Contents

CMBS

Spreads steady as CMBS supply rises

Generic US CMBS spreads were unchanged yesterday as bid-list volume continued to climb, reaching almost US$246m for the day. Secondary supply came from various vintages, with SCI's PriceABS data capturing tranches from 2005 to 2013.

Among the 2005-vintage deals, the BAYC 2005-1A A1 bond was out for the bid and talked in the very high-80s. The tranche was talked in the high-80s earlier in the month and was covered in the mid/high-80s in November.

CSFB 2005-C2 AMFL was covered at 92 handle, meanwhile, having been talked at 91 and in the low-90s in the previous session. Additionally, the CSFB 2005-C2 AMFX tranche was talked in the low/mid-300s and mid-300s and covered at 345, having been covered last week at 404.

Most BWICs came from 2006- and 2007-vintage deals. Among these was the BACM 2006-6 AJ tranche, which was talked in the low/mid-400s. The tranche was talked at around 500 in November and was covered at 97.91 in October.

BAYC 2006-3A A1 was talked in the low/mid-80s. The tranche was covered at 83.56 in November and its earliest price talk in the PriceABS archive comes from 4 February 2013, when it was talked in the low/mid-60s.

BSCMS 2006-PW11 F was talked in the mid-50s and low/mid-60s, having been talked at around 70 in the prior session. BSCMS 2006-T24 A4 was talked in the low-80s, BSCMS 2006-PW13 A4 was talked at around 90 and BSCMS 2006-PW13 AJ was talked in the mid/high-300s.

MSC 2006-HQ10 AJ was covered at 419. The tranche had been talked in the previous session in the mid/high-300s and in the high-300s.

As for the tranches from 2007-vintage deals, CD 2007-CD4 AMFX was talked in the very low-300s and covered at 297. The bond was talked earlier in the month at swaps plus 285 and was covered at 332 in December.

CWCI 2007-C2 AJFX was talked in the high-500s. The tranche was talked tighter than that in the low/mid-500s in October and covered in the very low-500s in June, having previously been covered at 434 in May.

GCCFC 2007-GG11 AJ was talked in the low-500s. The tranche was covered at 97 in November 2013 and first appeared in the PriceABS archive with price talk in the mid-80s in November 2012.

GECMC 2007-C1 AM was talked in the low/mid-300s and also in the mid/high-400s and was covered at 325. The tranche was also covered at 325 last week and at 327 in the week before that.

MLCFC 2007-7 AM also traded during the session. Price talk the day before had been in the low-400s and at 425.

More recently-issued tranches such as MSC 2011-C1 A2 were also circulating, with that tranche talked at around 70. It was covered at 75 on 2 December and at 72 on 9 August.

In addition, paper that had been issued last year was available, such as CGCMT 2013-GC17 AS - which was covered at 120. The class C tranche from the same deal was talked in the low-200s. Neither of those names had previously been picked up by PriceABS.

Finally, JPMBB 2013-C17 B was talked in the low-160s and in the mid-160s during the session, while JPMBB 2013-C17 C was talked at around 200.

JL

CMBS

CMBS secondary bucks quiet trend

US CMBS BWIC volume picked up considerably yesterday to about US$200m. Generic GG10 spreads remained largely unchanged, however, at swaps plus 165/163.

SCI's PriceABS data shows a number of bonds from various collateral and vintages out for the bid during yesterday's session. Among them was the COMM 2006-FL12 C tranche, which was talked at 98 and covered at 98.5. The tranche was talked at mid/high-90s in July 2013.

Fellow 2006 tranche LBUBS 2006-C7 AJ was talked at around 80 and in the low/mid-80s, before being covered at 82.19. It was last covered at 79.16 on 12 December, having been covered at 56.01 on its PriceABS debut on 5 June 2012.

Meanwhile, BACM 2007-5 AJ was talked in the mid/high-90s and at around 97 during the session, before being covered at 95. The tranche was previously covered at 95.25 on 12 December and was also covered at around 95 on 4 November.

CSMC 2007-C4 A4 was covered at 135. The same tranche was covered at 160 on 3 October and was talked at 340 when it first appeared in the PriceABS archive on 7 June 2012.

In addition, GECMC 2007-C1 AM was talked between the low-300s and low/mid-300s and was covered at 325. The tranche was covered last week at 327, having previously been covered at 500 on 20 September.

There was also a fair amount of post-crisis representation yesterday, such as the WFRBS 2011-C2 D tranche, which was talked in the mid/high-200s and the high-200s and was covered at 285. Price talk on the tranche a year ago today was in the mid/high-200s.

WFRBS 2011-C3 D was also out for the bid and covered at 279. WFRBS 2011-C5 E, meanwhile, was talked in the mid/high-200s and low-300s but did not trade.

COMM 2012-CR3 E was talked at around 300 and in the low-300s and was covered at 306. Price talk on the tranche last summer was at swaps plus 315 and the tranche was talked in November 2012 at plus 460 and in the mid/high-400s.

MSBAM 2012-C6 E was talked at around 300 and in the very low-300s, before being covered at 294. The tranche was previously covered at 298 on 17 April and was covered at plus 300 on 1 February.

WFCM 2013-BTC E was talked at around 325 and was covered at 345. The bond was talked earlier in the month at swaps plus 330 and was talked at around 70 when it first appeared in the PriceABS archive on 23 July.

Another tranche from a 2013 issuance - WFCM 2013-LC12 D - was also out for the bid. The name was talked in the high-200s and at around 300, before being covered at 335.

Finally, a number of FHMS bonds circulated during the session. FHMS K027 A2, FHMS K031 A2 and FHMS K033 A2 all traded.

JL

Structured Finance

SCI Start the Week - 27 January

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

Pipeline
As market participants decamped to Las Vegas last week, only five new deals were added to the pipeline. The transactions consisted of two ABS, an RMBS and two CMBS.

The ABS entering the pipeline were the £164m whole-business Arqiva Financing 2014-1 and €720m auto lease VCL 19 deals. The RMBS was ZAR1.59bn Fox Street 2, while the CMBS were US$1.299bn MSBAM 2014-C14 and US$1.26bn WFRBS 2014-LC14.

Pricings
Similarly, there were just six prints from the week. One ABS, a CLO, an ILS and three CMBS priced.

The ABS new issue was €417.5m E-Carat Compartment No.6, while the CLO was €437.5m Atlantes SME No.3. The CMBS prints comprised US$399.5m Annaly 2014-FL1, US$620m DBCCRE 2014-ARCP and US$1.11bn GSMS 2014-GC18. The US$100m Skyline Re series 2014-1 catastrophe bond rounded issuance out.

Markets
The European RMBS secondary market "paused to catch its breath" last week, according to asset-backed analysts at JPMorgan. Spreads were unchanged after three weeks of relatively sharp tightening, with senior Spanish RMBS spreads remaining at 205bp, the tightest they have been since March 2008.

It was also a quiet week for the European CLO secondary market, with Bank of America Merrill Lynch securitisation analysts reporting that were very few BWICs were seen. "Activity was restricted by the shortened US work week and the IMN ABS Vegas conference," they note.

The US CMBS market, meanwhile, saw BWIC volume start slowly before picking up markedly in mid-week (SCI 23 January). Generic GG10 spreads were largely unchanged at swaps plus 165/163, while SCI's PriceABS data captured cover prices for tranches such as COMM 2006-FL12 C and WFCM 2013-BTC E.

US non-agency RMBS trading was fairly light, Barclays Capital RMBS analysts note. They add: "Cash bonds continued to rally in minimal trading as prices were up half a point across sectors, except for jumbo FRMs. Among ABX indices, 06-2 triple-A rose 0.4 points, but other ABX and PrimeX indices were unchanged. The GSE credit M2 bonds tightened 0bp-4bp, while the M1 bonds were unchanged."

As for US ABS, there was no primary activity after issuers priced deals last week in advance of the IMN conference. "Spreads were unchanged this week as trading activity was light. Last week on the back of strong new issue execution, three- to seven-year triple-A FFELP spreads tightened by 2bp-7bp," JPMorgan analysts observe.

