Contents

Structured Finance

Reducing variation

Valuation standards on the cards

The International Valuation Standards Council (IVSC) is establishing a cross-industry taskforce to develop principles of best practice for the valuation of financial instruments. The move has been welcomed as a step towards increasing transparency and reducing variation in values.

The IVSC has been setting valuation standards many years, but the organisation's technical director Chris Thorne says it's clear that concern remains around the valuation of financial instruments, particularly derivatives. "A number of significantly different approaches towards valuations are used at present, many of which can produce significantly different outcomes. There is also a lack of understanding among many who rely on the valuations about the underlying principles behind different models, as well as their limitations, and no generally accepted benchmarks as to which valuation approaches are appropriate for different types of instruments. The variation in values of similar products between firms remains a significant concern to regulators."

The IVSC intends to set up a cross-industry taskforce to help identify the issues that need addressing and then develop some principles of best practice. The aim is to narrow the differences in approach by defining the generally acceptable ways of arriving at a valuation for different categories of instrument.

"Valuations always require a degree of judgment, but the role of standards is to limit the range of potential answers," Thorne explains. "At present, there is no benchmark against which to judge: auditors are told which model was used to arrive at a given valuation, but there's no internationally recognised standard to help understand whether the choice of model was appropriate."

Investors are looking for transparency, so the development of standards that demonstrate valuation methodologies are adhered to is a positive step, according to Houlihan Capital svp Robert Schaeffer. "Transparency is a leading issue for investors. Particularly institutional investors want to know that investments in an underlying fund have gone through the necessary due diligence and methodology processes," he says.

There still appears to be a level of suspicion about banks and the way that they value their books. But if there is a contextual framework that end-users of the valuation can understand, they are more likely to trust the answer.

"It's important to be clear about the objective of the valuation and the assumptions used. Valuations are based on hypotheses, so the terms of the hypothesis used need to be clearly documented. A good valuation is about analysing the facts and then applying judgment in a professional manner to reach a credible conclusion," Thorne observes.

Now that funds are required to register with the US SEC and have to implement fair value accounting, they also need to have formal valuation policies and procedures in place. "These methodologies need to be documented, so that investors and auditors can see that a methodology has been adhered to," Schaeffer notes. "Institutional-grade funds typically have pricing committees that go through a detailed process to establish proper marks on their investments and this is typically done on a quarterly basis."

He adds: "The increase in reporting allows investors to see that checks and balances are in place. Institutional investors commonly have a compliance check-list - the development of uniform standards provides them with one more box to check on this list."

The IVSC aims to have a more comprehensive suite of standards for the main classes of instruments within three years. The project is currently in the planning stage, but the goal is to make a formal announcement about the taskforce in the spring.

The hope is that most banks will see the principles as a positive development, as the standards should enable management to demonstrate that they followed recognised professional guidance for their valuations. "Once we have identified best practice through open consultation, it becomes much harder for a firm to persuade investors, auditors, regulators and others that an alternative approach is better. That could make life uncomfortable for a few outliers, but the overall objective is to build confidence and trust throughout the system," Thorne concludes.

CS

ABS

ABS supply picks up

US ABS BWIC volume picked up yesterday to around US$184m, with supply mainly driven by auto names. However, SCI's PriceABS data also captured a variety of aircraft, credit card, equipment and student loan tranches out for the bid.

Much of the supply came from auto tranches such as AMCAR 2012-4 D, which was talked in the 90 area. The tranche only made its first appearance in the PriceABS archive last week, when it was covered at 99. Similarly, the AMCAR 2011-5 D tranche had never before appeared in the archive and was talked in the 70 area.

The AESOP 2011-2A A tranche was another new arrival into the archive and was covered at 37, while DTAOT 2013-2A A was covered at 103 and DTAOT 2014-1A A was covered at 100. The FORDL 2012-B A4 tranche was talked at 100.17 and covered at 100.24, while FORDO 2013-B A2 was covered at 100.03, having been covered last month at 100.04.

Another name of interest was HUNT 2012-2 A2, which was talked at 100.02 and covered at 100.01. The tranche first appeared in the PriceABS archive in February 2013, when it was covered at plus 5.

MBART 2012-1 A3 was talked at plus 8, having been covered at 10 last month. There were also covers for MBALT 2013-A A2, NAROT 2012-B A2, NALT 2013-A A2B and SDART 2012-1 B.

SDART 2010-2 C was covered at 70, while SDART 2010-3 C was covered at 60. The TAOT 2012-B A2 tranche was covered at 100.01 and the TAOT 2013-A A2 tranche was covered at 100.04. Finally amongst the autos, there was also a cover at 100.22 for VWALT 2012-A A3.

Amongst the aircraft ABS names out for the bid was the AFT 1999-1A A1 tranche, which was talked in the low/mid-40s. Its two previous recorded covers - from July 2013 and October 2012 - were both also in the 40s.

PALS 2000-1 A2 was talked in the low/mid-30s. The tranche was recorded as a DNT twice last year, with price talk moving from the 40 area in March to the low/mid-30s in November. Meanwhile, the PALS 2001-1A A2 tranche was talked in the low/mid-40s.

There were three new credit card names for the PriceABS archive as CABMT 2013-2A A2 was covered at 45, CCCIT 2013-A12 A12 was talked in the mid/high-20s and CCCIT 2014-A1 A1 was covered at 49. Meanwhile CCCIT 2013-A1 A1 was talked at 11, having been covered at Libor plus 11 on 28 January.

A pair of JDOT tranches accounted for the equipment ABS supply. JDOT 2012-B A2 was both talked and covered at 100.01, while the JDOT 2013-A A2 tranche was talked and covered at 100.02.

There were also student loan ABS tranches circulating, as NCSLT 2006-3 A4 was talked and covered in the mid-80s. The tranche was also covered last month in the mid-80s and first appeared in the PriceABS archive on 24 January 2013, when it was covered at 74 handle.

Also out for the bid was the NCSLT 2007-1 A3 tranche, which was talked in the low-80s and covered in the mid-80s. The tranche was talked in October in the mid/high-70s.

JL

CLOs

CLO supply keeps coming

It was another busy session in the CLO secondary market yesterday. Supply was dominated by 1.0 mezzanine paper, apparently boosted by the liquidation of one manager's CLO-squared.

SCI's PriceABS data captured covers and price talk on 92 unique CLO tranches yesterday, with around two-thirds from the US and the rest from Europe. Vintages ran from several years pre-crisis all the way to 2013.

A couple of European bonds from the session were recorded as DNTs. The INTER 2X C tranche failed to trade (having been talked in the low-90s and at 93), while the TARA 1X IV tranche had been talked in the par area, in low-100s and at 103.

Considerably more names traded successfully, however. Among them was the ACAEC 2007-1X D tranche, which was covered at 89.03. Covers were also recorded for tranches such as BOYNE 1X C1, CADOG 1 B and DUCHS IV-X D.

CELF 2005-1X B was covered in the mid-90s, with price talk ranging from the mid-90s to mid/high-90s. The last recorded cover for the bond was at 94.49 in October.

HEC 2007-3X C was covered in the very high-80s, having been talked in the mid-80s, mid/high-80s, 90 area and at 90. The tranche was covered in January last year in the low-80s and has since been covered at 82.28.

JUBIL IIX B1 was covered at 99.5, with price talk in the high-90s, very high-90s and at 100-plus. The tranche was previously covered at 98.33 in December.

US CLO trading was even busier yesterday. Bonds out for the bid ranged from senior pre-crisis tranches such as SYMP 2007-5A A1 to post-crisis sub tranches such as ACIS 2013-1A SUB. The SYMP tranche was covered at 98.01, while the ACIS tranche was covered in the low-80s.

ACACL 2006-2A A2 was covered at 97.62, with price talk at 97 handle, low-97 handle and around 98. The tranche had been talked in the prior session at low-97 handle.

GCLO 2006-1X C was covered at 85.55, having been talked between the low/mid-80s and high-80s. When the tranche first appeared in the PriceABS archive in April 2013, it was covered in the mid/high-70s.

Another 2006-vintage tranche of interest is WITEH 2006-1A A2L, which was covered in the high-97s. The tranche did not appear in PriceABS last year, but was covered in November 2012 at 95.6.

Meanwhile, the WITEH 2013-1X B3L bond made its PriceABS debut yesterday. The US$4.4m tranche was talked at par.

That was just one of many 2013-vintage tranches circulating, with five different levels of price talk on ARES 2013-1A A and talk at 98 and high-98 handle for ARES 2013-1A D. Each of those names have appeared in PriceABS several times before, but CGMS 2013-1A D was another new arrival, talked at 98 handle and 98.5.

In addition, covers for tranches such as CECLO 2013-18A D, DRSLF 2013-26A F, OAKC 2013-8A A and RACEP 2013-8A A were seen. There were also a number of US CLO DNTs.

JL

RMBS

Stronger start for US RMBS

It was a promising start to the week for US RMBS, as non-agency BWIC volume picked up to reach US$477m. SCI's PriceABS data shows price talk for a number of legacy names out for the bid - with vintages as far back as 2000 represented - as well as covers on dollar-denominated bonds from recent-vintage European deals.

