Contents

Structured Finance

Supply squeeze

Spread compression to drive non-core issuance

A supply squeeze in European ABS is driving spread compression across asset classes and between senior and junior tranches. Against this backdrop, non-senior and non-core issuance is expected to pick up.

Rob Ford, ABS portfolio manager at TwentyFour Asset Management, questions whether there is room for European ABS spreads to move any tighter at the top end of the market. "Even with spreads at their current levels, large US bank chief investment office investors aren't currently in the market. So it will be a struggle to find enough additional significant demand that will drag spreads tighter."

He adds that there is a floor at the bottom end of the spread range, with credit improving across the board. "Spreads on any assets that have any yield left are compressing - whether it be between different sectors or across the capital structure. Many investors will eventually move on from these assets to find other yieldier investments."

As more investors compete for assets, accounts that were previously only comfortable with prime RMBS, for example, are now looking at buy-to-let and the top end of non-conforming transactions. Similarly, those that previously invested in senior BTL bonds are now looking at mezzanine/junior non-conforming tranches.

Asset class compression was particularly notable last year across senior Spanish and Irish RMBS and CMBS bonds, which appear to have settled at around four times the level of UK prime RMBS seniors, according to JPMorgan estimates. UK non-conforming seniors maintained their 2.25 times relationship with prime RMBS seniors over the course of the year.

"It seems perfectly feasible that the 'gap' between the more distressed asset classes - Spanish RMBS, Irish RMBS, CMBS - and the benchmark asset classes continues to narrow as accounts searching for yield continue to focus on the more 'exotic' asset segments. Spanish risk is our outperformer," JPMorgan European securitisation strategists observe.

They foresee a newer development in investor behaviour occurring over the coming months: the senior-junior compression trade. In asset classes where junior bonds are unlikely to experience principal losses (for instance, Granite and Dutch RMBS), mezzanine paper looks comparatively cheap. Continued narrowing in the dispersion of senior bond spreads should also see mezz positions outperforming.

"The only sector that is relatively immune from wholesale spread compression is CMBS because it's so deal-specific: valuations depend on the analysis of each underlying loan and property and the ability of the borrower to refinance. Maturity extensions and interest paid on the extension period further complicate the picture. It's understandable that there is nervousness about which transactions, or even which tranches of transactions, will ultimately repay - and therefore it's impossible to look at the European CMBS market on a sector-wide basis," Ford observes.

JPMorgan estimates that the volume of European securitisation bonds held by investors stood at €516bn at year-end, down from €557bn in 3Q13. This compares to the €707bn of bonds that are believed to have been retained by originators.

Despite the dearth of European ABS supply, there is some buying and selling occurring, according to Ford. "The key is to source assets without driving the market against you. There is reluctance among investors to sell to a certain point, but there's a price for everything. We're seeing decent turnover."

One way of sourcing some pick-up from deal to deal is to differentiate between servicers. "Some servicers are actively curing and bringing arrears down, and working loans out or refinancing them," Ford confirms. "A number of borrowers are now current again and prepayment rates are ticking up, especially in non-conforming and to some extent in prime assets. Granite is now prepaying at 14 CPR, for example, as borrowers increasingly look to refinance their mortgages."

In terms of credit picking, Ford says he tends to avoid later-vintage RMBS serviced by certain servicers. "One way to source a bit of extra yield is to analyse arrears performance across programmes to see whether any credit metrics are improving. In many cases, for instance, the payment schedules are now reverting for non-conforming deals that had previously hit arrears triggers."

In Spain spread tiering is emerging across originators, geography (coastal versus non-coastal) and vintage - albeit the sector is harder to analyse because there isn't the same depth of information as in the UK. Nevertheless, most Spanish residential mortgages are repayment loans, resulting in up to 10 years of payment history being available.

"Even though arrears may be high in Spain, many may be historical - borrowers may be paying, but are yet to make up the arrears. Most Spanish RMBS were underwritten at a relatively low LTV, meaning that they offer higher protection against recoveries," Ford notes.

Irish RMBS is poised to become another attractive jurisdiction. The sector has seen heavy arrears, but no foreclosures due to bank forbearance.

"One concern is that banks will be forced to begin foreclosing under the revised Code of Conduct on Mortgage Arrears, but how much will RMBS bonds really lose? Even if the deals see heavy losses, most senior tranches are well protected because the structures are robust and have de-levered over time," says Ford.

While European ABS spreads slipped back a little recently on concern over emerging markets, they appear to have bounced back, in line with the sector's historical resilience to broader volatility. Continued volatility could nonetheless become a catalyst for spread widening and increased secondary supply.

In terms of the primary market, Barclays Capital forecasts €55bn of publicly-placed European ABS issuance in 2014, of which RMBS represents €13.5bn. While UK prime and Dutch RMBS are expected to remain the stand-out sectors, two other trends could continue to gain momentum - increases in non-senior and non-core issuance.

These trends emerged during 4Q13, with the issuance of a UK non-conforming RMBS placed down to the double-B level (Precise Mortgage Funding No. 1), as well as an Irish (Fastnet Securities 9) and a Swedish non-conforming (Bluestep Mortgage Securities No. 2) transaction. Barcap European asset-backed analysts note that it would not be surprising to see issuance from other RMBS sub-sectors, whether it is publicly marketed or privately placed. Indeed, a French RMBS is rumoured to be in the works.

The impact of the UK's Funding for Lending Scheme is anticipated to take 6-12 months to run out. Consequently, this year each bank could reasonably be expected to issue one deal along with one or two from building societies, resulting in UK RMBS volumes of about £5bn. Meanwhile, Dutch RMBS issuance could slow towards the end of the year, due to the implementation of the Dutch National Mortgage Institute scheme (SCI 18 September 2013).

New issue triple-A rated RMBS bonds are pricing at 40bp-65bp over, depending on tenor and originator. At tighter spreads than this, Ford suggests that the paper is unlikely to go into Level 1 books. Banks will therefore be incentivised to buy covered bonds instead to satisfy their liquidity requirements under Basel 3.

"The primary supply picture is driven by technical factors: cost is a consideration, as well as the funding position of banks, regulatory pressures and accommodative central banks," Ford concludes. "If spreads widen or tighten, there will always be some investors incentivised to sell. But this needs to occur on a prolonged basis for it to help relieve the current supply/demand imbalance."

CS

ABS

Cards lead ABS rebound

US ABS BWIC volume surged to US$241m yesterday, up from just US$77m the day before. Supply was skewed towards credit card and auto bonds, where offering levels were mostly unchanged.

SCI's PriceABS data captured a range of names during the session, including CHAIT 2012-A3 A3, which was talked at plus 15 - having been talked last month at plus 12. The tranche appeared in PriceABS half a dozen times in 2H13, with one cover at plus 19.

Several auto names were also out for the bid, such as the ALLYL 2012-SN1 A3 tranche, which was talked at plus 18. The bond was talked in the high-teens last March.

AMXCA 2013-3 A was talked at plus 21, while CARMX 2013-4 A4 was talked at plus 28. When the latter tranche circulated in November, it was covered at 100.

SDART 2012-5 A3 was talked at plus 25. It had been talked last week at plus 26 and was talked in February of last year at plus 22.

In addition, the aircraft segment was represented in the form of AERLS 2007-1A G3, which was talked at 97 handle. The tranche was covered twice last year, including in the mid-90s on 27 June.

CLIF 2006-1A A was one of a few container ABS tranches circulating yesterday and was talked in the high-90s. When it first appeared in the PriceABS archive on 11 December 2012, it was talked at 97 handle.

Also in the containers space, TCF 2007-1A NOTE was talked in the high-90s. The tranche was also talked in the high-90s on its two previous appearances in the PriceABS archive.

Interestingly, the TMCL 2005-1A A tranche was also talked in the high-90s. On its previous appearances in the PriceABS archive it has always appeared alongside TCF 2007-1A NOTE and also been talked in the high-90s.

Equipment ABS paper rounded out yesterday's supply. CNH 2013-A A3, for example, was talked at plus 21 on its first appearance in the PriceABS archive.

JL

CLOs

Euro CLO equity in demand

European CLO investors are becoming increasingly competitive in their search for yield. Equity pieces are particularly well bid at present, as investors reassess default assumptions to acquire paper.

"Anything with a high yield is very well bid right now. Last week, for example, we saw good equity pieces of bonds such as CONTE 2007-1X and OHECP 2006-1X in the market. While they did not trade, we heard that they received really strong bids," reports one trader.

SCI's PriceABS data shows that the CONTE 2007-1X G tranche was talked at between the very high-20s and very high-40s last Thursday. The OHECP 2006-1X F1 bond, meanwhile, was talked at between the mid-60s and high-70s, having been covered as recently as December.

Offer prices for equity pieces are going up. The trader notes that investors are becoming far more diligent with their analysis as a result.

He says: "Investors are paying more attention to underlying assets and taking a much more detailed view as far as how the deal will perform. It is competitive, so they will run very low defaults for quality portfolios to see if they can reach those offer levels."

The trader says that investors frequently conduct very detailed analyses of underlying loans to try to calculate default rates as precisely as possible, rather than relying on standard assumptions. He also reports that double-A names have become very well bid.

"I do not know why double-As are so well bid, because the yields there are so tight. Maybe investors believe that such bonds will become triple-As soon or they are next in line to get paid," he says.

The trader continues: "My guess is that the activity there is being driven by dealers seeking volume. In equity, investors are looking far more at margin and anything with yield is very well bid."

Another bid-list is due to hit the market today, with pieces of equity names such as HARVT II-X F and HSAME 2006-IIX SUB included. The Harvest tranche recently traded in the mid/high-20s.