Deal news
• The JPMCC 2011-C5 US$49.7m class A1 notes paid off this month after three loans - the US$26.43m Lehigh Valley Portfolio, US$6.45m Morningstar of Chapel Hill and US$3.55m Morningstar of Virginia Beach - prepaid with yield maintenance. The move is part of a growing trend of CMBS 2.0 loans prepaying with yield maintenance as both commercial real estate prices and Treasury rates rise.
• Seven loans backing the CWCI 2006-C1 deal - totalling US$219m in outstanding balance - have been liquidated, including a couple of properties that were part of the large CWCapital Auction.com sale in December. Unusually, the sales resulted in an equity class loss reimbursement pay-out, which appears not to have been reflected in the January settlements for the CMBX.3 index.
• Fir Tree Partners has commenced a cash tender offer through its affiliate FT RMBS in connection with six RMBS that are subject to the proposed US$4.5bn JPMorgan settlement. The transactions involved are SACO 2006-3, 2006-5, 2006-6 and 2007-2, as well as BSMF 2006-SL1 and JPMAC 2006-WMC4.
• Proceeds from the sale and liquidation of Altius I Funding will be distributed on 28 January. The trustee for the ABS CDO had been directed by at least two-thirds of the aggregate principal amount of the controlling class to sell the collateral, following the occurrence of an EOD (SCI 6 January).
• An auction is to be held for Trainer Wortham First Republic CBO III on 13 February. The collateral shall only be sold if the proceeds are greater than the auction call redemption amount.

Regulatory update
• CREFC Europe and INREV have submitted comments to EIOPA on its technical report on standard formula design and calibration for certain long-term investments (SCI 20 December 2013). The two organisations call for certain CMBS to qualify for 'Type A' capital treatment - by reference to objective, qualitative criteria - and not to condemn all CMBS to 'Type B' treatment.
• The continued normalisation taking place in the US housing market provides scope for mortgage credit to expand from its current tight levels. However, Dodd-Frank ATR/QM requirements pose challenges for credit to expand to pre-crisis levels.
• Three community banks have disclosed negative tax impacts following the finalisation of the Volcker Rule. Cortland Bancorp, for one, has adjusted the carrying values of nine Trups CDO securities that are disallowed under the Volcker Rule to fair value through a non-cash other than temporary impairment (OTTI) charge to earnings for 2013. As of 30 September, the company reported in its consolidated balance sheet that the bonds are now classified as available for sale.

Deals added to the SCI New Issuance database last week:
ACIS CLO 2014-3; Capital Auto Receivables Asset Trust 2014-1; CAS 2014-C01; Chase Issuance Trust 2014-1; Citibank Credit Card Issuance Trust 2014-A1; Discover Card Execution Note Trust 2014-1; DT Auto Owner Trust 2014-1; Ford Credit Auto Owner Trust 2014-A; HLSS Servicer Advance Receivables Trust series 2014-T1; HLSS Servicer Advance Receivables Trust series 2014-T2; Oaktree CLO 2014-1; SLM Student Loan Trust 2014-1

Deals added to the SCI CMBS Loan Events database last week:
BSCMS 2005-PW10; BSCMS 2007-PW15; BSCMS 2007-PWR16; CGCMT 2005-C3; CSFB 2005-C4; CSMC 2006-C5; CWCI 2006-C1; DECO 2005-C1; DECO 2006-E4; DECO 2007-E2; DECO 2007-E5; DECO 2007-E6; DECO 2007-E7; DECO 8-C2; DECO 9-E3; ECLIP 2005-4; ECLIP 2006-1; EPICP BROD; EPICP DRUM; EURO 27; EURO 28; FLTST 2; FLTST 3; GCCFC 2007-GG9; INFIN SOPR; JPMCC 2005-LDP3; JPMCC 2006-CB15; JPMCC 2010-C2; JPMCC 2011-C5; LBUBS 2005-C5; MSC 2011-C2; MSC 2011-C3; OPERA CMH; PROUL 1; TAURS 2006-1; THEAT 2007-1 & THEAT 2007-2; TITN 2007-2; TITN 2007-3; TITN 2007-CT1; TMAN 6; TMAN 7; WBCMT 2007-C34; WFRBS 2013-C14; WINDM VII; WINDM X; WINDM XI; WINDM XIV

Top stories to come in SCI:
Corporate trust roundtable

CMBS

Change in strategy for INFIN SOPR?

Following a failure to pay, credit events have been called for the EHE Pool 1A and 2B reference obligations, representing almost 70% of the pool backing the Infinity 2007-1 Soprano CMBS (see SCI's CMBS loan events database). A work-out of the transaction is now expected to be significantly delayed.

In a typical synthetic CMBS, a credit event has two consequences: a work-out of the underlying loan via liquidation of the portfolio; and the cessation of pass-through of principal to noteholders, until the losses on the loan are realised and the underlying CDS is settled. Typically this second stage can take many years and Deutsche Bank European asset-backed analysts believe that there is no reason why the INFIN SOPR case should be any different - especially in light of reported personnel departures at Estama, the loan's asset manager.

Since the obligations were originally restructured in July 2011, Estama has been performing a borrower-led rundown of the loan, during which time there have been only minimal sales - causing amortisation targets to be missed and ultimately the credit events to be called. The Deutsche Bank analysts suggest that significant questions exist regarding the future strategy for the loan.

"A change in strategy by the special servicer resulting in a change in asset manager/sales agent must surely now be a very significant probability. The various administrative functions involved in this - prominently the establishment of a data room - would add to the delay in the loan being liquidated," they observe.

Given the additional complexity of the synthetic nature of the CMBS obligation and the consequent likelihood that sales proceeds will only be distributed to noteholders in one lump sum on the settlement of the CDS, settlement is now expected to be significantly later than anticipated. The analysts point to sometime in late 2017/2018, taking into account one year to build a data room, 12-18 months to sell the assets and 18-24 months to reconcile the loss/allow escrowed cash from the sale to be released.

On a positive note, the credit events have removed the uncertainty around the sequential trigger, with the 1A obligation now moving irrevocably to sequential pay. SCI's PriceABS data recorded a cover of 94.1 for the INFIN SOPR A tranche on 16 January (versus 88 on 11 November 2013), suggesting that the move had largely been anticipated.

However, the analysts note that there appears to be a lack of consensus on the waterfall across the rest of the capital structure, with class Bs indicatively pricing in the mid-60s - presumably on concerns of losses resulting from a lengthy pro-rata waterfall. They expect the breach of the trigger to be positive for both classes B and C.

CS

CMBS

Servicer replacement to spark investor activism?

Last week saw a first for European CMBS, when Hatfield Philips International was replaced with Mount Street as the primary servicer on all loans in Windermere XIV (see SCI's CMBS loan events database). The move is expected to spark increasing investor activism across the sector.

The WINDM XIV case marks the first time that an existing primary servicer has been replaced on a portfolio-wide basis in a multi-borrower, multi-loan European conduit CMBS. The replacement was driven by the lack of timely and transparent communication by the servicer about its work-out and value-maximisation strategy with respect to the underlying specially-serviced loans, according to ECM Asset Management.

"More importantly, this replacement may well herald the commencement of an era of increased activism by investors across the European CMBS space in general," the firm notes in a client memo. "Such activism is commonplace in more matured CMBS markets, like the US, and is a critical driver of investment returns. European CMBS investors, on the other hand, have hitherto largely played a passive role - not least because of severely constrained choices with respect to loan servicers."

However, the choice spectrum has widened over the past couple of years, with Mount Street and Solutus Advisors for example entering the market. ECM Asset Management believes that the European loan servicing business will "continue to shed its oligopolistic cloak" as investors step up their detailed loan-level scrutiny and seek to optimise recoveries and investment returns.

An extraordinary resolution - passed at a noteholder meeting on 20 January - paved the way for the servicer replacement. Mount Street has consequently become: the general master servicer in relation to the Baywatch, GSI and Sisu loans; the general special servicer in relation to the Baywatch loan; and the Italian delegate master servicer under the Italian servicing agreement. The Italian loan will also benefit from a short-term standstill to allow Mount Street to agree an exit strategy for the asset.

CS

CMBS

CMBS 2.0 prepayments on the rise

The JPMCC 2011-C5 US$49.7m class A1 notes paid off this month after three loans - the US$26.43m Lehigh Valley Portfolio, US$6.45m Morningstar of Chapel Hill and US$3.55m Morningstar of Virginia Beach - prepaid with yield maintenance. The move is part of a growing trend of CMBS 2.0 loans prepaying with yield maintenance as both commercial real estate prices and Treasury rates rise, Morgan Stanley CMBS strategists suggest.

The A1 class received an US$832,013 prepayment penalty, in addition to US$29m of principal. The A2 notes also received a US$7m principal prepayment, resulting in a US$422,277 prepayment penalty. Additionally, the class XA notes received a windfall prepayment penalty of US$2.4m.

In an analysis of the universe of CMBS 2.0 deals, the Morgan Stanley strategists identify a total of 17 loans totalling US$253m that have prepaid with penalties. While this trend may be expected for legacy transactions, the magnitude of CMBS 2.0 loans prepaying so soon after origination is somewhat surprising.

