid, according to Interactive Data. In addition, a mix of mezzanine subprime floaters was observed during the session.

Among the names captured yesterday by SCI's PriceABS service, CSFB 2004-AR8 2A1 was talked at 100 handle. That is the same level at which it was covered on 14 August 2012 - the last time it appeared in the PriceABS archive. Before that, it was covered in the very high-90s on 20 July 2012.

Also circulating during the session was OOMLT 2005-4 A3, which was talked in the high-90s. The bond had also been talked in the high-90s back in March and was talked in the mid-90s on 13 August 2012. RAMP 2006-EFC1 A2, which had not previously appeared in the PriceABS archive, was likewise talked in the high-90s.

In addition, a considerable amount of US dollar-denominated Granite bonds were out for the bid. For example, the GRAN 2004-1 2A1 tranche was covered at 99.25, having previously been covered at 98.76 on 18 September and at 98.76 on 16 April. It first appeared in the PriceABS archive on 12 July 2012, when it was covered at 96.95.

Meanwhile, GRAN 2004-3 2A1 was covered at 99.33. It was covered at 98.1 on 22 July and at 97.75 on 8 July, having been covered at 96.85 a year earlier on 12 July 2012.

GRANM 2005-2 A6 was covered at 99.005, while GRANM 2006-1A A5 was covered at 98.84. There were also covers for GRANM 2006-2 A4, GRANM 2006-3 A3, GRANM 2006-4 A4 and GRANM 2006-4 A6.

The GRANM 2007-1 2A1 tranche was covered at 98.83, having been covered at 98.65 on 18 October and 98.53 on 4 October. The tranche was covered at 98.18 a little over a year ago on 6 December 2012.

GRANM 2007-2 2A1 was covered at 98.81. It was covered at 98.76 last month and at 98.31 three months ago. Its first cover of the year was in March, at 98.14.

The final GRANM tranche captured by PriceABS was GRANM 2007-2 3A1, which was covered at 98.95. The tranche had been covered at 98.35 on 18 September and at 98.16 on 16 April.

JL

Structured Finance

SCI Start the Week - 16 December

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

Pipeline
The pipeline has not dried up just yet as new deals were still being announced last week. As well as one new ABS, two ILS, one RMBS, six CMBS and three CLOs were announced.

The ABS was A$500m Crusade ABS Series 2013-1 Trust, while the ILS were US$75m Queen City Re series 2013-1 and US$200m VenTerra Re series 2013-1. The RMBS was RUB4.4118bn TKB-1.

The CMBS were: US$1.1bn COMM 2013-CCRE13; US$297.15m CVS Lease-Backed Pass-Through Series 2013 Trust; US$1.1bn JPMBB 2013-C17; US$330m Spirit Master Funding VII Series 2013-1 and Series 2013-2; and US$1.04bn WFRBS 2013-C18. The CLOs were US$349m Allegro CLO I, Black Diamond CLO 2013-1 and US$400m Highbridge Loan Management 3-2014.

Pricings
In addition, a healthy level of completed issuance was observed last week. Alongside nine ABS prints, three RMBS, four CMBS and two CLOs also priced.

The ABS were: US$750m Chase Issuance Trust 2013-9; US$1.25bn Citibank Credit Card Issuance Trust 2013-A12; US$183m CPS Auto Receivables Trust 2013-D; €500m Elenia Finance; €657m FCT Ginkgo Sales Finance 2013-1; Y40bn KAL Japan ABS 10 Cayman; US$1.041bn Trade Maps 1 Series 2013-1; US$305m Turbine Engines Securitization 2013-1; and US$482.93m Utility Debt Securitization Authority Series 2013T. The RMBS prints were €4.35bn BBVA RMBS 12, €2.614bn Lowland Mortgage Backed Securities 3 and US$154.33m Nationstar Mortgage Loan Trust 2013-A.

The CMBS pricings comprised: US$1.2bn Aventura Mall Trust 2013-AVM; US$295m CGWF 2013-RKWH; US$230.09m Selkirk No.1 2013-1; and US$113m Selkirk No.2 2013-2. Finally, US$306m MCF CLO III and €306m North Westerly CLO IV were issued.

Markets
European ABS secondary activity was heavily dominated by auto tranches towards the end of the week, as SCI reported on 13 December. SCI's PriceABS data recorded a number of auto tranches covered at or around par during Thursday's session, as well as credit card names such as COUK 2004-1 A, which was covered at 99.971.

US ABS spreads are being driven more by broader market concerns, such as tapering, than sector-specific ones. "Secondary spreads on private student loans continue to move to tighter levels, although volumes remain relatively light," say analysts at Bank of America Merrill Lynch. "The demand for higher yielding assets in other credit-sensitive securitised products (e.g. non-agency RMBS and CMBS) should continue to spill over into the off-the-run ABS sectors."

It was a good week for US agency RMBS, according to analysts at Barclays Capital. They note: "Mortgages outperformed significantly this week, with a strong up-in-coupon bias following the strong payroll print. Rates did not move much after the payroll print and significant decline in unemployment rate, which indicated that the market still expects tapering to start in March 2014."

As for US non-agency RMBS, bid-list volume was boosted mid-week by the liquidation of the US$5.1bn ING list (SCI 12 December). Most of the supply consisted of block-sized senior option ARM bonds, although fixed-rate supply was also up.

Tightening was also seen in US CMBS early in the week (SCI 11 December). Tuesday's session contained a range of vintages, from 2004 to 2013, as Tuesday's BWIC volume came in at around US$200m.

In the US CLO market, meanwhile, there was an early boost as a BWIC with over 80 cash CLO/CDO items totalling over US$800m in original face value circulated (SCI 10 December). A lot of price talk was observed on the names, although trading was less frequent.

Deal news
• The US SEC has charged Merrill Lynch with making faulty disclosures about collateral selection for Octans I CDO and Norma CDO I. Merrill Lynch is also accused of maintaining inaccurate books and records for a third CDO and has agreed to pay US$131.8m to settle the charges.
• 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.
• 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.

Regulatory update
• 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 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.
• The US Fed has issued a final rule that makes technical changes to its market risk capital rule to align it with the Basel 3 revised capital framework adopted earlier this year. Technical changes to the rule reflect modifications by the OECD regarding country risk classifications.
• 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.
• 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.
• The Volcker Rule's treatment of ABCP conduits is expected to motivate conduit sponsors to employ full unconditional liquidity coverage and remove an important regulatory risk from the sector. To be exempt from the covered fund definition under the rules, outstanding ABCP must be fully supported and liquidity commitments must be available to fund for the full face amount of all outstanding ABCP without exceptions for asset credit performance.
• 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.
• PNC Bank has reached an agreement in principle with Freddie Mac to resolve substantially all indemnification and repurchase obligations related to loans sold between 2000 and 2008. PNC will pay the GSE US$89m - less credits of US$8m - to resolve existing and future repurchase obligations and to compensate Freddie Mac for losses.
• 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.

Deals added to the SCI New Issuance database last week:
Apidos CLO XVI; Auto ABS German Loans Master; BlueMountain CLO 2013-4; Cars Alliance Auto Loans Germany V series 2013-1; Cathedral Lake CLO 2013 ; CNH Capital Canada Receivables Trust series 2013-2; Figueroa CLO 2013-2; IM BCG RMBS 2; ING IM CLO 2013-3; JFIN Revolver CLO; Nissan Auto Receivables 2013-C Owner Trust; Octagon Investment Partners XVIII; RESIMAC Bastille Trust series 2013-1NC; Richmond Park CLO ; Sound Point CLO IV; VNDO 2013-PENN

Deals added to the SCI CMBS Loan Events database last week:
BACM 2003-1; BACM 2004-2; BACM 2006-3; BACM 2006-6; BSCM 2006-PWR11; BSCMS 2006-T24; BSCMS 2007-PW15; COMM 2007-C9; CSFB 2001-CF2; CSMC 2006-C4; CSMC 2007-C1; DECO 2006-C3; DECO 2007-C4; ECLIP 2006-1; EURO 25; EURO 28; GCCFC 2005-GG3; GCCFC 2007-GG9; GECMC 2007-C1; GMACC 2004-C1; GSMS 2005-GG4; GSMS 2006-GG8; GSMS 2012-GC6; GSMS 2013-GC10; JPMCC 2005-LDP2; JPMCC 2006-LDP9; JPMCC 2007-CB18; JPMCC 2007-LD11; JPMCC 2008-C2; LBUBS 2004-C8; MLCFC 2007-8; MSC 2012-C4; OPERA GER3; OPERA METC; PROMI 2; SBM7 2000-C3; TITN 2006-3; TMAN 5; TMAN 7; WBCMT 2005-C20; WBCMT 2005-C20 & LBUBS 2005-C3; WFRBS 2012-C9

Top stories to come in SCI:
Developments in solar ABS

CDS

Idiosyncratic risk to boost CDS volume

The credit derivatives market is entering 2014 amid a regulation-induced transformation. While capital rules and collateral remain challenges to market efficiency, Morgan Stanley credit derivative strategists anticipate that the transparency and potential increased liquidity of a centrally cleared and electronically traded market could be transformative.

"We believe that a more active idiosyncratic risk environment will motivate increased single-name credit hedging activity, resulting in a potential boost to CDS volumes after years of falling liquidity," they observe. "Credit pickers will find much value in the negative basis in 2014. Much like the cash CLO market, there is plenty of demand for synthetic equity-like tranche risk with double-digit yields, more so than can be produced by hedgers or regulatory capital relief exercises."

