Contents

ABS

Cards support US ABS secondary supply

US ABS bid-list supply during yesterday's session was mainly accounted for by credit card names. BWIC volumes reached almost US$150m with auto, aircraft and student loans paper also circulating.

SCI's PriceABS data captured a varied mix of credit card tranches out for the bid in yesterday's session. Among them was the BOIT 2004-C2 C2 tranche, which was talked at Libor plus 45 and covered at 38.

AMXCA 2012-4 A was talked at Libor plus 26. The tranche had been talked in the high-20s in January and traded in October, when price talk had been in the low/mid-30s and mid-30s.

The CCCIT 2005-C2 C2 tranche was talked at Libor plus 55 and covered at 52. The tranche previously appeared in PriceABS in April 2013, when it was covered at 62.

There were also a couple of CHAIT tranches, with CHAIT 2007-C1 C1 talked at Libor plus 80 and covered at 79. That tranche had been covered at Libor plus 83.8 in January and also traded in August 2013.

CHAIT 2012-A3 A3, meanwhile, was talked at plus 14. The tranche was covered at plus 15 last month and was talked at plus 12 in January, having appeared in the PriceABS archive several times since its debut in July 2013.

GEMNT 2012-4 B was talked at Libor plus 70 and covered at 88, while MBNAS 2004-C2 C2 was talked at Libor plus 40 and covered at 39. Each of the tranches previously appeared in the archive in August 2013.

Rounding out the credit card supply was the WFNMT 2013-A A tranche, which was talked in the low-50s and covered at 50. It was previously covered on 21 November 2013 at 70.

While much of the supply came from credit card names, other sectors were also represented. The AMOT 2012-5 A auto ABS tranche was talked in the mid-40s and covered at 47. The tranche was previously covered at plus 53 on 20 November 2013 and was covered the week before that at plus 57.

In the aircraft space, the AIRFP 8.027 10/01/19 tranche was talked in the mid/high-100s. A US$1.268m slice of the tranche was traded last month.

PALS 2000-1 A2 was another aircraft name out for the bid and was talked in the low/mid-30s. The tranche was talked and covered at the same level on 6 February and also traded on 5 February.

Lastly, in the student loan space, the ACCSS 2003-A B tranche was talked in the mid-high 70s. The tranche is seldom seen and previously appeared in the PriceABS archive on 30 January 2013, when it was talked in the mid-70s.

JL

CMBS

CMBS investors play waiting game

It has been a quiet week for the European CMBS market as investors on either side of the Atlantic remain in 'wait and see' mode. One trader reports that clients appear to be waiting for spreads to widen, although US accounts could spark some activity.

"There is a lot of interest in European CMBS from investors in the US. They are generally happier than European accounts to take a bit more risk in return for a bit more yield," the trader says.

He continues: "The problem is that while a few of them are active, there are more that are still waiting on the sidelines and considering their options without committing. I think they are a bit disappointed by the size of the market, because the mezzanine options are limited."

European hedge funds also seem to have been put off by the lack of high-yielding paper available. At the same time, asset managers - who might have otherwise stepped in - often find that senior bonds are not rated highly enough.

But the trader notes that events to the east of Europe might provide the spark that many market participants are seemingly waiting for. "Ukraine could be a market hiccup that would drive the market wider," he says. "Prices are up right now and people say that they want to buy when prices are down. The problem with that is that once a dip does come, those buyers say that they do not want to buy when prices are moving down."

The trader adds: "I think what we need now is for investors to start coming in and being a little bit braver. The opportunities are there."

Meanwhile, the latest loan-related news to surface involves Talisman 4. Principal losses could now reach the class A notes as the transaction's two remaining defaulted loans - DT12 and Valentine - are expected to suffer losses under recent proposals from the loans' sponsor. Subordination currently stands at €110m, but the losses could be €113.5m, with secondary market pricing likely to soften as a result of these developments.

SCI's PriceABS data picked up the TMAN 4 B tranche out for the bid yesterday. It was recorded as a DNT, having been talked on Wednesday between the low-80s and low-90s.

The TMAN 5 and TMAN 6 B bonds were also circulating during the session. While the former was another DNT, price talk on the latter was at 72.

JL

RMBS

US RMBS BWICs back in bulk

US non agency RMBS bid-list volumes picked up considerably yesterday to reach almost US$850m for the session. Activity was up across fixed rates, hybrids and subprime, with SCI's PriceABS data capturing a mix of covers and DNTs.

One such subprime bond was the CWL 2006-26 M1 tranche, which traded during yesterday's session. The tranche was previously picked up by PriceABS almost a year ago on 11 March 2013, when it was talked in the low/mid-single digits, and first appeared in the archive in August 2012, when it was talked in the low-singles.

CWL 2006-21 2A3 was covered at 84 handle, which is the same level at which it was covered on Friday. The tranche appeared on bid-lists a couple of times last year and was first picked up by PriceABS on 31 July 2012, when it was covered in the low/mid-70s.

Another Countrywide tranche - CWL 2007-12 1M1 - was also traded during the session. That tranche had not appeared in PriceABS before.

Among the other names of interest from the session, LXS 2007-15N 4A1 was covered at 71 handle. The tranche was previously covered last May in the low-70s and first appeared in the PriceABS archive a year before that, when it was talked in the mid-50s.

MSAC 2007-HE1 A2C was covered at 61 handle, which is the same level at which it was covered on Friday. The tranche had been talked in the high-50s in mid-February.

MSAC 2005-HE2 M3 was traded in the low/mid-80s. The tranche was previously talked in December in the 90 area but failed to trade.

OOMLT 2007-1 2A3 was covered at 57 handle, having also been covered at that level on Friday. The previously recorded cover before that was at 54 handle on 23 May 2013.

RALI 2006-QO7 1A1 was covered at 64 handle. When it was first picked up by PriceABS on 27 November 2012 it was talked in the low-50s.