Activity levels in fixed-rate names remained light, but picked up slightly from the end of last week for hybrids. The biggest pick-up was seen in subprime RMBS, where several senior and mezzanine floaters circulated during the session.

The earliest-vintage tranche captured by PriceABS yesterday was SAST 2000-2 BV2, which was talked in the high-80s. The tranche first appeared in the PriceABS archive on 19 September 2012, when it was talked in the mid-60s.

BSABS 2001-3 M2 was talked in the high-80s and the high-90s. The RASC 2002-KS2 MI1 tranche, meanwhile, was talked in the high-70s.

Other early-vintage tranches were circulating as well, including CWL 2003-3 M2 and EQABS 2003-3 M2. Tranches from 2004 and 2005 were more numerous.

There were also a few tranches from 2007, such as CBASS 2007-MX1 M1, which was talked in both the low/mid-40s and the low-80s. When it first appeared in the PriceABS archive on 18 June 2013, the tranche was talked in the mid/high-30s.

RAMC 2007-3 AF3 was talked in the high-50s to 60 area and in the low-60s. The bond was talked in the high-50s last February. WMALT 2007-OA3 4AB, meanwhile, was talked in the high-teens.

In addition, several US dollar-denominated tranches of European RMBS attracted covers during the session. Among these was ARKLE 2012-1A 2A1, which was covered at 101.55, having previously been covered in October at 101.82 and before that in August at 101.85.

Similarly, FOSSM 2012-1A 2A2 was covered at 101.47. The bond also traded last month and was covered twice in December, first at 101.51 and then at 101.52.

Covers were also recorded for GMFM 2011-1A 2A1 and HMI 2011-3A A2, at 101.15 and 101.01 respectively. The last recorded cover for the former bond was at 101.42 in September and the last for the latter was at 101.15 in August.

LAN 2012-2A 1A was covered at 101.68, having been covered on 27 August at 101.64 and on 5 August at 101.6. Finally, SMI 2012-1A 1A was covered at 101.5, having been last covered at 101.743.

JL

Structured Finance

SCI Start the Week - 3 February

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

Pipeline
The pipeline was busy with deals passing through last week. Three new ABS, three RMBS and two CLOs remained in the pipe by Friday.

The ABS were VCL Master Residual Value Compartment 1 Series 2014-1, VCL Master Residual Value Compartment 1 Series 2014-2 and VCL Master Residual Value Compartment 1 Series 2014-3. The RMBS being marketed were US$373m JPMMT 2014-1, A$500m PUMA 2014-1 and US$1bn STACR 2014-DN1, while the CLOs were US$616.2m GoldenTree VIII and US$403.4m Golub Capital Partners CLO 18.

Pricings
Many transactions were issued last week, several of which had spent little time in the pipeline. Among the prints were eight ABS, an RMBS, two CMBS and three CLOs.

The ABS pricings comprised: US$1bn Ally Master Owner Trust Series 2014-1; £164m Arqiva Financing 2014-1; US$201m Edsouth Indenture No.5 Series 2014-1; US$650m Exeter Automobile Receivables Trust 2014-1; US$1.34bn Hyundai Auto Receivables Trust 2014-A; €690m Kigoi 2013; US$458.5m Nelnet Student Loan Trust 2014-1; and €720m VCL 19.

The RMBS print was £200m EMH Treasury 2014 and the CMBS were US$675m COMM 2014-TWC and US$1.299bn MSBAM 2014-C14. Finally, US$273m ALM V Refinancing 2014-1, US$644m ICG US CLO 2014-1 and US$624m LCM XV rounded the issuance out.

Markets
US ABS BWIC volume reached a monthly high towards the end of January (SCI 28 January). Bid-list volume approached US$500m to start the week, with auto and student loan names driving supply.

Meanwhile, the US agency RMBS market moved wider as the Fed announced it would further reduce its asset purchases. "The week diverged for bonds, as the front half saw a higher and steeper curve, but things reversed with a back half rally and benchmark rates eventually moved net lower as overseas negatives overwhelmed markets with a risk-off tone. MBS spreads were incrementally wider as the Fed tapers further, and we continue to be negative/underweight the basis over the medium term," note Wells Fargo RMBS analysts.

As for US non-agency RMBS, secondary volumes were significantly boosted by a US$1.15bn GSE list on Thursday. "We look for trading activity to remain elevated next week as the Dutch State Treasury Agency looks to sell the remaining securities from its ING portfolio. The US$2.2bn list will contain 234 line items, equally split between fixed and hybrid bonds," Bank of America Merrill Lynch RMBS analysts observe.

US CMBS secondary activity also picked up last week as the market returned to business after the ABS Vegas conference. BWIC volume climbed early in the week, with SCI's PriceABS data displaying a range of vintages out for the bid during Tuesday's session (SCI 29 January).

Both the US and European CLO markets were also busy last week, as SCI reported on 30 January. Wednesday's session was particularly busy, with PriceABS capturing cover prices for US tranches such as ACIS 2013-1A SUB and European ones such as ACAEC 2007-1X D.

Finally, JPMorgan European asset-backed analysts note that the European RMBS market witnessed a slight change in investor behaviour, as there was more focus on Italian risk in the secondary market. "On the week, we move Italian RMBS seniors/juniors in by 5/10bp respectively," they report.

Deal news
• Starwood Capital has confirmed its successful bid for a pool of REO assets in the CWCapital Asset Management CMBS auction (SCI 16 January). These loans are securitised in GSMS 2007-GG10 (with a US$185m exposure), MLCFC 2007-5 (US$106m), WBCMT 2006-C28 (US$22m) and BACM 2007-1 (US$5.5m).
• Last month 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 Dutch State Treasury Agency has launched its third competitive auction for the securities underlying the ING Illiquid Assets Back-up Facility. The auction will be conducted by BlackRock Solutions and comprises US$2.06bn current face across 234 non-agency RMBS.
• 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.
• 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 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.
• 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.
• 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 the completion of its latest Vitality Re V catastrophe bond - the US$200m five-year series 2014-1.
• Auctions have been scheduled for the Crystal Cove CDO, Margate Funding I CDO and Libertas Preferred Funding I transaction on 14, 18 and 19 February respectively. The collateral shall only be sold if the proceeds are greater than or equal to a deal's total senior redemption amount.

Regulatory update
• The US SEC is to hold an open meeting on 5 February to discuss Regulation AB 2. Specifically, the Commission will consider whether to adopt rules revising the disclosure, reporting and offering process for ABS.
• The European Commission has proposed rules to prevent large banks from engaging in proprietary trading. The rules would also give supervisors the power to require those banks to separate certain potentially risky trading activities from their deposit-taking business if the pursuit of such activities compromises financial stability.
• 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).
• 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.

Deals added to the SCI New Issuance database last week:
GSMS 2014-GC18; Jubilee CLO 2014-XI; Skyline Re 2014-1; Vitality Re V series 2014.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-3; BACM 2007-1; CGCMT 2006-C5; CSFB 2005-C1; CSFB 2005-C2; CWCI 2007-C2; DECO 2007-E6; DECO 7-E2; DECO 8-C2; ECLIP 2006-2; ECLIP 2007-1; EMC VI; EPICP BROD; EPICP CULZ; EPICP VRET; FLTST 3; FOX 1; GSMS 2007-GG10; JPMCC 2007-LD11; JPMCC 2007-LDPX; JPMCC 2013-INN & JPMCC 2013-INMZ; LBUBS 2006-C6; MLCFC 2007-5; MLCFC 2007-7; TAURS 2006-1; TITN 2005-CT2; TITN 2006-5; TITN 2007-3; TITN 2007-CT1; TMAN 6; WBCMT 2005-C22; WBCMT 2006-C28; WINDM X; WINDM XI; WINDM XIV.

Top stories to come in SCI:
Corporate trust roundtable

CMBS

Varied lease renewal rates in US CMBS

US CMBS credit quality has improved in many ways, but upcoming lease expirations continue to provide a potential source of downside shock. While they are difficult to calculate and predict, certain factors appear to make non-renewals more or less likely.

The probability of a lease renewal depends on the asset and the tenant. Certain property types and geographies appear to have greater or lesser likelihoods of lease renewals, while certain types of tenant may also be more or less likely to move out when a lease expires.

Barclays Capital CMBS analysts examined reported occupancy and DSCR levels for loans both before and after lease expiration to calculate renewal rates. They also compared changes in NOI and DSCR, estimating that around 30% of leases expiring in 2012-2013 were not renewed in their entirety. This is a marked improvement from 2009, when the figure was nearly 50%.

There is a clear difference in non-renewal rates among different property types, with the rate of non-renewals highest for office properties, at about 40%. By contrast, retail and industrial non-renewal rates were between 20% and 30%.

As for tenants, those associated with the finance industry are most at risk of not renewing: nearly 50% of finance tenants vacated or downsized upon lease expiration in 2012-2013. Government tenants showed far more stability, with only 21% of leases not renewed at expiration, notwithstanding some high profile vacancies such as with the Skyline Portfolio (see SCI's CMBS loan events database).