With respect to single-name CDS trades, the Morgan Stanley strategists note that the risk-reward for cash relative to CDS is more balanced today, given valuations, dollar prices and the outperformance seen in the latter. Nevertheless, they believe that trading themes vary by region.

For example, the US cash-CDS basis is currently at its most negative level post-crisis. Negative basis trades are consequently recommended in the US (given idiosyncratic risks), as well as convexity packages (as a way to position for binary outcomes). Such trades should benefit from a rise in rates, which would help the cash leg of the trade, given the 'floor' that is expected on dollar prices beyond a certain point.

In Europe, yield generation via CDS is expected to be the dominant theme. A relatively modest forecast for European credit returns for 2014 and an overall deleveraging theme mean that net issuance should be limited for the cash bond market. These flows are likely to push CDS tighter than cash bonds, similar to the US credit market.

At the same time, credit curves - whether cash or synthetic - are extremely steep across regions. "Leaning against such steep curves too early in a credit cycle is generally not fruitful," the strategists observe. "But at such extreme levels, one can have the carry and own default protection too. The US credit cycle is fairly mature at this point, favouring index level flatteners as a hedge."

Meanwhile, within the world of volatility and options, they believe that the best long volatility positions are in rates and FX, given that is where tail risks are anticipated to form. But monetising skew through covered shorts (buy protection and sell OTM payers) or simply payer spreads is recommended in credit.

Finally, rising dispersion and idiosyncratic single-name risk, steep curves and the potential for higher defaults make the tranche market interesting from a positioning perspective. In bespokes, the market continues to face the challenge of demand-supply mismatch and capital efficiency for dealers. Yet reasonable issuance has been observed this year (at around US$15bn delta adjusted) and the strategists expect to see ongoing activity in 2014, driven by the demand for yield and potential regulatory capital hedging from banks.

Given the potential move in rates, they also suggest that an opportunity could emerge in the principal-only space within tranches, given lower dollar prices and hence limiting the loss in a worst case default scenario.

Bank of America Merrill Lynch credit derivatives analysts suggest being long European junior-mezzanine tranches versus their US counterpart as one relative value trade going into 2014. Long-dated junior-mezz tranches have been among the best performers in 2013; however, the iTraxx 9 10-year 3%-6% tranche has significantly underperformed its US counterpart - the CDX.IG9 10-year 3%-7% - despite its thicker subordination.

A long on the European versus a short on the US junior-mezz can provide around 85bp of spread pick-up, according to the BAML analysts. They indicate that European junior-mezz should be trading well inside its US counterpart.

In delta-adjusted terms, CDX.IG9 10-year 3-7% has tightened by 5.1% points so far this year, compared to 2.7% for iTraxx 9 10-year 3%-6%. But CDX.IG 9 has suffered four credit events, reducing the subordination of the US junior-mezz tranche to 2.36%, compared to a full 3% subordination for iTraxx 9 junior-mezz.

CS

RMBS

Further large-lot sales expected

January is anticipated to be an attractive time to bring a large portfolio sale to market, with many investors likely having excess cash to put to work. Of the few large RMBS holdings left that could come to market, the remainder of the ING IABF assets and the GSE portfolios provide the best opportunities for investors to source bonds in large lots in 2014, Bank of America Merrill Lynch RMBS analysts suggest.

Approximately US$6.5bn remains in the ING portfolio, which has a higher concentration of deals originated before 2005. The remaining bonds in the portfolio are highly concentrated in the alt-A and jumbo sectors, with a few option ARM POA bonds that have not yet traded. The names are split between seniors (55%) and super seniors (44%).

"These lower yielding sectors will likely eliminate some of the hedge fund buyers that emerged to bid on the first list - which contained lower dollar priced, higher yielding option ARM bonds - and bring in more banks and money managers. If tapering does occur earlier in the year, prices on the lower yielding segments may be biased lower, which would lower the proceeds received for the bonds. Despite the potential price weakness, we look for non-agency spreads to continue to compress over the course of 2014," the BAML analysts observe.

The remaining portion of the portfolio has a high concentration of deals that could potentially receive proceeds from pending settlements. However, many settlements are structured so that supplemental recoveries are distributed across deals based on forecasted cumulative losses. The collateral has lower cumulative losses compared to bonds on the list that traded last week, making settlement proceeds comparatively less impactful to overall valuations, according to the analysts.

Meanwhile, an estimated US$90bn in non-agency RMBS remains in the GSE portfolios, roughly 83% of which is from the 2006 and 2007 vintages, and 85% of which are seniors. Roughly 75% of the GSE holdings is backed by subprime ARM collateral, with continued FHFA litigation resolutions potentially making the GSEs more likely to offer more subprime bonds in 2014.

CS

RMBS

GSE portfolio execution closer?

Fannie Mae and Freddie Mac have released updated loan-level pricing adjustment (LLPA) matrices, effective from 1 April. After adjusting for the removal of the adverse market delivery charge (AMDC), it appears that nearly all mortgages will see their LLPAs at least offset the reduction in AMDC and a vast majority will see net increases in excess of the 25bp AMDC.

Bank of American Merrill Lynch RMBS analysts note that higher LTV is impacted more severely by the changes relative to low FICO, with LLPAs increasing by 75bp-100bp. LLPAs for better-quality borrowers, with 680-760 FICO scores and 70-80 LTVs, will increase by 25bp-50bp. Only 1% of GSE borrowers will see a net 25bp reduction in LLPAs.

Pre-May 2009 borrowers with LTVs over 95 will not be exposed to any change in LLPA. The BAML analysts suggest that this is designed to help underwater borrowers backing the CQ/U6 and CR/U9 eligible loans.

RMBS strategists at Barclays Capital point out that the higher-LTV mid/high-FICO population are prime candidates for private market lending. "The FHFA may be attempting to shift market share to the private sector by hiking the fees for these loans. Lower FICO borrowers are unlikely to find private market execution and, hence, the FHFA may be maintaining some credit availability for them," they explain.

The Barcap strategists note that the current level of annual guarantee fees is only about 8bp lower than what would be required for portfolio execution to become preferable. "With [the LLPA] hike, we are even closer to some of the execution shifting to that route," they suggest.

The BAML analysts view the LLPA changes as a net positive for interest-only and premium MBS, particularly those backed by high-LTV MHA collateral. The FHFA estimates that the combined changes amount to 14bp for 30-year product, based on recent issuance.

"Given a 10bp base g-fee increase, this implies a 4bp impact from LLPA changes," the analysts observe. "This is roughly consistent with two-thirds of the borrowers getting a 50bp LLPA increase and a price multiple of 8x."

CS

CLOs

Pricing change

CLO pricing methodologies and differences discussed

Representatives from Bloomberg, CIFC and Kanerai discussed CLO pricing methodologies, as well as differences between legacy and 2.0 deals during a live webinar hosted by SCI in October (view the webinar here). Topics included changes in the underlying loan market and where to find relative value. This Q&A article highlights some of the main talking points from the session.

Q: How has the CLO market evolved over recent years?
A: Cynthia Sachs, global head, Bloomberg Valuation Service: The market has changed a lot during my time. We are now seeing increased pressure from the investor community and audit community to see CLO portfolios priced by independent third-party valuation providers.

Tranches have historically been priced via in-house proprietary models based on internal assumptions and only on a monthly basis. Increased regulation and auditor demands now require these prices to be validated by outside sources.

Another change we are seeing is a push beyond the traditional CLO buyer base to less conventional investors, such as retail funds, who require daily NAVs that go beyond the traditional month-end process. There is a reach for yield, but in order to attract investors the market needs frequent, independent valuations and that increased transparency is causing a paradigm shift to increased liquidity.

Oliver Wriedt, head of capital markets and distribution, CIFC: We are in the fourth year of the resurgence of the CLO market subsequent to the financial crisis and really have been going from strength to strength. We are on track for a record year for issuance and we attribute the success that the market enjoys today to the strong performance that virtually all funds demonstrated back in 2008 and 2009.

Importantly, the investor composition really has changed dramatically. Whereas the pre-crisis market was dominated by ABCP conduits, by SIVs and by bank negative basis books, those investors do not really exist today, such that we have had to establish an entirely new investor base which is made up principally of US banks and banks across the Asia-Pacific region, notably Japan.

The triple-A class has become far more important than it was before the crisis and the mezzanine part of the capital stack has become much more attractive to banks. Equity investors have also changed away from insurance companies and pension funds to dedicated private equity funds, hedge funds and more opportunistic capital.

The most important change is that the CLO market has become one where an investor can capture total return. It is an actively traded market and investors are drawn to it because they are able to express views. The market has evolved dramatically and pricing CLOs correctly is critical to the success and the growth of our market.

Q: How do changes in the loan market affect CLOs and modelling assumptions?
A: Wriedt: Modelling has become quite a bit more challenging post-crisis because the underlying collateral market has changed dramatically. We have seen the introduction of Libor floors to make up for the low levels of Libor, thereby introducing duration risk into the structure really for the first time, as well as OIDs and call protection.

The underlying collateral pool today exhibits a modest amount of duration risk, which is obviously enhanced through leverage through the equity tranche, as well as a little bit of convexity associated with the original purchase discount and call protection. As a result, it is a very different proposition to the quasi-static pools we were looking at pre-crisis, where loans were priced on a very standardised basis without floors, without discounts and certainly without call protection.

These features were introduced to make the underlying asset class more attractive, but they have also made it more difficult to model transactions. Repricing has also become a key concern and we saw a lot of repricing early in the year; it is really anyone's guess what next year will bring and whether a strong credit market will lead to another wave of repricings.