SASC 2007-BC1 A4 was covered at 81 handle. It was covered slightly lower at 80 handle last week but before that was covered in the high-70s.

WAMU 2007-OA6 1A, which came back as a DNT in January, was covered yesterday at 86 handle. The tranche has made multiple appearances in PriceABS, having first been talked in the low/mid-60s on 4 June 2012.

There were also a couple of tranches which were new to PriceABS, such as a US$20m piece of the JPMAC 2007-CH5 M4 tranche which was successfully traded. A US$9m piece of the SAIL 2003-BC1 M1 tranche was also covered at 96.

While many of the tranches out for the bid were traded yesterday, some did come back as DNTs. Among them were AMSI 2005-R4 M5, CARR 2006-NC2 M1 and PPSI 2004-WHQ1 M5, as well as two tranches new to PriceABS: FFML 2005-FFH3 M5 and HVMLT 2005-9 B7.

JL

RMBS

US RMBS gathering steam

US non-agency RMBS supply picked up yesterday as BWIC volume reached around US$664m. That level is set to rise with Freddie Mac preparing to sell US$1.15bn of legacy paper.

The Freddie bid-list, which is due tomorrow, is expected to be the biggest bulk secondary sale of non-agency RMBS bonds since the final ING liquidation a month ago (SCI 31 January). It is understood to include 46 individual securities, of which just over half are non-investment grade and backed by subprime collateral.

The loans are said to be seasoned and generally performing well. Average face value is thought to be in the low-90s, with demand expected to be strong.

As for yesterday's supply, SCI's PriceABS data shows 43 unique US non-agency RMBS tranches out for the bid, with several trading. Supply was dominated by a mix of subprime and fixed-rate bonds, with adjustable-rate supply also higher than it had been to start the week.

For example, AMSI 2004-R² M1 was covered at around 80 during the session. When it first appeared in the PriceABS archive on 25 July last year, it was talked in the mid-80s.

BSARM 2005-12 12A1 was talked at mid-80 and covered at 87.33. The tranche was previously talked in the mid-80s in November and in the low/mid-80s in October.

CWL 2006-BC5 2A3 was covered in the low/mid-80s. When it first appeared in the PriceABS archive on 1 April 2013, the bond was talked in the low-70s and mid-70s.

Several Countrywide tranches were circulating yesterday, with CWALT 2005-79CB A5, CWALT 2006-6CB 1A4, CWALT 2006-J2 A10 and CWHL 2006-10 1A2 all also attracting covers. Additionally, CWALT 2006-19CB A4 was out for the bid and talked in the high-80s.

The HEAT 2006-5 2A3 tranche was another interesting name seen during the session. The tranche first appeared in the PriceABS archive in July 2012 (when it was talked in the low-50s) and had not made an appearance since January 2013, but was covered yesterday in the mid-80s.

LUM 2006-6 A1 was talked at high-80 and covered at 87.58, while MSM 2006-11 2A2 was covered in the low-80s. A couple of other names of note were the RALI 2007-QO2 A1 tranche (which was covered in the mid/high-50s) and the RAMP 2006-EFC1 M3 tranche (which was covered in the high-50s).

Trade prices were also captured for a range of names. For instance, MSHEL 2006-2 M1 traded in the low/mid-60s, as did SABR 2006-OP1 M4. Both NCHET 2005-B M1 and OOMLT 2005-5 M2 traded in the mid-60s, while PPSI 2005-WHQ4 M2 traded in the mid-70s.

JL

ABS

Tiering forecast for water WBS

Fast-tracking of business plans among certain UK water companies is expected to drive tightening across their securitised bonds. The move follows the release of Ofwat's guidance on allowed weighted-average cost of capital (WACC) for the 2015-2020 regulatory period (PR14) (SCI 10 February).

Allowed returns are likely to fall to 3.85% for PR14, versus 5.1% for the previous regulatory period (PR09). In its base-case scenario, Moody's believes that ratings will be stable for the leveraged opcos (except for Southern Water Services) - albeit they will be more volatile, given the lower returns.

In Moody's base case, dividends will continue to flow out of the opco to service the holdco Anglian, Kelda and Thames bonds during PR14. "With the holdco bonds of Anglian, Kelda and Thames now offered at spreads of 350bp, 340bp and 410bp respectively, they offer value relative to the other holdco bonds of Heathrow and NWENET, with a potential pick-up of between 70bp and 170bp," observe Barclays Capital European securitisation analysts. "On an absolute level, the 6% yield on the Thames holdco bonds looks attractive, given the risks, and relative to Ofwat's guidance on the allowed return on equity for the sector of 5.6% during PR14."

Since dividends will likely continue to be paid out for Anglian, Kelda and Thames, the Barcap analysts suggest that Moody's has confirmed the downside risk on these bonds is limited to a one- to two-notch downgrade rather than default. "In our view, Anglian and Kelda will likely opt for fast-tracking of their business plans from April 2014, which should be a catalyst for a significant tightening in these bonds. Southern remains a concern and, as a result, we would expect these bonds to trade wide of the rest of the sector until the end of this year/early next year, when we would expect the company to outline the balance sheet support and improvement plan to avoid any dividend block from the opco."

Southern did not take action during PR09 to defend its ratings, which were downgraded due to the structure of the index-linked swaps and also under recovery of revenue. Given a reluctance to inject equity or restructure its swaps in PR09, Southern's opco and holdco bonds are expected to remain wide of the sector.

If water companies accept the allowed returns as currently proposed by Ofwat, the analysts believe that a number of levers are available for them to pull in order to keep headroom against covenants and rating action. These levers include: injecting equity into the opco; the flexibility offered by totex; reducing dividends; issuing index-linked debt; capital programme efficiencies; and operating outperformance.

CS

Structured Finance

SCI Start the Week - 10 March

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

Pipeline
After a busy couple of weeks, the pace of deals joining the pipeline increased even further last week. Eight new ABS, one ILS, five RMBS, one CMBS and three new CLOs were announced.