Tenants in anchored retail malls have been more likely to renew than those in unanchored centres, according to the Barcap study. However, there does not appear to be any materially higher risk for retailers under pressure, such as JCPenney or Best Buy - although this could change.

"Unlike office properties - which generally have a more diverse set of tenants - retail leases tend to be concentrated in a few names and therefore are prone to single-name credit risk. And, given that the CDS for some of these names is trading at very elevated risk of default, we continue to see a relatively high likelihood of non-renewal for these tenants over the coming years," note the analysts.

By geography, non-renewal rates are higher where there is greater real estate supply and less demand, such as some areas with a high concentration of finance tenants like Chicago and Stamford. Properties in the Bay Area and in Texas are at the opposite end of the supply/demand scale and have particularly low non-renewal rates.

In most cases the loss of a single large tenant is not expected to push large volumes of loans into term default, as most loans still report 1.2x DSCR, even after a dip in occupancy. However, a decrease would raise the risk of higher balloon defaults at the maturity date.

It is also worth noting that a reduced DSCR would likely lead a loan to fall below the threshold required for a successful refi. "The reduced NOI is likely to be a bigger factor when it comes to finding a refinance outlet at the maturity date - for instance, current underwriting standards for conduit deals would typically not allow for a loan reporting DSCR in the 1.2x range," the analysts conclude.

JL

RMBS

Prior delinquents provide opportunities

As part of a move to reduce its retained portfolios, Freddie Mac last year began securitisation programmes for current modified loans and re-instated loans (SCI 24 May 2013). The GSE's H pool, M pool and R pool securities represent new collateral types for agency RMBS that are expected to make attractive investments.

Freddie Mac has only issued a small number of H pools, M pools and R pools so far. Meanwhile, around US$1bn of Freddie Mac loans are being modified each month, further bolstering the enterprise's holdings.

H and M pool programmes allow for the securitisation of performing loans that have been brought current by modification and have remained current for six months. H pools have been modified through HAMP, while M pools generally have not - although M pools can include loans modified through HAMP if the new rate is fixed.

R pools consist of loans that have been delinquent but have become current without modifications. Just under half (45%) of all permanent GSE modifications since mid-2009 have been conducted through the HAMP platform.

The biggest drivers for modified loan re-default performance are expected to be payment reduction, delinquency status at modification, months current after modification and original FICO. A comparison with Freddie's unmodified R pool programme provides some insight into voluntary prepayments.

Although R pool loans were cured without modification, they are expected to perform similarly to M pool loans. One of the key issues driving M pool prepayments will be HARP eligibility, with little difference expected between 30-year and 40-year speeds.

Barclays Capital RMBS analysts predict M pool three-year CRRs of 3.4% for 3.0s, 4% for 3.5s, 5.4% for 4.0s, 10.2% for 4.5s and 14.3% for 5.0s. Those forecasts are consistent with observed MA pool prepayments - although, as those pools were only recently issued, it is too early to draw definitive conclusions.

Involuntary three-year projected speeds are 7%-13% CDR, with higher coupons generally exhibiting worse credit performance. That is driven by the fact that payment relief is less substantial for higher coupons and the fact that original FICO tends to be worse.

Current CDRs are not necessarily a reliable indicator of steady state defaults for the securities, as it takes four months for a loan to even reach the 120-days delinquent bucket and empirical defaults are still in the ramp phase. However, 30-day delinquencies are growing, which is suggestive of further CDR increases.

With lower coupons fully out-of-the-money, the Barcap analysts project 3%-4% CRR for M pools, with rate incentives driving payments into the mid-teens for MA 5s. A rally of 100bp would move the CRR into the mid-20s.

"[M pools'] high re-default rates suggest that they should offer investors a decent amount of extension protection. At the same time, HARP eligibility should allow these pools to prepay rather fast in a rally. Given that these pools are non-deliverable, have little empirical prepayment data and are likely to have elevated speeds as a discount, we think this could be an attractive asset," the analysts note.

H pools in many ways will mirror M pools. Freddie Mac's HAMP modifications experience lower re-default rates than their non-HAMP counterparts. Bank of America Merrill Lynch RMBS strategists suggest that whether WAC increases result in increased re-defaults will be largely dependent on forward home price appreciation.

R pool re-performers generally have higher WACs and shorter WAMs than H and M pools, so rate and term refinancings are likely. Borrowers have substantial equity in their homes and are thus motivated to pay. The BAML strategists consequently believe that, following a two-year ramp-up period, these pools will prepay in line with their original cohort.

"As more issuance comes to market, modified loan pools will offer an attractive opportunity for long-duration investors, given their reduced convexity and stable cashflow profiles," the strategists conclude.

JL

Structured Finance

SEC charges two for 'parking' scheme

The US SEC has charged two Wall Street traders at separate firms who were involved in a fraudulent scheme whereby one temporarily placed securities in the other's trading book. Thomas Gonnella is alleged to have solicited the assistance of Ryan King to avoid being penalised by his own firm for holding securities for too long.

Gonnella is alleged to have arranged for King to purchase several securities, with the understanding that he would repurchase them later at a profit for King's firm. Parking securities in King's trading book thus reset the holding period when Gonnella repurchased them, avoiding incurring any charges to his trading profits and year-end bonus for having aged inventory.

The alleged process caused Gonnella's firm to lose around US$174,000 and both he and King were eventually fired for the misconduct. The SEC says Gonnella parked a total of 10 securities with King, beginning with several Bayview Commercial Asset Trust CMBS bonds in May 2011.

King has agreed to settle the SEC's charges by disgorging his profits and being barred from the securities industry. The litigation against Gonnella continues in a proceeding before an administrative law judge.

Structured Finance

New hire to source Euro opportunities

Fir Tree Partners has appointed Peter Calabro as md to lead the firm's expanded focus on European investment opportunities. He was formerly head of European sourcing in the London office of Mount Kellett Capital, specialising in distressed investment opportunities in transactions ranging from single name corporate credit, private equity and real estate.

Calabro has also worked in the special situations group at Goldman Sachs. He was a director in the high yield and leveraged capital markets group at Lehman Brothers.

CDS

Markit signs Korean agreement

Markit has signed an agreement with Korean firm Koscom, which will now distribute Markit's CDS data via its terminal network. Korean investors will gain access to Markit's iTraxx Asia indices and global sovereign and corporate CDS data.

CMBS

CMBS servicing merger completed

Mount Street has acquired Morgan Stanley Mortgage Servicing (MSMS). The acquisition gives the commercial real estate loan servicer a significantly larger CMBS platform.

The MSMS team is located in London and Frankfurt and provides servicing on commercial loans and CMBS in the UK, France, Germany, Italy, Netherlands, Belgium and Switzerland. Mount Street ceo Ravi Joseph was head of European securitisation at Morgan Stanley between 1998 and 2004, while managing partner Paul Lloyd was MSMS vp at the same time.

Risk Management

Consultancy opens OTC derivatives hub

GreySpark Partners has expanded its Asia-Pacific operations by opening its first Australian office, in Sydney. GreySpark Partners Australia will provide institutional investors and banks with consulting services in risk management, electronic trading and market structure.

The Sydney office will also act as the capital markets consultancy's Asia-Pacific advisory hub for OTC derivatives clearing. The team will be led by md Braian Szwarcberg-Poch.

Before joining GreySpark, Szwarcberg-Poch helped to establish and distribute Barclays' OTC client clearing offering in the UK and Europe. He will be assisted by Malavika Shekar, who previously led a number of programmes in the global OTC clearing team at JPMorgan in London.

RMBS

FHFA RMBS claim settled

Morgan Stanley has agreed to settle RMBS claims brought by the FHFA for US$1.25bn. The company will also record an addition to legal reserves of US$150m, reducing income by US$97m after tax.

The settlement covers faulty RMBS sold to Fannie Mae and Freddie Mac (SCI 5 September 2011). The agreement in principle is subject to final approvals by the parties.

RMBS

Lehman settles with Fannie

Lehman Brothers Holdings Inc's US$2.15bn settlement with Fannie Mae has been approved in the New York bankruptcy court. The GSE's original claim against the bank was for US$18.9bn, but it had since agreed that the reserve for its claim would be US$5bn.

The agreement involves a sign-off among Lehman, Aurora Commercial Corp, Aurora Loan Services and Fannie Mae. The GSE will also be required to provide documents allowing for administrators to pursue breaches of representation and warranty claims against third-party mortgage originators.

RMBS

Arch completes mortgage insurance move

Arch US MI (Arch) has completed its acquisition of CMG Mortgage Insurance Company, having entered into an agreement last year with the sellers CUNA Mutual and PMI Mortgage Insurance (SCI 12 February 2013). The acquisition and operating platform will form the foundation for Arch Mortgage Insurance Company (Arch MI) to offer mortgage insurance throughout the US.