Q: Which are the key factors when pricing CLOs?
A: Jesse Knapp, md, Kanerai: At Kanerai, the first thing we do is identify the factors that traders and portfolio managers care about when they trade the sector, observe how these various factors differentiate the pricing between one tranche and another, and then apply what we learn across the universe of tranches. This requires a lot of work integrating individual tranche metrics and broad market data.

Once we have calculated the various metrics, we run a comparison against a very broad data set of market information, so that we can understand how the market is pricing different deal and tranche characteristics. Specific observations on a tranche are always valuable, but that value of such observations declines over time. We utilise direct observations, as well as observations of similar securities to inform where the best approximation of trading levels would be for each individual tranche in the universe.

Q: What are the pricing differences between a 1.0 CLO and a 2.0 CLO?
A: Knapp: The differences begin with portfolio quality, as the 2.0 deals have higher overall portfolio quality than the 1.0 deals, which means lower default rates but also greater exposure to asset repricings. If you look at 2007 deals versus 2012 deals, the 2012 transactions have faster asset repricing speeds to the magnitude of a few CPR relative to the older transactions.

Another difference is the deleveraging of the 1.0 transactions. The composition of the assets is changing and the average life is shortening, so you really need to take into account the most recent data, whereas on 2.0 transactions the portfolios are changing but the structures are not because they have not passed their reinvestment period and so the subordination levels are reasonably constant.

Another area of difference is that the 1.0 transactions have more flexibility on manager reinvestment, especially after the reinvestment dates. Bond coupons also differ and call risk is something we look at very closely.

Q: How should managers approach these differences?
A: Wriedt: Credit risk is all-important and the risk factors for CLO 1.0 deals are substantially different from the 'clean' collateral that is associated with CLO 2.0s. With new collateral, there are the Libor floors, OIDs and call protection, all of which make it more attractive than pre-crisis collateral.

Deleveraging is a key performance driver in CLO 1.0 and leads to increased concentration risk. As it is often the good borrowers that refinance and not the bad borrowers, at some point you will likely reach a point where you have a more concentrated portfolio and are more exposed to some of the more challenging names. That introduces different credit risks from what you will find in a 2.0 deal.

There is also documentation risk and although documentation is different from deal to deal, it is far more standardised among 2.0 deals. Documentation needs to be studied very closely, particularly as it relates to the manager's ability - and frankly willingness - to invest post-reinvestment because at times managers have taken liberties to interpret documents freely in such a way that those have been managed to the clear detriment of the debt investors, solely to the benefit of extending the equity arbitrage.

Finally, and perhaps most importantly from our vantage point, the total return opportunity in 1.0 is just not what it was. Prices have rallied, so it is now the discounted 2.0 market which is offering the ability to capture positive convexity.

2.0 deals provide the opportunity to capture total return across the entire capital stack and that has been the game-changer that has attracted real money investors. You can express a view and it has become a very attractive, very cheap tradable market.

Sachs: From talking to clients, that is the view right across the marketplace. As investors are looking across many asset classes on a relative value basis, they continue to focus on CLOs because they are cheap, but of course they need valuations to support that.

Q: What are the specific considerations for valuing equity tranches?
A: Knapp: One way we look at the sector is to start with the market value NAV of the equity if the deal were to be liquidated today. When we map and price all the assets backing all the deals throughout the universe, we can get a feeling for what the liquidation values would be.

Beyond market value NAV and liquidation value, there are several other characteristics which need to be taken into account to determine the valuation of an equity tranche. We also look at the thickness of a tranche, the yields across different scenarios and other aspects, such as portfolio liquidity and the collateral manager.

Q: How is call risk built in under different scenarios?
A: Knapp: Call risk is a factor we include in our model. Many 2.0 deals are being priced at a discount to create total return activity and, as that total return is realised and prices get into the par to 101 or higher range, the upside is going to be limited.

Q: To what extent do regulatory constraints impact pricing?
A: Sachs: Regulatory intensity is playing a significant role in the CLO market, in structured products and in corporate credit in general. We are watching the regulatory dynamic very closely, particularly in structured products, as the market continues to struggle with the uncertainties around risk retention.

Regulation and audit mandates are pushing the envelope to bring greater transparency to the market and that is particularly important for new investors. The asset class has historically been opaque and this big push to open the market up and get more transparency is a healthy progression.

Q: How important is standardised pricing?
A: Wriedt: Returns in Treasuries, municipal bonds and investment grade bonds have been disappointing and against that backdrop CLOs produce compelling absolute and relative returns. Pricing and transparency have been the predominant barriers to entry and, as we collectively work away at this barrier, it is going to open up the asset class to a much larger investor base and the attractiveness of the asset class is as compelling as it has ever been, given the lack of alternatives.

Q: How can the lack of transparency be overcome?
A: Sachs: The BVAL/Kanerai solution makes a lot of sense for the marketplace. Through Kanerai we distribute daily pricing on CLOs, which involves very dynamic model-based relative value prices that are generated on a consistent basis.

It is not done in a black box way; rather, the market can look at daily prices which are dynamically derived from current market spread. This perspective and that kind of independent transparency are revolutionary for this market.

Q: Where is relative value?
A: Wriedt: If you look at the first generation of CLOs, there were certain truths, such as 20% prepayment speeds, 2% annual defaults and 70-75 cent recoveries. The market used those assumptions to price equity and then investors would run variations on that same theme, but those metrics do not apply to today's market.

We have not seen such low prepayment speeds for four and a half years and the 2% CDR also seems inappropriate, given the prolonged period of little to no defaults that we have observed, particularly as it relates to the newer clean collateral. We think it makes more sense to assume lower defaults for a period of time and then see those stepping up as the credit cycle ensues.

More importantly, reinvestment assumptions were not controversial pre-crisis in that all collateral priced somewhat uniformly, but reinvestment assumptions in CLO 2.0s are critically important and there are very different views on where the market is headed and whether those should be wider than where the market is pricing today or substantially tighter. That introduces a significant amount of variability into a given valuation exercise.

It is probably not too controversial to suggest that the CLO 2.0 triple-A opportunity is, for those investors who can afford to be in an investment that yields less than 2% to maturity (based on today's Libor, at least), the cheapest part of the capital stack. However, the total return opportunity, particularly in junior mezz, is compelling. As far as equity is concerned, we think 2.0 equity is interesting, particularly if there is transparency.

The 2.0 market is compelling across the stack, but we do also recognise the appeal of very short-duration 1.0 opportunities. Given where prepayment speeds are, there is some certainty around having a 0.5- or one-year WAL opportunity that obviously does not exist in the 2.0 market, but generally we would skew the discussion to relative value being squarely in the 2.0s.

Q: What are the prospects for the European CLO market?
A: Wriedt: The challenge for the European market is that there is nowhere near the depth of market that we have in the US. Absent the ability to select collateral carefully and to build diversified high quality portfolios, introducing term leverage to a concentrated pool where there is a lot of selection bias introduces significant risk.

If you look at the performance of European CLO equity versus US equity, it has been a very different experience and, until the European market grows to a point where you can truly diversify portfolios, we think that market is going to continue to be challenged. We have obviously seen a resurgence of the new issue transactions, but we continue to be concerned by the small absolute size of the European market. Whereas the loan market in the US is outgrowing the high yield bond market significantly, that is not the case in Europe where high yield bonds continue to rule the day.

Structured Finance

Industry vet to lead structured solutions

ACGM has appointed Alfredo de Angelis as senior md and head of global structured solutions within the firm's investment banking and advisory group. He has extensive experience in the US, Latin America, EMEA and Asia-Pacific.

De Angelis has over 20 years of experience in structuring and trading corporate and structured finance products as well as in credit derivatives. He has previously worked at Merrill Lynch, where he helped to establish the structured credit arbitrage group, as well as at AIG Trading Group and Fidelity Investments.

Structured Finance

Blackstone names new cfo

Blackstone Mortgage Trust has appointed Paul Quinlan as cfo, replacing Geoffrey Jervis who is leaving the company. Quinlan will also serve as cfo for Blackstone's real estate debt strategies group.

Quinlan was previously Blackstone's head of financial planning and business development and cfo for Blackstone Advisory Partners. He has also worked at Bank of America Merrill Lynch and at PricewaterhouseCoopers Securities.

Structured Finance

Multi-boutique firm acquisition agreed

Lightyear Capital and employees of RidgeWorth Investments have entered into an agreement to acquire RidgeWorth from SunTrust Banks for up to US$265m. The asset management firm wholly owns six boutiques, including Seix Investment Advisors.

The leadership of RidgeWorth and its five wholly owned boutiques and one minority owned boutique will continue to manage the business and investment strategies. Alongside Seix Investment Advisors, these boutiques consist of Ceredex Value Advisors, Certium Asset Management, Silvant Capital Management, StableRiver Capital Management and Zevenbergen Capital Investments.

Structured Finance

SIFMA names new ceo

SIFMA has appointed Kenneth Bentsen as president and ceo. He was formerly SIFMA's president.

Before being appointed SIFMA president, Bentsen was evp of public policy and advocacy, overseeing SIFMA's legal, legislative and regulatory affairs. Before joining the association he was president of the Equipment Leasing and Finance Association and a member of the US House of Representatives and earlier in his career he was an investment banker specialising in mortgage finance at George K Baum & Company and at Drexel Burnham Lambert.

Bentsen takes over from Judd Gregg, who is stepping down as ceo. Gregg will continue to work with the association as a senior advisor.