The ABS were: US$731.4m AmeriCredit Automobile Receivables Trust 2014-1; US$774.18m Chrysler Capital Auto Receivables Trust 2014-A; US$180m CPS Auto Receivables Trust 2014-A; US$672m Hyundai Auto Lease Securitization Trust 2014-A; €600m SC Germany Auto 2014-1; US$300m Sierra Timeshare 2014-1; US$669.45m SLM 2003-12 A6, which was remarketing; and US$1.25bn Toyota Auto Receivables 2014-A Owner Trust.

The ILS was US$300m Merna Re V. As for the RMBS, they consisted of: Lanark Master Issuer Series 2014-1; US$508.6m New Residential Advance Receivables Trust Series 2014-T1; US$511.6m New Residential Advance Receivables Trust Series 2014-T2; US$41.5m New Residential Advance Receivables Trust Series 2014-VF1; and €275m Saecure 14.

The newly-announced CMBS was WFRBS 2014-C19. Finally, the US$363.75m Cedar Funding III, Ocean Trails V and US$600m OZLM VI CLOs joined the pipeline.

Pricings
It was also a very busy week for deals departing the pipeline. Last week saw eight ABS prints, with two ILS, three RMBS, four CMBS and seven CLOs also pricing.

The ABS prints were: US$140.43m ACER 2014-1; US$800m Chesapeake Funding 2014-1; US$850m Citibank Credit Card Issuance Trust 2014-3; US$850m Discover Card Execution Note Trust 2014-2; US$103.8m HERO Funding Series 2014-1; US$509m Nelnet Student Loan Trust 2014-2; US$573m PHEAA Student Loan Trust 2014-1; and A$629.52m SMART ABS Series 2014-1US Trust.

The ILS pricings were US$270m East Lane Re IV Series 2014-1 and US$125m Gator Re series 2014-1, while the RMBS were A$400m HBS Trust 2014-1, £361m Paragon Mortgages 19 and A$1bn Progress 2014-1 Trust. The CMBS new issues comprised: US$1.016bn CGCMT 2014-GC19; US$1.2bn COMM 2014-UBS2; US$460.2m GP Portfolio Trust 2014-GPP; and US$306.3m GSMS 2014-NEW.

Finally, the CLO prints consisted of: US$514.4m Ares XXIX; US$417m Battalion V; US$614m GoldenTree VIII; US$584m KVK 2014-1; US$580m Mountain Hawk III; US$420m OCP 2014-5; and €435m St Paul's IV.

Markets
BWIC volumes last week climbed in the European RMBS secondary market to return to average levels, while steady demand resulted in strong execution, according to securitisation analysts at Bank of America Merrill Lynch. They note: "The bulk of activity in the periphery was in Portuguese RMBS and Spanish mezz, including programmes with lower-quality collateral pools. Periphery and non-prime continue to outperform core/prime markets; thus, the credit compression theme is still here."

It was a quiet week for the European CMBS market, however, as SCI reported on 7 March. One trader reports that clients appear to be waiting for spreads to widen, although US accounts could spark some activity.

"There is a lot of interest in European CMBS from investors in the US. They are generally happier than European accounts to take a bit more risk in return for a bit more yield," the trader says.

US non-agency RMBS bid-list volumes picked up considerably to reach almost US$850m on Wednesday (SCI 6 March). SCI's PriceABS data captured a mix of covers and DNTs, with activity up across fixed rate, hybrid and subprime bonds.

Activity in the US CMBS market was largely steady, with US$233m seen on Tuesday's BWICs (SCI 5 March). A considerable chunk of that supply was accounted for by the US$116.358m MLCFC 2007-7 AJ bond, which PriceABS shows was talked in the mid/high-40s during Tuesday's session.

In the US ABS space, secondary spreads were largely unchanged, Wells Fargo structured product analysts observe. "A modest amount of ABS new issue volume seemed to generally support current spread levels," they add.

Deal news
• Vivarte's decision to suspend payments on its debt (SCI 18 February) has served as a wake-up call regarding tail risk in European CLO portfolios. While further spread tightening is anticipated across the 2.0 capital structure (notwithstanding current macro concerns), investors are likely to be more selective in 1.0 paper, given emerging idiosyncratic risks.
• The noteholder dispute over Mount Street's replacement of Capita as the special servicer for Titan Europe 2007-1 (NHP) (see SCI's CMBS loan events database) is diverting attention away from the more pressing issue that capital expenditure is not adding significant value. Selling the portfolio now rather than waiting for valuations to increase appears to make more sense.
• Dynasty Property Investment is prepping its second cross-border CMBS. Dubbed China Real Estate Asset Mortgages, the US$290m transaction is backed by nine retail properties in nine cities across China.
• Five Granite Master Issuer Series 2006-3 tranches have been downgraded, following a correction to an input used in the rating process. The affected ratings had either been affirmed or upgraded on 18 February.
• Cowen and Company has been appointed as liquidation agent for Blue Edge ABS CDO, the collateral of which will be disposed of via a public auction. The collateral will be split into five separate portfolios for sale: Alt-A RMBS, mixed RMBS, ABS CDO assets, CRE CDO assets and zero-factor assets.
• An auction is slated for Kleros Preferred Funding on 24 March. A separate auction has been scheduled for Trainer Wortham First Republic CBO V on 21 March.

Regulatory update
• The Basel Committee has published the results of its latest Basel 3 monitoring exercise. A total of 227 banks participated in the study, comprising 102 large internationally active banks (Group 1 banks) and 125 Group 2 banks.
• The EBA has published a report on the leverage ratio that provides a policy analysis and a quantitative assessment of the impact that would derive from aligning the current Capital Requirements Regulation (CRR) definitions of the leverage ratio's exposure measure to the revised Basel 3 standard published by the Basel Committee on 12 January. The report uses data collected for the Basel 3 monitoring exercise as of 30 June 2013 through a sample consisting of 173 EU institutions from 18 member states.
• A trial court's decision to dismiss Assured Guaranty Municipal Corp's claims for rescessory and consequential damages in an action against Credit Suisse regarding US$1.8bn in RMBS has been reversed. New York's Appellate Division, First Department has also reinstated claims for damages.