Excluding the three JPMCC 2011-C5 exposures, the largest five 2.0 loans to prepay by balance are: US$47.36m Courtyard by Marriott Waikiki (securitised in MSC 2011-C3), US$24.88m Inland Western Retail Portfolio (JPMCC 2010-C2), US$20m Bethel Shopping Center (MSC 2011-C3), US$19.98m Courtyard San Diego Old Town (MSC 2011-C2) and US$19.06m Harbor Properties (DBUBS 2011-LC3.

The strategists note that the prepayment of 2010 and 2011vintage loans reflects the rise in property valuations that has occurred since they were originated. "Consider that the Moody's/RCA CPPI has risen nearly 50% since the beginning of January 2010. This is allowing borrowers to pay significant penalties while profiting handsomely on the sale of the property," they explain.

At the same time, Treasury rates have increased meaningfully, meaning that it is less cost-prohibitive to pay yield maintenance. This is because the yield maintenance penalty is usually calculated as the difference between the then-current Treasury rate and the loan coupon over the remaining life. Theoretically, if Treasury rates were to rise above the coupon, there might not be a yield maintenance penalty.

CS

Insurance-linked securities

Banner year for ILS secondary market

The insurance-linked securities market experienced a surge in issuance last year to end only US$800m short of 2007's record US$8.24bn issuance. It was also a very strong year for the secondary market and the tightening seen in 2013 is set to carry over into this year.

Swiss Re Capital Markets reports that catastrophe bond supply hitting its trading desk last year surpassed the total secondary volume from the year before, demonstrating the continued liquidity in the market. Trading was more uniform throughout the year than it had been in the previous one, which is consistent with a more uniform new issuance schedule and a higher number of funds willing to trade around their positions.

Secondary market spread tightening accelerated in Q4 as primary execution continued apace. Higher yielding bonds have seen greater demand and there was a spike in trading for bonds maturing before the start of this year's US hurricane season. This was driven both by portfolio managers with low cost of capital looking for low risk returns and by funds that preferred to exit such positions and put capital to work for longer-term deals.

Swiss Re notes: "Towards the latter part of the year, we observed some degree of a lack of synchrony in the convergence of secondary spreads towards new issuance levels. This is true particularly for bonds with the same sponsor and risk profile to the new issue."

It appears that although investors may be willing to pay up to sponsors in return for size in the primary market, in the secondary market investors are more cautious about paying up to other investors. Other considerations, such as portfolio constraints, may also be contributing to the hesitation in showing aggressive bids.

While there is a sizable new issue pipeline, the pace of issuance is expected to be slow in the first couple of months of 2014. As there are also many bonds set to mature, investors are already turning to the secondary market to secure more bonds and this will keep spreads tight.

JL

RMBS

GNMA prepayments examined

Ginnie Mae loan-level disclosures indicate that FHA-to-conventional refinances are a meaningful contributor to GNMA prepayments, Barclays Capital RMBS analysts note. They suggest that long-term GNMA new production discount speeds could be 3-4 CPR faster than their conventional counterparts.

The loan-level data allows voluntary and involuntary prepayments to be attributed precisely to specific loan types. A Barcap analysis of the data shows that FHA voluntary speeds for many post-May 2009 GN2 cohorts are 9-10 CRR.

The analysts believe that this is too high to be fully explained by turnover and FHA-to-FHA refinances alone. "After taking into account the change in FHA mortgage premiums in a refinance transaction, all of these cohorts are out-of-the-money at current rates," they explain. "This suggests the FHA-to-FHA refinances should be a small contributor to overall speeds. Indeed, FHA-to-FHA streamline applications have trickled to a halt, declining to 1,500-3,000 from its prior run-rate of 25,000-30,000." Rather, many borrowers appear to be refinancing conventionally, similar to behaviour seen in the G2JM space.

The G2SF 3.52012 cohort has an FHA voluntary speed of 7.7 CRR, according to the analysis. The FHA-to-FHA refinance contribution should be negligible, given the cohort is 95bp out-of-the-money. Even if turnover accounts for 5 CRR, this suggests that the remaining 2.5-3 CPR could be attributable to FHA-to-conventional refinances.

"Consistent with pure housing turnover, VA loans show little prepayment sensitivity across credit score," the analysts observe. "In contrast, FHA speeds demonstrate a sharp FICO gradient, too steep to be explained by turnover alone. This is an indicator of the FHA-to-conventional effect, given the onerous premium structure these borrowers are paying."

Further, strong FICO and low current LTV FHA borrowers are prepaying at 15-20 CRR. The analysts note that this segment of borrowers is the most capable of bridging the credit gap in obtaining a conventional loan. They incur the least LLPA and private MI fees, which maximises the FHA-to-conventional refinance incentive.

"We believe this demonstrates that FHA-to-conventional refinances are already a meaningful contributor to realised speeds. This effect is likely to grow as HPA continues to improve the equity position of these borrowers, thus reducing required LLPA and private MI costs," the analysts conclude.

CS

ABS

Trepp invests in solar analysis platform

Solar energy investment analysis and decision making platform Mercatus has closed its Series A round of financing. Trepp has joined Vision Ridge Partners, Augment Ventures and Shah Capital in investing in the company and Trepp coo Dan Gottlieb will also join Mercatus' board.

Mercatus allows lenders and capital market investors to harness the strength of its investment analysis and analytics platform to create better liquidity and capital flows for projects or portfolios. Trepp will work with Mercatus to expand the availability of the non-proprietary data collected in its platform in a bid to develop the role of the capital markets in the solar asset class.

Structured Finance

Law firm strengthens finance team

Alexandra Margolis has joined Nixon Peabody's global finance team as a partner in New York. She joins from Skadden, Arps, Slate, Meagher & Flom, where she served as counsel.

Margolis has significant leveraged finance and banking experience and specialises in leveraged cashflow and asset-based syndicated and bilateral credit facilities as well as acquisition financings, first and second lien facilities, repurchase facilities, investment fund financings, senior and mezzanine financings and intercreditor arrangements. She also has experience in debt restructurings, debtor-in-possession credit facilities and exit financings.

Structured Finance

SIX incorporates pre-LEIs

SIX Financial Information is teaming up with Avox to provide pre-legal entity identifiers (pre-LEIs). The service will source pre-LEIs from the issuing local operating units and map them to SIX's global securities database, providing clients with greater data access for enhanced decision making.

Cross-referencing pre-LEIs to SIX's security and entity reference data will help clients to achieve the transparency and consistency required to comply with regulations such as EMIR, Dodd-Frank and Solvency II. Avox specialises in legal entity data and will source pre-LEIs from all local operating units before providing a consolidated file with the identifiers to SIX, with entities then matched to an Avox ID (AVID).

CDS

International credit alliance formed

Serone Capital Management and Swiss Capital Alternative Investments have entered into a strategic alliance to further develop their activities in the international credit markets. The union allies Serone's structured credit and credit derivatives expertise with Swiss Capital's programme of enhanced credit solutions in the private debt markets.

CLOs

Buy-out triggers CMA assignment

Certain employees of RidgeWorth Capital Management are set to acquire the firm and its wholly-owned boutiques from SunTrust Banks, in partnership with Lightyear Capital affiliates. The transaction is expected to close in 2Q14.

No changes are currently planned to the Seix Investment Advisors investment team as a result of the move and the firm will continue to be wholly-owned by RidgeWorth. However, the transaction constitutes an assignment of the collateral management agreements for the Baker Street Funding CLO 2005-1, Baker Street CLO II, Mountain View Funding CLO 2006-1, Mountain View CLO II, Mountain View CLO III and Mountain View CLO 2013-1 deals managed by Seix.

CMBS

CRE firm names president

Cornerstone Real Estate Advisers has appointed Scott Brown as president of the firm. He will join next month and take over from David Reilly, who will remain as ceo.

Brown has 26 years of real estate experience and has been involved in securitisations, REITs and various other investment structures. He joins from CBRE Global Multi Manager, where he was head of the Americas and has also served as head of global real estate at Ennis Knupp and Associates.

CMBS

CMBS trading vet appointed

Angel Oak Capital Advisors has appointed Kin Lee as a senior portfolio manager. He will focus on building and managing strategies within the CMBS market.

Lee was previously an executive director at Nomura Securities and was head of CMBS trading at both Mizuho Securities and RBS Greenwich Capital. He has also worked in CMBS trading at Credit Suisse and Donaldson, Lufkin & Jenrette.

Risk Management

Integrated pricing offering created

Numerix CrossAsset Integration Layer has been integrated into MathWorks' MATLAB offering. Risk managers and analysts will be able to leverage Numerix calculations to create fully customised, robust financial applications for pricing, modelling and analysis of complex financial instruments and structured products.

The integrated offering enables MATLAB users to price any conceivable derivatives instrument from within the MATLAB environment. It provides access to an enhanced level of pre-trade analysis, model validation and testing and model comparison.