Further equity names are expected on a Friday BWIC, with the market anticipated to remain active through to the end of the week.

JL

ABS

Seasonality affects auto valuations

There can be significant month-to-month changes in US auto loan ABS prepayment speeds. This degree of seasonality introduces valuation considerations that some investors may not have considered.

An analysis by Wells Fargo consumer ABS analysts suggests that traders should pay particular attention to the calendar when buying and selling auto loan ABS. They note that short-run changes in prepayment speeds can have transitory, but meaningful, effects on bond valuations.

Prime auto loan ABS shelves - such as ALLYA/CARAT, CARMX, FORDO, HAROT and NAROT - typically experience a strong spike in prepayment rates above trend in April, as well as above-trend prepayments through the middle of the year. Prepayments are then strongly below trend towards the end of the year and into January.

There is more differentiation among subprime auto loan ABS shelves. Prepayments still spike in April for names such as AMCAR and SDART, but then prepayments are below trend in the middle of year - and markedly so in SDART's case.

The April spike is common to all auto loan ABS and is likely attributable to buyers using annual bonuses or tax refunds to make vehicle down payments. Holiday weakness at the end of the year is also broadly experienced, although SDART differs from AMCAR or the prime shelves in experiencing above-trend prepayments in January.

Prepayment speeds for prime shelves are particularly volatile between March and May, swinging from strongly below trend to well above it. Taking the FORDO 2012-D A4 bond as an example and using prepayments speeds from this volatile period shows the effects of seasonality.

The price of the FORDO 2012-D A4 bond in the Wells Fargo analysts' baseline scenario is 100-2 ¼. During March prepayment speeds that would be nearly 8% below trend and the price would drop by two ticks.

"April's prepayment speed for FORDO is about 10% above the 12-month trend and the faster prepayment speed translates into an increase in value of more than four ticks from the March scenario. The May scenario has a seasonal factor that is about 5% above trend, although the prepayment speed (1.68 ABS) is closer to the 12-month trend and the price declines by just over one tick," the analysts explain.

They continue: "This example indicates, in our view, how important seasonal changes in prepayment speeds can be in the valuation of auto loan ABS. We believe that ABS market participants should take account of seasonality when making the buy/sell decision."

JL

Structured Finance

SCI Start the Week - 17 February

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

Pipeline
Last week saw a healthy mix of deals added to the pipeline. Three new ABS, two ILS, an RMBS, two CMBS and two CLOs were announced.

The ABS comprised US$515.6m Castlelake Aircraft Securitization Trust 2014-1, Driver China One and US$241m TAL Advantage V series 2014-1. The ILS were US$200m Kizuna Re II and Queen Street IX.

The newly-announced RMBS was RUB2.5bn Mortgage Agent APB 2, while the CMBS were US$186.8m CSMC Trust 2014-SURF and US$957.6m JPMBB 2014-C18. Meanwhile, US$400m Mountain Hawk III and US$500m Venture XVI round out the transactions currently being marketed.

Pricings
It was also a busy week for issuance. There were nine ABS prints, as well as an RMBS, a CMBS, a whole business securitisation and four CLOs.

The ABS pricings comprised: US$1.023bn CNH Equipment Trust 2014-A; US$801.2m Enterprise Fleet Financing Series 2014-1; US$1.25bn Fifth Third Auto Trust 2014-1; US$1.15bn Ford Credit Floorplan Master Owner Trust 2014-1; US$418m Ford Credit Floorplan Master Owner Trust 2014-2; US$234m JGWPT 2014-1; US$1bn Nissan Auto Receivables 2014-1 Owner Trust; £175m Scot Roads Partnership Finance; and US$450m World Financial Network Credit Card Master Note Trust Series 2014-A.

The RMBS print was A$2.5bn Medallion Trust Series 2014-1, the CMBS was US$1bn COMM 2014-CCRE15 and the WBS was £450m Manchester Airport Group Funding. Finally, the CLO new issues consisted of: US$572m Neuberger Berman CLO XVI; US$400m OFSI Fund VI; €726.7m Quadrivio SME 2014; and US$278m Tennenbaum Senior Loan 2014-1.

Markets
The European ABS market last week witnessed the partial distribution of two previously retained Italian deals - Alba 5 and SIENA 2010-7, the former at a DM of 110bp. "After a two-week hiatus, ABS secondary spreads resumed their grind tighter, with the majority of asset classes closing the week inside [the previous] week's levels. Once again, the yieldier end of the range benefited from the largest contraction in spreads," note JPMorgan ABS analysts.

US ABS BWIC volume surged in midweek to US$241m after a quiet start, as SCI reported on 13 February. SCI's PriceABS data shows supply concentrated in credit card and auto bonds, with aircraft, container and equipment ABS rounding out supply for Wednesday's session.

The US non-agency RMBS secondary market saw BWIC supply of about US$1.5bn. Wells Fargo RMBS analysts note: "The non-agency market was quieter this week, with no new deals coming to market or no large bid-lists for the market to digest. Nevertheless, trading activity remained robust."

Meanwhile, US CMBS spreads recovered well from their January wides as concerns about contagion from emerging markets have dissipated, according to Barclays Capital analysts. They add: "New issue dupers, which had drifted as wide as swaps plus 95bp, have now compressed back to swaps plus 90bp. There has been strong demand lower down the capital structure: 3.0 triple-Bs have climbed back to swaps plus 370bp, about 20bp tighter than end of January."

Deal news
• The February remit for GSMS 2007-GG10 shows that 16 CMBS loans totalling US$592.6m were liquidated in the CWCapital auction at a weighted average loss severity of 51.3%. While this outcome is better than expected, the sale appears to have been barbelled, with some properties not commanding as high a price as the last appraisal value would suggest.
• BACM 2007-2 has become the first CMBS containing a pari passu part of the US$1.3bn Beacon Seattle & DC Portfolio loan to report a pay-down this month. The move follows the recent sale of the Plaza Center & US Bank Plaza buildings for US$186.5m (see SCI's CMBS loan events database).
• The February remit report for BACM 2008-1 shows that proceeds from the sale of a property identified as part of the CWCapital auction have been applied to the CMBS trust. Overall a total of US$76.2m of principal proceeds was received for the transaction, resulting in the full pay-off of the A2 class and a US$52.4m payment to the A3s, reducing the balance to US$22.6m.
• Restructurings are progressing, at different stages, for three UK Lehman RMBS: ESAIL 2007-PR1, ESAIL 2007-6NC and MARS 4. First, restructuring proposals have been implemented for ESAIL 2007-PR1 (SCI 5 February), with an aggregate amount of US$64.87m of proceeds converted into an amount of £39.78m.
• S&P has respectively lowered to double-C from double-B minus and single-B plus its ratings on the US$100m Queen Street II Capital and the US$150m Queen Street III Capital catastrophe bonds. At the same time, the agency removed the ratings from credit watch, where they were placed with negative implications in November (SCI 25 November 2013).
• A challenge brought by a junior noteholder in five Trups CDOs regarding the trustee's interpretation of the transactions' payment mechanics has been transferred from a Minneapolis district court to the US District Court for the Southern District of New York (SCI 16 December 2013). The action - involving Tropic CDO I, II, III and IV and Soloso CDO 2005-1 and 2007-1 - has also been consolidated into a single proceeding.
• Fir Tree Partners has terminated its cash tender offer for six RMBS (SCI passim). All of the trusts that were subject to the offer are involved in active litigations against JPMorgan for breaches of representations and warranties.
• An estimated US$465m of delinquent CMBS loans are due for sale via Auction.com next month. JPMCC 2007-LDPX (serviced by C-III) has the largest exposure to the sale, according to Barclays Capital figures, with US$136m of assets out for the bid.
• IIG Trade Finance has completed an innovative securitisation of non-bank Latin America-based trade finance loans. Dubbed Trade Finance Funding I, the US$220m CLO was structured, arranged and placed by Deutsche Bank and will be managed by The International Investment Group.
• An auction has been scheduled for RFC CDO II, an ABS CDO, on 3 March. The collateral shall only be sold if the proceeds are greater than or equal to the redemption amount.

Regulatory update
• Approval of the US$8.5bn Countrywide RMBS settlement (SCI 3 February) has been stayed by Justice Saliann Scarpulla of the New York State Supreme Court. On the appeal of objectors including AIG, 19 February has been set as the date for oral arguments on the issues raised by Judge Kapnick's decision.
• US CLO volume totalled US$2.5bn last month, markedly down from the US$9.8bn reached in January 2013. Uncertainty about the Volcker Rule has contributed to this reduction in issuance, but it has also impacted the structure of the deals that have launched.
• The CFTC and the European Commission say they have made "significant progress" towards harmonising a regulatory framework for CFTC-regulated swap execution facilities (SEFs) and EU-regulated multilateral trading facilities (MTFs), as contemplated under the Path Forward statement issued in July 2013. The Path Forward statement set out that the CFTC and EC would work together on extending appropriate time-limited transitional relief to certain MTFs, in the event that the CFTC's trade execution requirement was triggered before 15 March 2014.
• ESMA has published a consultation paper setting out the draft regulatory technical standards (RTS) required for the implementation of the CRA3 regulation. The draft RTS - which complements the existing regulatory framework for credit rating agencies (CRAs) - cover: disclosure requirements on structured finance instruments (SFIs); the European Rating Platform (ERP); and the periodic reporting on fees charged by CRAs.
• IOSCO has published a consultation report on its 'Code of Conduct Fundamentals for Credit Rating Agencies', which proposes significant revisions and updates to the current CRA code. The organisation proposes to revise the code to take into account the fact that CRAs are now supervised by regional and national authorities.
• TARP's biggest programme, the Capital Purchase Program (CPP), is winding down. Many of the banks left in it are smaller community institutions with typically narrow geographical footprints and franchise recognition that struggled to attract new capital through new issuance or generate interest from private investors at auction sales. Trups CDOs are exposed to those banks.
• MarketAxess estimates that less than 20% of CDS index volume is trading on SEFs, ahead of the 26 February 'made available to trade' (MAT) deadline. Together the eight products that fall within the CDS MAT determination represent 80% of overall volume in CDS index market.