Deals added to the SCI New Issuance database last week:
Alba 5; Ally Auto Receivables Trust 2014-SN1; Ascentium Equipment Receivables 2014-1; Barclays Dryrock Issuance Trust series 2014-1; Carlyle Global Market Strategies Euro CLO 2014-1; CGCMT 2014-GC19; Citibank Credit Card Issuance Trust 2014-A2; COMM 2014-UBS2; CSMC Trust 2014-SAF1; E-Carat 3; Golub Capital Partners CLO 18; Harvest CLO VIII; Limerock CLO II; Race Point V CLO; Regatta III Funding; SLM Private Education Loan Trust 2014-A; TORRENS Series 2014-1 Trust; Trafford Centre Finance; Tuolumne Grove CLO 2014-1; USAA Auto Owner Trust 2014-1; Volvo Financial Equipment Series 2014-1; Zais CLO 1.

Deals added to the SCI CMBS Loan Events database last week:
COMM 2013-CCRE10; DECO 2006-E4; DECO 9-E3; EMC VI; EPICP DRUM; EURO 25; EURO 27; FLORE 2012-1; GCCFC 2007-GG9; GMACC 2004-C3; GMACC 2006-C1; GSMS 2007-GG10; GSMS 2012-GCJ7; INFIN SOPR; LBUBS 2005-C2; LBUBS 2006-C3; MLCFC 2007-5; TITN 2006-3; TITN 2007-2; TITN 2007-CT1; TMAN 4; WINDM VIII; WINDM X.

Top stories to come in SCI:
Developments in Chinese ABS

CLOs

Refinancing promises big savings

Up to US$30bn of US CLO 2.0 deals could be candidates for refinancing this year, with refinancing or repricing potentially saving equity holders 20bp-50bp in liability costs. However, the pace of such activity will depend on factors such as upfront cost and secondary CLO paper providing competition for buyers.

Individual tranche refinancing or repricing options began with the arrival of CLO 2.0. While both options serve to decrease CLO liability costs short of a full redemption, there are differences. A refinancing redeems a tranche and replaces it with a new one with a lower coupon, while the less commonly used repricing option reduces the coupon without redeeming the tranche.

A refinancing or repricing can also entail changing the reinvestment period, depending on the documentation of the deal. Equity investors therefore would need to weigh the relative merits of liability cost saving and asset trading opportunities near the end of the reinvestment period.

Of the deals issued from 2010 to early 2012, seven have engaged in tranche refinancing or repricing since the start of last year. All of them refinanced at least the triple-A notes, which had average coupons of Libor plus 151bp before refinancing.

JPMorgan CDO analysts note that those tranches each saved 25bp-175bp in coupon, with an estimated overall 19bp-90bp annual reduction in all-in liability cost. Adjusted by leverage, the cost saving to equity is 1.7% to 5.4% per year.

Some CLOs changed the length of their reinvestment periods, such as OHA Intrepid Leveraged Loan Fund and BMI CLO I, which each brought their end of reinvestment date forward by at least a year. Those refinancings brought their triple-A coupons down to around Libor plus 90bp, which is where seasoned triple-A CLOs were trading at the time.

More recent refinancings and repricings have kept reinvestment periods unchanged. Triple-A coupons for these deals have typically been cut less strongly to around Libor plus 120bp-130bp, which is where benchmark CLO triple-As of similar WALs were trading.

The average coupon of refinanced triple-A notes in 2014 is 152bp. The JPMorgan analysts note that 10 CLOs are still in their non-call period, while 33 are outside of their non-call period with triple-A coupons at or above 150bp. By the end of the year, they suggest that US$14bn of CLO 2.0 triple-As will become refinancing candidates.

Although triple-A notes account for most of a CLO's funding cost, savings in mezzanine can also contribute to a lower all-in cost. A significantly flatter credit curve means that subordinated tranche coupons can be reduced more drastically than triple-A coupons.

The average all-in funding cost of the four deals refinanced in 2014 - Dryden XXII Senior Loan Fund, ALM V, Race Point V CLO and ING IM CLO 2012-1 - is 222bp. The analysts calculate that by the end of the year there will be 75 CLO 2.0s with all-in funding costs greater than 200bp which will have rolled out of their non-call periods.

If coupons on all outstanding floating-rate triple-As could be reduced to Libor plus 120bp via refinancing or repricing, then US$19.8bn of CLOs from 44 deals that will roll out of non-call periods this year could save at least 1.7% in equity return. However, that saving does not consider the upfront cost of refinancing.

"Taking into account both CLO 2.0 funding cost and potential saving in equity returns, we think up to US$20bn-US$30bn CLO 2.0s could be candidates of refinancing this year. However, the actual refinancing volume could be much lower, given there is upfront cost and friction to do so and the supply would be competing with secondary CLO paper for buyers and would also depend on triple-A market pricing," the analysts conclude.

JL

CLOs

Euro CLO equity performance positive

European CLO equity cashflows have lagged their US cousins for several reasons, but their prospects continue to improve as credit conditions strengthen in Europe. Average returns increased last year and the broader economic recovery is yet to be fully factored in.

JPMorgan CLO strategists analysed 213 European CLO equity tranches issued from 1999 to 2011, representing around €10.9bn in original notional. They estimate European CLO equity total returns of around 55.6% in 2013, including an average 12.8% cashflow return.

By comparison, returns on the ELLI and Eurostoxx 50 indices were 8.6% and 22.7% respectively. Typical carry return on European CLO equity positions last year was 38.1%, according to the strategists. That figure is slightly below US carry of 39.8%, but more than ten times the 3.5% Eurostoxx 50 dividend yield and nearly seven times the 5.8% average carry on European high yield bonds.