Arch's charter has also been expanded to allow it to conduct non-credit union mortgage insurance business. Arch MI enters the market as a government-sponsored enterprise-approved mortgage insurer with the infrastructure to begin operations immediately.

As part of the transaction, CUNA has entered into a distribution agreement with Arch MI to exclusively manage the distribution of mortgage insurance to credit unions. The CMG MI sales team will remain CUNA Mutual employees dedicated to serving their credit union customers.

RMBS

Court excludes Countrywide mod claims

While the US$8.5bn rep and warranty settlement between Bank of America and Bank of New York on 530 Countrywide shelf trusts has been approved by Justice Barbara Kapnick, releases on certain modification related claims have been excluded as Bank of New York was found to have acted unreasonably in its role as trustee. The ruling could delay cashflow payments to bondholders.

Because the full releases provided for in the proposed settlement have not been fully accepted by the court, the parties may now need to come to a written agreement accepting the order. Alternatively, Bank of America may view this as a minor issue and continue with the settlement regardless, since it provides broad relief from rep and warranty and servicing liabilities.

As well as the possible requirement of a written agreement, other issues may cause delays. The judgement may be appealed and the trustee will also need tax approvals to be able to pass the cashflow on through the REMIC structure without tax implications for investors.

Barclays Capital RMBS analysts believe it is possible that final approvals may be available by 2Q14. The cash has to be paid out within 90 days of final approvals, so investors could receive the cash in the second half of this year, although delays in the process could push that back to late 2014 or 2015.

Some investors have claimed that many of the PSAs require Countrywide to repurchase loan modifications made in lieu of refinancing and a smaller subset require it to repurchase modes regardless of the reason. The court also found that the trustee had not considered these distinctions when settling the claims, which is why they have been excluded from the settlement.

If Bank of America is required to buy back all the modified loans on certain deals and some on the CWL shelf deals, it could have a significant effect. Bank of America may agree to increase the payout on deals that were most affected by this PSA language or it may fight mod claims separately, possibly even delaying the whole settlement to reduce potential payouts.

ABS

Strong fundamentals seen in equipment ABS

Lessons learned from the last two broader economic recessions leave US equipment ABS well-positioned to weather future economic downturns, Fitch says. This is in stark contrast to the elevated delinquency and loss levels that small-ticket equipment ABS suffered during the 2000/2001 recession.

Fitch's analysis shows that equipment ABS weathered the most recent downturn reasonably well. Part of the reason for this discrepancy lies primarily in the different issuer compositions seen within small-ticket equipment ABS during both recessions.

"The small-ticket equipment ABS market of the late-1990s was dominated by independent thinly-capitalised originators, while fierce competition led to aggressive underwriting at the expense of portfolio quality," comments Fitch director Peter Manofsky. "Flash forward to the great recession and the equipment ABS market consisted of a smaller number of established better-capitalised finance companies, along with improved underwriting - which is in large part why the structures fared better."

Delinquencies and losses remain low for both small-ticket and heavy metal equipment ABS. However, Fitch does expect these levels to normalise and rise modestly in 2014, while rating performance is expected to be stable to positive.

The potential emergence of new originators in the equipment ABS space may add some degree of uncertainty, specifically in relation to those that may have not benefited from the lessons learned through the prior two recessions. Nonetheless, Fitch believes that the fundamentals of equipment ABS remain strong.

ABS

Aircastle redemption offers upside

In a move that surprised the market, Aircastle is set to prepay the senior notes of the ACST 2006-1 aircraft ABS on 18 February. The ACST 2007-1 G1 securities rallied as a result, rising from the low- to mid-90s to the mid- to high-90s.

The deal was callable at any time by the issuer. Since it had not been refinanced by its expected maturity date of 15 June 2011, all excess cashflows are being used to pay down principal on the senior notes, rather than being paid to Aircastle as the residual owner in the deal. Together with easing conditions in the aircraft financing market, ABS analysts at Barclays Capital believe that this may have driven the sponsor to redeem the bonds at this time.

The ACST 2006-1 class A tranche has a total current balance of US$220m, down from US$560m at issuance. The assumed portfolio value of the remaining 27 aircraft stands at approximately US$529m last month.

All excess cashflows are additionally being used to pay down the senior notes of ACST 2007-1, rather than being paid to Aircastle, since that deal is now also past its expected maturity date of 8 June 2012. The class A notes have a current face amount of US$590m, down from US$1.17bn at issuance, and are backed by 41 aircraft. As such, the Barcap analysts suggest that it may be more difficult for the sponsor to find an alternative financing source for this transaction, so it may choose to wait for the deal to amortise further before refinancing the notes.

"We maintain our overweight recommendation on legacy aircraft ABS issued in 2005-2007, given their short durations and reasonably attractive yields. While a refinance of some of these securities would certainly be an upside scenario for investors, even absent a redemption, we continue to believe that these deals represent good value for investors willing to incur some liquidity risk," they observe.

ABS

Captive autos outperform in Europe

European captive auto loan ABS collateral strongly outperforms non-captive collateral, according to DBRS. Four years after origination, average captive auto ABS arrears over 60 days are at 1%, compared to 5.6% for non-captive transactions.

The difference in performance is due to factors such as region, vintage, loan seasoning, underwriting and structure. Captive issuers also have a strong advantage at the point of sale as they can pick and choose the better quality borrowers through vehicle-related incentives and subvented finance, typically resulting in higher-quality borrowers.

Region plays a significant role in performance, with German auto ABS delinquencies over 60 days averaging only 0.5% after four years. Transactions from France, Italy and the UK have also performed strongly, while Portugal and Spain are the largest underperformers at 6.4% and 8.6% after four years.

The difference between captive and non-captive performance is clearly seen in Spain. Captive autos register only 2.4% of 60-plus day delinquencies after three years, versus 6.7% for non-captive autos.

Conversely, captive transactions in the UK and Germany have actually underperformed non-captives. In the latter jurisdiction, captive 60-plus day delinquencies are 0.5% but for non-captives the average is just 0.1%.

DBRS notes that transaction quality has improved since the beginning of the financial crisis. In the three years after the crisis, 60-plus day delinquencies remained below 2% on average. By contrast, pre-crisis transactions contained 60-plus day delinquencies at over 2% for six vintages, with particularly high delinquency rates in 2000 and 2007 transactions.

Performance among auto manufacturers is strong for BMW and Renault, with the latter maintaining the lowest level of 60-plus day delinquencies after three years due to long revolving periods in its transactions. GMAC and PSA both perform well for the first two years, after which changing composition causes a deterioration in performance.

Structured Finance

Reg AB vote postponed

The US SEC has decided to delay the vote on Regulation AB 2, which had been planned for tomorrow's open meeting (SCI 31 January). It is expected to be a temporary postponement and a separate notice will be issued when the item is rescheduled for Commission consideration.

Separately, 13 senators have sent the SEC a letter in connection with purported conflicts of interest in the credit ratings industry. The letter asks the Commission to respond by end of this week to a number of questions regarding its plans to determine whether reforms are necessary for ABS ratings.

Structured Finance

Sukuk industry poised for growth

Long-term prospects for the sukuk industry remain promising, according to S&P. The agency notes that regulators continue to build and strengthen their frameworks to minimise barriers in the market and deepen liquidity.

"After a slowdown in 2013, with sukuk volumes declining by 13%, we anticipate that the sukuk industry will expand again in 2014 - partly driven by corporate and infrastructure issuers in the Gulf," comments S&P credit analyst Samira Mensah. "What's more, total issuance will exceed US$100bn for the third year in a row if yields remain attractive for issuers. And, after weakening in 2013, we believe issuance could pick up again in Malaysia in 2014 as its investment programme resumes."

The agency notes that Malaysia already benefits from a broad sukuk investor base and liquid debt market, so the increased interest from issuers - notably in the Middle East and Asia - in tapping the Malaysian ringgit and US dollar market should continue over the next few years as the country cements its leading position in the industry. Indeed, now that Malaysia is adopting private sector investment, S&P believes that non-sovereign issuance could accelerate in 2014-2015, continuing the trend witnessed in 2013 at a global level.

Overall, the agency anticipates double-digit growth in issuance by Gulf corporate and infrastructure entities, due in part to large infrastructure financing needs. Sovereign sukuk could also slowly emerge as an alternative to fund growth in African countries. However, S&P believes that a regulatory push is necessary to strengthen frameworks, lower barriers to entry and deepen liquidity in the sukuk markets.

Structured Finance

South African SF to remain 'resilient'

Fitch predicts that the performance of assets backing South African structured finance will be resilient in 2014 amid a stalling domestic economy. The agency consequently expects the South African structured finance transactions it rates to perform within base-case assumptions.

Borrowers continue to benefit from a low interest rate environment, which has helped offset lacklustre growth in the country and aid debt serviceability across asset classes. While the recent interest rate increase of 50bp by the South African Reserve Bank was earlier than expected, Fitch believes that only substantial increases in the interest rate would have a meaningful impact on the performance of structured finance transactions. Any material additional tightening of monetary policy, as a result of continued steep depreciation of the rand and inflationary pressures, may change the stable outlook for the sector.