RMBS

RMBS vet joins advisory

Tanya Rajput has joined Opus Capital's client services group as a director. She was previously at Redwood Trust and before that worked at Arch Bay Capital, Washington Mutual and Countrywide.

RMBS

RMBS cross trade charges settled

A California-based investment adviser has been sanctioned for engaging in cross trading of RMBS which favoured certain clients over others and for concealing investor losses which resulted from a coding error. Western Asset Management Company has agreed to pay more than US$21m to settle with the US SEC and with the US Department of Labor.

Western Asset engaged in illegal cross trading during the financial crisis by refusing to sell RMBS and similar assets into a declining market as clients sought account liquidations. Rather than sell the securities at market prices, Western Asset arranged for certain broker-dealers to purchase the securities and sell them on again to different Western Asset clients who had greater risk tolerance.

Because Western Asset arranged to cross the securities at the bid price rather than a price representing an average between the bid and ask price, the firm acted improperly, says the SEC. Western Asset allocated the full benefit of the market savings on the trades to buying clients and denied the selling clients around US$6.2m in savings.

Separately, the firm was also found to have breached its fiduciary duty by failing to disclose and promptly correct a coding area which caused the improper allocation of a restricted private investment to the accounts of nearly 100 ERISA clients. Western Asset did not notify its ERISA clients what had caused the losses until nearly two years later and did not reimburse them.

Without admitting or denying the SEC's findings, Western Asset has agreed to distribute more than US$7.4m to clients harmed by the cross trading violations and pay a US$1m penalty to the SEC and US$607,717 to the Labor Department. The firm will also distribute more than US$10m to clients harmed by the coding error and pay a US$1m penalty to the SEC and US$1m to the Labor Department.

RMBS

RMBS trading probes settled

Jefferies Group has agreed to pay US$25m to settle US criminal and civil probes into RMBS trading abuses. The firm was investigated after former trader Jesse Litvak was charged with RMBS fraud a year ago (SCI 29 January 2013).

Jefferies will pay US$11m to counterparties harmed in certain trades, US$10m to the US Attorney's Office and US$4m to resolve an investigation by the US SEC. The deal includes a non-prosecution agreement with the US Attorney's Office in Connecticut.

ABS

Subprime auto ABS remain 'protected'

A potential slow-down in the growth of US auto sales and increased competition to maintain market share could encourage lenders to reach out to borrowers with weaker credit. Based on a comparison of credit metrics of subprime auto ABS deals that were issued in 2011 - when underwriting was tighter - with deals from 2012 and 2013, Wells Fargo ABS strategists suggest that undue systemic risk does not appear to be building in the sector, however.

Some easing in underwriting seems evident from pool-level data. Credit metrics - such as larger loan size, longer loan terms and low seasoning - point to a modest increase in risk, according to the Wells Fargo strategists. But other factors, including loan-to-value ratio, FICO score, weighted-average coupon and percentage of used cars, seem to be neutral.

On the structural side, higher rating agency expected cumulative net losses builds in more risk, but higher expected excess spread and initial credit enhancement suggest that subprime auto ABS are still well protected. "Nevertheless, there has been some increase in default rates and net losses," the strategists observe. "We believe that a normalising of credit availability has expanded lending to more subprime borrowers. However, the economic backdrop may not be expanding rapidly enough for these borrowers to improve their financial conditions."

They suggest that an increase in defaults over the past two years may be more the result of a weak economic environment rather than a decline in underwriting standards on the part of lenders.

Structured Finance

RFC issued on sovereign approach

Fitch has published a criteria exposure draft detailing how ratings of structured finance (SF) notes and covered bonds (CVB) are constrained by the credit quality of the sovereign to which the transaction is exposed. In particular, it provides detail regarding the agency's current approach to assigning SF and CVB ratings that are higher than the relevant sovereign local currency issuer default rating (LC IDR). It also details new criteria proposals for ratings of multi-jurisdictional SF notes or CVB.

"Fitch believes that it is not possible to completely de-link SF and CVB ratings from the credit quality of the relevant sovereign," says Michele Cuneo, senior director in the agency's SF team. "A high level of sovereign default risk raises the prospect of extreme events occurring in a country and reduces the certainty of performance projections for SF and CVB assets. CVB are also further affected by sovereign risk through its impact upon the issuing bank and liquidity of the cover pool."

The criteria are not expected to affect ratings assigned to SF notes or CVB, whose securitised or cover pool assets are concentrated in a single jurisdiction, as it reflects Fitch's current global analytical practices with respect to rating caps. Similarly, no major revision of the base-case and stress assumptions currently applied by the agency is expected. These are expected to incorporate sufficient cushion to withstand the risks discussed in these criteria, including the proposed sovereign distress scenario.

However, some of the ratings assigned to multi-jurisdictional SF notes and CVB may be downgraded upon implementation of the proposals. Fitch has identified 15-20 multi-jurisdictional SF transactions (out of 85) that could have one or more tranches downgraded, in most cases by one or two notches, and two multi-jurisdictional CVB programmes (out of 15) that could see downgrades by one or two notches on one or more bonds.

As detailed in the exposure draft, the ratings of SF notes and CVB issued in foreign currency cannot exceed the country ceiling (CC) of the country of the assets, unless the transfer and convertibility (T&C) risk is mitigated. Where T&C risk is mitigated, ratings cannot be higher than four notches above the CC.

In addition, Fitch SF and CVB ratings are capped at a maximum of six notches above the sovereign LC IDR. This cap is independent from the CC-related cap and represents an additional rating constraint reflecting the increased likelihood of extreme macroeconomic events and significant adverse events occurring that the agency associates with a high level of sovereign default risk. In all cases where SF notes or CVB are rated above the sovereign LC IDR, it expects the credit protection available to the notes or bonds to be sufficiently robust to withstand the stresses resulting from a sovereign default, such that they are not expected to default in such a scenario.

SF and CVB ratings in countries that are part of currency unions would not exceed the country's CC, which captures the risk of the imposition of capital controls and/or an exit from the union. This is because Fitch expects that upon an exit from the union, T&C risk may not be mitigated and/or event risks could be acute.

Due to their diversified country risk exposure, T&C risk can become a secondary rating driver for multi-jurisdictional structures. For this reason, the agency is proposing to apply a specific and less stringent approach, where the exposure to sovereigns with a lower CC than the SF or CVB rating is below 20%. As in the case of single-jurisdiction SF transactions or CVB, exposure to macroeconomic and/or event risks is analysed separately and may lead to rating caps if material, regardless of the T&C risk assessment.

Fitch is seeking feedback on the exposure draft by 28 February.

Structured Finance

Turkish covered bonds bolstered

The Turkish Capital Market Board has released a definitive communiqué that unifies and improves two existing pieces of legislation that govern mortgage assets and other assets that back covered bonds. Moody's says in its latest Credit Outlook publication that the credit-positive legislation will enable issuers to better match cover pool assets with covered bond liabilities, reduce market risk and mitigate operational risks in case of issuer insolvency.

The legislation enables the use of derivatives, which will facilitate the issuance of foreign-currency covered bonds and ensure adequate currency-risk protection for covered bondholders. The amendments achieve this by allowing derivatives to become an integral part of a cover pool - which previously had only been the case for mortgage covered bonds - and by removing any limitation for the use of derivatives. The previous rules had a limit of up to 15% of the cover pool's net present value.

The legislation also calls for new stress tests aimed at protecting cover pool value against sharp fluctuations in currency-exchange and interest rates. All covered bonds must comply with monthly stress tests to determine if there is a mismatch between the cover assets and the covered bonds. In the interest rate stress test, the stressed present value of the assets must exceed the present value of the liabilities for most asset classes by at least 2%.

However, Moody's notes that the tests do not sufficiently protect against potentially higher discount rates in the case of an asset fire sale, where interest rates can widen by more than 300bp following an issuer default in an illiquid secondary loan market such as Turkey. This is especially the case for mortgage loans with much higher durations than loans to SMEs, for example.

If a covered bond issuer breaches a stress test, the cover pool monitor will freeze collections from the cover assets in a separate account for the repayment of the covered bonds, thereby providing protection from continuous deterioration of the cover pool. If the issuer does not fulfil its payment obligations, the cover pool monitor will ensure that the underlying cover pool borrowers redirect their payments to a separate account to avoid a comingling of cover asset cashflows with the issuer's other assets in an insolvency.

The cover pool administrator can manage the cover pool actively by selling the cover pool in full, in part or by arranging bridge financing that the cover assets will secure. The cover pool administrator can also sell the entire cover pool and transfer the covered bond obligation to another entity, or suggest the early amortisation of the covered bonds if it benefits the bondholders.