While it may be too early to assess European CLO 2.0 performance, equity from newer issuances could offer roughly double the carry of the average European high yield credit. Average secondary market prices for European CLO equity rose by 17.5% last year, but remain at just below the early 2011 post-crisis peak.

The remaining number of stressed legacy credits, low NAVs and number of deals that are exiting their reinvestment periods mean that a further significant price upside is unlikely. "That said, rising prices demonstrate investor confidence; combining carry and capital returns, Euro CLO equity total returns were 55.6% in 2013 - just shy of 64.3% in 2012," note the strategists.

While the averages are impressive, there is considerable variation among CLO equity returns. As much as 24% of the universe returned no cashflows at all last year due to OC failure, while some of the best performers produced cashflow returns of 20%-30%.

Much of the cashflow return variance is down to vintage. Almost half of the CLOs still outstanding in the 2002-2004 vintages stopped cashflows versus only 17% of the 2005-2007 vintages, so cashflow return for the second group is several multiples of the first group.

The number of paid-down CLO 1.0 deals is increasing and the average paid-down deal has returned lifetime cumulative cashflows of 87.4% of original tranche balance - a 12.6% average principal loss, assuming a par entry point. However, this may not be representative of CLO 1.0 deals as a whole as the strategists believe that the average quality of outstanding deals is higher than paid-down ones, with cumulative returns capable of exceeding 100%.

European CLO equity performance is expected to depend on how residual stressed names are resolved. There may be a lag of up to a year between the European economic recovery and credit ratings, so CLO WARFs may not fully reflect the improving wider picture.

Legacy CLOs were printed without Euribor floors, but the proportion of Euro loans with Euribor floors has started to grow over the last two years, which should be a positive development for the 2.0 market. With Euro CLO liability costs appearing to be in line with or tighter than those in the US, and European loans tending to be a little wider in spread, the strategists also believe that there may be more of a spread arbitrage to capture.

JL

CMBS

Adverse selection on the rise?

Boosted by the FHFA's decision to limit GSE originations through tighter underwriting, the share of multifamily loans in US CMBS conduits has increased over the past year and now stands at 18%, according to Barclays Capital CMBS analysts. They warn that since agency financing remains about 50bp cheaper than private financing, there is some potential for adverse selection in CMBS conduit multifamily loans.

Freddie K debt yields and LTVs have shown a marked tightening over the past year, while the same metrics for conduit multifamily loans have stayed relatively flat. While there is little evidence of pro-forma underwriting, conduit multifamily loans also tend to show higher beta in terms of financial performance. NOIs for recent conduit multifamily originations were 10% above last year's and nearly 30% above 2010-2011 levels.

"Given this evidence of adverse selection, the rising share of multifamily in conduits should not be treated as a blanket positive, despite the outperformance of the sector. On the other hand, recently-issued Freddie K mezz may benefit from the improvement in collateral quality," the Barcap analysts observe.

Per unit valuations for non-student Freddie K loans has increased from about US$110,000 in 2012 to US$130,000-US$140,000 now - indicating better quality collateral. In contrast, the analysts point out that per unit valuations in CMBS conduits fell to US$80,000-US$90,000 in 2013.

"Some of this is due to geographic distribution: Freddie K has a higher share of underlying loans in better areas, compared with conduits," they explain. "Even within an MSA, the agencies attract better quality collateral. We find that in most geographies, average cap rates for Freddie K loans are 80bp-100bp lower than conduit multifamily [loans]."

Meanwhile, student housing accounts for 10%-20% of the assets backing multifamily loans in CMBS conduits. But after a spate of new construction in 2012, student housing has been under pressure - with REITs specialising in this market underperforming the broader apartment REIT index. Against this backdrop, Freddie has reduced the share of student-housing loans in its deals, with exposure to the collateral now down to 1%.

CS

RMBS

Housing reform to progress?

US Senate Banking Committee chairman Tim Johnson and ranking member Mike Crapo have reached an agreement on a housing finance reform proposal. While most of the detail isn't new, the requirement for 10% private capital coverage upfront has caused some surprise.

SFIG notes that the proposal includes: winding down and ultimately eliminating Fannie Mae and Freddie Mac; promoting a smooth transition period to the new system by providing specific benchmarks and timelines to guide the Federal Mortgage Insurance Corporation (FMIC) and market participants; mandating 10% private capital upfront and creating a mortgage insurance fund to protect taxpayers against future bail-outs; creating a member-owned securitisation platform that will issue a single standardised security guaranteed by the FMIC; establishing a cooperative entity with a cash window to ensure lenders of all sizes have access to the secondary mortgage market; retaining the 30-year fixed-rate mortgage; and maintaining broad liquidity in the TBA market. A transition to a FMIC will likely involve building a federal mortgage insurance fund similar to the FDIC's deposit insurance fund, with the GSE securitisation and servicer functions anticipated to be offloaded to a separate entity.

The draft legislation is similar to the Corker-Warner 'Housing Finance Reform and Taxpayer Protection Act' introduced in June 2013, RMBS analysts at Bank of America Merrill Lynch confirm. "The principles floated in the announcement are largely in line with those laid out by the Administration and some bipartisan camps," they observe. "These include taxpayer protection in a housing downturn; support for a stable, liquid and efficient mortgage market; a continued preference for the fixed-rate 30-year loan; prepayable mortgages; access to lenders of all sizes; and a broad access to credit. None of this is new."

But what is surprising is the continued requirement for a 10% private capital coverage upfront, which is the same amount that Corker-Warner called for and which the BAML analysts had expected to be reduced. They add that the 10% threshold for private capital coverage pushes out the timeline for a full transition to FMIC model.

"If origination were US$1trn per year, this would imply the need for US$100bn of new capital/funding per year while the programme is ramping up, which could be challenging. The need for a credit bid associated with every new mortgage could also prove to be limiting to the overall MBS market size and homeownership rate going forward," the analysts explain.