CDO

SEC CDO charges settled

The US SEC has charged Merrill Lynch with making faulty disclosures about collateral selection for two CDOs that it structured and marketed to investors. Merrill Lynch is also accused of maintaining inaccurate books and records for a third CDO and has agreed to pay US$131.8m to settle the charges.

The SEC says Merrill Lynch failed to inform investors that hedge fund firm Magnetar Capital exercised significant influence over collateral selection for Octans I CDO and Norma CDO I. Magnetar bought the equity in those CDOs and its interests were not necessarily aligned with those of other investors because it hedged those equity positions by shorting against the CDOs.

The alleged misconduct took place in 2006 and 2007 and included giving Magnetar a contractual right to object to the inclusion of certain collateral in the Octans I CDO which had been chosen by the supposedly independent collateral manager, Harding Advisory. Harding has been charged separately for its role in misleading investors (SCI 21 October).

The SEC has also charged the managing partners at NIR Capital Management for its role in the Norma CDO. Without admitting or denying the SEC's findings that they abdicated their own responsibilities in allowing Magnetar to influence portfolio selection, NIR's Scott Shannon and Joseph Parish have agreed to pay more than US$472,000 and exit the securities industry.

Merrill Lynch is also charged with violating book and records requirements for Auriga CDO, which was managed by an affiliate. The bank improperly avoided recording many warehoused trades when they occurred, delaying its obligation to pay carry until after the CDO priced.

CMBS

CMBS pro to lead West Coast operations

CCRE has appointed Bill Whalen as md to lead operations in its new office in San Francisco. He will focus on originating fixed and floating rate loans and expanding the firm's multifamily lending and securitisation business on the West Coast, reporting to ceo Anthony Orso.

Whalen was previously md at Wells Fargo Multifamily Capital. He has also worked at Hamilton Zanze & Company and at Wachovia.

Insurance-linked securities

SAC Re sale agreed

Hamilton Insurance Group has entered into a definitive agreement to acquire SAC Capital Advisor's hedge fund-style reinsurer SAC Re. The transaction is expected to close prior to 31 December, subject to Bermuda Monetary Authority approval and other closing conditions.

The investor group buying SAC Re includes former Marsh & McLennan president and ceo Brian Duperreault, Two Sigma Investments, Capital Z Partners and Performance Equity Management. Upon closing, the company will be renamed Hamilton Re, with Duperreault at the helm. Two Sigma will become the sole investment manager for Hamilton Re's investable assets.

The sale follows last month's agreement with the US Attorney for the Southern District of New York and the Assistant Director-in-Charge of the New York Office of the FBI to resolve insider trading charges against four companies SAC Capital Advisors, CR Intrinsic Investors and Sigma Capital. Under the Agreement, which is subject to court approval, the SAC companies plead guilty to securities fraud and wire fraud in connection with a large-scale insider trading scheme.

The agreement imposes a US$1.8bn financial penalty on the SAC companies - the largest insider trading penalty in history - split between a US$900m fine in the criminal case and a US$900m forfeiture judgment in a civil money laundering and forfeiture action filed by the US government simultaneously with the criminal charges. It also provides that the SAC companies and their affiliates will no longer accept outside investor funds and will shut down operations as an investment adviser.

AM Best notes that the financial strength rating and issuer credit rating of single-A minus (Excellent) of SAC Re are unchanged but remain under review with negative implications until the closing of the acquisition. The agency notes, however, that the signing of the definitive agreement is a positive development for SAC Re and - should the transaction close as expected - it will fully resolve the reputational risks associated with SAC Capital. Nevertheless, an evaluation of Hamilton Re's new business plans and investment strategy will still need to be undertaken.

RMBS

Bank reaches RMBS settlement agreement

PNC Bank has reached an agreement in principle with Freddie Mac to resolve substantially all indemnification and repurchase obligations related to loans sold between 2000 and 2008. PNC will pay the GSE US$89m - less credits of US$8m - to resolve existing and future repurchase obligations and to compensate Freddie Mac for losses.

PNC has already agreed to settle with Fannie Mae. The completion of the two agreements resolves the majority of PNC's outstanding and potential indemnification and repurchase obligations related to loans sold to the GSEs.

RMBS

FHFA individual claims to proceed

The US District Court for the Southern District of New York has allowed the FHFA to proceed with its claims against several individual defendants in connection with RMBS purchased by Fannie Mae and Freddie Mac between 2005 and 2007. Certain individuals who signed the relevant shelf registration statements but did not sign the relevant prospectus supplements moved to dismiss the action on the grounds that they could not be held liable for misstatements in prospectus supplements that they did not sign.

A recent Lowenstein Sandler memo notes that in denying the individual defendants' motion to dismiss, US District Judge Denise Cote concluded that under SEC Rule 430B information in a prospectus supplement is "deemed to be part of and included in the registration statement on the earlier of the date and time of the first contract of sale of securities in the offering to which such subsequent form of prospectus relates". According to the court, it was clear that "the SEC intended individuals to remain liable for 'fundamental changes' to the information in a registration statement, as they had been previously" and "Rule 430B therefore does not exempt the individual defendants from Section 11 liability for misstatements contained in the prospectus supplement".

Separately, US Bancorp has entered into an agreement with Freddie Mac that resolves substantially all repurchase obligations related to representations and warranties made on loans sold to the GSE between 2000 and 2008. After adjusting for credits related to prior repurchases, US Bancorp will make a one-time US$53m cash payment to Freddie Mac.

RMBS

US REIT makes board addition

Two Harbors Investment Corp has appointed Jacques Rolfo to its board of directors. The derivatives and structured products specialist was formerly ceo at CIFG and has also worked at CDC Group, Lehman Brothers and The World Bank.

ABS

Stable outlook for German commercial ABS

The fall in German corporate insolvencies in 2013 to a 14-year low will lead to decreasing default rates in German commercial ABS transactions, according to Fitch, supporting its stable ratings outlook for the sector in 2014. The decrease in corporate insolvencies is consistent with the agency's expectation of a benign economic environment in Germany, which is incorporated into its deal-by-deal base-case default assumptions.

The decrease in corporate insolvencies is expected to translate into moderately decreasing default rates in structured finance transactions where the securitised portfolios contain contracts originated with corporate obligors. Fitch projects default rates to remain in line with its base-case assumptions and below its assumptions in higher rating stress scenarios, thereby supporting a stable ratings outlook on commercial ABS transactions.

Most insolvencies have been at SMEs with a turnover of up to €5m. Fitch expects this to remain the case, as these companies have proved more sensitive to weaker exports caused by the continuing weakness in the eurozone.

The impact of the fall in corporate insolvencies is therefore likely to be more pronounced on the default performance of commercial ABS transactions, where the obligors are usually smaller, than on the default performance of balance sheet SME CLOs.

German credit bureau Creditreform estimates that corporate insolvencies in Germany will drop to 26,300 companies in 2013, from 28,720 in 2012. The figures for the year as a whole are better than might have been expected after the 3.4% year-on-year increase in 1H13 that resulted from slowing economic activity in Germany and Europe. The improvement reflects increasing equity ratios and stronger net financial positions at German firms, including SMEs, as well as rising business confidence.

ABS

Volcker to spur full conduit support

The Volcker Rule's treatment of ABCP conduits will motivate conduit sponsors to employ full unconditional liquidity coverage and remove an important regulatory risk from the sector, Fitch says. To be exempt from the covered fund definition under the rules, outstanding ABCP must be fully supported and liquidity commitments must be available to fund for the full face amount of all outstanding ABCP without exceptions for asset credit performance.

Current conventions for ABCP liquidity support agreements include 'partial support' contracts, where the provider bank is not obliged to fund for defaulted assets. Partially supported programmes will consequently require restructuring to be excluded from the rule's definition of a covered fund. Fitch expects that they will convert to full support at the conduit or individual transaction level over the next several months.

Many sponsors have already restructured to issue under different legal exemptions and developed the ability to issue liabilities in addition to traditional ABCP-like callable, putable and investor-option extendible notes for liquidity coverage management purposes.

However, while the final rule removes one regulatory risk, a number of regulatory obstacles that are largely out of conduit operators' control will likely limit growth in the sector in the coming year. As of 30 November, US ABCP outstandings stood at US$250bn on a non-seasonally adjusted basis, according to the US Fed. This marks an 18% decline from year-end 2012 level and is 80% lower than the peak of US$1.2trn in July 2007.

ABS

RFC on tobacco ABS approach

Moody's is seeking comments on proposed changes to its rating approach for tobacco settlement revenue securitisations. Specifically, the agency is proposing to change its cashflow modelling assumptions for the non-participating manufacturer (NPM) adjustment provisions.

"We're proposing these changes in response to the December 2012 settlement of the NPM adjustment disputes for 2003 through 2012 by 22 states and territories, and certain tobacco companies," says Irina Faynzilberg, a Moody's vp-senior credit officer.

The settlement changed the calculation of the NPM adjustment for the 22 states. The changes are generally negative for the credit quality of outstanding tobacco bonds, but Moody's expects a limited ratings impact.

Feedback is requested by 10 January 2014. The agency will finalise the changes to its cashflow assumptions for tobacco settlement revenue securitisations after taking responses to this request for comment into account, following which it will publish its revised methodology and take rating actions on any affected tranches.

ABS

Tax lien RFC issued

Moody's is seeking comments on a new methodology that covers its approach to rating tax lien ABS. If the proposed methodology is adopted, the agency does not expect any rating changes to currently outstanding US tax lien-backed transactions.