The legislation allows the regulator to appoint other banks to manage the pool if a back-up servicer can't be found, reducing disruption risk following issuer default. Moreover, the legislation has an issuance limit of 10% of the total issuer's assets for banks and 5x issuer's equity for specialised mortgage lenders, which allows for the replenishment of the cover pool and protects unsecured creditors' interests. These limits can be doubled for issuers rated single-A or higher.

"By having more eligible assets, issuers can more easily replace assets that become ineligible. If an issuer becomes insolvent, unsecured creditors would have recourse to a greater portion of the issuer's assets that otherwise would be encumbered to covered bondholders," Moody's concludes.

Structured Finance

Asian ratings poised for positive performance

S&P expects collateral performance and structural enhancement to underpin stable to marginally positive ratings performance for Asia-Pacific structured finance securities. However, tranches that have key rating dependencies on transaction counterparties could continue to be affected by the credit conditions that would impact the credit profiles of the counterparties, the agency says.

The economic outlook is mixed across countries where outstanding Asia-Pacific structured finance securities are predominantly domiciled. S&P expects economic growth to be relatively flat in Australia, for example: a growth of 2.6% is forecast in 2014, improving to 3% in 2015. As mining investment declines, the strength of the recovery in non-mining sectors of the economy will underpin the growth trends in the country.

GDP growth in the Japanese economy is forecast to decline to 1.4% in 2014 and 1.2% in 2015. Household spending power in Japan will slow in the next two years as a result of an increase in the consumption tax and this is likely to dampen the nation's growth prospects and pose a key challenge for the Bank of Japan's reflation efforts.

In South Korea, S&P forecasts GDP growth to strengthen to 3.5% in 2014 and 3.8% in 2015. The growth trend in South Korea continues to be more dependent on global economic conditions.

Despite the mixed economic outlooks in these countries, the likelihood of the agency's downside scenario of slower regional growth and continuing financial market volatility appears to have subsided for now. Most RMBS and ABS ratings are anticipated to remain stable in 2014, based on the expectation that collateral performance will remain stable and credit enhancement will continue to build up in percentage terms as the underlying asset pools pay down. The subordinated classes of Australian prime RMBS that have a high dependency on lenders' mortgage insurance (LMI) are likely to remain sensitive to any changes in the financial strength ratings of LMI providers, however.

The number and volume of CMBS outstanding in the Asia-Pacific region have continued to decrease due to a lack of new issuances and the ongoing repayment of existing transactions. Nevertheless, stable performance is forecast in the CMBS sector in 2014, except for securities that are currently vulnerable to non-payment from realising losses from CRE loans that have defaulted.

S&P expects outstanding synthetic structured credit ratings to continue to follow global trends and reflect the credit quality of the underlying reference entities around the globe. While the performance of these securities was more stable in 2013 than during the worst periods of the financial crisis, they remain sensitive to further deterioration in the credit quality of referenced entities due to unresolved stresses in the eurozone.

The agency notes that external factors are the key risk to its ratings outlook, although the composition of these risks has changed. The key risks relating to a greater-than-expected slowdown in China and the market turbulence related to the tapering of asset purchases by the US Fed have narrowed. A weaker-than-expected economic recovery in the US, potential market volatility caused by the Fed's ongoing tapering and an adverse reaction to shifting policy expectations could result in downside risk.

Furthermore, stresses in certain industry sectors in the Asia-Pacific region could have a flow-on effect on the household sector and impact the credit conditions for structured finance. Specifically, a potential increase in unemployment, weakening household income and dampening consumer sentiment could cause the housing market to become more subdued, property prices to decrease and the housing loan and consumer finance serviceability of some borrowers to come under pressure. However, S&P believes the senior classes of notes are well positioned to absorb the impact of such a downside scenario.

The desire to rebuild securitisation and covered bonds as part of a diversified funding source strengthened in the Asia-Pacific region in 2013, according to the agency, and investor interest in the region grew. However, new issuance has remained subdued, with the exception of Australia RMBS - which saw the strongest issuance volume in 2013 since 2007.

Australia and Japan are likely to see more issuances than the rest of Asia in 2014, though momentum suggests potential development in the region. Issuance this year is likely to be dominated by RMBS, followed by ABS.

Structured Finance

PCAs to address commingling risk

German securitisations are increasingly being structured with a PCA that is a collection account in the name of the servicer but pledged to the SPV. This PCA differs from the typical servicer collection account in that collected moneys should not be commingled with the servicer's insolvency estate in case of servicer insolvency. In Fitch's view, the PCA could reduce such commingling risk that has previously been covered by commingling reserves or other structural features.

Fitch has been provided with legal opinions stating that the pledgee (SPV) is entitled to enforce its pledge (granted by the originating bank), even if a moratorium is imposed on the insolvent servicer. While this supports the PCA concept, the agency notes that it is yet to be legally tested.

The PCA is similar to the 'specially dedicated account' that has been frequently used in French securitisations. However, while the specially dedicated account concept in France is backed by law implying that the collected funds are for the exclusive benefit of the SPV, the German PCA is contractual and not backed by specific legislation.

Typically the PCA - to which the underlying debtors pay their instalments - is solely created for the purpose of the securitisation and no other funds are paid into this account, thus allowing clear identification of the collected funds. Furthermore, the SPV is the sole party entitled to dispose of the collections in the PCA. These aspects, in Fitch's view, minimise the operational and legal risks.

The agency says it expects the validity of the pledge of the PCA to the SPV to be supported by a transaction-specific legal opinion specifying that the imposition of a moratorium on an insolvent servicer would not affect the right of the SPV to enforce its pledge. Even with a valid pledge to the SPV, there remains some uncertainty as to whether the servicer's insolvency administrator may impose a moratorium over the PCA, thus delaying the transfer of collections to the SPV for a certain period.

Further, Fitch expects payment interruption risk to be mitigated, for example, by a liquidity reserve to provide for payments due within the period of a moratorium.

Structured Finance

CIR RFC issued

Moody's has published a request for comment seeking feedback on proposed changes to its methodology for assigning counterparty instrument ratings (CIRs). The agency is proposing to change how it assesses the effect of counterparty linkage on swap CIRs in order to conform to its cross-sector rating methodology on assessing swap counterparties in structured finance cashflow transactions. If the proposed changes are adopted, it expects to take rating actions - generally being upgrades or downgrades of one notch - on a small number of CIRs.

CDO

CDO sale scheduled

An auction for the Margate Funding I CDO has been slated for 18 February. The collateral shall only be sold if the proceeds are greater than or equal to the auction call redemption amount.

CDO

ABS CDO auction due

An auction has been scheduled for Crystal Cove CDO on 14 February. The trustee shall sell the collateral only if the sale proceeds are at least equal to the total senior redemption amount.

CDO

Trups CDO on the block

An auction will be conducted for Libertas Preferred Funding I on 19 February. The collateral shall only be sold if the proceeds are greater than or equal to the total senior redemption amount.

CDO

Trups CDO cures trending up

The number of combined US bank Trups CDOs defaults and deferrals declined to 26.5% at end-December, compared with 27.3% at end-November, according to Fitch's latest index results for the sector. Approximately 0.33% of this drop is attributed to the removal of the defaulted and deferring collateral of one Trups CDO that no longer has outstanding ratings from the agency, with the remainder of the difference due to new cures.

Only one new default occurred in the last month of 2013. One issuer, representing US$10m in collateral held in two CDOs, jumped to default without prior deferral. Additionally, one bank - representing US$5m of collateral - re-deferred on its Trups in one CDO.

Ten banks representing US$190.9m of collateral cured in December. The month-to-month change in the cured notional balance was less than that, however, due to the re-deferral and removal of the collateral that was held by the CDO that is no longer rated by Fitch.

For the entire year, 17 new deferrals and defaults were significantly lower than the 51 recorded in 2012. The cures also trended higher, with 69 new cures in 2013 compared to 50 in 2012.

CDO

Banks feel Volcker pinch

Three community banks have disclosed negative tax impacts following the finalisation of the Volcker Rule.

Cortland Bancorp, for one, has adjusted the carrying values of nine Trups CDO securities that are disallowed under the Volcker Rule to fair value through a non-cash other than temporary impairment (OTTI) charge to earnings for 2013. As of 30 September, the company reported in its consolidated balance sheet that the bonds are now classified as available for sale.

The amortised cost of these securities is US$10.5m, while the fair value produced by a discounted cashflow model aggregates this to US$8.5m. Management estimates that the reduction in value will result in a US$1.3m after-tax charge to earnings for 2013.

Similarly, First Defiance Financial Corp has reported a US$219,000 after-tax loss, as a result of US$337,000 in OTTI losses recognised on US$1.9m of CDOs, while Webster Financial Corp disclosed a US$4.7m after-tax impact from an OTTI charge on its CDO and CLO positions.

CDO

CBO on the blocks

An auction is to be held for Trainer Wortham First Republic CBO III on 13 February. The collateral shall only be sold if the proceeds are greater than the auction call redemption amount.