They suggest that the proposal is based on the FDIC model, which protects bank deposits and is supported by those who believe that government should continue to guarantee the bulk of the MBS market. "The elimination of affordable housing goals appears to be a concession to the right side of the aisle at the expense of the left, and the potential greater attention on multifamily lending is a new feature Corker-Warner did not focus on."

A draft bill is expected to be made public later this week and then move to a Senate Banking Committee vote by the last week of March. The analysts suggest that while the bill will likely pass in the Senate Banking Committee, it is less likely to reach a Senate vote this year, given that broader Democratic sponsorship might be required for it to pass. However, the analysts believe that the House is unlikely to support the bill because the House Financial Services Committee has a different view of how GSE reform should proceed.

CS

Structured Finance

Rating agency names new leader

Moody's has promoted Michael West to global head of structured finance ratings. He was previously global head of corporate finance rankings and will be replaced in that role by Mark Gray.

Structured Finance

FCA names investment banking head

The UK Financial Conduct Authority (FCA) has appointed Julia Hoggett as head of investment banking in its supervision division, beginning in early May. She joins from Bank of America Merrill Lynch, where she is currently md responsible for a range of debt capital markets products, including European commercial paper, covered bonds and green bonds in EMEA.

Hoggett was previously the ceo of DEPFA ACS Bank Ireland and has also worked at JPMorgan in debt capital markets roles covering sovereign, supranational and agency and emerging markets clients. She will report to Will Amos, the FCA's director of wholesale banking and investment management.

CMBS

Google buys into online marketplace

Google Capital has invested US$50m in Auction.com. A Google representative will join the online marketplace's board of directors and another will take a board observer position.

Auction.com will be able to tap into Google's digital marketing expertise and target a bigger share of the global real estate market. Google joins other strategic shareholders in the company, including Starwood Capital Group, Starwood Property Trust, Stone Point Capital and funds managed by affiliates of Fortress Investment Group.

Risk Management

Swap clearing business chief appointed

LCH.Clearnet Group has named Daniel Maguire as global head of its interest rate swap clearing business, SwapClear. He is based in New York and will report to LCH.Clearnet ceo Michael Davie.

Maguire was previously head of SwapClear in the US and global head of product and marketing. He has also worked at JPMorgan in its commodity exotics and hybrids business and began his career working at LCH.Clearnet in OTC derivatives.

RMBS

Trader convicted of TARP offences

A federal jury in New Haven, Connecticut has convicted former Jefferies md Jesse Litvak of multiple offences connected to a scheme to defraud customers trading in RMBS. He was convicted on 10 counts of securities fraud, a count of defrauding TARP and four counts of making false statements within the jurisdiction of the US government.

Litvak is the first person convicted of a crime related to the TARP bailout PPIP programme. He allegedly manipulated facts and made misrepresentations about bonds he was buying and selling to financially benefit his firm and, through bonuses, himself (SCI 29 January 2013).

As a broker-dealer, only Litvak knew the selling and asking prices of parties, with the bond seller and buyer both in the dark. He is said to have exploited that information by misrepresenting the seller's asking price to the buyer and the buyer's asking price to the seller, pocketing the difference in the prices paid by the buyer and to the seller.

Litvak allegedly also took bonds held in his firm's inventory and sold them to RMBS buyers after inventing a fictitious third-party seller. Doing so allowed him to charge the buyer an extra commission.

ABS

Lower losses seen on CDQ, DP loans

Italian Cessione del Quinto (CDQ) and Delegazione di Pagamento (DP) consumer loan products pose risks because of their greater complexity, but provide enhanced security and generally imply lower losses than standard consumer loans, Moody's says. These products saw total issuance of €4.5bn in 2013, around 50% of which was concentrated with the top four players in the market.

"CDQ and DP loans, as opposed to typical unsecured consumer loans, are backed by an employee's salary and also benefit from insurance covering the risks of unemployment and death of the employee. These factors provide enhanced security and generally imply lower losses compared with standard consumer loans portfolios. However, CDQ and DP loans pose unique credit risks because of their greater complexity," says Paula Lichtensztein, avp-analyst in Moody's structured finance group.

She adds: "The servicing of CDQ/DP portfolios is more complex than a typical unsecured consumer loan portfolio due to the fact that repayments are collected from the employer rather than directly from the obligor. Therefore, the employer's operational risk plays an important role in the cashflow timing, especially when there are large concentrations on a single entity."

While both CDQ and DP loans are collateralised by an employee's monthly salary, repayments on CDQ loans may not represent more than 20% of the net monthly salary and a CDQ loan cannot be revoked or attached by third-party creditors. DP loans possess some unique characteristics that generally render them a slightly higher credit-risk profile than CDQ loans.

Moody's highlights that the main source of loan defaults is the debtor's loss of monthly income due to redundancy, job suspension, resignation or death. However, upon an obligor's death or unemployment, an insurer undertakes to cover the gap between the outstanding amount of the loan and the amount recovered directly from the debtor and from any severance pay.

Mainly due to the recourse to severance payments and insurance coverage against life and unemployment risk, CDQ/DP historical data has shown higher recovery levels compared to other personal loan products in Italy and in Europe, Moody's observes.

ABS

PAYE expansion to boost FFELP prepays

President Obama's proposed expansion of the existing Pay as You Earn (PAYE) plan for student loan borrowers could decrease default risk and increase prepayments in FFELP ABS portfolios, Fitch says.

The PAYE plan only applies to borrowers from the direct loan programme, but FFELP borrowers could benefit by consolidating their FFELP loans into direct consolidation loans. Fitch believes that the credit quality of the collateral pools in FFELP trusts would improve, as borrowers who intend to take advantage of the PAYE would have higher overall chances of default. The agency also expects the expansion of this plan to marginally increase prepayments on FFELP trusts collateralised by loans originated prior to 1 October 2007.

The current plan began in early 2013 and caps a borrower's monthly federal student loan repayment at 10% of their monthly discretionary income. It also forgives any unpaid loan principle after 20 years of qualifying payments or 10 years for public service full-time employees.