"Tax lien securitisations are backed by liens on properties arising out of delinquent property taxes, assessments, sewer rents, sewer surcharges, water rents and/or other charges imposed by a municipality, township or county," says Moody's vp Xiaochao Wang. Sponsors are typically municipalities or financial institutions that have purchased the tax liens from a municipality

Feedback on the proposal is requested by 31 January.

ABS

Innovative trade finance ABS debuts

Citi and Santander have closed the inaugural ABS issuance from Trade MAPS, a global multi-bank asset participation programme aimed at enhancing trade banks' ability to support global trade flows and grow their trade finance portfolios. The programme is intended to address a number of challenges facing the banking industry, including capital management, liquidity, increased credit constraints and Basel 3 capital requirements.

"The programme is designed to benefit the broader industry by establishing an origination and funding platform for trade banks with global market positions, creating a highly diversified and granular pool of assets ultimately translating into access to a new and wider investor base," comments John Ahearn, global head of trade at Citi.

The programme offers trade banks the ability to fund their originated trade finance assets in a capital- and balance sheet-efficient manner through issuances of medium-term ABS. The US$1bn three-year debut issuance - Trade MAPS 1 series 2013-1 - comprises five classes of notes and is backed by corporate and financial institution-related US dollar-denominated trade finance loans originated by Citi and Santander.

Rated by S&P and Fitch, the US$874.4m triple-A rated class A notes priced at 70bp over one-month Libor, the US$77.6m single-A class Bs priced at 125bp over, the US$31.3m triple-B class Cs at 225bp and the US$16.6m BB/B class Ds at 500bp. An unrated US$41.1m equity tranche was retained by Citi (US$14.8m) and Santander (US$26.3m).

The Trade MAPS programme is based on a multi-jurisdictional structure that enables both Citi and Santander branches or entities domiciled in Asia, Latin America, Europe, Middle East and North America to sell trade finance assets via multiple SPVs. These entities then fund themselves through an offshore SPV - Trade MAPS 1.

At closing, there will be five local SPVs located in Ireland, Hong Kong and Singapore, issuing funding securities or off-shore trust certificates backed by trade finance assets. The securities will be allocated to two groups: asset group one (Santander) and asset group two (Citi).

The transaction has a combined 36-month revolving and accumulation period and a 24-month tail period. During the revolving period, principal collections will be used to reinvest in new eligible trade finance receivables. During the accumulation period, principal collections will be set aside to pay the notes in full at expected principal payment date.

If during the revolving period, a local seller is unable to sell trade finance assets to the local SPV, the transaction may purchase them from a different seller within the programme.

The transaction benefits from asset group revolving period stop events (AGRPSE) and series amortisation events (SAE), which protect investors from a deteriorating asset pool and certain operational risks, according to Fitch. If an AGRPSE is activated, the transaction stops revolving for the asset group that activated the trigger; however, under certain circumstances, the event can be cured. If an SAE is activated, the transaction will start amortising and collections will be used to prepay the notes

Citi, Morgan Stanley and Santander were joint book runners on the transaction. The master programme administrator is FTI Consulting.

Structured Finance

First-half weighting for CDO supply

JPMorgan has surveyed CDO BWIC volume from 1 January to 29 November, based on original notional balances. They find that US CDO BWIC volume dropped by 42% year-over-year to US$36.9bn, driven by a reduction in ABS CDO bid-lists, with the liquidation of the Maiden Lane portfolios boosting activity in 2012.

However, US CLO BWIC volume of US$22.48bn is around 5% higher than 2012 levels. At US$10.4bn, Euro CDO BWIC volume has increased by 63% over the same period last year.

By original rating, volume of triple-A and double-A rated CLO paper has reduced by US$2.6bn (-22%) and US$72m (-6%) from 2012, according to JPMorgan figures. On the other hand, in single-A through equity, a US$3.88bn (18%) increase in BWIC volumes was seen year-over-year, the majority of which was driven by a US$1.8bn (157%) increase in double-B BWICs.

The survey suggests that volume was weighted significantly more towards 1H13, with a circa US$5bn reduction in triple-A BWIC volume from 1H2013 to 2H2013. Certainly the supply of chunkier triple-A BWICs seen in 1H13 has been replaced with smaller clips in 2H13.

CDO strategists at JPMorgan note that several factors may contribute towards this development, including the growth of and opportunities in the CLO 2.0 market, as well as CLO 1.0 amortisation. Triple-A 1.0 bonds have deleveraged faster-than-expected this year based on high prepayment rates in the high yield loan market. As such, some investors may have elected to hold debt rather than sell.

Structured Finance

Italian lease ABS, SME CLO outlooks differ

Weaker structural features in Italian lease ABS compared with Italian SME CLOs mean that Fitch's 2014 rating outlook for the two sectors is different, despite both being exposed to Italian SME asset performance. Most outstanding Italian ABS leasing transactions were structured so the portfolio could be replenished during the initial revolving period and that the mezzanine tranches could be repaid on a pro-rata basis with the most senior notes, subject to minimum portfolio performance conditions. However, some of them provided less protection for senior noteholders, for example, by not including a mandatory switch from pro rata to fully sequential pay-down close to the end of the deal, when obligor concentration and adverse selection are typically a risk from a credit perspective.

Some originators supported their transactions by buying back large amounts of defaulted and delinquent loans. While this support has reduced the amount of defaults the transactions had to bear, without it Fitch believes that some revolving periods would have been halted well before their scheduled expiry date. Also, some pro-rata conditions would not have been met, which weakened the protection available to the senior notes.

Another key difference between Italian ABS leasing deals and SME CLOs lies in the security package of the underlying loans. Almost 70% of loans in SME CLO pools are backed by mortgages, while the ownership of leased assets is not transferred to lease ABS SPVs and no specific security is created for the SPV's benefit.

As a result, leasing deals are exposed to the originator's creditworthiness because the receivables arising from the sale and/or re-lease of the underlying financed assets on debtor default - which Italian originators typically transfer to the SPV upon collection thereof - may not be swept to the SPV's accounts if the originator is insolvent. Consequently, Fitch does not give credit to recoveries from the sale or re-lease of the leased assets when setting recovery assumptions for rating scenarios above the originator's rating in leasing transactions.

These relative weaknesses mean that the agency's rating outlook for Italian ABS leasing transactions in 2014 is negative, while for Italian SME CLOs it is stable/negative, even though it has a negative asset performance outlook on Italian SME collateral.

Structured Finance

SFR risks analysed

Morningstar has published a report detailing six areas that it recommends investors pay close attention to in future single-family rental securitisation proposals.

One area is the risk presented by multiple borrowers/property managers. Only a few investors and property managers have an inventory of rental homes large enough to issue a single-borrower securitisation and that have the capability to manage all of the properties in-house.

One solution may be to pool together properties owned by smaller investors/property managers into a single securitisation trust. However, there are unique risks to this type of structure that would need to be addressed, such as cash management oversight to avoid the leakage of cash. Also, since property management replacement could be more likely, the replacement trigger and related transition should be well-planned.

Another area highlighted in the report is stabilisation of properties. Stabilised properties that have been rehabbed, marketed and leased are the best candidates for securitisation, according to Morningstar. Properties that are not leased pose additional risks and may need additional credit enhancement to protect against the increased uncertainty.

Rehab quality is a third area of concern. The quality of upfront rehab investment can substantially impact the future maintenance and capex expenses of SFR properties. A proven high quality of initial property may result in a lower credit enhancement requirement than similar properties that have undergone a less rigorous rehab or that have assumed tenants from previous landlords.

In respect of leasing and marketing SFR properties, if rental supply outpaces rental demand, investors should be aware of the property manager's leasing and marketing policies and practices. Loose tenant underwriting policies and/or a track record of exceptions to underwriting policies may result in higher cashflow volatility and credit enhancement requirements, Morningstar notes.

Meanwhile, smart property managers with flexible policies aimed at providing a quick turnaround can improve turnover time and reduce overall vacancy time. Since vacancy is an important driver behind the net cashflow available to make debt service payments on securities, the quality of delinquency and vacancy policies can affect the amount of required credit enhancement protection.

Finally, as with any securitisation, data quality is extremely important when assessing the risk in an SFR transaction. The use of third parties to verify data can reduce the uncertainty of that data, while the use of a standard platform by the property manager to process data can reduce complications if a property manager replacement is required. The standardisation of a data tape could further aid in the analysis of SFR securitisations.

Structured Finance

Euro retention rules finalised

The European Banking Authority has published final draft regulatory technical standards (RTS) on securitisation retention rules and related requirements, as well as its final draft implementing technical standards (ITS) on the convergence of supervisory practices relating to additional risk weights in the case of non-compliance with the retention rules. The rules aim to provide greater clarity and transparency for market participants, and will support compliance and foster convergence in supervisory practices across the EU.

The key objectives of the draft RTS are to: create an alignment of interest and information between securitisation sponsors, originators, original lenders and investors buying securitisation transactions; and facilitate the implementation of the 5% retention and disclosure requirements of the sponsor, originator or original lender and the due diligence requirements of investors in securitisations. The draft ITS specify the measures that are to be taken by competent authorities in cases of material breaches of the securitisation retention rules and related requirements. In particular, they provide assessment criteria for breaches, as well as calculation and implementation for additional risk weights that are to be applied by competent authorities.

The final standards have been sent to the European Commission for their adoption as EU Regulations that will be directly applicable throughout the region.