Deals added to the SCI New Issuance database last week:
Avis Budget Rental Car Funding Series 2014-1; Bank of America Credit Card Trust 2014-1; Capital One Multi-asset Execution Trust 2014-1; CarMax Auto Owner Trust 2014-1; CIFC Funding 2014; CSMC Trust 2014-IVR1; Dryden 31 Senior Loan Fund; FREMF 2014-K36; ING IM CLO 2014-1; Madison Park Funding XIII ; PFS Financing Corp Series 2014-A; Southern Housing Group ; Volkswagen Auto Lease Trust 2014-A; WFRBS 2014-LC14

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-4; BACM 2007-2; BACM 2008-1; BACM 2008-1, BACM 2007-4m BACM 2007-5 & MLMT 2008-C1; BSCMS 2007-PW15; CD 2007-CD4; CGCMT 2007-C6; COMM 2006-C7; COMM 2006-C8; COMM 2007-C9; DECO 2006-C3; DECO 2006-E4; DECO 2007-E5; ECLIP 2006-2; ECLIP 2006-3; EURO 23; EURO 25; EURO 28; FOX 1; GCCFC 2007-GG9; GECMC 2005-C4; GMACC 2006-C1; GSMS 2007-GG10; INFIN SOPR; JPMCC 2007-LD11; JPMCC 2007-LDPX; JPMCC 2008-C2; MLMT 2005-MCP1; REC 6; TITN 2005-CT1; TITN 2006-2; TITN 2007-1; TITN 2007-CT1; TMAN 7

Top stories to come in SCI:
ILS outlook

CLOs

Euro CLO collateral evolves

Last year saw 21 European CLOs price and several of those deals have now passed their effective dates. Compared to legacy deals, changes in collateral composition are already becoming apparent.

Legacy European CLOs typically included a minimum requirement for the percentage of senior secured loans in the ramped-up portfolio, which has generally been replaced in 2.0 deals by a 90% requirement for senior secured loans or senior secured bonds. Fixed-rate collateral tends to be limited and, as most high yield bonds are fixed-rate, bonds still account for only a minority of CLO 2.0 collateral.

Floating rate high yield bond issuance increased last year to €5.5bn, providing CLO managers with a convenient instrument for avoiding the mismatch that results from marrying fixed-rate bonds with floating rate CLO liabilities. A sample of 12 European CLO deals analysed by Bank of America Merrill Lynch analysts shows that on average floating rate note buckets account for 9.2% of collateral.

Among those 12 deals, the minimum required percentage of senior secured loans or bonds varies from 75% to 90%. The actual proportion of senior secured loans or bonds is frequently higher - at 100% in several deals - although this is expected to change as managers make use of their non-senior buckets to varying degrees.

Most 2.0 collateral has been euro-denominated and only four of the deals the BAML analysts studied contains any non-euro collateral, with some deals not permitting any non-euro collateral at all. Most debt tranches have also been issued in euros, so including non-euro collateral may require costly hedging.

Most collateral comes from Western Europe, with exposure to Portugal, Ireland, Italy, Greece and Spain averaging just 7.5%. Additionally, 60% of collateral across the 12 deals is 2013-vintage, suggesting that most has been obtained in the primary market.

"Although a number of new issue deals have used collateral from called legacy CLOs, it appears new issue CLOs are still sourcing a majority of collateral in the loan primary market. Given the pace at which legacy deals are amortising (we estimate outstanding legacy European CLOs fell €12.6bn to €61.5bn outstanding in 2013, of which around 20% is still reinvesting), the CLO primary market will become increasingly important for European leveraged loan issuance," note the analysts.

Asset maturities are fairly evenly spread between 2017 and 2020, with no assets so far having a maturity date beyond 2023. Most CLO tranche final maturities are between 2025 and 2027.

The weighted average margin on floating rate collateral appears to vary between 3.9% and 4.6%, while the weighted average coupon on fixed-rate collateral varies between 5.2% and 9.3%. Business equipment and services, healthcare and cable television are the top industries in European CLO 2.0 deals, while many of the top issuers are the same as in legacy deals.

JL

RMBS

Final straight for legacy issues?

After some GMAC/RFC deals wrapped by FGIC began to receive settlement payments in the January remittance (SCI 7 February), this month and the next should see further cash flow through for the remaining bonds. Additional returns are also expected to emerge as a result of ongoing settlement negotiations.

FGIC entered into a settlement with ResCap debtors, deal trustees and certain investors last year to resolve claims relating to 47 trusts (SCI 30 May 2013). That agreement provided a payment of US$253.3m from FGIC and those deals no longer have any future claims against the insurer, with the policies of those deals commuted.

As part of the ResCap reorganisation plan, the settlement granted FGIC allowed claims of US$337.5m against ResCap, US$181.5m for GMAC Mortgage and US$415m against RFC. The settlement also released ResCap from the remaining FGIC claims against them.

The FGIC-wrapped GMAC/RFC deals received a cash payment from FGIC in the January remittance period for part of the unpaid outstanding and future claims that would have been received under the FGIC policies. RMBS analysts at Bank of America Merrill Lynch note that these pay-outs are instead of payments outlined in the FGIC rehabilitation plan, which will be paid to remaining FGIC-wrapped bondholders.

The effective date of the FGIC plan for bondholders was 19 August 2013, with investors given 90 days to submit a claim and FGIC given a further 60 days for an initial payment date. The initial cash payment percentage was set at 17% and should imminently begin to flow through to RMBS trusts that were not commuted as part of the ResCap settlement agreement.

The remainder of the permitted policy claims will be treated as a deferred payment obligation (DPO) that will be paid if and to the extent that excess cash becomes available. The DPO will accrete at a 3% per annum rate and will continue to accrete until the full claim is paid.

The ResCap settlement also granted Ambac allowed claims of US$207m against GMAC debtors and US$22.8m against RFC debtors. Ambac currently holds US$44.8m of aggregate cash received from the ResCap estate, of which US$13.4m is due to be distributed to 10 policies: GMACM 2005-HE3, RALI 2006-QH1, RAMP 2003-RS1, RAMP 2004-RS9, RAMP 2004-RS5, RASC 2002-KS1, RASC 2002-KS4, RASC 2002-KS6, RASC 2002-KS8 and RASC 2004-KS4.

Other Ambac-insured deals have received supplemental payments in excess of 25% in recent months. These include certain CHWEL 2004-T, HVMLT, IMSA, INDX and LXS deals.

"To the extent Ambac makes supplemental payments to satisfy outstanding claim amounts, these deals would then allow excess spread to be used to reimburse Ambac prior to covering current period losses. If Ambac does not make these supplemental payments, it would still have this liability outstanding, which would be paid down based on the plan of rehabilitation once it is finalised and approved but it would not have the benefit of capturing current excess spread in the deal," note the BAML analysts.

An estimated US$431m in cash proceeds is also expected to be paid out by ResCap across an additional 1,100 deals in the February and March remittance periods. "We estimate an additional US$326m will be paid out over the coming months as remaining assets are liquidated. The approximate estimated total of US$758m would resolve US$10.2bn in allowed claims resulting from approximately US$40bn in realised and our projected underlying collateral losses. The US$758m estimated payout would therefore represent 1.9% of realised and our projected collateral losses," the analysts add.

Meanwhile, FHFA litigation is also ongoing. Civil settlements from eight of the 18 banks that the GSEs filed litigation against to date have recovered US$9bn.

The GSEs are understood to have held back on selling the majority of its non-investment grade subprime bonds due to the number of lawsuits outstanding on many of the deals. Recent settlements with various banks may allow the GSEs to start selling these securities as a way to further reduce their less liquid holdings, the analysts suggest.

In terms of global settlements, JPMorgan has agreed to pay US$4.5bn in cash to investors to cover 330 RMBS trusts (SCI 18 November 2013). The trustees have an extended deadline to 16 March to accept the offer, after which investors could still opt out or object to the settlement.

Together with the JPMorgan settlement and a similar one for Countrywide (SCI passim), there are unresolved issues around Wells Fargo and Morgan Stanley RMBS. However, the scope for how many representation and warranty cases may yet be introduced was narrowed by a recent court ruling that cases must be filed within six years of when the representation to repurchase was made on the closing date of the mortgage loan purchase agreement and not when the alleged failure to repurchase occurred (SCI 7 January).

HSBC has, as trustee, filed a motion for the court to reconsider the ruling and the issue could yet go to the appeals court. "Even if the ruling is overturned, we are moving sufficiently away from the financial crisis and we believe we are at the beginning of the end of working through remaining legacy mortgage issues. As uncertainty surrounding non-agency litigation and settlements has started to be lifted in recent months, we look for further clarity to emerge throughout 2014," the analysts conclude.

JL

Structured Finance

A merry-go-round of reform

Anu Munshi, managing partner at B&B Structured Finance, assesses the current regulatory environment

Anyone trying to keep track of bank regulations should be excused for clutching their head, screaming or both. The dizzying rash of regulations - with their revisions, implementation dates and their interpretation by different regions - is enough to give one a headache.

Take the credit valuation adjustment (CVA) charge for OTC derivative trades required by Basel 3 as an example. The CVA charge is an amount banks have to reserve against potential mark-to-market losses from a deterioration in the creditworthiness of their counterparties to non-cleared derivative trades.