Borrowers must have taken their first federal student loan on or after 1 October 2007 and at least one Federal Direct Loan on or after 1 October 2011 to be eligible. President Obama's proposed 2015 Budget would remove the date requirements and expand the number of borrowers dramatically, according to Fitch.

ABS

Credit card maturities to decline

US credit card ABS maturities will decline sharply in the next few years, says Fitch. The rating agency projects maturities to top US$41bn in 2014 before falling to just over US$21bn in 2016.

Historically low rates during the credit crisis led to many credit card issuers pulling back on securitisation, but levels may soon rise again. Overall issuance this year is expected to be between US$30bn and US$35bn, which is consistent with recent years.

As maturities trend downwards, Fitch expects new credit card ABS issuance to hold at these recent levels or even trend higher as issuers start securitising a larger portion of their portfolios. Total prime credit card ABS outstandings rose US$8bn last year to US$122bn, indicating issuers' willingness to use securitisation as a funding source once more.

ABS

US ABS ratings stability underlined

S&P reports that the creditworthiness of US ABS generally remained stable in 2013. Specifically, 99.8% of the transactions rated triple-A at the start of year had the same rating at the end of the year or were paid off in full, while none defaulted.

From 1983 through 2013, 82.8% of US ABS originally rated triple-A kept that rating or were paid in full, while 0.2% defaulted. S&P says it has lowered the ratings on 17.2% of these securities since 1983 and half of the downgraded deals ultimately paid in full.

Most of the downgrades in recent years stemmed from ties to the sovereign rating on the US, which the agency lowered to double-A plus from triple-A in August 2011, with the remainder generally due to monoline insurers that were downgraded.

In general, stability and default rates are highly correlated with ratings. Higher-rated securities tend to have greater stability and fewer defaults. However, even ABS with ratings lower than triple-A have demonstrated relatively stable creditworthiness and low default rates in the US.

Upgrades dominated US auto loan ABS rating transitions in 2013: the overwhelmingly good performance reflects a combination of strong collateral performance, sequential-pay deal structures and resulting deleveraging leading to high levels of credit enhancement and shorter liability maturities than those of other types of structured assets. As of 31 December 2013, 95.8% of the auto ABS since 1985 that were originally rated triple-A either kept the triple-A rating or were paid off in full, while none have defaulted.

Historically, upgrades have generally outweighed downgrades in rating categories below triple-A, while only four of the approximately 3,000 auto ABS tranches S&P has ever rated have defaulted (one in 1998, one in 2002 and two in 2011). All of these defaults were subordinated bonds originally rated doule-B or lower and came from three separate auto transactions.

On an initial-to-current basis, historical downgrades mainly came from subprime auto transactions. None have been for credit-related reasons, but rather stemmed from a downgrade to a monoline bond insurer.

US credit card ABS ratings have been relatively stable since 1983, reflecting a combination of generally strong collateral performance, relatively conservative assumptions covering various economic cycles, sufficiency of liabilities' credit enhancement and the transactions' fast pay-down structures. As of 31 December 2013, 96.5% of the credit card ABS originally rated triple-A since 1983 have kept the rating or were paid in full. S&P has lowered its ratings on 3.5% of tranches originally rated triple-A; the majority of these ultimately paid off in full and 0.2% defaulted.

Historically, the creditworthiness of FFELP student loan ABS has been generally stable because the US Department of Education guarantees the underlying loans at a minimum rate of 97%. However, private student loan ABS have been more adversely affected by economic cycles, given the difficulties of finding a job to start making or support payments on their loans.

During the 12 months ended 31 December 2013, 100% of student loan ABS rated triple-A at the beginning of the year remained at triple-A or were paid in full. From 1984 through December 2013, 49.1% of student loan ABS originally rated triple-A kept the same rating or were paid in full and none defaulted.

Structured Finance

Positive performance for hedge funds

Hedge fund performance was strongly positive in February, with average returns the highest since January 2012, according to eVestment. In particular, distressed funds posted their best returns in more than two years at 3.18%.

In the face of below-average investor interest in Q4 and elevated redemptions in January, credit strategies posted solid returns in February at 1.71% and are among the better performers so far in 2014. "Since monthly flows began to wane for the broad credit universe in October 2013, returns have been at an annualised pace of 14%, benefitting those who were not quick to redeem in the face of a potential rising rate environment," eVestment notes.

MBS funds returned 0.75% in February, with returns of 1.87% year to date.

Structured Finance

RFC issued on SFR deals

Moody's has laid out its approach to rating single-family rental (SFR) securitisations. At the same time, the agency has issued a request for comment on the related rating methodology.

Together with Morningstar and Kroll, Moody's rated the first deal in this sector - Invitation Homes 2013-SFR1 - in November 2013 (SCI passim). The rating agency says it expects an increase in single-family home rentals based on a number of fundamental economic trends and an increase in the investment in these properties by institutional buyers.

In rating Invitation Homes 2013-SFR1, Moody's noted the risks in such deals, given the limited amount of historical information about vacancy rates, expenses and cashflow. As a result, the analysis does not centre on the transaction's rental cashflow to meet its long-term obligations. Instead, Moody's evaluation of the issuer's ultimate ability to repay investors was based on the liquidation value of the homes under a heavily stressed scenario.

"To account for a scenario in which the securitisation trust must sell all or a substantial portion of the portfolio in a distressed market, we apply a substantial home price depreciation factor, considering historical price movements, forecasts of future prices, the diversity of the pool and the expertise of the manager," explains Moody's md Navneet Agarwal.

The agency also conducts a rigorous evaluation of the operational competence of the sponsor, property manager, servicers and other third parties, as well as the transaction's structural and legal framework. "The sponsor and the property manager are both in positions to preserve the value of the collateral," says Agarwal. "We will evaluate the sponsor's financial capacity and flexibility, as well as the property manager's expertise in managing single-family properties."