CDO

ABS CDO liquidated

Proceeds from the sale and liquidation of Altius I Funding will be distributed on 28 January. The trustee for the ABS CDO had been directed by at least two-thirds of the aggregate principal amount of the controlling class to sell the collateral, following the occurrence of an EOD (SCI 6 January).

All of the securities were sold or terminated via an auction on 14 January. The trustee is set to issue a note valuation report detailing the amount of funds held back to cover administrative and/or liquidation expenses.

CDS

Alstom CDS widen on negative sentiment

CDS market sentiment towards Alstom has worsened in the last week after the company cut its profit forecast due to lacklustre demand for power equipment, according to the latest case study from Fitch Solutions. Alstom spreads widened by 35% last week, notably underperforming Fitch's European Industrials CDS Index, which moved 6% wider.

After pricing consistently in line with triple-B spread levels, CDS referencing Alstom's debt are now testing below investment grade levels. Fitch notes that CDS market sentiment for Alstom may have been further impacted by recent news reports of an investigation into its Brazilian operations, alleging that the firm paid bribes to gain public contracts in the late 1990s and early 2000s.

CDS liquidity for Alstom increased slightly last week, moving up three rankings to trade in the 23rd global percentile. Meanwhile, Fitch's five-year probability of default for the firm grew by 112% last week from 5.05% to 10.7% as equity markets echoed the negative sentiment.

CLOs

Euro CLOs facing headwinds

Fitch expects issuance of European CLOs to continue in 2014, after €7.5bn of the securities - consisting of 21 transactions by larger established managers - was placed last year. Issuance will be a function of availability of loan collateral, managers' capital reserves to fund the retention stake and the clarification of the treatment of CLOs under the Volcker rule, according to the agency.

In particular, the retention stake rule is expected to be the primary brake on issuance this year. Fitch estimates that €3bn-€4bn of capital injections by managers would be necessary to refinance CLO 1.0 transactions. However, the agency believes that managers are now able to obtain funding for a part of the retention stake if held in the form of rated CLO tranches - in effect, leveraging the retention stake - which may help to reduce the capital burden.

Given the limited primary issuance of European leveraged loans, Fitch expects that collateral for new CLOs will chiefly come from bank balance sheets and called CLO 1.0 deals. In the latter case, the agency estimates that €6bn-€11bn could become available for refinancing, potentially funding 15 to 30 CLO 2.0 transactions in the next 18 months.

Fitch notes that the CLO market has turned into an investor rather than an issuer market, as reflected in transaction structures. "For example, managers have to manage their portfolios under stricter rules after the end of the reinvestment period compared with CLO 1.0 transactions," says Galen Moloney, senior director in Fitch's structured credit team. "We do not expect CLO 2.0 structures to change dramatically from those issued to date, as long as the investor base remains limited, particularly at the senior level."

CMBS

Innkeepers up for sale

The Chatham/Cerberus joint venture has put the 51-hotel, 6,847-room Innkeepers portfolio up for sale via Eastdil Secured. The asset is being offered unencumbered by management contracts and has a US$950m interest-only loan in place that is assumable, subject to certain conditions.

The portfolio benefits from US$171m (or approximately US$25,000 per room) in capital expenditures since 2007. Operating performance was strong last year, with estimated RevPAR growth of 5.5%, a RevPAR penetration index of 129 and estimated EBITDA of approximately US$101m.

The 51 properties were valued at US$1.26bn, as of 15 July 2013. The joint venture has already returned 92% of Chatham's original capital investment, the firm says.

The portfolio is encumbered by a US$575m first mortgage that is securitised in JPMCC 2013-INN and a US$375m mezzanine loan, of which US$27.75m was securitised in JPMCC 2013-INMZ. US$86.25m of the first mortgage and the US$27.75m securitised mezz loan are pre-payable pursuant to permitted property releases without a spread maintenance premium, according to CMBS strategists at Morgan Stanley. The remaining US$488.75m of the first mortgage may be voluntarily prepaid in whole at any time, subject to a spread maintenance payment (1%) on the principal amount of such prepayment if it occurs prior to the payment date in September 2014.

The borrowers are required to pay a release price based on the amount of total debt being prepaid as part of the release. The release price is 100% if 0%-15% of the initial principal balance is released and 115% if greater than 15% of the initial principal balance is released.

The release of assets will be subject to the maintenance of a debt yield that is equal to or greater than the greater of the NOI debt yield immediately prior to the release or the NOI debt yield at closing. In addition, the NOI debt yield on the remaining properties must be at least 9.22% but in no case will need to exceed 11%.

CMBS

Conduit credit quality hits 2005 lows

US CMBS conduit loan credit quality has decreased to the levels of the late 2005 issuance, requiring more credit enhancement to offset increased credit risk, according to Moody's. The agency says that credit enhancement levels for deals in 1Q14 will be nearly 9% to achieve a Baa3 rating, 300bp higher than the levels necessary for a Baa3 rating in early CMBS 2.0 deals.

The average Moody's loan-to-value (MLTV) ratio for conduit CMBS transactions that the agency rated in 4Q13 increased by 50bp to 103.5%, a CMBS 2.0 high. It expects conduit leverage to increase more in 1Q14, with a quarter of loans sized to about 75% of market value, traditionally the boundary of underwriters' guidelines.

Leverage has also increased because of the higher proportion of subordinate debt backing conduit loans: roughly one in eight Q4 loans had subordinate debt behind it. Furthermore, even though loan leverage in Q1 transactions aligns with those from the second half of 2006 in terms of loan proceeds relative to stabilised value as measured by MLTV, credit quality overall aligns with that of the late 2005 issuance given recovering property fundamentals, the protection from term default afforded by current debt service coverage ratio levels and the lower share of interest-only loans.

The collateral quality of CMBS 2.0 deals could also slip because of the increased use of master leases, which make the collateral appear more fully leased and the income higher than it is in reality.

CMBS

Italian government exposure analysed

Fitch says that ratings on outstanding Italian CMBS will not be affected by recent legislative changes, which include further termination rights for certain public entity tenants. The agency has identified three CMBS with material exposure to Italian government leases.

In an attempt to cut rental costs and optimise occupied space related to administrative functions, Law decree No. 151 of 30 December 2013 introduced further changes to legislation previously approved by the Italian Parliament. Public administration entities, regions, local entities and constitutional bodies will be granted a one-off additional termination right - to be exercised by 31 December 2014 - with notice to be communicated to the respective landlord by 30 June.

Furthermore, Decree 151 introduces a formal approval process for renewal of existing leases that reach expiry. The Italian public land agency will only grant its consent if government-owned space is not available and rental levels for the assets are in line with market conditions, Fitch notes.

The three CMBS with material exposure to Italian government leases are: FIP Funding (representing 100% of rental income), Patrimonio Uno CMBS (81%) and Windermere XIV CMBS (39%). For the first two deals, the new lease renewal approval process is not applicable, since an exemption applies if the respective assets are owned by investment funds purposely set up by the Italian Ministry of Finance. The provisions of the one-off additional break clause may be applicable, subject to further changes in the conversion of Decree 151 into law.

However, the lease agreement between the government tenant and the real estate investment funds is subject to specific clauses that - subject to minimum flexibility - only allow vacation for the entire portfolio. These provisions were expressly regulated by law decrees published at the transactions' closing.

While FIP Funding and Patrimonio Uno may now be exposed to additional lease break risk from March (when Decree 151 will have been converted into law) to end-June (end of the notice period), Fitch considers that the majority of assets are instrumental to state activity, given their type and large surface area. "We believe the portfolios cannot easily be vacated without disrupting the normal functions of the public entities currently in occupation. Also the tenant has not served notice at the end of the initial nine-year lease term for either transaction," it explains.

Given these considerations and the short risk horizon, the agency does not expect the new break optionality to be exercised. Moreover, the specific exclusion of FIP and Patrimonio from the lease renewal approval process suggests that transactions with government investment funds could also be excluded from the additional break option clause, once Decree 151 is converted into law.

For Windermere XIV's Fortezza 2 loan, meanwhile, the residual term of the current leases is not long enough to materially alter the rating analysis at loan exit. Fitch expects a protracted loan work-out after maturity and the collateral value is largely estimated on the basis of stabilised stressed rental values, regardless of the leases in place.

Furthermore, the longest lease in Fortezza 2 is secured against the Rome headquarters of a state-owned company responsible for the Italian Ministry of Finance's IT services. There is a high chance that the tenant will remain in occupation, although it could successfully negotiate rent reductions following the new provisions of Decree 151.