The agency notes that the unsecured lending market has grown substantially since 2010, peaking in 2Q13. However, the proportion of accounts classified as current fell to 62.4% in 3Q13 from 71.1% in 3Q12. Although Fitch does not rate any South African unsecured lending transactions, it expects asset performance to be stable to negative in light of regulatory pressure and the deteriorating macroeconomic environment.

The South African government could introduce a credit amnesty (SCI 18 October 2013), which would clear certain negative credit records held with the bureaus, but Fitch believes this could bring uncertainty to both secured and unsecured lending. Unsecured lenders are more likely to be affected by the move, given their reliance on credit bureau information and lack of internal records for new customers. Fitch expects a limited impact on the transactions it rates as loans were underwritten based on fuller credit histories and originated with larger institutions with access to internal historical data.

Structured Finance

EU prop trading rules proposed

The European Commission has proposed rules to prevent large banks from engaging in proprietary trading. The rules would also give supervisors the power to require those banks to separate certain potentially risky trading activities from their deposit-taking business if the pursuit of such activities compromises financial stability. Alongside this proposal, the Commission has adopted accompanying measures aimed at increasing the transparency of certain transactions in the shadow banking sector.

The proposal will apply only to the largest and most complex EU banks with significant trading activities. It will ban proprietary trading in financial instruments and commodities, as well as grant supervisors the power to require the transfer of other high-risk trading activities - such as market-making, complex derivatives and securitisation operations - to separate legal trading entities within the group (so-called subsidiarisation). It will be possible for banks to not separate activities if they can show to the satisfaction of their supervisor that the risks generated are mitigated by other means.

To prevent banks from attempting to circumvent these rules by shifting parts of their activities to the less-regulated shadow banking sector, structural separation measures should be accompanied by provisions improving the transparency of shadow banking. The accompanying transparency proposal therefore provides a set of measures aiming to enhance regulators' and investors' understanding of securities financing transactions.

Structured Finance

Reg AB 2 vote scheduled

The US SEC is to hold an open meeting on 5 February to discuss, among other topics, Regulation AB 2. Specifically, the Commission will consider whether to adopt rules revising the disclosure, reporting and offering process for ABS.

The revisions would require asset-backed issuers to provide enhanced disclosures, including information for certain asset classes about each asset in the underlying pool in a standardised, tagged format. The shelf offering process and eligibility criteria for ABS would also be revised.

Structured Finance

Underwriting standards slipping

The OCC's latest annual survey of credit underwriting suggests that underwriting standards in the US continue to ease, with easing noted within both commercial and retail products. The move comes as banks continue to adapt to changing economic conditions and competition.

OCC examiners noted easing underwriting standards and increasing loan volume, with banks' increasing risk appetite and greater market liquidity cited as factors that contributed to easing standards. Large banks, as a group, reported the highest share of eased underwriting standards.

Loan portfolios that experienced the most underwriting easing include indirect consumer, credit cards, asset-based lending and leveraged loans, according to the survey. Loan portfolios that experienced the most underwriting tightening included high loan-to-value home equity and conventional home equity.

"This year's survey showed a progression toward easing underwriting standards as the economic environment stabilises," comments John Lyons, senior deputy comptroller and chief national bank examiner. "As banks ease standards to improve margins and compete for limited loan demand, examiners will continue to monitor underwriting standards to ensure they are prudent and are applied consistently, regardless of whether loans are underwritten to hold or distribute."

The survey includes 86 of the largest national banks and federal savings associations and covers the 18-month period ending 30 June 2013. The survey covered loans totalling US$4.5trn, representing approximately 87% of total loans in the national bank and federal savings association system.

Structured Finance

Positive outlook for LatAm securitisation

Prospects for the Latin American structured finance markets in 2014 are good, according to S&P. In particular, the agency expects demand among Mexican issuers and Brazilian investors to create new opportunities for dynamic securitisation structures.

A rebounding Mexican economy is likely to increase funding needs for local issuers, while an anticipated slowdown in the Brazilian economy may spur investor demand for secured transactions. Additionally, a stronger Brazilian regulatory framework should encourage new issuance in the Fundo de Investimento em Direitos Creditórios market (SCI 25 July 2013).

S&P reports that Brazil led issuance volumes across the region last year, followed by Mexico and Argentina. As in past years, the relative cost of securitisation versus using senior unsecured debt will continue to be a focal point for issuers and investors, given the current low interest rate environment. Diversification will also play a role, as global investors seek to complement their portfolios with familiar products from new frontier markets.

Latin American securitisation issuance is anticipated to remain predominantly domestic, as local capital markets become more dynamic and provide ample and cost-effective funding for domestic entities. At the same time, S&P expects new and unique asset classes to proliferate across the region.

Recent landmark energy reform coupled with changes to the fiscal framework should support the Mexican government's infrastructure spending programme, thereby driving GDP growth in 2014. This could encourage a more vibrant structured finance market, given the increased funding needs by companies and originators after an already-strong 4Q13.

S&P believes that new transactions in the country could grow by 10%-20% this year, while volume may increase at a slightly slower pace as new and smaller originators enter the market. Together with RMBS, the agency anticipates that issuance in Mexico will comprise ABS (auto, equipment lease and commercial trade receivables), new private sector consumer finance deals (unsecured payroll-deductible loans and micro-lending ABS) and commercial future flow securitisations.

Amid a scenario of weakened GDP growth and more economic uncertainty in Brazil, meanwhile, domestic fixed income investors may turn towards structured financings that offer a combination of greater security than senior unsecured issuances and higher returns. S&P forecasts issuance growth of 15%-25% for the country.

On the credit quality side for consumer debt, the agency expects to see three developments under its base-case scenario: residential mortgages will keep gaining popularity, gradually leading to the emergence of an RMBS market in Brazil; origination of payroll-deductible loans will continue migrating to large banks and, consequently, their securitisation will be solely opportunistic and limited; and younger vintages of auto loans will perform better given new origination standards, which should encourage higher levels of securitisation issuance. For commercial obligations, including the corporate middle market, the agency expects the exit of some players - such as Banco Rural and Banco BVA - and the risk aversion of remaining market participants to stimulate CLO issuance.

Under such arrangements, securitisation vehicles could be a source of funding to non-investment grade corporations, replacing banks that want to reduce their exposure. Additionally, the reluctance from banks to lend to the middle market sector could force corporations to leverage their trade receivables portfolios, increasing issuance volumes of new FIDCs backed by such assets.

The Argentine securitisation market will remain primarily local in 2014, with ABS leading new issuance. Transactions are likely to be predominantly backed by consumer loans originated by white good retailers and personal loans originated by financial institutions and cooperatives.

Credit card receivables from regional credit card companies are the third major securitised asset in the country and they will slowly start to gain market participation in 2014. Also, S&P is expecting an increase in trade receivables issuance during the first quarter, thanks to agriculture-related companies that require funding.

Continued economic success of the Andean region should also lend itself to increased securitisation activity in Colombia, Peru and Chile as consumer lending takes further hold. For example, an increase in private consumption will likely further stimulate the Peruvian consumer credit markets and encourage the emergence of ABS products to complement the existing RMBS infrastructure. S&P predicts positive transaction performance through 2014, allowing banks to opportunistically leverage their existing structured finance programmes.

In 2013, new issuance in Columbia decreased to just one RMBS for approximately US$222m, as opposed to a yearly average of four transactions. This decline was related to the Colombian federal government ending tax incentives on these types of deals. The relatively high cost of securitisations will continue to be a challenge for the Colombian market because banks have not yet found it to be cost-effective.

Last year marked a comeback to the cross-border market for Chilean securitisations, with the LATAM airline ticket receivables transaction. More cross-border ABS transactions are anticipated to be issued out of Chile in 2014.

After more than two years since the last placement, a new RMBS transaction was placed in the local Panamanian market in 2013 for US$45m, with the underlying collateral comprising residential mortgage loans in El Salvador. Finally, continued strong performance among existing Guatemalan and Costa Rican future flow programmes will continue to attract investors to new transactions.

CDS

Sovereign CDS liquidity analysed

ISDA has published a research note examining the liquidity impact of the implementation of the EU short selling ban on sovereign CDS (SCI 21 November 2012). The report finds that liquidity has declined not only in the iTraxx SovX Western Europe index, but also in the iTraxx Europe Senior Financials index during the post-regulation period.

In order to establish a permitted sovereign CDS position under the rules, investors must hold offsetting risk, such as the underlying sovereign bond or other exposures correlated to sovereign debt. This change raised concerns about the impact on portfolio hedging, the potential for a reduction in sovereign CDS liquidity and the implications of a reduction in the ECB's bond-buying programme.

The ISDA report reveals that the liquidity of the iTraxx SovX Western Europe index has substantially diminished in the period following the announcement of the political agreement on the sovereign CDS ban and, more acutely, when the regulation became effective. Average weekly volumes and trade counts of iTraxx SovX Western Europe index constituent single-name CDS have also declined in nearly all cases, with the largest declines observed in the most liquid sovereigns.