The US has adopted the CVA charge in a way that is broadly consistent with Basel 3. However, the EU has diverged from Basel 3 by adopting the CVA charge in a form that exempts EU-based banks from this charge for transactions with non-financial corporates¹.

The idea is to be consistent with the European Market Infrastructure Regulation (EMIR), which exempts non-financial corporates from centrally clearing derivatives, effectively allowing them to enter into OTC derivative trades without having to post collateral. If non-financial corporates were subject to the CVA charge, it would undermine their benefit of avoiding collateral costs under EMIR.

While such treatment for non-financial corporates in the EU may be consistent with European regulation, it diverges from internationally agreed standards and creates an uneven playing field for banks globally. Given these concerns, some EU member states are considering imposing a capital 'add on' to address the CVA exemption, which gives national regulators the ability to impose requirements for additional capital. So, not only is the EU approach different from the US approach, but there is the potential for a lack of consistency within the EU itself.

Then there's the leverage ratio - a key component of Basel 3, which requires banks to hold at least 3% of their overall assets in Tier 1 capital. The leverage ratio is meant to constrain excessive leverage by setting a minimum standard for how much capital banks must hold against all their assets, not just their risk-weighted assets.

The US is moving towards a more stringent approach to the leverage ratio, subjecting banks to tougher requirements than the Basel 3 leverage ratio - from 'advanced approaches' banks² having to comply with both the Basel 3 leverage ratio (3%) and the US Tier 1 capital-to-assets leverage ratio (generally 4%), to the largest banking organisations having to maintain a supplementary Basel 3-based leverage ratio of at least 5%, failing which they would be restricted in making capital distributions and discretionary bonus payments.

On the other hand, the European Commission has indicated that it is still reviewing whether the leverage ratio should be introduced as a binding measure at all. The EU has adopted the leverage ratio as a measure determined by the national regulator for each institution.

While the UK has introduced a binding 3% leverage ratio on its largest banks, other EU member states may choose lower ratios. So, again we have a divergence of approach between the US and the EU, and also within the EU.

The Basel Committee recently revised its definitions of bank exposures used to calculate the leverage ratio and will continue to review the ratio, as it will only be implemented on 1 January 2018. So further changes could be afoot, and this means that the US and the EU could revise their positions yet again.

And then there are the Basel 3 risk weights for bank securitisation exposures. The Basel Committee has prescribed different ways for banks to assign risk weights for their securitisation exposures when determining their risk-weighted assets for regulatory capital.

The Basel Committee recently published its second consultative document on risk weights for bank securitisation exposures under Basel 3. The recent proposal prescribes a different set of approaches from the originally proposed rules for banks to risk-weight securitisations. Among other changes, the new proposed rules no longer confer an automatic 1250% risk weight to senior securities downgraded to a rating between double-B minus and double-C plus.

The US, however, has already finalised its version of Basel 3 rules, so US banks will have different risk weights against their securitisation exposures than European or international banks. If the Basel securitisation proposal is finalised in its current form, US regulators may look at revising the US bank securitisation framework to be more in line with the revised Basel 3 rules.

And round and round we go... And no, you can't get off this ride.

¹ Where transactions are considered bona fide hedges for the non-financial corporate and do not exceed certain thresholds specified in EMIR.
² US banking groups with consolidated assets of at least US$250bn or consolidated foreign exposures of at least US$10bn.

Structured Finance

SEC enforcer rejoins law firm

Milbank, Tweed, Hadley & McCloy has appointed former US SEC co-director of enforcement George Canellos as a partner and global head of its litigation department. Much of his time at the SEC was spent on cases involving RMBS.

Canellos will start in mid-March. He has worked at Milbank before, as well as at Wachtell, Lipton, Rosen & Katz and as an assistant in the US Attorney's Office in New York.

Structured Finance

Law firm beefs up Asian unit

Hogan Lovells has appointed Andy Ferris as a partner in its international debt capital markets (IDCM) team in Singapore. He will work with IDCM partner Andrew Carey and on bond restructuring with Neil McDonald.

Ferris joins from Allen & Overy, where he was a senior associate. He advises clients on issues of debt and equity-linked instruments throughout the Asia-Pacific region.

Structured Finance

West Coast SF team bolstered

Winston & Strawn has appointed Daniel Passage as a partner and Francisco Flores as of counsel in its Los Angeles office. The pair will complement the firm's existing national platform in structured finance and deepen its West Coast practice.

Passage was previously at Bingham McCutchen where he served in the structured transactions group. He has also worked at O'Melveny & Myers and at Brown & Wood and specialises in securitising novel asset classes.

Flores also joins from Bingham McCutchen. Before that he was at O'Melveny & Myers and at Manatt, Phelps & Phillips. Alongside structured finance he focuses on cross-border transactions in Latin America.

Structured Finance

Asian advocacy group founded

ASIFMA has launched an asset management group to advocate the views and interests of Asian asset managers at local, regional and global levels. ASIFMA's Asset Management Group (AAMG) is being led by Eugenie Shen and currently has 15 members.

AAMG intends to function as the collective voice of the asset management industry in Asia, promoting the development of liquid, efficient and open capital markets in the region by driving consensus and developing best practices and uniform standards. It will work closely both with its members and with policy makers.

Shen is a lawyer with 30 years of experience in New York, South America, Europe and Asia. She has worked for Broadview Advisers, PineBridge Investments Asia, TTE Corporation, China Advisory Group, Morningside, the Hong Kong Stock Exchange, Chase Manhattan and Shearman & Sterling.

Other key members of the steering committee include Kai Sotorp of UBS, Ajai Kaul of Alliance Bernstein, Jed Laskowitz of JPMorgan and Lachlan Campbell of Income Partners. As well as those firms, the current AAMG members are Amundi Asset Management, BlackRock, BNP Paribas Investment Partners, Eastspring Investments, Goldman Sachs Asset Management, Neuberger Berman, Principal Global Investors, Schroders, State Street Global Advisors, Threadneedle Investments and Wellington Management.

Structured Finance

Fund administrator acquired

TMF Group has purchased an outstanding 49% of Custom House Global Fund Services to become the sole owner. The acquisition allows it to further expand into the alternative investment sector.

The purchase combines TMF's corporate and financial institutional network with Custom House's fund administration services, enabling both companies to expand in new and existing market segments. TMF will be able to offer the industry an independent, global partner for fund administration services and solutions across the middle and back office.

Custom House founder Dermot Butler will serve as president of TMF Custom House Global Fund Services, stepping down from his role as chairman. Mark Hedderman will remain as ceo.

CDO

CDO manager replaced

Dock Street Capital Management has been appointed successor collateral manager to Libertas Preferred Funding I, following the resignation of Cira SCM (SCI 4 November 2013). Moody's has confirmed that the move will not affect its rating on the CDO.

Under the terms of the appointment, Dock Street agrees to assume all the responsibilities, duties and obligations of the collateral manager under the agreement. In reaching its conclusion, Moody's considered the experience and capacity of Dock Street to perform duties of collateral manager to the issuer.

For other recent CDO manager transfers, see SCI's database.

CLOs

CIFC hires for middle-market

CIFC Asset Management has appointed Peter McLaughlin as md in New York to strengthen its middle-market offering. He joins from Longroad Asset Management, where he was head of originations, and has also worked at Gottex Middle Market Debt Fund, Contrarian Capital Management, GoldenTree Asset Management, Wells Fargo Foothill and JPMorgan.

CMBS

Orrick adds CMBS pair

Orrick, Herrington & Sutcliffe has appointed William Cullen and Janet Barbiere as partners in its structured finance group in New York. The pair specialise in CMBS.

Cullen and Barbiere both worked at Kaye Scholer and before that at Thacher Proffitt & Wood and at Sidley Austin. They frequently act as CMBS issuer and underwriter counsel for investment banks and also represented the FDIC in recent CMBS transactions.

As well as his CMBS work, Cullen has also been involved in the workout and restructuring of defaulted real estate loans and securities, the sale and liquidation of performing and distressed financial assets and the sale of servicing platforms and investment advisory businesses. Barbiere also has experience in real estate syndications, origination and servicing programmes and the secondary mortgage market.

CMBS

CMBS production pro appointed

Matt Stevens has joined the production team at Greystone as a director. He will focus on origination for debt financing solutions across Fannie Mae, Freddie Mac, FHA, CMBS and Greystone's proprietary lending platforms.

Stevens has over 15 years of commercial lending and banking experience and will report to Rick Wolf. He was previously at Alliant/ACRE Capital and has also worked at Chuchill Mortgage Capital.

Insurance-linked securities

Insurance manager adds two

Kane has expanded its US team with two business development hires. The ILS specialist has added Monica Everett as business development director and Hannah Hayes as business development associate.

Everett will take responsibility for building customer relationships and identifying new business opportunities. She was previously vp of Willis Insurance for North America and has also worked at Heffernan Insurance Brokers, John Burnham Insurance Services and Lexco Insurance Brokers.

Hayes was previously at Clearwire Corporation, responsible for project management and operations support for a large sales team. She has also worked at Bissell-Hayes Realtors, Keller Williams Realty and Electra-Tek Carolinas.

ABS

Diversified aircraft ABS prepped

Goldman Sachs is in the market with Castlelake Aircraft Securitization Trust 2014-1. The US$515.57m transaction is believed to be the first aircraft securitisation to feature turboprop collateral.

The deal is supported by a pool of 79 aircraft initially leased to 26 lessees located in 17 countries, representing approximately 58% of sponsor Castlelake's managed aircraft fleet by number of aircraft. The collateral pool includes 19 distinct aircraft types across three fleet categories: widebody (accounting for 42% of the initial pool), narrowbody (25%) and turboprop (33%).