CMBS

DSCRs under pressure

Every major CMBS underwriting metric declined in 2013 except for debt service coverage ratio (DSCR), but with interest rates likely to rise over the next two years DSCR will likely decline too, according to Fitch. In turn, the agency is likely to raise credit enhancement levels if higher interest rates push DSCRs down.

Even if current levels of DSCR are maintained, Fitch says it will increase CMBS credit enhancement if other underwriting parameters continue their deterioration. "Debt on new CMBS deals will be increasingly comprised of first and second mortgages and mezzanine financing in order to refinance loans coming due over the next few years," comments Fitch md Huxley Somerville. "Subordinate debt in CMBS deals already rose in the second half of last year and stands to do the same in 2014 as the refinancing debt wall approaches." Particularly problematic may be CMBS deals containing loans underwritten with expected net operating income increases that do not come to fruition.

Another troubling trend from 2013 was the increase in interest-only loans, with Fitch reporting over 50% of loans having some form of IO period. The agency finds this practice counterintuitive, given the current low interest rate environment. With the likelihood of interest rates being higher at refinance and the potential for lukewarm economic growth over the term of the loan, the logic of removing a strong mitigant to CMBS refinance risk in a higher rate world is questionable at best, it notes.

CMBS

Loss reimbursements to diverge?

The recent loss recoupment to the D tranche of CWCI 2006-C1 (SCI 20 January) appears not to have been reflected in the January settlements for the CMBX.3 index, of which the transaction is a constituent. The loss on the AJ tranche resulted in pay-outs on the AJ.3 sub-index, however.

CMBX documentation allows for a 'write-down reimbursement' payment - made by the protection buyer to the protection seller - which includes any payments made in reduction of prior write-downs on the underlying bonds. CMBS analysts at Barclays Capital believe that the loss reimbursement on the D tranche qualifies for this payment, but the synthetic D tranche in the A.3 sub-index reported only a small US$108 shortfall recoupment amount this month on a US$1m notional trade. No write-down reimbursement amount was reported, which the analysts estimate should have been about US$7,400 on a US$1m notional trade.

"This is likely due to the way the trustee is reporting the loss reimbursement payout, as an 'interest adjustment' rather than a previous loss reimbursement," the Barcap analysts suggest. "And because the CMBX interest adjustment payments are capped at the index coupon, the 'interest shortfall reimbursement' payments on the synthetic index do not compensate for the missing 'write-down reimbursements'."

As servicers step up bulk liquidations of distressed loans, loss reimbursement payments will likely become more common over the coming months. Further divergence could consequently emerge between principal payments on cash and synthetic positions if the CMBX settlement methodology remains in the current form, according to the analysts.

CMBS

High-LTV loan resolutions eyed

Fitch reports that January has been a busy month for EMEA CMBS loan maturities, with all but three of the 24 loans from the agency's portfolio that are maturing in 1Q14 falling due this month. The majority of the loans maturing between January and March have Fitch-calculated loan-to-values (LTV) of 80% or above, making refinancing at maturity difficult without sponsor intervention, the agency suggests. Of these 19 high-LTV loans, it believes that 15 have no equity.

"Early maturity results reported by servicers seem to back up Fitch's view, indicating that low leverage loans did repay or are close to redemption, whereas the highly leveraged loans defaulted or are entering standstill or work-out," says Mario Schmidt, associate director in Fitch's structured finance team.

Four loans defaulted ahead of their maturities as a result of covenant breaches. All four loans had Fitch-calculated LTVs of 100% or above.

Six maturing loans were extended previously, by between one and three years. In two cases, leverage still remains too high (at around 100%) for full repayment of the loans without further equity investment.

As in previous quarters, upcoming bond maturities limit the special servicer's options on a number of loans. Seven loans have tail periods of three years or less.

Fitch's maturity repayment index improved to 57.9% for 4Q13 from 56.1% during the previous quarter.

Insurance-linked securities

Open-source modelling framework unveiled

An open, independent natural catastrophe loss modelling platform has launched after two years in development. Dubbed Oasis Loss Modelling Framework, the offering is owned by 21 insurers, reinsurers and brokers, but is open to anyone with an interest in creating new catastrophe risk models.

Oasis is not-for-profit and aims to bring down the costs of modelling, as well as providing transparency and greater flexibility for users. The framework is designed to operate as a set of plug-and-play components, which can be developed by any member to meet various needs.

Initially, a number of commercial models will be available on the platform, including: four for flood (two for the UK plus Australia); three for earthquake (the US, North Africa and the Middle East); Cascadia tsunami; and Brazilian bush fire. Members can also introduce their own models into the framework and invite others to run them too. In addition, they are able to develop models for sale or licence to other users.

Insurance-linked securities

Vitality Re deals scrutinised

Moody's says it views the risk and required capital reduction from Aetna's medical benefit claims transactions as "quite modest and temporary". The comment comes after its latest Vitality Re V catastrophe bond - the US$200m five-year series 2014-1 - completed last week.

Each transaction provides collateralised excess of loss reinsurance coverage limited to the principal amount of the notes issued by the vehicle on a portion of Aetna's group commercial health business. Aetna has obtained regulatory approval to consider the cat bonds as risk-reduction transactions that reduce its capital requirement by allowing statutory capital credit for the assets held by the reinsurer in collateral accounts.

To the extent that Aetna replaces a significant portion of its long-term capital held at its regulated subsidiaries with the capital credit from these transactions, the credit implication would be negative, according to Moody's. However, Aetna to date has limited the amount of coverage obtained in these transactions to an aggregate of US$600m, as of 31 December 2013. The new US$200m cat bond closely follows the expiration of its first two deals (Vitality Re and Vitality Re II), effectively reducing the overall amount outstanding to US$500m.

With respect to risk reduction, Moody's notes that the reinsurance agreements are structured with relatively high attachment points. The initial attachment points for the latest Aetna transaction are medical loss ratios (MLRs) of 102% (US$140m class A notes) and 96% (US$60m class B notes). The reinsurance initially exhausts at MLRs of 116% for the class A notes and 102% for the class Bs, which the agency believes are unlikely to be reached, given that Aetna's MLR has fallen to a narrow range of 78%-81% over the past three years.

The Vitality Re V MLR attachment points will be reset annually to maintain an attachment probability and expected loss at or below those initially modelled and established at inception. "Although we recognise there is some extreme tail risk reduction for Aetna as a result of these transactions - for example, in the event of a pandemic - we believe the probability of claims reaching the attachment point is fairly remote. As a result, we do not believe that there is a substantial risk reduction provided by the transaction," Moody's observes.

Meanwhile, the funds being held in the collateral accounts only cover the risk of excess claims for this specific block of policies and therefore are not available to support other businesses and financial risks at Aetna, the agency adds. This is in contrast to unallocated capital held at operating subsidiaries, which is generally available to cover multiple liabilities and contingencies.

Furthermore, because the transaction will be in effect for a limited number of years and there can be no assurances that the transaction will be replicated at maturity, the capital support being provided by the funds in the collateral accounts is temporary. As a result, the capital support from this transaction is more limited and temporary in the financial protection it provides, Moody's concludes.

Risk Management

FpML gets reporting functionality

ISDA has published its recommendation for FpML version 5.6, which is designed to allow the industry to fulfill reporting requirements in jurisdictions where reporting to trade repositories is expected to go live this year. Version 5.6 provides support for data and reporting requirements in Singapore, Australia and Canada as detailed by the regulators in those jurisdictions. Further functionality has also been included to support reporting to the Federal Financial Markets Service (FFMS) in Russia and to better enhance message routing to different reporting jurisdictions.

The existing ISDA Master Agreement structure has been improved with additional information to satisfy reporting requirements. With increased flexibility around the representation of trade identifiers - including full support for unique trade identifiers (UTI), unique swap identifier (USI), legal entity identifier (LEI), interim CFTC compliant identifier (CICI) and full integration of the ISDA OTC derivatives taxonomies - FpML provides a standard that promotes consistency, interoperability and transparency in the derivatives markets.

In addition, pre-trade functionality has been enhanced with additional product representation and, as part of the clearing functionality, pre-clearing quotation messages were added to verify the clearing eligibility of products. The standard also includes improved functionality to handle the expiry and exercise of options.

While the FpML standards committee continues to focus on the coverage of the regulatory reporting requirements in different jurisdictions, work is ongoing on further standardisation and product representation for different asset classes. The emphasis on clearing and electronic execution workflows is likely to increase further as well. The committee has started work on version 5.7.

Risk Management

Collaboration sought in collateral management

The DTCC says that financial firms could face significant cost, risk and operational challenges managing margin requirements in the years ahead. In its latest white paper, entitled 'Trends, Risks and Opportunities in Collateral Management', the organisation calls for collaborative solutions that leverage market infrastructures to help the industry meet increasing demands.