Several other EU-regulated single-name sovereign CDS have also declined in terms of average weekly volume and trade count during one or both periods under study. Concurrently, nearly all non-EU single-name sovereign CDS showed increases in both average weekly volume and trade count during the post-regulation period.

In addition, declines in average weekly volume and trade count have been observed in the iTraxx Europe Senior Financials index during the post-regulation period, supporting the IMF's concern about a possible loss of interest in EU-regulated credit (SCI 12 April 2013). Finally, since the regulation became effective, ISDA has observed a breakdown of the average correlation between proxy hedges - such as the iTraxx Europe Senior Financials index and EU-regulated single-name sovereign CDS - from 89% to 37%.

CDS

CDS definitions delayed

The launch of the 2014 ISDA Credit Derivatives Definitions has been delayed until the September CDS index roll date. An implementing protocol for the documentation had previously been anticipated to be introduced ahead of a proposed 20 March deadline (SCI passim).

ISDA says its credit steering committee (CSC) has worked with infrastructure providers and clearinghouses over the past three months to develop an appropriate implementation schedule for the new Definitions, including an assessment of the various changes to existing infrastructure that are necessary to support the change. This working group determined that a longer timeframe would enable market participants and infrastructure providers to make the necessary operational and infrastructure changes and to allow a smooth adoption of the documentation with minimal impact on markets.

The final Definitions are nevertheless expected to be published soon.

CLOs

CLOs shown to be 'robust'

S&P says it has rated more than 1,100 US cashflow CLOs with an aggregate note balance of more than US$645bn since the mid-1990s. At year-end 2013, 705 of these CLOs remain outstanding, with an aggregate note balance of approximately US$293bn.

The majority of the remainder have been paid in full and had their rating withdrawn. Only 25 tranches have defaulted and had their rating lowered to D as a result.

"The data show that very few of the rated CLO 1.0 tranches have defaulted, despite these CLOs weathering through one and in some cases two recessions," comments S&P credit analyst Daniel Hu. "We believe a clearer picture emerges from this data, presenting CLOs as a robust platform that has been able to withstand significant levels of economic stress."

In 2013, 161 S&P-rated US CLO transactions closed, totalling US$78.8bn in notes, compared with 112 deals totalling US$53.3bn in 2012. By volume, 2013 saw the third-largest amount of new issuances the agency has rated in a single year following 2006 and 2007, which saw US$94.9bn and US$101.1bn respectively.

CLO 1.0 transactions saw significant upgrades during 2013 and few downgrades, while CLO 2.0 transactions continued to show stable rating performance and had few upgrades and no downgrades.

CMBS

Share of specially serviced loans down

The improving economy has driven a drop in delinquency rates and a decrease in the share of loans in special servicing, according to Moody's Q413 US CMBS and CRE CDO surveillance review. The agency's base expected loss for conduit/fusion transactions fell to 8.95% in the fourth quarter from 9.01% the previous quarter. Its Commercial Mortgage Metrics (CMM) weighted average base expected loss also fell to 6.8% from 7.7% in the previous quarter.

"Our CMM base expected loss corresponds to delinquency rates and the share of loans in special servicing," says Michael Gerdes, md and head of US CMBS & CRE CDO surveillance at Moody's. "The drop reflects the improving prospects for GDP growth in the US and a declining unemployment rate."

Improving market fundamentals also resulted in a faster pay-down rate for non-performing loan (NPL) securitisations than Moody's had anticipated. "Better real estate market conditions, wider availability of capital at low interest rates and greater investor interest in commercial real estate contributed to the rapid pay-off rate," adds Gerdes.

Given the recovering real estate markets, the agency expects the share of specially serviced (SS) loans to continue decreasing and servicers to instead ramp up their use of resolutions. The overall share of SS conduit loans fell by 65bp to 8.9% in 4Q13 from 9.5% in Q3, the fifth consecutive quarterly decline. The share of SS loans has contracted by 384bp from the April 2011 peak of 12.7%.

Loan modifications continued for borrowers, with 64 loans modified, amounting to US$1.5bn during the period. Monthly volume averaged 21 loans and US$510.1m. Loan extensions and principal write-offs were the most widely used modification strategies, according to Gerdes.

Positive trends boosted performance in all commercial real estate (CRE) sectors during the quarter. Looking ahead, an increase in construction is not expected to affect performance in the multifamily sector, while the hotel sector will continue to improve, albeit at a slower pace.

"The office and retail sectors will not absorb excess supply until after 2014, which will delay their recovery," cautions Gerdes. "Also, US metro areas will recover at different rates, with central business district markets recovering before suburban markets."

CMBS

CRE borrowers surveyed

The CRE Finance Council (CREFC), in collaboration with FPL Associates, has conducted a survey of commercial real estate borrowers to better understand their decision drivers in choosing a lender. The survey results also reveal borrower sentiment regarding lender competitiveness.

Among the key take-aways from the survey is that 43% of respondents expect to target commercial banks for funding in 2014 - a margin of 2:1 over other lenders - with 46% likely to increase their borrowing volume for new financings, compared to 21% of respondents indicating a decrease. Only 30% of respondents will increase refinancing volume, while 35% will decrease it.

Regarding 2013 work-out and/or special servicing events, CMBS followed by commercial banks saw the highest percentage of activity, with 31% and 24% of respondents having experienced some type of event. Two-thirds of respondents had a positive experience with commercial banks; conversely, two-thirds of respondents had a negative experience with CMBS.

88% of respondents had either a neutral or positive experience with life insurance companies. Private capital tied GSEs with 77% neutral or positive experiences.

The survey also highlighted that the most important factors in borrowing decisions are loan terms, certainty of execution, and rates and fees, followed closely by loan proceeds. Commercial banks and life companies were said to be the most competitive lending sources overall, except with respect to loan proceeds. CMBS is the most competitive lending source on proceeds, however.

Respondents overwhelmingly believe that lenders across the board are becoming more competitive.

With respect to overall satisfaction with loan experiences, commercial banks and life insurance companies shared the top score, followed by GSEs, private capital and CMBS. CMBS lagged all other lender types in post-closing experience satisfaction.

Lenders covered by the survey include banks, life insurance companies, CMBS, GSEs and private lenders. Nearly 100 respondents representing a wide range of owner/borrower types and diversified portfolios participated.

CMBS

Majority of non-defaulted loans to refinance

An estimated 86% of the US$16.4bn in Fitch-rated non-defaulted commercial mortgage loans with maturities in 2014 is expected to be able to refinance. Assuming a current market mortgage rate of 5% and a 30-year amortisation schedule, loans that have a debt service coverage ratio of at least 1.25x should be able to refinance.

Approximately US$15.4bn of the maturing loans have reported year-end 2013 financials. The weighted average coupon for these loans is relatively high at 5.65%, which should make refinancing easier if current market rates stay between 5% and 5.25%.

Of the maturing loans with reported financials, the majority had balances that were US$30m or less (accounting for a total of US$9bn), with 45 loans greater than US$50m (ranging between US$50m and US$555m) accounting for US$4.6bn.

The amount of performing loans with reported financials that have upcoming maturities by quarter is: US$2.2bn (representing 14% of the total performing loans with reported financials Q1); US$3.6bn (24%) in Q2; US$4.bn (31%) in Q3; and US$4.8bn (31%) in Q4. Loans maturing in 2014 by property type are: retail (US$5.8bn or 37%); office US$4.8bn or 31%); multifamily (US$1.7bn or 11%); hotel (US$1bn or 7%); industrial (US$884m or 6%); and other (US$1.2bn or 8%).

The largest loan by balance with a 2014 maturity is the Sawgrass Mills, with US$1.2bn of the US$1.5bn outstanding senior debt securitised in Fitch-rated CMBS (including JPMCC 2007-LDP12, JPMCC 2007-CIBC20, BACM 2007-4 and BACM 2007-5). The loan was scheduled to mature in July 2014, but paid off in January (see SCI's CMBS loan events database).

The second largest loan maturing in 2014 is the Arundel Mills, with US$308m of the US$369m outstanding senior debt in Fitch-rated securitisations (including BACM 2007-4, BACM 2007-5 and MLMT 2008-C1). The asset was scheduled to mature in August 2014, but was also refinanced in January and should be reflected in the February remittance data.

Another large loan with a 2014 maturity that has already paid off is Pacific Place, representing US$75m of outstanding senior debt and US$23m of subordinated debt securitised in GECMC 2004-C2. The loan was scheduled to mature in March 2014 and was paid off in January 2014.

The next wave of loan maturities is scheduled between 2015 and 2017, with US$188bn set to mature.

CMBS

Loss severity pushes up

US CMBS liquidation volume remained steady in January at US$1.28bn, but several large losses pushed the average loss severity up significantly, according to Trepp. Of the loans that were liquidated, 94% fell into the greater than 2% loss severity category.

Overall January loss severity came in at 58.51%, up from December's 50.36% and more than 10 percentage points higher than the 12-month moving average of 46.82%. The number of loans liquidated during the month was 79, resulting in US$746.85m of losses. The average disposed balance last month stood at US$16.16m - well above the 12-month average of US$12.56m.