Separately, the EBA has launched a public consultation on draft guidelines providing guidance to both originator institutions and competent authorities when assessing significant risk transfer (SRT) for securitisation transactions. The guidelines will be part of the EU Single Rulebook in the banking sector and aim to ensure harmonised assessment and treatment of significant risk transfer across all EU Member States. The public consultation runs until 17 March 2014.

The EBA says it recognises that securitisation can be used as an effective credit risk transfer tool and for risk management purposes. If certain criteria are met, including the SRT requirements, originator institutions of a securitisation may consider the credit risk transfer in the calculation of own funds requirements. However, to avoid regulatory capital arbitrage, it is important that competent authorities and originator institutions consider a range of factors when assessing whether effective credit risk transfer has occurred and SRT requirements have been met in a given transaction when transferring the credit risk to an independent third party.

In this respect, the proposed guidelines include: requirements for originator institutions when engaging in securitisation transactions for SRT; requirements for competent authorities to assess transactions that claim SRT; and requirements for competent authorities when assessing whether commensurate credit risk has been transferred to independent third parties.

The deadline for the submission of comments on the guidelines is 17 March.

Structured Finance

Capital rule changes introduced

The US Fed has issued a final rule that makes technical changes to its market risk capital rule to align it with the Basel 3 revised capital framework adopted earlier this year. Technical changes to the rule reflect modifications by the OECD regarding country risk classifications.

The final rule also clarifies criteria for determining whether underlying assets are delinquent for certain traded securitisation positions. It clarifies disclosure deadlines and modifies the definition of a covered position. Each of these changes makes the market risk capital rule consistent with the revised capital framework that will come into effect in January 2015.

In addition, the Fed has made minor modifications to the Basel 3 revised capital framework to clarify the criteria for subordinated debt instruments that may be counted as tier 2 capital.

Structured Finance

CLO supply expectations polled

With a head-count of 180, last week's SCI 7th Annual Seminar saw a 38% increase in attendance on the previous year's conference. Sponsored by Banca IMI and Reed Smith, the seminar focused on credit market dislocation and alternative ways of optimising CLO and ABS returns. Presentations from the event can be downloaded here.

In a poll conducted after the seminar, delegates were asked about their expectations regarding European primary CLO volumes in 2014. Of the respondents, 68% forecast that issuance would reach between €10bn-€20bn, 21% forecast that it would be below €10bn and 11% said that it could total over €20bn.

Delegates were also asked what their single largest area of concern is in the securitisation market today. Three-quarters of respondents said that regulation is, while 7% voted for loan supply, and transparency, data quality and liquidity received 4% of votes each.

Finally, when asked which asset classes and topics they would like to see covered in greater depth, 79% of respondents suggested CLOs and 50% chose secondary markets.

Structured Finance

CRA debuts SF approach

Scope has published its first methodology guidelines for rating and monitoring structured finance products. The guidelines lay down the key principals that the rating agency intends to apply to all types of structured finance instruments and present how key criteria are integrated in the rating process.

Scope believes that the analysis of qualitative factors, based on objective components, plays a crucial role in assigning a rating. The agency says it will draw on its framework for rating asset management quality developed over the past ten years, as well on as a stress testing and breakeven analysis to supplement its quantitative approach. In particular, it believes that qualitative assessments are essential to differentiate transactions whose assets require intensive care, dynamic management or active work-out, such as managed CLOs or CMBS.

"Scope´s objective is to offer European capital markets a sustainable alternative to existing credit agencies - one that enhances transparency and fosters a diversity of opinions," says Guillaume Jolivet, author of the methodology guidelines.

Scope´s rating methodology for structured finance instruments relies on three analytical blocks: collateral risk analysis, focusing on the credit quality of the underlying collateral; counterparty risk analysis, examining the risks and risk-mitigating factors associated with the key parties involved in the transaction; and structure-specific analysis, looking at the characteristics of the issuing vehicle, structural aspects of the rated instrument and other transaction-specific risks.

Comments from market participants on the guidelines are welcome by 30 January.

Structured Finance

Stable outlook for LatAm SF

Fitch foresees stability across Latin American structured finance sectors in 2014. On average, asset portfolios are expected to perform within base-case assumptions, reflecting stable economic conditions within each of the major Latin American countries.

The ongoing positive dynamics of the Brazilian oil industry support Fitch's stable outlook for offshore vessel contract monetisation transactions in the cross-border market. Stable unemployment, despite sluggish GDP growth, drives the agency's stable outlook for local Brazilian ABS.

Meanwhile, Fitch's outlook for Mexican RMBS varies across segments. While the outlook remains negative for Mexican RMBS sponsored by private sector non-bank financial institutions (NBFI), the agency expects recoveries within this segment to continue stabilising in 2014.

Fitch continues to see widespread use of payroll deductible loans (PDLs) throughout Latin America. These products significantly mitigate willingness to pay risks and the agency expects Latin American SF transactions backed by PDLs to remain stable in 2014.

Fitch affirmed more than 85% of Latin American SF transactions in 2013. While the downgrade/upgrade ratio continues to hover around 2/1, the majority of negative rating actions are isolated to NBFI Mexican RMBS.

CDO

Trups CDO payments challenged

A junior noteholder in five Trups CDOs is challenging in court the trustee's interpretation of the transactions' payment mechanics. The transactions involved are Tropic CDO I, Tropic CDO II, Tropic CDO III, Tropic CDO IV, Soloso CDO 2005-1 and Soloso CDO 2007-1.

According to an S&P comment, the junior noteholder contends that certain provisions of the indenture may be interpreted to permit interest payments to junior noteholders, even when the senior overcollateralisation tests are not satisfied. If successful, the challenge would alter the effectiveness of the transactions' senior OC tests, the agency notes.

However, S&P says that a rating action or credit watch placement is not necessary at this point in time.

CDO

Trups CDO defaults, deferrals flat

The number of combined defaults and deferrals for US bank Trups CDOs has remained at 27.3% at the end of November, according to Fitch's latest index results for the sector. One issuer, representing US$2m in collateral, deferred on its Trups during the month. No new defaults and no new cures were recorded.

Year-to-date there have been 15 new deferrals and defaults, compared to 47 over a comparable period last year. The total number of cured issuers remains the same from October, with 59 cures year to date, compared to 40 last year.

Across 79 Trups CDOs, 222 bank issuers have defaulted and remain in Fitch's portfolio, representing approximately US$6.5bn. Additionally, 277 issuers are currently deferring interest payments on US$3.8bn of collateral. This compares to 349 deferring issuers totalling US$5bn of collateral at this time a year ago.

CDS

Independent CLOB introduced

MarketAxess Holdings has rolled out MarketAxess Trade Crossing Hub (MATCH), believed to be the first independent central limit order book (CLOB) for single-name credit default swaps. The service is designed to offer a new way to trade single-name CDS, with market participants able to send and receive anonymous orders, to be accessed by all other market participants. Barclays will act as the primary market maker to help ensure the availability of continuous two-way markets on the platform.

MATCH began operations earlier this year with select single name swaps available to a limited number of clients. The platform has now further expanded, allowing a broader group of global market participants to access liquidity in a wider universe of the most frequently traded single-name CDS. Trade details can be delivered via straight-through-processing for increased post-trade efficiency and risk management.

CDS

Single-name clearing introduced

LCH.Clearnet has expanded its credit default swap clearing (CDS) service, CDSClear, to offer single-name CDS clearing. European members and clients can now benefit from significant capital efficiencies through risk offsets between 187 single-names and existing index products via Monte Carlo Simulation VaR-based portfolio margining.

European clients can also benefit from improved portability conditions through the clearer's asset tagging solution. This solution allows clearing members to track which of their client-related non-cash collateral and positions can be 'ported' to another member in the event of a default, in line with EMIR requirements.

CLOs

Euro VFNs re-emerge

PineBridge Investments has closed its €335m Euro-Galaxy III CLO, which features a variable funding note (VFN) that provides enhanced flexibility and efficient cash management during the ramp-up phase. It is the first European CLO to include a VFN since the financial crisis.

Arranged by Barclays Bank, Euro-Galaxy III marks the nineteenth CLO that PineBridge has completed. As of 17 December, the firm had US$9.41bn of leveraged finance assets under management.

CMBS

CMBS refi wave decoded

Trepp estimates that US$1.4trn in US commercial mortgages will mature between 2014 and 2017, with CMBS loans representing about a quarter of the total. The firm predicts that US$346bn in CMBS loans will mature between 2014 and 2017, with a peak of US$113bn maturing in 2016.

Among the six major regions of the US, the Northeast has the greatest amount of loans maturing between 2014 and 2017, at almost US$100bn. The Northeast represents 30% of the total, followed by the Pacific and Southeast regions, each with almost 20% of maturing loans. The Midwest, Southwest and Mountain states each represent less than 15% of maturing loans, according to Trepp.

In order to estimate how these maturing loans will fare, the firm examined current trends in newly originated loans. Trepp data shows that most commercial property loans underwritten in 2013 have an LTV ratio of about 60%, while multifamily loans have an LTV that is about 70%. In some cases, these recent LTV ratios are well below the LTV ratios of maturing loans, which raises the question of whether maturing loans can be refinanced in today's more restrictive lending environment without requiring additional equity.

Trepp notes that the lodging sector is currently performing very well, but because of the cyclical nature of the hospitality business and its strong correlation to economic activity, it has significant potential for volatility. For lodging properties, borrowers trying to refinance loans should be able to meet loan-to-value requirements in 2014 and 2015. It is not until 2016 and 2017 that borrowers may need to inject more equity to meet current underwriting standards.