The report notes that projections on rising margin calls are running as high as 1000%, with demand for collateral outstripping supply. According to the DTCC, this will: increase pressure on firms' operating margins, including increased funding costs and capital requirements; increase operational risk both for market participants and the financial system; overwhelm the current operational processes and system infrastructures; and require technology changes to create comprehensive record keeping and reporting across the broad collateral environment of providers and services.

"Regulatory changes implemented over the past two years - and those still to come - have the potential to overwhelm firms and market participants with operational and risk challenges of a magnitude we have never seen before," comments Mark Jennis, DTCC md, strategy and business development. "This paper reinforces that collaborative infrastructure solutions are critical to solving the most challenging margin issues today because they will leverage the expertise and knowledge of multiple providers, as well as address the problems in a more holistic manner. The reality is that collateral challenges will be far more extensive than what has been reported thus far, and in many cases fragmented solutions will only address certain parts of the problem and may lead to unintended consequences."

The white paper offers insight and solutions to the following issues and broad strategic initiatives that are emerging as the demand for high-quality collateral rises: exposure calculation and margin management; portfolio margining; collateral optimisation; record keeping and reporting; communication standards; and reference data. The DTCC says it is committed to continue collaborating with industry partners to develop solutions that address the operational costs and risks associated with the increased demand for collateral.

RMBS

RMBS loss severities up

US RMBS loss severities rose last quarter, following six straight quarters of declines, according to Fitch's latest quarterly index for the sector. Home price growth began to slow in 4Q13, while timelines continued to lengthen.

"Judicial foreclosure states were a particular problem spot with respect to longer timelines last quarter, even as timelines in non-judicial states start to level off. Longer liquidation timelines result in higher loss severities due to greater carry costs and higher potential for property deterioration," comments Fitch director Sean Nelson.

Another notable development from last quarter involved servicer advancing. Specifically, the rate at which servicers advanced missed borrower payments increased in 4Q13 for the first time since the onset of the financial crisis.

"All things being equal, greater advancing typically results in higher loss severities - though the recent increase in advance rates suggests that servicers are starting to see greater recoveries as a result of the home price gains," Nelson adds.

RMBS

Fir Tree launches tender

Fir Tree Partners has commenced a cash tender offer through its affiliate FT RMBS in connection with six RMBS that are subject to the proposed US$4.5bn JPMorgan settlement. The transactions involved are SACO 2006-3, 2006-5, 2006-6 and 2007-2, as well as BSMF 2006-SL1 and JPMAC 2006-WMC4.

"We believe Fir Tree is offering a better recovery with a more certain payment outcome on a much faster timeline for the RMBS subject to our tender than the proposed JPM settlement," comments Clinton Biondo, an md at the firm. "Holders will get their money now rather than waiting for the settlement pay-out, which could potentially take months or years, if it happens at all."

All of the RMBS trusts subject to Fir Tree's tender offer are involved in active litigations against JPMorgan for breaches of representations and warranties made by JPMorgan regarding the credit quality and characteristics of the loans it sold to these trusts. Fir Tree funds are currently acting as directing holders in all of these litigations, except that involving the JPMAC 2006-WMC4 trust. Fir Tree intends to seek to continue these litigations and to exclude all of the RMBS subject to its tender offer from the JPM settlement, irrespective of the outcome of the tender offer.

The tender offer is scheduled to expire on 19 February, unless it is extended. Seaport Group Securities is the dealer-manager for the offer.

RMBS

Borrowers 'still struggling'

Recent US home price growth has been insufficient to help some borrowers still struggling to pay their mortgages, Fitch says. The agency notes that this is evidenced in the growing percentage of borrowers entering foreclosure with positive equity in their homes.

Fitch estimates that the percentage of borrowers entering foreclosure with positive equity has roughly doubled in the last two years. While equity continues to be an important factor for borrower payment behaviour, income and ability to pay are key drivers as well.

The inability of some borrowers to recover as the economy has moderately improved seems particularly evident in many of the RMBS loans that have been entering into the foreclosure process over the past few years, according to the agency. "In many cases, troubled borrowers with equity are unable to sell their properties because the proceeds of the sale would not be enough to cover the mortgage amount, the closing costs and the backlog of missed payments. Loans entering foreclosure today have missed roughly two years of payments on average, more than double the pre-crisis long-term average," it explains.

The changing composition of borrowers entering foreclosure may also help explain why those with positive equity continue to struggle. The percentage of loans entering foreclosure that had been cash-out refinances at origination has increased steadily since 2008 and now accounts for 50% of the total. Today's tighter loan underwriting and origination guidelines may prevent many of these borrowers from tapping the equity in their homes to cover expenses.

Furthermore, approximately half of all loans that recently entered foreclosure have been unsuccessful in at least one prior loan modification. The percentage of loans entering foreclosure that had been underwritten to subprime guidelines has increased as well. Such attributes suggest that many of these borrowers were either overleveraged at origination or had payment challenges in prior years and have few alternatives now and may be able to remain in the home until the foreclosure process is complete.

The age of loans entering foreclosure also continues to climb steadily. Borrowers recently entering foreclosure have loans that are roughly eight years seasoned on average, compared to the pre-crisis average of 2-3 years. As such, loans with positive equity that are entering foreclosure today may be more adversely selected due to the length of time prior to entering foreclosure and the potential for disrepair.

"It is possible that some portion of borrowers currently in the foreclosure process obtained additional and/or secondary financing subsequent to the origination of their first liens," Fitch says. "The additional leverage could also be a factor in their ability/willingness to pay and whether the borrower is in a positive equity position."

RMBS

MI ratings to remain stable

Moody's expects the ratings for Australian mortgage insurance (MI) companies to remain stable over the next 12 months. This is because MI companies are well-capitalised, have low and stable loss ratios, and retain their strong market positions.

"We view the operating environment for the Australian MI industry as broadly supportive," says Ilya Serov, a Moody's vp and senior credit officer. "While there are downside risks of house price inflation and Australia's move away from resources-led investment growth, our central forecast is for sound - though moderately below-trend - GDP growth of 2%-3% this year. Consequently, Australian MIs' financial profiles - characterised by surpluses to regulatory capital requirements and relatively low loss ratios - will help the industry offset any risks, should the operating environment deteriorate."

The agency suggests that the threat to the MI industry of excessive price increases is moderate because the inflation does not appear to be fuelled by excessive credit growth or a broad-based loosening of lending standards. Housing credit growth remains subdued, at about 5% per annum, and the proportion of high loan-to-value (LTV) ratio mortgages (some 15% of new loans with LTV ratios in excess of 90%) is below the averages seen prior to the financial crisis.

While recent house price increases have been most prominent in Sydney, housing affordability metrics for the city indicate some scope for further appreciation, as affordability has steadily improved since 2003.

Moody's expects the industry's low loss ratios, compared with global MI peers, to remain benign or improve as older and riskier vintages are replaced over time by safer and more recent originations - thereby improving average asset quality metrics. However, the portfolios of Australian MI companies are concentrated relative to global peers, thereby exposing them to volatility in performance due to weakness either in a particular region or in relation to a single client.

RMBS

Current loan sales slammed

SN Servicing Corporation's recent sale of both current and delinquent mortgage loans from scratch and dent RMBS trusts exposes the transactions to market value risk and raises concerns about potentially high losses in the deals, Moody's notes in its latest ResiLandscape publication. In one of the trusts - Security National Mortgage Loan Trust 2002-2 - investors lost US$8.1m as a result of the sales.

Moody's notes that selling current loans out of a REMIC trust contravenes standard servicing practices of RMBS servicers: the agency believes that the transaction documents did not permit such action. Sales of current loans result in the depletion of credit support, even in highly enhanced deals.

Over July and August 2013, the pool balance on the Security National Mortgage Loan Trust 2002-2 dropped from US$13.9m to US$842,398 while only US$1.9m was remitted to the bonds in principal and interest. The balance of contractually current loans dropped from US$9.4m to US$649,031 and the balance on delinquent loans dropped from US$4.6m to US$193,366. As a result, the class M1 bond lost its entire outstanding principal of US$5.3m and investors in the class A3 bonds lost US$2.8m, or 52%.

When contacted, the servicer informed Moody's that it reimbursed itself for recoverable advances on previously liquidated loans. These advances were not reported in the trustee reports.

In the PSA, the master servicer covenants "not to engage in any 'prohibited transaction'" under the REMIC rules. The REMIC rules define a prohibited transaction as the sale of a loan that is neither in default nor imminent default. Further, the sale of current loans also contravenes standard RMBS servicing practices for REMIC trusts.

SN Servicing has not provided Moody's with adequate information to assess the implications of the loan sales on our ratings on the transactions. Because of this, as well as its opinion that the transaction documents do not permit sales of current loans, the agency has withdrawn its ratings on 33 tranches in nine Security National deals.