Since January 2010, servicers have been liquidating at an average rate of US$1.18bn per month.

CMBS

Starwood bid surprises to the upside

Starwood Capital has confirmed its successful bid for a pool of REO assets in the CWCapital Asset Management CMBS auction (SCI 16 January). The pool - which was acquired for US$191m - comprises seven office assets (representing 1.3 million square-feet) and four retail assets (representing 295,000 square-feet), with a cumulative unpaid principal balance of US$310.3m.

A Morgan Stanley analysis implies a 50.4% loss severity on the loans after considering ASERs, P&I advances and T&I advances. "We believe this is a better-than-expected scenario," CMBS strategists at the bank note. "This compares to an ARA-implied severity of approximately 60%. Additionally, the purchase price was 26% higher than the most recent appraisal value implies."

The portfolio includes the 3800 Chapman, 500 Orange Tower, Arrowhead Creekside, Avion Lakeside, East Thunderbird Square North, Greenfield Gateway, Howe Corporate Center, Lincoln Ridge Retail, Plaza Squaw Peak, Shoppes at Home Depot and Southcreek Corporate Center II properties. These loans are securitised in GSMS 2007-GG10 (with a US$185m exposure), MLCFC 2007-5 (US$106m), WBCMT 2006-C28 (US$22m) and BACM 2007-1 (US$5.5m).

"We are pleased to be acquiring an income-generating portfolio of REO assets located in markets with attractive fundamentals," comments Mark Keatley, svp at Starwood Capital. "We intend to sell several assets in the near term and deploy our in-house REO/work-out team and operating platforms to create value on the remainder of the pool."

CMBS

Eighth straight drop for CMBS delinquencies

The Trepp US CMBS delinquency rate decreased by 18bp to 7.25% in January, marking the eighth straight month of improvement. The decrease can be attributed to the almost US$1.3bn in previously delinquent loans that were resolved with losses over the course of the month.

By removing these delinquent loans from the numerator, the rate saw 24bp of improvement. Loans that cured totalled almost US$1bn in January, which resulted in 18bp of additional downward pressure on the delinquent loan percentage.

Previously delinquent loans that were resolved without losses totalled US$163m in January, pushing the delinquency rate lower by another 3bp. However, new delinquencies totalled about US$1.8bn, pushing the rate up by 32bp. Finally, almost US$1.3bn in loans were defeased last month.

Insurance-linked securities

State-sponsored cat bonds proliferate

Fitch expects continued growth in catastrophe bonds from state- and government-sponsored insurance organisations this year. The agency reports that investor demand remains considerable, while the cost of sponsoring a cat bond has continued to converge with the cost of ceding risk to the traditional reinsurance markets.

The cat bond market has seen a significant influx of deals from repeat sponsors, such as Citizens Property Insurance Corp, Louisiana Citizens and the North Carolina JUA/IUA, over the past five years. Continued growth is expected to remain for these types of sponsors in the US, as well as internationally.

Well-structured cat bond deals are becoming a practical solution in the higher risk portions of sponsor reinsurance programmes, which is expected to drive further issuance in 2014. Continued US growth is expected to come from repeat sponsors looking to expand their use of the capital markets, as well as from international organisations presented with increasingly innovative and viable risk transfer alternatives. The availability of potential sponsors in the US will be moderated by the limited number of state wind pools and other publicly-sponsored catastrophe insurance organisations now operating, however.

Three outstanding catastrophe bonds totalling US$1.1bn are set to mature this year, anchored by the single largest catastrophe bond in history - a US$750m issue sponsored by FL Citizens (Everglades Re). Investor demand for higher yielding property catastrophe risk below the top layer of the sponsor's reinsurance programmes has remained strong, illustrated by the subsequent issue sponsored by FL Citizens in 2013 (Everglades Re series 2013) that attaches ahead of the previous deal.

Fitch notes that US$5bn of state/government-sponsored catastrophe bonds have been issued since 2001, with approximately 64% of those issued over the past two years. About US$1.5 billion of the bonds were issued in 2013, tripling the level of annual issuance that was experienced as recently as in 2011.

The majority of outstanding bonds are focused on US hurricane and earthquake risk, as these perils have been the most thoroughly modelled and widely-understood to date. State and government sponsors have predominately gravitated towards utilising indemnity triggers, as they limit basis risk with pay-outs that correspond with actual loss experience.

Almost three-quarters (70%) of the US$3.7bn of outstanding issuances by state/government sponsors utilise an indemnity trigger, according to Fitch. Over the last two years, the only deals that utilised parametric or modelled loss triggers were unique risks for the market with less historical modelling experience. They include Bosphorus 1 Re (Turkish earthquake), Multicat Re (Mexico earthquake/hurricane), MetroCat Re (storm surge) and Golden State Re (workers compensation).

The North Carolina JUA/IUA has tapped to the cat bond market four times, more than any other sponsor of this type. The organisation's most recent foray was Tar Heel Re, which was significantly oversubscribed, doubling in size during the marketing phase to complete at US$500m.

The US$400m Bosphorus 1 Re, sponsored by the Turkish Catastrophe Insurance Pool, was a significant step for the international market. It is the second outstanding publicly-sponsored non-US catastrophe bond, following the MultiCat Mexico series sponsored by the Fund for Natural Disasters in Mexico.

Risk Management

LEI recommendation issued

The European Banking Authority has published a recommendation on the use of unique identification codes for supervisory purposes for every credit and financial institution in the EU. The recommendation aims to harmonise the identification of legal entities, in line with proposals by the Financial Stability Board (FSB), to ensure consistent and comparable data.

The EBA last year finalised implementing technical standards (ITS) on supervisory reporting, designed to ensure uniform reporting requirements across all EU Member States in a number of areas as of July 2014. In this process, the EBA recommends that all competent authorities use a single supranational identifier for each credit and financial institution.

The recommendation supports the adoption of a global legal entity identification system (GLEIS) proposed by the FSB and endorsed by the G20, which aims to deliver unique identification of parties to financial transactions across the world. Given that the GLEIS is not yet fully operational, the EBA considers that the use of a pre-legal entity identifier by competent authorities is the best short-term solution. Competent authorities must notify the EBA as to whether they comply or intend to comply by 29 March.

Risk Management

Agencies urged to revisit LCR

The Clearing House Association, the American Bankers Association (ABA), SIFMA, the Financial Services Roundtable (FSR), the Institute of International Bankers (IIB), SFIG and the International Association of Credit Portfolio Managers have filed a comment letter with the OCC, the Federal and the FDIC on the proposed rules regarding the liquidity coverage ratio (LCR). The associations are concerned that certain aspects of the US agencies' proposal diverge from the standards established by the Basel Committee in ways that generally are not warranted and consequently encourage them to revisit the proposal to improve the accuracy and suitability of the LCR as a measure of actual liquidity risk.

The associations note that a divergence from the Basel LCR could impact market liquidity, as well as firms with cross-border operations. Hence they support an internationally consistent LCR and are seeking more flexibility in what can be held in liquidity pools to buffer the effects of the US proposed rule. Only under unique circumstances should the US diverge from the Basel LCR and impose a shorter implementation schedule, according to the letter.

Further, the associations state that the effects of divergence could be exacerbated due to new regulations on capital, leverage and other prudential standards, as well as by the implementation of the wide-spread reforms in the Dodd-Frank Act.

Risk Management

Reporting interface extended

Calypso Technology has released an interface to the DTCC's Global Trade Repository service (GTR) for EMIR reporting in advance of the 12 February deadline for EMIR trade repository reporting for all asset classes. The module is an extension of Calypso's OTC Clearing Solution and builds on its DTCC GTR for Dodd-Frank reporting on OTC derivatives. Key functionalities include intraday reporting of new trades, reporting of lifecycle events and price reporting.

Risk Management

Reporting service supports EMIR

MarkitSERV has begun reporting OTC derivative trades in rates, credit and equities for customers subject to the EMIR ahead of the 12 February compliance date, in order to facilitate the loading of historical trades into a trade repository. Before the first compliance deadline was set by ESMA, MarkitSERV had sent several million trade records to the DTCC Derivatives Repository on behalf of over a hundred firms.

MarkitSERV already provides services for the trade reporting regimes of the: Australian Securities and Investments Commission (ASIC), Hong Kong Monetary Authority (HKMA), Japan Financial Services Agency (JFSA), Monetary Authority of Singapore (MAS), OTC Derivatives Regulators Forum (ODRF) and US CFTC. It offers a complete unique transaction identifier (UTI) service for a range of asset classes across all supported regimes.

RMBS

RMBS tender amended

Fir Tree Partners has amended certain terms of its cash tender offer for six RMBS that are subject to the proposed US$4.5bn JPMorgan settlement (SCI 23 January). Importantly, the offer now includes on a trust-by-trust basis a minimum aggregate principal balance of securities required to be tendered. The right to extend the withdrawal deadline, the expiration date or the settlement date or to terminate the offer was also amended to allow the offeror to exercise any such right on a trust-by-trust or tranche-by-tranche basis, as opposed to in whole but not in part.