The initial pool of lessees is relatively diversified, but exhibits greater exposure to developed markets, with the largest concentrations in North America (31.8%) and Europe (31.3%). Three of the top-ten lessees are US carriers, accounting for 29.6% of the initial pool value. Kroll Bond Rating Agency views the large US exposure as a strong mitigant to the transaction's overall default probability, as the US passenger airline industry is one of the strongest operating environments within aviation markets.

With an approximate weighted average age of 17.5 years, the Castlelake 2014-1 fleet is significantly older than the younger vintages included in recent lease securitisations, according to KBRA. Due to the advanced age of the aircraft pool, the agency assumes that a substantial portion of the initial fleet is liquidated upon the scheduled expiration of the initial lease. As a result, there is limited reliance on the re-leasing of aircraft assets within Castlelake 2014-1 as compared to other aircraft ABS transactions.

The tail risk of the transaction is borne predominantly by the leasing of the turboprop assets, since they compose the majority of aircraft generating lease cashflows for a second term. Although the leasing market for turboprops is not as extensive as that for commercial jets, KBRA views turboprops as a fleet type with a long useful life, good leasing characteristics and strong value retention.

The capital structure comprises three tranches rated by KBRA: US$303.54m single-A rated series A1 loans, US$50m single-A rated series A2 loans and US$162.04m triple-B rated series B loans. The notes fully amortise based on a targeted schedule calculated over a nine-year straight-line basis.

Commencing in the fifth year of the transaction, there will be a cash sweep equal to 50% of all available collections remaining after payment of interest, principal, expenses and replenishment of the liquidity and maintenance reserves. The cash sweep will increase to 75% during the sixth and seventh years of the transaction. If principal is still outstanding after year seven, the transaction will enter a rapid amortisation period.

ABS

Solar platform enhanced

Solar energy firm Mercatus has released its second-generation platform to accelerate securitisations of residential and commercial portfolios. Mercatus 2.0 includes new and enhanced features, such as portfolio analysis and automated ratings for both the residential and commercial segments. It also features enhanced tools to help investors make more informed decisions when allocating budgets and resources with enhanced data and analytics for real-time performance measurements.

Since its 2009 inception, the firm has assessed over 11 GW of solar projects and currently serves 40% of the distributed generation US solar market. Subscribers to the Mercatus platform are currently targeting US$1.2bn in dedicated capital deployment for distributed generation solar investments in 2014.

ABS

Call prospects up in container ABS

Calls are expected to be the primary area of focus in 2014 for container ABS investors. Wells Fargo structured product strategists note that many 2012 deals are callable beginning in 2Q14 and, based on current approximate yield levels, these call prospects are quite cuspy.

Seven container ABS were called in 4Q13: three 1.0 deals (GESEA 2004-1 and 2005-1 and TCF 2006-1) and four deals from the 2010-2011 vintages (TAL 2010-2, CLIF 2011-2, CRNN 2011-A1 and 2011-A2). Based on current levels, it appears likely that the early 2012 vintage transactions will be called, according to the Wells Fargo strategists.

"The later 2012 vintage deals have lower coupons, including some with sub-4% coupons. While these deals may be less likely to be called, we still recommend that investors assume that the call will happen, while hoping for a pleasant surprise," they add.

The strategists also recommend that container ABS investors keep an eye on box ordering patterns to monitor supply discipline. Additionally, the focus should not only be on container lease rates, but also on lease terms.

"Given the choice, we favour lessors that are more willing to make small concessions on price rather than leasing terms," they observe.

The supply and demand picture for container ABS is positive, as container production and fleet growth during the past 2-3 years has been below container trade growth rates and utilisation is high. Lessors reported higher box prices, higher lease rates and quicker pick-ups by customers in January. However, it remains to be seen if this is sustainable or whether it is a by-product of an early lunar New Year.

Structured Finance

MSHDA case to set precedent?

The Lehman bankruptcy court in December applied the US Bankruptcy Code's safe harbour for swaps in determining that the provisions of a swap agreement Lehman was a party to with the Michigan State Housing Development Authority (MSHDA), which addressed the calculation of settlement amounts upon termination of the swap, when liquidation provisions fall within the safe harbour. Moody's notes that this decision is in contrast to prior decisions of the court, which had denied the applicability of the safe harbour to issues arising with other Lehman swap counterparties, and is a credit positive development for securitisations when they rely on swaps.

In the MSHDA case, Judge James Peck of the US Bankruptcy Court for the Southern District of New York found that applying the settlement method called for by the swap terms upon a failure to pay or the bankruptcy of the Lehman counterparty was an integral part of liquidation of the swap and thus is protected by the swap safe harbour. The court's holding was not affected by the swap's designation of the settlement calculation method for bankruptcy differing from the settlement calculation method called for in other termination circumstances.

The decision is credit positive for CLOs and other transactions that rely on the ability to terminate swaps in the event of a counterparty's bankruptcy because it provides court acknowledgement of the applicability of the swap safe harbour, according to Moody's. It also provides acknowledgement that the settlement method chosen by the parties under a swap agreement is an integral part of the liquidation rights protected by the safe harbour.

The agency suggests that the case provides a meaningful precedent of a bankruptcy court's recognition that the safe harbour cannot be interpreted so narrowly as not to apply to the calculation of settlement amounts. Prior decisions of the Lehman bankruptcy court had refused to recognise the applicability of the swap safe harbour to other contract terms related to swap transactions, including flip clauses (SCI passim).

Structured Finance

Op risk proposal to be revised

S&P is making a number of changes to its proposed methodology for assessing operational risk in structured finance transactions, based on responses it received to its RFC (SCI 5 October 2011). The changes include additional operational risk factors, revised risk considerations for key transaction parties based on the substance of their roles and additional transparency regarding circumstances where, because of the specific nature of the operational risk, the agency will not issue or maintain structured finance ratings.

The changes also expand the scope of the proposed methodology and would apply to key transaction parties in stand-alone single- and multi-family housing bond issues, tender option bond issues and covered bond issues where the ratings on the covered bonds are delinked from the issuer credit rating on the bank. Given the revised scope, S&P intends to publish an updated request for comment before finalising its criteria approach.

Structured Finance

Stable outlook for Canadian ABS

Moody's is maintaining its stable outlook for Canadian ABS and RMBS in 2014 because of the improving Canadian economy, which should support already strong collateral performance. Assets backing Canadian ABS and RMBS are predominantly consumer receivables, whose performance correlates to economic conditions.

"Rising Canadian GDP and employment bode well for the performance of securitised collateral," says Richard Hunt, a Moody's vp and senior analyst. Canadian GDP accelerated to an annualised rate of 2.7% in 3Q13 from 1.6% the previous quarter and is expected to continue growing in 2014. Moody's Analytics expects growth of 2.8% this year, as the recovering US economy and a weakening Canadian dollar accelerate the demand for Canadian goods and services.

Delinquency and charge-off rates for credit card ABS receivables, which are currently back to their pre-crisis levels, are anticipated to continue improving. Monthly principal payment rates will likely remain high because of the large proportion of Canadian cardholders that use premium reward-based cards for convenience, rather than credit purposes. Well-seasoned collateral pools and stable issuer ratings support the strong and stable outlook for Canadian credit card ABS.

Canadian auto ABS performance should also remain strong in 2014, with net losses staying near their all-time lows. "The auto industry trend towards lengthening loan terms could result in higher loss rates, but we've seen no evidence of this to date," says Hunt. Any impact of longer loan terms will be offset by positive trends in the economy and prime borrower credit profiles.

Moody's also anticipates another year of strong performance by equipment-backed transactions, based on the expectation that the agriculture and construction sectors will benefit from the ongoing growth in the economy.

Meanwhile, the Canadian RMBS market made a comeback in 2013, with Genesis Trust II issuing notes backed by a pool of prime-quality, revolving, variable-rate lines of credit originated by Toronto-Dominion Bank and secured by residential properties in Canada. The performance of this transaction will benefit from prime obligor quality and high levels of borrower equity in the pool, Moody's notes.

Structured Finance

New Russian SPVs highlighted

The official text of Federal Law No. 379-FZ 'On Amendments to Certain Legislative Acts of the Russian Federation' was published on 23 December 2013 (SCI passim). A recent Liniya Prava client memo outlines the highlights of the legislation as it pertains to securitisation.

The law provides for the securitisation of non-mortgage assets and creates a legal framework for project finance transactions, including by introducing concepts such as a nominal account agreement and an escrow account agreement. For these purposes, two new SPV types have been introduced: special purpose financial companies (SPFCs) and special purpose project finance companies (SPPFCs).

Similar to mortgage agents, such companies are established for bond issuance purposes. However, in contrast to a mortgage agent, the subject of the pledge under such bonds is not a mortgage pool but monetary claims. Bonds can be secured by: the pledge of monetary claims under obligations that will arise in connection with the disposal of property, rendering of services, production of goods and performance of works; or by other property necessary for the implementation of a project.

Activity performed by SPFCs is generally similar to that of a mortgage agent, according to Liniya Prava. SPPFCs are established for long-term (not less than three years) investment project purposes.

Finally, the establishment of an SPV allows rating agencies to assess the quality of a pool subject to securitisation rather than the reliability of a legal entity, as with mortgage agents.

CDO

Trups CDOs exposed to CPP

TARP's biggest programme, the Capital Purchase Program (CPP), is winding down. Many of the banks left in it are smaller community institutions with typically narrow geographical footprints and franchise recognition that struggled to attract new capital through new issuance or generate interest from private investors at auction sales. Trups CDOs are exposed to those banks, Fitch reports.