Meanwhile, the office sector's recovery has been slow and uneven. Top markets are performing well, but lenders have been more restrictive in secondary and tertiary markets.

Office loans maturing in 2017 have a much higher LTV ratio than those maturing in 2014. In 2014 borrowers should have little trouble refinancing, as current LTV ratios are higher than those of maturing loans.

Between 2015 and 2017, however, refinancing troubles could emerge - barring significant property value appreciation or a loosening of underwriting standards. By 2015, the LTVs on maturing office sector loans will exceed those of new loans in all regions. By 2017, the Midwest region will face the greatest problems, followed by the Northeast, Southeast and Mountain states.

Industrial borrowers may face significant challenges refinancing maturing loans from a loan-to-value perspective. In 2014 the LTV ratios for maturing loans are close to those for recently originated loans, which may limit refinancing problems, but the story changes in 2015. Industrial is one of few product types where the LTV ratio for maturing loans decreases in 2017.

Industrial properties in the Southeast, Northeast and Pacific states should be able to meet LTV requirements in 2014, but by 2015 and beyond, borrowers could have a difficult time refinancing.

In almost every region of the country, retail borrowers will find it difficult to meet current LTV requirements when refinancing maturing loans, Trepp suggests. Near-term issues will likely be most significant in the Mountain states, but by 2017 the Pacific and Northeast states will require the greatest injections of equity to refinance at current LTVs.

CMBS

Troubled malls have 'exaggerated impact'

Absent additional enhancement, the credit quality of new issue US CMBS conduit and fusion transactions is at risk because of high losses from defaulting loans on troubled malls, Moody's reports. The agency says that a default of a single mall loan can have an exaggerated impact on trust performance: even though these defaults have accounted for only 1% of liquidations since 2008, they constitute 20% of the liquidations that resulted in dollar losses above US$20m with a loss severity rate higher than 75%.

"The default of a single mall can reverberate throughout the trust because of the large size of mall loans and the high losses they can incur," comments Moody's director of commercial real estate research Tad Philipp. "Troubled malls will continue to have a negative impact on seasoned CMBS, despite improvement in the overall economy."

Moreover, changes within the mall market could put weak malls at risk of becoming failed malls, further exacerbating the levels of defaults and losses to CMBS trusts. "Malls are increasingly divided between those that are strong performers that can attract high-quality tenants and weak malls that don't have the same clout," adds Philipp. "Loans on weak malls continue to be originated for securitisation, despite mounting evidence of poor performance."

Given the risk posed by these weak mall loans, Moody's says it assigns credit enhancement levels commensurate with the risk when loans backed by troubled malls appear in loan pools and applies a high likelihood of default and a high severity rate to new issue CMBS and surveillance backed by poorly performing mall loans.

"When a mall's long-term viability is in doubt, we introduce stress scenarios up to and including 100% probability of default with a large loss," Philipp continues.

CMBS

Excess proceeds for REO loan

In an unusual outcome for an REO loan, the Astor Crowne Plaza asset has paid off significantly above par. The US$73.4m loan, securitised in GSMS 2005-GG4, was sold this month for US$116.6m - slightly above its most recent appraisal, as of August.

The property had been transferred to special servicing in May 2009 and was subsequently placed in REO. The sale had been widely expected for some time, with the asset first put up for auction in mid-2012.

The development led to a number of noteworthy cashflow implications for the trust, according to a Barclays Capital analysis. First, the loan remitted enough cash to pay prepayment penalties, amounting to US$6.6m. This was distributed to the AAB, A4, A4A and XC tranches of the deal.

In addition, the sale generated US$10.5m of excess liquidation proceeds, even after paying back the loan and sundry advances, servicer fees and penalties. This was applied to reimburse losses to the bottom-most outstanding tranche; consequently, the K tranche received US$10.5m of cash this month. The bond had US$212,000 of outstanding balance at the beginning of the December remittance period.

CMBS

Large dispositions drive late-pays lower

US CMBS late-pays fell by 22bp in November to 6.10% from 6.32% a month earlier, according to the latest index results from Fitch. The drop was led by four large dispositions.

The largest disposition was the note sale of the original US$190m StratReal Industrial Portfolio I loan (securitised in BACM 2007-1) via a fair-value purchase option (see SCI's CMBS loan events database). Roughly US$124.5m in principal proceeds from the sale were passed through to the trust in November. A loan balance of US$65.m remains outstanding as the special servicer, CWCapital, pursues collection of a US$6.5m letter of credit.

The US$167m Windsor Capital Embassy Suites Portfolio (GSMS 2006-GG6) was also disposed of and reported a loss in November of US$26m. In addition, the US$94m Boulevard Mall (GECMC 2003-C2 and GMAC 2003-C2) was sold for a reported US$54.5m, resulting in a combined loss of US$42.2m to the two trusts. Finally, the US$80m One Campus Drive (BACM 2006-3) was sold for US$8.35m, with a reported loss of US$64.4m.

November remittance reporting also identified assets included in CWCapital's multi-asset marketing plan, with bids anticipated this month. The largest assets identified include: US$468m Two California Plaza (GSMS 2007-GG10); US$360m Solana (BACM 2007-1 and JPMCC 2007-LDP10); US$190m Montclair Plaza (WBCMT 2006-C28); US$175m Four Seasons Resort and Club (WBCMT 2006-C28); US$160m 119 West 40th Street (GSMS 2007-GG10); US$104m Maguire Anaheim Portfolio (GSMS 2007-GG10); and US$80m Resurgens Plaza (MLCFC 2007-5).

The largest addition to the delinquency ranks last month was the US$92m Cerritos Corporate Center (MLMT 2006-C1), for which foreclosure (via a deed in lieu) now appears imminent. At the same time, the US$78m Sierra Vista Mall (COMM 2006-C8) fell 60-days delinquent, while the US$63m Buckingham Portfolio (GCCFC 2007-GG9) defaulted at maturity and is now reported as a non-performing matured balloon loan.

October and November saw several new CMBS 2.0 delinquencies. In October the US$6.6m Wood Forest Apartments loan (COMM 2012-LC4) fell 60-days delinquent, with performance suffering under the prior management. Occupancy is reported to have improved since the removal of the management in August and the borrower is working to bring the loan current.

Two 2.0 loans were reported as 60-days delinquent in November: the US$9.4m Lynn Portfolio (COMM 2012-CCRE3) and the US$9.1m Campus Habitat (FREMF 2010-K9). However, according to the servicer, the Lynn Portfolio is current and is expected to be removed from the delinquency index next month.

In November, resolutions of US$1.4bn outpaced new additions to the index of US$620m. Additionally, Fitch-rated new issuance volume of US$4.8bn exceeded US$4.5bn in portfolio run-off, causing a modest increase in the index denominator.

November saw some large movements among the major property types. Most notably, the delinquency rate for the industrial sector plunged over one percentage point thanks to the StratReal Portfolio I note sale.

Hotel also posted a strong performance due to the Windsor Capital Portfolio disposition. Meanwhile, office delinquencies improved modestly, with a high volume of resolutions partly offset by the addition of Cerritos Corporate Center. Multifamily and retail were mostly flat month over month.

Current and previous delinquency rates are: 8.5% for industrial (from 9.68% in October); 7.01% for multifamily (from 6.98%); 6.96% for hotel (from 7.64%); 6.77% for office (from 6.95%); and 5.78% for retail (from 5.79%).

CMBS

Heavy retail concentrations seen

KBRA notes in its November month-in-review report that the steady supply of retail loans has been a consistent theme in US CMBS 2.0/3.0 deals. The agency observed heavy retail concentrations in each of the three conduit transactions it rated last month, ranging from 30.6% to 55.4%, with an average of 45%.

This is well above the average retail concentration among the 29 conduits it rated through 30 November 2013 of 32.8%. More notably, two of the three transactions (CGCMT 2013-GC17 and MSBAM 2013-C13) had significant retail concentrations of 49.1% and 55.4% respectively.

Each deal's exposure spanned across various retail segments, including regional mall, outlet centres, anchored retail centres and strip malls. Anchored properties represented at least 64.1% of the retail exposure in each deal and 31.4% of the transaction exposure.

MSBAM 2013-C13 also had a sizeable mall exposure, at 24.6% of the pool, which was comprised of the two largest loans in the pool - Stonestown Galleria (12.8%) and The Mall at Chestnut Hill (11.8%). The malls' reported respective inline sales were 33% and 70% above the International Council of Shopping Center's national average.

CMBS

Sponsor indicted for fraud

The sponsor of and property manager for one of the loans backing the WFRBS 2013-C18 CMBS currently in the market has been indicted on federal criminal charges. The disclosure, in connection with a US$38.5m pari passu piece of the US$113.5m Sullivan Center loan, comes six days after Fitch issued a presale and expected ratings for the transaction.

Larry Freed and Caroline Walters, respectively president and vp/treasurer of Joseph Freed and Associates, were indicted on seven counts of bank fraud, one count of mail fraud and five counts of making false statements to banks. The indictment was filed on 12 December and seeks forfeiture of US$2.995m in alleged fraud proceeds.

While the indictment is new information, Fitch already highlighted sponsor credit issues as a primary concern in its presale and stressed its asset volatility score to address potential volatility as a result of possible sponsor related issues. In addition, the property manager has limited control to approve any lease or any agreement involving more than US$15,000.

The property manager may also be removed and replaced upon a conviction of fraud. Consequently, Fitch notes that the updated disclosure will not impact the transaction's expected ratings.