RMBS

RFC issued on Aussie set-off risk

Moody's has requested comment on the approach it is proposing in assessing set-off risk in relation to bank deposits for securitisations and covered bond transactions in Australia. The proposal follows further legal advice that obligors can set off deposits against securitised debt, provided that the deposits were in existence at the time notice of assignment was given.

If the proposed methodology is adopted and based on the agency's preliminary analysis, it expects limited rating actions on Australian RMBS. However, it will be seeking deposit data from originators in order to provide a better assessment of the rating impact.

Moody's approach assumes that if an originator defaults, each obligor with deposits over A$250,000 will set off the excess amount against its securitised debt because the Financial Claims Scheme (FCS) guarantees deposits of up to A$250,000 per person. Consequently, obligors will not assert set-off in respect of deposits for which they have received (or will receive) a compensation payment.

In determining the set-off exposure for each transaction, Moody's gives value to the FCS according to the available data on obligor deposit amounts. If the originator covenants to indemnify the issuer for losses resulting from set-off, the agency will generally assume that the issuer's loss will be reduced by any recoveries it receives from the insolvent originator.

As for whether or not static credit enhancements for set-off risks are adequately sized, Moody's will generally assume that: the amount of deposits will increase over time; and there will be deposit flight, such that depositors will withdraw monies from current accounts or transfer monies to overseas accounts or accounts with another bank of 15% of the increased deposit in the period leading up to originator or sovereign default. Where credit enhancement for set-off is not funded at closing and the trigger is set at a loss of A3 or above, the agency assumes that the enhancement will be duly provided. If the trigger is set lower than this, it may give limited or no value to the enhancement.

RMBS

Further ESAIL restructuring underway

Noteholders of another UK RMBS - ESAIL 2007-PR1 - have directed the trustee to execute the sale if remaining Lehman claims via an auction. The auction was completed on 28 January and the issuer agreed to transfer all of its rights related to the remaining claims for US$22.68m. Acenden has been appointed for the purpose of managing the rating agencies, performing certain calculations and drawing up accounts of the issuer as required in relation with the restructuring proposals.

RMBS

'Unusual' accounting flagged

A number of US RMBS that were originally serviced by Bank of America but were recently transferred to Nationstar received no principal payment and limited interest payments last month. The accounting of advance recoupment on a number of transactions also appears to be unusual.

The lack of principal payments seems to have resulted from Nationstar's heavy recoupment of P&I advances made by BofA in the past, according to Barclays Capital RMBS analysts. While acquiring servicers typically increase modifications to recoup advances, in this case advances were recouped on a large number of delinquent loans without any modifications as non-recoverable advances.

The accounting of the advance recoupment on the HVMLT 2004-11, 2005-1, 2005-3 and 2005-10, as well as BAFC 2007-B, BOAA 2007-2 and FFMER 2007-H1 deals was also somewhat unusual. The Barcap analysts note that Nationstar appears to have capitalised just the advanced principal while not capitalising the advanced interest amount. Hence the full amount of advances recouped cannot be captured from the loan-level balance capitalisation.

"The recouped interest advances seem to have been directly recovered from the total cashflow collection for the deals," they observe. "In many cases, these were reported with a negative scheduled interest or non-recoverable advances. In most of the affected deals, the total advanced P&I amount on all delinquent loans is likely to be more than the January trust collection."

The affected deals could potentially receive pay-outs that are close to zero in the next several months.

RMBS

Third IABF sale announced

The Dutch State Treasury Agency (DSTA) has launched its third competitive auction for the securities underlying the ING Illiquid Assets Back-up Facility. The auction will be conducted by BlackRock Solutions and comprise US$2.06bn current face across 234 non-agency RMBS.

Eight broker-dealers have been invited exclusively to submit bids for the portfolio based on the strength of their reverse inquiries. They are Bank of America Merrill Lynch, Barclays, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, Nomura and RBS.

Bids are due by 4 February. The decision to allocate will be based on the strength of the final bids.

RMBS

Home prices face headwinds

US home prices are continuing their upward push nationwide, though the trend faces strong headwinds from persistent labour market struggles and depressed median wages, according to Fitch's latest sustainable home price update.

Home price growth is maintaining a near-record pace in much of the western US as supply remains tight, with new home sales limited by low construction rates. Additionally, existing inventory is restricted by both underwater borrowers unable to sell their homes and a large number of properties still mired in extended foreclosure proceedings.

"In markets with short supply, increased demand from institutional investors and individual borrowers returning to recovering markets has created the conditions for the sharp climb in prices," comments Fitch director Stefan Hilts.

Unemployment is now down to its lowest level in five years (6.7%). However, a closer look at this aggregate number shows that much of the improvement is driven by workers dropping out of the labour force.

"Without a strong employment base, it is difficult to find sustainable support for the rapid growth in home prices across much of the country," adds Hilts.

GDP growth is another area where strong numbers may be disguising economic weakness. Last quarter's annualised growth rate of 4.2% marked the strongest numbers in nearly a decade. However, median wages remain depressed as the economic base has declined in many traditional employment sectors, with 4Q13 median household income 8% lower than in 1999 in real terms.

"With median wage levels stagnant, many potential buyers do not have the resources necessary to participate in the home ownership market," Hilts concludes.

RMBS

RFC issued on TBA margining

FINRA is seeking comment on proposed amendments to FINRA Rule 4210 to establish margin requirements for transactions in the To Be Announced (TBA) market. The proposal - which is designed to reflect the growth of the TBA market and to replace current interpretive materials under Rule 4210 that have become outdated - is informed by the set of best practices adopted by the Treasury Market Practices Group (TMPG) of the New York Fed.

Specifically, the proposal aims to reduce counterparty credit risk. It would accomplish this by addressing maintenance and variation (also referred to as mark-to-market) margin requirements, risk limit determinations, concentrated exposures and exemptions for de minimis transfer amounts and for transactions cleared through registered clearing agencies.

The proposal would apply to all TBA, specified pool and ARM trades that settle over more than one business day and all CMO trades that settle over more than three. For transactions with other FINRA members, non-member registered broker-dealers, banks, thrifts, insurers, investment companies, states, pensions and mortgage bankers hedging origination pipelines, the member would have to collect any mark-to-market losses within five business days or liquidate the position. For transactions with other accounts, the member would have to collect maintenance margin equal to 2% of the market value of the securities within five business days or liquidate the position, as well as any variance margin.

Additionally, members would have to set risk limits for every counterparty and report to FINRA/stop any new transactions, if net uncollected margin over five days exceeded 5% of the member's net capital for a single account or group of commonly controlled accounts or 25% of its net capital for all accounts combined. Members would not need to collect margin on trades of US$250,000 or less, although it would affect calculations of member capital.

Comments on the proposed requirements are due by 26 February. FINRA is considering implementing the new requirements within six months.

RMBS

German affordability to remain sustainable

Fitch says that despite rising house prices, mortgage affordability in Germany should remain sustainable, supporting its stable outlook for RMBS transactions. Aggregate debt-to-income (DTI) in the country has been stable over the last few years, with a slight downward tendency.

Affordability reflects rising disposable income, Germany's unemployment being at its lowest level since reunification and historically low interest rates. Fitch projects that house prices will continue to rise in the foreseeable future, due to ongoing strong demand boosted by a flight to tangible assets triggered by concerns about inflation and the euro crisis, as well as the attractive yield-risk profile of buying a property.

The agency's expectation of sustainable affordability is further supported by a recent study conducted by LBS, the building and loan association of the German savings banks. The study determined the average minimum income necessary to obtain a mortgage loan as a percentage of the average income in different regions of Germany. It concludes that in most regions the average income is enough to secure financing of a property purchase.

In some parts of eastern Germany, even incomes below the regional average would be sufficient. Exceptions can be observed in certain large cities (for example, Munich or Frankfurt) and rural districts (Landkreis Starnberg in Bavaria), where above-average income is necessary to obtain a loan.

Continued affordability, together with increased demand for properties as a safe and profitable investment haven, has led to steadily growing mortgage lending. Since 2009, the average yearly increase in new mortgage lending was 7%, according to data of the European Mortgage Federation.

Fitch expects lending volumes to continue increasing at a similar pace as observed in the previous years. However, given the limited property supply and the fairly low propensity to home ownership in Germany, lending is not anticipated to overheat.

RMBS

Fed further reduces purchases

The New York Fed is set to reduce its asset purchases next month by a further US$10bn, evenly split between agency MBS and Treasuries (SCI 19 December 2013). The bank now plans to buy US$30bn of agency MBS and US$35bn of Treasuries per month.

The Fed will maintain its existing policies of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and of rolling over maturing Treasury securities at auction. The bank says its sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative.

Purchases of agency MBS will continue to be concentrated in newly-issued agency MBS in the TBA market and purchases of longer-term Treasury securities will continue to be distributed using the existing set of sectors and approximate weights. These purchase distributions could change if market conditions warrant.