Of the US$1.8bn Fitch-rated Trups CDOs, US$1.2bn is attributed to two issuers domiciled in Puerto Rico, both of which are challenged by the region's economic conditions. First BanCorp and Popular hold US$239m and US$935m of CPP securities respectively. Popular is current on its Trups, while First BanCorp is deferring on the US$225m in notional value.

Most financial institutions in the programme are also facing a steep dividend increase this year, from 5%-9% on the CPP preferred shares.

At the end of January, only US$2.1bn across 84 banks remained in the programme, as a result of a three-pronged exit strategy that included outright repayments, restructurings and auction sales. Fitch-rated Trups CDOs have the combined exposure to 47 remaining CPP participants (down from 108 last year), whose combined CPP investments comprise US$1.8bn of the remaining US$2.1bn.

These issuers represent US$813m in Trups held by Fitch-rated Trups CDOs. Interest on US$673m in Trups collateral (US$755m of CPP) across 34 issuers is currently being deferred on. Seven issuers (US$82m in Trups and US$120m in CPP) cured their prior deferrals.

CDO

Trups CDO action transferred

A challenge brought by a junior noteholder in five Trups CDOs regarding the trustee's interpretation of the transactions' payment mechanics has been transferred from a Minneapolis district court to the US District Court for the Southern District of New York (SCI 16 December 2013). The action - involving Tropic CDO I, II, III and IV and Soloso CDO 2005-1 and 2007-1 - has also been consolidated into a single proceeding.

Answers to the petition from all interested parties are due by 28 February. Parties participating in the proceeding are then expected to file any pre-motion letters for motions for judgment on the pleadings by 31 March.

CDS

Crossover constituents to increase

The iTraxx Crossover Index is set to expand by 10 names to 60 during the March 2014 index roll. This will be done by leveraging the iTraxx Crossover Supplementary List rules, with updated iTraxx Europe Index rules reflecting this change to be published in the coming weeks. Markit says the move is in response to the continued growth in high yield bond issuance.

CLOs

CLO issuance forecast revised

JPMorgan has revised its downside forecast for US CLO issuance in 2014 to US$38bn, or 42% lower than its US$65bn base case, due to regulatory volatility. The bank's supply expectations for European CLOs remain at €10bn-€15bn, given the level of investor demand across the region.

CDO strategists at the bank have also revised their end-2014 US CLO primary triple-A spread target to 145bp over Libor from 125bp-130bp over. "The CLO credit curve will remain flat with regulation affecting banks, but the point is that our minus US$17bn downside net supply case will not be enough to feed the demand of CLO carry - a reason why we still have a tighter (albeit marginally) triple-A spread forecast, even if not all of this carry is reinvested," they explain. If 2014 supply declines to US$38bn, net supply will drop into negative territory (minus US$17bn), falling short of an estimated US$12bn CLO carry.

The JPMorgan strategists estimate that banks represent about three-fourths of triple-A interest, while asset managers represent 7% and insurance companies 12%. In a downside case where there is no Volcker Rule clarification, they assume that US bank triple-A CLO demand could drop by around 80%. Real money and insurance demand could rise to an extent as spreads remain wide, but these investors are a much smaller part of the CLO triple-A investor base to begin with.

Meanwhile, the European CLO primary triple-A spread target stands at 135bp-140bp over Euribor. Valuations in the region are supported by the lack of wide triple-A spreads in European ABS, except in peripheral names, according to the strategists.

CLOs

Vivarte exposure eyed

French retailer Vivarte last week suspended payments on €2.8bn of buyout debt while it negotiates a restructuring. The move could cause some European CLOs to fail their coverage tests, resulting in a diversion of cashflows from junior to senior tranches.

European securitisation analysts at Bank of America Merrill Lynch estimate that Vivarte accounts for around 2% of the underlying collateral in European CLOs, with the exposure varying from deal to deal. Following the Vivarte announcement, some spread widening was seen lower in the capital structure for some transactions, particularly where there is greater exposure to Vivarte or where coverage tests are already close to failing.

In total around €160m of bonds appeared on BWIC lists over the week, most of which traded, in contrast to the previous week when many line items did not. Triple-B spreads now range mostly from the 400s to 500 DM, while double-B spreads are now mostly in the 600s to 700 DM, according to BAML. Few original triple-A or single-A bonds were out for the bid last week, while double-A spreads appeared to be mainly in the high 100s DM.

CLOs

Euro ramp-up risk overdone

European CLO managers do not appear to have found it difficult to ramp up their portfolios, with most reaching their effective dates ahead of the anticipated time, S&P reports. The agency has analysed ramp-up activity in 2013, given that managers faced a dearth of new loans to use as collateral, introducing the risk of investment in lower-quality less diverse assets.

S&P analysed data for nine European CLOs that were issued last year and have now reached their effective date: ALME Loan Funding 2013-1, Ares European CLO VI, Cairn CLO III, Carlyle Global Market Strategies 2013-1, Dryden XXVII Euro CLO 2013, Grand Harbour I, Harvest CLO VII, Herbert Park and St Paul's CLO II. Overall, assets in effective-date portfolios were found to have a slightly higher collateral quality than expected at closing.

The agency also observed more loans in the effective-date portfolio, although this is largely due to a lower-than-expected bond exposure in the Herbert Park transaction. The CLOs are mostly exposed to assets in the UK, Germany and France, with less than 10% exposure to peripheral European countries.

"Overall, we observe that managers have experienced less difficulty ramping up their portfolios than some market commentators may have expected, with most transactions reaching their target size ahead of time and obtaining better credit quality portfolios on their effective dates than targeted at closing," S&P notes. "Our comparisons of the target and effective date portfolios also suggest that managers have not had to acquire collateral with lower yields than expected and that the gap between actual and covenanted spreads has generally been higher than targeted."

However, there appears to be a slightly more concentrated obligor and industry concentration in the effective date portfolio. Across transactions, there is also a slightly higher allocation to senior secured bonds than targeted, although they generally account for a fairly low proportion of CLO portfolios - often a significantly lower proportion than the transaction documents allow.

CLOs

GSO/Blackstone tops manager rankings

Moody's top-10 CLO manager rankings in the US, Europe and globally have changed little since 2012, despite issuance in the US reaching a post-crisis high last year and issuance in Europe making a comeback. Ten new players entered the US CLO market in 2013, while Apollo expanded into the European market.

In the US, 81 managers issued new CLOs in 2013, compared to 56 managers in 2012. Over half the 81 issued two or more deals.

CIFC and GSO/Blackstone remained the top two CLO managers in the US by number of deals, as of 31 December. Carlyle moved into the top three, given that it now manages 25 deals.

Highland was the leader by dollar amount (managing about US$12bn of assets), followed by CIFC (with US$11.5bn under management). CSAM took third place by dollar amount, managing 21 deals amounting to US$10.4bn. ING added US$1.6bn in three CLOs last year, which brought its total assets under management to US$6.8bn across 16 CLOs. Invesco, Alcentra and KKR were pushed out of the US top ten.

The most active US managers in 2013 were Ares and CIFC, both closing six CLOs each, amounting to around US$3bn. GSO and Oak Hill followed closely, with five deals each. Carlyle, CVC/Apidos, MJX and Octagon each closed four CLOs.

The top 10 managers accounted for 25% (by number of deals) of new US CLO issuance last year. Managers with ten or more CLOs accounted for 45%, while new managers accounted for 4.5%.

Eighty-nine managers, who currently manage 91% of the US$278bn CLO market, had taken on CLO 2.0 deals prior to end-2013. Around 38% of CLO 1.0 managers have yet to manage a CLO 2.0 transaction. Of the existing CLO 1.0 managers, 35% returned to the CLO market in 2013 to issue their first CLO 2.0 deals, accounting for 18% of total issuance volume.

Ares and CSAM lead the US CLO 2.0 market by dollar amount, each managing US$5bn of assets. Ares also tops the ranking by number of deals, with 10 CLO 2.0 deals under management.

GSO/Blackstone and Carlyle follow closely in terms of total assets under management. Octagon and MJX made the top-10 by number of deals for the first time.

Palmer Square Capital Management, MCF Capital Management, DFG Investment Advisers, GLG Ore Hill, MidOcean Credit Fund Management, Chicago Fundamental Investment Partners, KCAP Financial, AXA Investment Managers, Credit Value Partners and Hildene Leveraged Credit entered the US CLO market for the first time in 2013.

Meanwhile, the number of European CLO managers stands at 45. Alcentra remains the largest CLO manager in the region, followed by Carlyle, Intermediate Capital Managers and GSO/Blackstone. For the first time, Ares made the top-10 by assets under management, managing six CLOs of about €2.3bn.

Seven managers dominated European new issuance in 2013, closing seven CLOs of about €2.3bn. Three managers in the top 10 - Avoca, Ares and Pramerica - issued one CLO each, for a total of €1bn. Apollo, Cairn Capital, CSAM and CQS also issued one CLO each.

Private equity firms continue to dominate the global CLO market. GSO/Blackstone remains the global CLO powerhouse, managing 39 CLOs totalling US$14.8bn. Carlyle follows closely by both number of deals and assets under management.

Moody's notes that the CLO industry remains concentrated: in the US, the ten largest managers account for about one-third of the deals it rates. Twenty-one have ten or more CLOs under management, accounting for 52% of total assets under management, up slightly from 2012. Similarly, in Europe the ten largest managers control about half the market.

CLOs

CLO refinancing options examined

Moody's notes in its latest CLO Interest publication that more refinancing options have become available for recent CLO 2.0 transactions. The agency says that the ability to refinance liabilities, either partially or in whole, is credit positive because refinancing enhances the available credit support and offsets the negative effects of loan re-pricings.