The Sullivan Center is a 15-story 943,944 square-foot mixed-use office/retail building located within the Chicago central business district. The property secures a loan originated by UBS Real Estate Securities.

CMBS

CMBS surveillance criteria tweaked

Fitch has updated its US fixed rate multi-borrower CMBS surveillance and Re-REMIC criteria.

Under the changes, loss severity for the performing loan stress was increased to 50% (from 45%) to more closely reflect recent experience. This change is expected to increase overall transaction level loss severities slightly, but is not expected to have a significant rating impact.

Additionally, the deterministic test assumptions have been updated to more closely reflect new transaction rating criteria. The impact of this change is potentially more significant, as the new tests may result in downgrades (or less upgrades) to investment grade ratings on more concentrated pools. Nonetheless, the change is not expected to affect a significant number of deals, Fitch notes.

CMBS

Weaker credit warning

Fitch says it recently provided preliminary feedback on several US CMBS that included a higher percentage of loans from new originators. While these loans may not raise a red flag when measured simply by DSCR and LTV, other factors - including property locations, sponsors' experience levels and histories, and esoteric or unusual property types - showed these loans to be weaker credits. As a result, the agency increased the cashflow haircuts and loss severities, which resulted in stressed loss rates beyond what the lenders' LTVs and DSCRs implied.

Fitch suggests that the pressure on small and new CMBS originators to make loans and compete with established lenders is forcing them to make less desirable loans and reducing underwriting quality in recent deals. Smaller originators are more likely to make loans that are backed by properties in tertiary locations, with histories of unstable cashflows or lacking sufficient structures.

Further, their lack of skin-in-the-game has shifted all risks to the investors, according to the agency. The newer B-piece buyers that have entered the market may also present potential concerns, as they may not have the skills or resources to effectively screen these types of loans.

Fitch also points to an increased risk in refinancing. "It is an open question whether these properties will be able to increase revenues sufficiently to address the likely rise in interest rates at refinancing in ten years," the agency notes.

Insurance-linked securities

ILS growth 'causing concern'

EIOPA says in its 2H13 Financial Stability Report that the strong flow of new capital into insurance-linked securities is "causing some concerns" and needs to be monitored. The authority notes that inflows into the sector originate mostly from fixed income investors that are searching for yield, but don't necessarily have the modelling capabilities and experience to fully analyse the underlying risks and complexity of the insurance market. Without adequate supervision, such developments could cause systemic risk, it explains.

The report states that the ILS market has reached its highest levels for both new issuance and outstanding volumes since 2007. Issuance of catastrophe bonds has increased and the use of sidecars expanded in order to absorb insurance underwriting capacity.

At the same time, spreads were down between 30% and 45% in 1H13, compared to 4Q12. Natural catastrophe rates have also experienced a downward trend in 2013, albeit they are expected to stabilise next year.

The report indicates that significant change in the market has been driven by subdued economic growth and a low yield environment, increasing demand from investors that are searching for safe investments uncorrelated with other assets. It adds that over the next few years funding is expected to increasingly come from alternative sources, such as sidecars.

Risk Management

MAC contracts get CUSIPs

SIFMA's Asset Management Group and ISDA, working in collaboration with CUSIP Global Services, have developed CUSIP numbers for the Market Agreed Coupon (MAC). MAC contracts were developed jointly by SIFMA and ISDA earlier this year (SCI 24 April).

The two associations believe the establishment of CUSIP numbers, as a standardised method for identifying MAC contracts, will facilitate trading and transparency in the interest rate swaps marketplace. CUSIPs are expected to enhance the operational efficiency of the contracts, assist in position collapsing and streamline communications between market participants.

RMBS

Loan-level disclosure enhanced

Fannie Mae has commenced publication of monthly loan-level disclosure for single-family MBS. The data will be updated monthly and will provide loan-level details for loans underlying single-family MBS with issue dates beginning after 1 January. The loan-level disclosure files are accessible via PoolTalk, Fannie Mae's online disclosure application.

In addition to releasing monthly loan-level disclosure, Fannie Mae has enhanced its PoolTalk Glossary and updated its PoolTalk Frequently Asked Questions to further assist market participants in understanding its disclosures.

RMBS

Investors on the hook for 'consumer relief'?

S&P says it is unclear how the US$4bn in consumer relief agreed under JPMorgan's recent US$13bn settlement with the US Department of Justice (SCI 20 November) will be paid, as the settlement provides 'credit' towards this amount to be given for certain types of actions. The agency suggests that in cases where securitised loans are modified, the bank will get credit towards the settlement, while actual losses will be borne by the securitisation investors.

According to the settlement terms, US$9bn - which is the actual dollar amount that JPMorgan will pay as part of the settlement - will go towards resolving pending and potential legal claims with various parties in connection with RMBS that JPMorgan, Bear Stearns and Washington Mutual issued. The other US$4bn will be provided over the course of the next few years until 31 December 2017 and used for loan modifications, lending programme to creditworthy borrowers in the "hardest hit" and major disaster areas, "anti-blight" efforts, REO property donations and funds donated to community redevelopment activities.

While principal write-downs on loans are given a US$1 credit per US$1 write-down, a US$1.25 credit per US$1 write-down is given if the principal write-downs are for loans in what are considered the hardest hit areas. At the other end of the spectrum, a 50 cent credit per US$1 write-down is given if the loan is in a securitisation.

Additionally, the settlement establishes minimums and caps for certain types of actions, such as a US$300m credit cap on first-lien principal forbearance. But there is a US$2bn minimum credit on principal forbearance and forgiveness on first-liens and second-liens as a whole.

S&P notes that in cases where loans in securitisations are modified, JPMorgan will get credit towards the settlement, while actual losses will be borne by the securitisation investors. "In other words, for loan modifications provided to borrowers whose loans are in securitisations, JPMorgan will not be remitting any amounts of the settlement to the securitisation trusts to fulfil the consumer relief obligations of the settlement. In these deals, JPMorgan must still abide by the terms defined in the transaction documents and may also need to obtain investor consent prior to providing consumer relief," the agency observes.

S&P currently rates 470 transactions for which JPMorgan is listed as a master servicer, servicer or sub-servicer, with a current outstanding balance of approximately US$81bn. The majority of these transactions already allow most types of loan modifications, so investor consent may not be necessary. Contacting and identifying investors has proven difficult for trustees and transaction parties, so this could be a formidable obstacle to modifying loans where investor consent is required, according to the agency.

As for deal-level impact, a large increase in modifications for any particular transaction could result in: a drop in the weighted average coupon paid by the collateral; an increase in losses from principal forgiveness or forbearance modifications; and an increase in prepayments if loans are refinanced. A drop in delinquent loans and an increase of re-performing loans may also occur.

"While some of the loans that would end up in the re-performing loan bucket may come directly from a delinquent bucket, some may also come from the current bucket, depending on how aggressive the modifications are," S&P warns. "We note that non-delinquent loans still existing in outstanding trusts have already typically performed well to date and may be able to continue to perform well without a modification. Therefore, consumer relief provided for these loans in the form of modifications that may not be needed may result in less cash to the related trusts than would have otherwise been received without the modification."

Also of note is a 115% 'early incentive' credit for all consumer relief activity offered or completed by 1 October 2014. This may incentivise JPMorgan to front-load many of the modifications within the next year, the agency suggests. Given that providing a modification within a securitisation to a loan in a hard hit area prior to this date can provide a cumulative credit of 71.88 cents per dollar as opposed to just 50 cents per dollar, a pick-up in the level of modifications provided for transactions that contain more of these types of loans could occur.

RMBS

Divergence seen in Aussie delinquencies

Fitch reports that Surfers Paradise, in Queensland, has become the worst performing postcode in Australia for missing housing loan payments - with a 30+ days delinquency rate of 4%. The improvement in property markets over the past six months and the sale of a significant number of foreclosed properties means that Nelson Bay in New South Wales is no longer the worst performing postcode in terms of mortgage repayments, which it had been continuously since this November 2007.

On average the delinquency rate across Australia decreased to 1.25% at end-September 2013, down from 1.45% at end-March 2013, driven by seasonal factors including the reduced effect of Christmas overspending. Local trends in unemployment and economy have become the major drivers in regional mortgage performance in the current low interest rate environment.

Tasmania replaced Queensland as the worst performing state in Australia for payment of residential housing loans. The 30+ days arrears in Tasmania improved by only 3bp to 1.51% at September 2013, below the national average improvement of 20bp.

At end-September, 90+ days arrears in Tasmania were at a record high of 0.68%. Fitch believes that stagnation in the local housing market and unemployment were the key drivers of Tasmania's underperformance.

Delinquencies in the non-metropolitan area of Western Australia have increased significantly by 30bp to 1.76%, as at September. This geographical area has experienced an increase in unemployment, coupled with declining house prices over the six months to September. Non-metropolitan regions in New South Wales and Queensland have also not improved as much as the rest of Australia.

Hume City in Victoria was the worst-performing region in Australia, with a 30+ days delinquency rate of 2.10% at end-September, replacing Fairfield-Liverpool (NSW) - which had been the worst-performing region over the past seven and a half years. Both regions have historically shown strong sensitivity to mortgage rates due to socioeconomic factors, such as high unemployment and low-income households.

Delinquency rates were little changed in Australia's most affluent regions. Lower Northern Sydney (NSW), South East Inner Brisbane (QLD), Northern Middle Melbourne (VIC) and Central Metropolitan Perth (WA) were the best-performing regions in their respective states. The delinquency rates in these regions remained broadly unchanged in the 0.45%-0.74% range.