As the non-call periods of most 2011-2012 vintage CLOs continue to end, more of them can be expected to refinance. Refinancing the senior-most triple-A rated tranches should generally have the greatest impact on the cost of funding and the available excess spread in a transaction, Moody's observes. Deals from the 2011 and 2012 vintages with expiring non-call periods and high liability costs will be primary refinancing candidates in 2014, especially if CLO liability spreads narrow.

Equity holders in most early CLO 2.0 transactions can elect to either refinance or redeem the deal in whole once the non-call periods end. By 2012, however, giving CLO equity classes the ability to affect individual tranches refinancing had become commonplace - a trend that is likely to continue this year as the non-call periods of a slew of late-2011 and 2012 vintage CLOs end. Refinancing of an individual tranche is easier to execute than the optional redemption or refinancing of an entire deal.

Since January 2013, at least five CLO 2.0 transactions that Moody's rates (ALM Loan Funding 2010-3, OHA Intrepid Leveraged Loan Fund, Ares XVI CLO, BMI CLO I and Dryden XXII Senior Loan Fund) have refinanced a portion of their debt when their non-call periods expired. The average time between the closing date and the refinancing date was a little over two years, which coincides with the expiration of the non-call period. Liability spreads of triple-A rated tranches in refinanced transactions have dropped by 55bp on average.

Step-up tranches generally have an 18-month non-call period, versus the typical two-year non-call period for the remaining CLO tranches. The incentive to call or refinance step-up tranches is amplified by the increases in their liability spreads with the passage of time. The non-call periods of these transactions' step-up tranches will start ending in late-2014 or early 2015, with the pace of refinancing set to accelerate as a result.

Another option available for some CLO 2.0 transactions is tranche re-pricing, which allows for the reduction of CLO liability spreads without issuing new notes. Re-pricing availability varies by transaction: some allow the re-pricing of any tranche, while some limit re-pricing to the non-triple-A rated tranches. Although re-pricing seems less burdensome and more cost-effective than refinancing, issuers have not so far resorted to this option because of execution challenges.

New issue CLO spreads have moved differently at the senior and subordinate levels, making the economics of refinancing different from the top to bottom of the capital stack. Investors in refinanced senior tranches accept below-market coupons in exchange for shorter durations and more collateral certainty, while tighter spreads are the main drivers for mezzanine and junior tranches to accept a refinancing. Some of the refinanced transactions terminated their reinvestment period early in conjunction with the refinancing, to allow for a faster amortisation of their senior notes.

Spread tightening alone could support the refinancing of mezzanine and junior tranches, according to Moody's, because their new issue spreads have narrowed considerably since early 2012. Spread compression has impacted the lowest-rated tranches the most.

CMBS

Barbelled resolutions for GG10

The February remit for GSMS 2007-GG10 shows that 16 CMBS loans totalling US$592.6m were liquidated in the CWCapital auction at a weighted average loss severity of 51.3%. While this outcome is better than expected, the sale appears to have been barbelled, with some properties not commanding as high a price as the last appraisal value would suggest.

"The net proceeds upon liquidation totalled US$426m, which was 22% higher than the most recent appraisal value on a weighted average basis. However, there were six loans where the sales price was lower than the most recent appraisal value," Morgan Stanley CMBS strategists explain.

Similarly, the weighted average loss severity of 51.3% compares to an ARA-implied loss severity of 57.7%. However, there were nine loans where the loss severity was greater than what the ARA implied.

Notable resolutions include: US$160m 119 West 40th Street, which was liquidated with a US$48.9m loss; US$103.5m Maguire Anaheim Portfolio, which was liquidated with a US$56.6m loss; US$44.44m Hughes Airport Center II, which was liquidated with US$30m loss; and US$44.37m 3800 Chapman, which was liquidated with a US$20.2m loss. Several large properties that were identified as part of the CWCapital auction were not liquidated, including Two California Plaza, although the US$468m asset is listed as being under contract. Also not liquidated were National Plaza I, II, III (US$40.05m UPB), Montvale Plaza (US$25m UPB) and Berry Town Plaza (US$21m UPB).

Overall, US$300.6m of principal proceeds were received, resulting in a full pay-off of the A3 tranche and a US$7.4m principal payment on the A4 tranche. Losses were realised through the class G tranche, but not before 100% of the interest shortfalls were reimbursed on the class AJ through H tranches. Subordination on the A4 notes is now 29.31%, while the AM and AJ credit enhancement is 16.27% and 7.31% respectively.

CMBS

Late-pays drop on bulk sales

US CMBS delinquencies declined by 9bp in January to 5.89%, from 5.98% a month earlier. Late-pays are poised to fall by approximately 40bp over the next two months, however, due to CWCapital bulk asset sales being finalised and reflected in the February and March remittances. These distressed sales will likely bring the overall rate to below 5.5% by the end of the quarter.

To date, 16 CWCapital-serviced assets totalling US$593m in stated balance from the benchmark GSMSC 2007-GG10 transaction were reported as disposed/liquidated in the February remittance (see SCI's CMBS loan events database). These dispositions will drive the delinquency rate 14bp lower in February. The largest of the asset sales included the US$160m 119 West 40th Street and the US$103.5m Maguire Anaheim Portfolio, which resulted in losses of 31% and 55% respectively.

In January, resolutions of US$1.2bn outpaced additions to the index of US$783m. However, Fitch-rated new issuance volume of US$3.5bn fell short of US$4.3bn in portfolio run-off last month, causing a modest decrease in the index denominator.

The largest addition to the index last month was the US$74m One HSBC Center securitised in GSMS 2005-GG4. The loan fell 60-days delinquent after the largest tenant, HSBC Bank, vacated most of its space at its 31 October 2013 lease expiration.

Meanwhile, the largest resolution in January was the sale of the REO Metropolis Shopping Center (BACM 2007-3). The asset, which had an original loan balance of US$86m, was sold in the second half of December for a US$66.3m or 77% loss.

All major property types saw improvements last month. The industrial sector led the way, with a 45bp drop as resolutions outpaced new delinquencies by a 4:1 margin. Hotels and retail saw declines of roughly 20bp or more, while multifamily and office delinquencies fell by roughly 10bp each.

Current and previous delinquency rates are as: 8% for industrial (from 8.45% in December); 6.77% for office (from 6.89%); 6.38% for multifamily (from 6.48%); 6.26% for hotel (from 6.50%); and 5.44% for retail (from 5.63%).

CMBS

CMBS commutations announced

MBIA Insurance Corp has disclosed that it commuted policies insuring approximately US$3bn of CMBS exposure, in which the reference CMBS were originally rated single-A, for a cost in excess of the third-quarter statutory loss reserve. The monoline says it now has approximately US$760m of CMBS exposure remaining, in which the reference obligations were originally rated triple-B, of which approximately US$391m is expected to generate losses in the next few years and for which it has established statutory loss reserves.

The announcement comes as Moody's placed on review for upgrade the ratings of 203 classes of US structured finance securities wrapped by MBIA and its affiliated insurance companies. The securities impacted include certain RMBS, ABS and CDOs. The action is driven by Moody's placing on review for upgrade the B3 insurance financial strength (IFS) rating of MBIA Corp.

CMBS

Further positive CWCap outcomes

The February remittance for the MLCFC 2007-5 CMBS recorded US$192m of liquidations across 10 properties listed in the CWCapital bulk sale. The dispositions resulted in US$103.7m of realised losses, implying a 54% severity, according to CMBS analysts at Barclays Capital.

The liquidations pushed losses up to the F tranche of the transaction. After including US$67m of scheduled pay-downs, incoming principal fully paid back the A3 tranche and paid down the ASB by US$69m and the A1A by US$21m.

As was the case with the GSMS 2007-GG10 sales (SCI 13 February), the Barcap analysts note that net proceeds for MLCFC 2007-5 appear to be about 12% higher than the most recent appraisals would indicate. Of note, the US$50m Plaza Squaw Peak and US$43.1m East Thunderbird loans were liquidated for US$24.3m and US$28.8m respectively, in contrast to appraisals of US$20.7m and US$23m.

Four properties backing US$193m of distressed loans that were listed in the auctions are yet to be liquidated. The largest of these is the US$80m Resurgens Plaza that was last appraised at US$53m.

Servicer commentary indicates that a sale of the property is scheduled to close in March. As such, the MLCFC 2007-5 duper should become the front-cashflow class in the coming months.

CMBS

LDP11 bucks liquidation trend

Remittances have been reported for three more US CMBS with exposure to the CWCapital bulk sale - BACM 2007-1, JPMCC 2007-LDP11 and WBCMT 2006-C28. LDP11 appears to have bucked the trend for net sales proceeds to exceed recent appraisal values.

Seven JPMCC 2007-LDP11 loans totalling US$323m were liquidated at a weighted average loss severity of 73%, which is 10% higher than what the ARA implied, according to Morgan Stanley figures. Net proceeds totalled US$162m - a weighted average of 7% higher than the most recent appraisal value. But three loans were liquidated for lower than their most recent appraisal value, including the US$150m Hyatt Regency - Jacksonville loan, which was sold for 9% lower than the most recent appraisal value.

The transaction received US$88.7m of principal proceeds, resulting in partial payment of principal to the A2, ASB and A1A notes. The class J to T notes were written off in full, while class H was written down by 45%. Finally, the class AJ to J notes were reimbursed for their previous cumulative interest shortfalls.

BACM 2007-1 reported more favourable results, as eight loans totalling US$60.2m were liquidated at a weighted average loss severity of 47%, or 13% lower than the ARA-implied value. The US$44m proceeds paid down about a quarter of the A3 tranche, while ASER reimbursement interest proceeds repaid shortfalls on the AJ-F tranches. Losses wrote off the N-P tranches and almost all of the M tranche.

Finally, 18 WBCMT 2006-C28 loans were liquidated by CWCapital, accounting for US$548m of the outstanding balance. The sales pushed through US$183m of losses on the deal at 33% severity, according to Barclays Capital figures, and US$366m of unscheduled principal paid down at the top of the structure.

The A2 and A3 classes were fully paid down, while the A1A and APB tranches took partial pay-downs. Losses were realised all the way up to the F tranche, with the reimbursement of nearly US$17m of ASERs and other interest enough to pay back all outstanding shortfalls down to the L class.

CMBS

NPL sales gather pace

The availability of debt finance for European commercial real estate rose dramatically last year and the pace of non-performing loan sales looks set to increase in 2014. European securitisation analysts at Bank of America Merrill Lynch expect a conservative portion of the resulting transaction volume to fuel future CMBS issuance.

CBRE last month put the total volume of outstanding CRE loans in Europe at around €926bn. Of the underlying properties, 34% are located in the UK, 25% in Germany, 20% in Spain and Portugal, 17% in France and the remainder are located in the rest of Europe.

Some 58% of outstanding debt represents the refinancing or extension since 2008 of older loans. Just 15% represents new lending since 2008.

The BAML analysts expect that extensions will continue to be a common outcome for many loans due to mature over the next three years. At end-2010, €127bn of European CRE loans were scheduled to mature in 2014. That figure has since increased to €205bn, with extensions of older loans believed to account for the bulk of the increase. Further, €538bn of loans are due to mature within the next three years, many of which are backed by secondary quality property and have high LTVs.

€30.3bn of CRE loan and REO sales were conducted last year, up from €22.5bn in 2012, according to Cushman & Wakefield data. The firm estimates that CRE loan sales worth €45.2bn are currently underway, with the pipeline of disposals said to total at least €33.7bn.

US private equity firms - including Lone Star, Apollo, Fortress and Cerberus - accounted for roughly 70% of these transactions. European asset management agencies, such as NAMA and Sareb, represent an increasing share of supply.

The number of Australian, Canadian and US lenders increased from 12 at the start of the year to 35 at the end. Traditional bank lenders represented 55% of all lenders surveyed in 1Q14, down from 67% in 1Q12, as debt funds and private equity lenders enter the market.

At present, there are 41 debt funds investing in Europe, representing potential capital of €22.1bn. The funds operate a mixture of senior and mezzanine strategies, with higher return expectations meaning that they are more likely to lend against secondary quality property.

As a result of the increase in available debt finance and competition between lenders, the maximum LTV available increased in 2013 while loan margins tightened. The interest in peripheral European countries among new lenders stands out in particular.

For instance, the maximum LTV available in Spain increased by 10 points to up to 60%. At the same time, loan margins have decreased to roughly 300bp-500bp from 500bp-650bp a year ago.

Risk Management

OBO trade completed

Tradeweb Markets has completed what is believed to be the first swap trade by a futures commission merchant 'on behalf of' (OBO) a US-based asset manager on a swap execution facility (SEF). Credit Suisse successfully executed a five-year high yield credit default index swap via TW SEF on behalf of an asset manager, which cleared at ICE Clear Credit.

Tradeweb recently enabled agency access to TW SEF, providing market participants with flexible, sponsored access to liquidity in derivatives. In addition to OBO trading on TW SEF, customers may also gain direct market access (DMA) supported by an introducing agent, with connectivity to independent software vendors (ISVs) scheduled to go live in the coming months.

Risk Management

SEF, MTF harmonisation progressing

The CFTC and the European Commission say they have made "significant progress" towards harmonising a regulatory framework for CFTC-regulated swap execution facilities (SEFs) and EU-regulated multilateral trading facilities (MTFs), as contemplated under the Path Forward statement issued in July 2013. The Path Forward statement set out that the CFTC and EC would work together on extending appropriate time-limited transitional relief to certain MTFs, in the event that the CFTC's trade execution requirement was triggered before 15 March 2014.

Accordingly, CFTC and EC have engaged in further dialogue regarding the treatment of MTFs under the CFTC's regulatory regime, building upon the common objective to rigorously and expeditiously implement the G20 commitments - particularly with regard to mandatory trading on regulated and organised platforms. As a result, CFTC staff today issued two no-action letters providing relief to certain EU-regulated MTFs.

The first no-action letter provides no-action relief for: qualifying MTFs from the SEF registration requirement; parties executing swap transactions on qualifying MTFs from the trade execution mandate; and swap dealers and major swap participants executing swap transactions on qualifying MTFs from certain requirements under the CFTC's business conduct rules. A separate short-term no-action letter provides limited relief for all registered MTFs through 24 March, in order to provide sufficient time for MTFs to identify themselves to the CFTC as a condition to the relief and comply with certain other conditions for obtaining relief.

The CFTC is currently developing a rulemaking to set out a process under section 5h(g) of the Commodity Exchange Act for foreign-based swap trading platforms to seek appropriate regulatory treatment under US law. The first no-action letter will expire upon the effective date of such rulemaking.

Risk Management

SEF volumes low ahead of MAT

MarketAxess estimates that less than 20% of CDS index volume is trading on SEFs, ahead of the 26 February 'made available to trade' (MAT) deadline. Together the eight products that fall within the CDS MAT determination represent 80% of overall volume in CDS index market.

The universe of required transactions falling under MAT is substantial in terms of its proportion of the market, MarketAxess notes. However, the majority of volume is concentrated in the two main indices - the CDX.IG and the iTraxx Main - which together account for 66.5% of volumes in the overall market.

"While we anticipate there may be a fall in industry-wide CDS index volumes in the days following the MAT implementation date, the majority of active participants are ready for the new world," MarketAxess observes. "Once the dust has settled, we believe that the industry will benefit from the increased liquidity and greater efficiency that come from more open and competitive swaps markets."

RMBS

RMBS tender withdrawn

Fir Tree Partners has terminated its cash tender offer for six RMBS (SCI passim). All of the trusts that were subject to the offer are involved in active litigations against JPMorgan for breaches of representations and warranties. On those trusts where Fir Tree is acting as a directing holder, it says it will continue to vigorously seek to prosecute these litigations going forward.

RMBS

'Broken swap' restructurings progressing

Restructurings are progressing, at different stages, for three UK Lehman RMBS.

First, restructuring proposals have been implemented for ESAIL 2007-PR1 (SCI 5 February), with an aggregate amount of US$64.87m of proceeds converted into an amount of £39.78m. £1.5m converted realised termination amounts were credited to the restructuring costs ledger and the remainder to the distributable termination proceeds ledger, according to RBS.

The currency of each class of notes was also amended to sterling from euro at the rate of 1:1 and class pool factors were reduced. The margin of the class M, B, C and D notes was amended to 1.46%, with the class A margin remaining unchanged at 0.4%

Second, ESAIL 2007-6NC noteholders have passed an extraordinary resolution related to the sale of the remaining claims against LBSF and LBHI, first stage restructuring proposal following the sale, and a further restructuring following the first stage restructuring. Agfe has consequently been appointed as auction/FX agent to solicit bids from the prospective purchasers, as well as manage the auction process and agree the conversion of the sale proceeds and distribution amounts from US dollar to sterling.

Finally, a noteholder meeting for MARS 4 has been convened for 12 March to consider an extraordinary resolution to enter into a termination and settlement agreement with LBSF and LBHI. LBHI and LBSF have indicated to the issuer an agreed claim amount of US$13.5m in exchange for the issuer agreeing that all collateral (£3.67m, as of 5 February) held by HSBC in connection with the hedging agreements be returned to LBSF. JCRA has advised the issuer that this proposal is in its best interests.

RMBS

NHG approach clarified

S&P has published additional criteria for assessing the support from the NHG guarantee in Dutch RMBS. The criteria clarify the methodology the agency uses for the analysis of Dutch government support under the NHG programme.

The criteria apply to all new and existing Dutch RMBS and covered bond deals where the benefit of the guarantee provided under the Dutch NHG programme is incorporated. S&P does not expect any outstanding ratings to be affected by the changes.

RMBS

Return to flexible lending welcomed

The Dutch Finance Ministry last month published the minutes of its periodic meeting with the Authority for the Financial Markets and Dutch Lenders Association regarding the application of the Code of Conduct for mortgage lending. Moody's considers flexible lending to be credit positive as normal lending practices cautiously return to the Dutch RMBS market.

The agency notes in its latest Credit Insight publication that key Dutch lenders have expressed their commitment to customisation within existing affordability criteria. But recent legislation and tight controls have limited mortgage providers in their use of these so-called 'explain cases'.

The tightened criteria included in the Code of Conduct led to the reduction of maximum loan-to-income (LTI) multiples for all borrower types, ultimately affecting high-income borrowers most. However, as of January 2014, the tightening of LTI criteria stabilised.

In addition, the actual volume of loans originated above the maximum LTI affordability criteria has reduced significantly. For example, for loans originated in 2009-2012, the percentage of LTI explain cases reached approximately 16%, down from the peak at 59% in 2006.

This particularly affected mortgage loans available to self-employed borrowers, as affordability is typically difficult to determine for this segment. As a result, an unintended further tightening of the underwriting criteria occurred.

Although self-employed borrowers are more exposed to economic volatility, they have a limited overall impact on Dutch RMBS, owing primarily to: lower loan-to-foreclosure values (LTFVs), compared with employed borrowers; the recent reduction of explain cases; and concentrated exposure in key economic regions. As criteria have stabilised and lenders have expressed commitment to customisation within existing affordability criteria, lending especially to self-employed borrowers should cautiously return in 2014, according to Moody's.