Feedback on Moody's approach is invited by 10 April.

CDO

ABS CDO approach updated

Moody's has updated its approach to rating ABS CDOs, affecting the ratings on 47 tranches in 34 US deals and four tranches in four European deals. The move is expected to have a generally positive impact of roughly one notch on senior tranches in the majority of these transactions.

The updates to the methodology include: lowering the resecuritisation stress factors for RMBS, CDOs exposed to investment grade corporate assets and ABS backed by franchise loans or by mutual fund fees; using a common table of recovery rates for all structured finance assets (except for CMBS and ABS CDOs) that reflect higher loss severities for defaulted structured finance assets; and providing more guidance on the rating caps Moody's applies to deals experiencing event of default.

The methodology update is expected to impact 9.2% of outstanding ABS CDOs. The ratings for each of the affected transactions will be placed on review for upgrade, with the review expected to be completed within six months.

In conjunction with the ABS CDO methodology update, Moody's has also released a new version of its CDOROM software - version 2.12-1.

CDO

Mapping approach reviewed

S&P is reviewing the methodology it uses when establishing a correspondence table - or mapping - of a third-party institution's internal credit scores to its global rating scale. The objective of the criteria review is to promote transparency on how institutions' internal credit scoring systems can be mapped to the agency's global rating scale.

The correspondence table is used to statistically map the unrated assets within a diversified CDO asset portfolio to S&P's global rating scale, so that all assets within the portfolio can be evaluated using CDO Evaluator. The agency expects that the criteria will describe what it takes into account when determining whether an institution's internal credit scoring system can be mapped to its global rating scale.

The criteria will consider the institution's credit risk scoring system and the characteristics of the population from which the securitised loans will be selected - specifically, the geographical scope, industries and asset types represented. The criteria will also consider the sufficiency of data collected, the institution's credit approval process and how internal scores are assigned to the obligors.

S&P expects to publish the final criteria by the end of this month. The magnitude and extent of any CDO rating changes resulting from these criteria will depend on the final criteria. The agency isn't publishing a request for comment, as these new criteria do not constitute a material change to its methodologies and assumptions.

CDO

ABS CDO auction due

An auction is slated for Kleros Preferred Funding on 24 March. The collateral shall only be sold if the proceeds are at least equal to the total senior redemption amount. The collateral manager has the option to purchase the securities for a purchase price equal to the highest bid.

CDO

SME CDO criteria tweaked

Fitch has updated its global rating criteria for SME CDOs. The updated assumptions are not expected to have an impact on any current ratings.

Fitch has increased the average annual default rate expectation for the Netherlands to 4% from 3%. The revised country benchmark reflects the current weak economic environment, the recent performance of Dutch SME CLOs and Dutch banks' observed default rate for SMEs. However, for vintage SME CLOs, the default probability assumption is largely determined by the observed default rates.

Fitch has also updated its market value decline (MVD) expectations for commercial properties to reflect the higher price volatility of commercial properties compared to residential properties. The increase is primarily at the non-investment grade categories, with MVDs increasing to 55% from 45% at the single-B rating category but remaining at 80% at the triple-A level.

In addition, the agency now differentiates for countries in economic stress and has thus aligned the commercial MVD of Italy, Portugal and the Netherlands with Spain. For these countries, the MVDs range from 62.5% at the single-B level to 80% at the triple-A level.

Fitch has also observed that the work-out process on defaulted loans can be particularly lengthy in Italy and Spain and has adjusted its general approach in determining the recovery timing vector. Recovery proceeds in the first five years of the work-out process are primarily driven by originator observed data, while later recoveries that have less of an impact on transaction cashflows are based on the agency's recovery framework and are assumed to be received by year ten. However, if recovery data from the originator is deemed to be insufficient, the recovery lag can be extended well beyond year 10 so that annual recovery proceeds do not increase over time.

Finally, assumptions for the cure rate between default and foreclosure have been changed. While the cure rate on a base-case scenario remains dependent on historical data provided by the bank, the tiering for higher rating scenarios has decreased by 10%. They now range between 80% at the single-B rating category to 15% at the triple-A level. Highly rated tranches are now less dependent on cure rate, Fitch says.

CDO

Interest rising in Lehman claims

Interest is rising among international dealers in buying claims in the Lehman Brothers Australia bankruptcy. Amicus Advisory notes in a recent client memo that in nearly all cases a broker or dealer wishing to purchase an investor's claim will only be willing to do this once that claim is validated by the liquidator, PPB, and formally documented as an accepted claim.

"Few buyers ever wish to take risk on an investor's claim prior to its formal acceptance for the obvious reason that as soon as an investor receives money for their claim, they will not be motivated to further it through the final acceptance stage and the buyer risks the claim lapsing or being rejected and becoming worthless due to a lack of support from the original holder," the memo states.

Amicus Advisory believes that no former Lehman client - apart from the Parkes, Wingecarribee and Swan Councils - has had their claims officially accepted at this stage. The firm points out that litigation funder Bentham IMF also has an interest in the claim and any investors funded by the firm should discuss the situation with it if they wish to sell their claim.

Bids for the claims seen so far appear to be on the low side at 40%-45% of the accepted claim amount. Amicus Advisory says that the average estimate of claims recovery is closer to 50% and may ultimately be higher, depending on the number of investors that make claims.

CDO

ABS CDO auctions due

A special majority of Fourth Street Funding class A1 noteholders have directed the trustee to liquidate the collateral. It is currently anticipated that this will be effectuated by means of one or more public sales. The move follows the occurrence of an EOD and the subsequent acceleration of the deal's maturity.

Meanwhile, a separate auction is to be conducted for Bluegrass ABS CDO II on 31 March. The assets shall only be sold if the proceeds are at least equal to the redemption amount.

CDO

Trups CDO on the block

An auction is to be held for InCapS Funding II on 14 March. Keefe, Bruyette & Woods has been engaged as auction call redemption agent. Completion of the auction is subject to receipt of at least two bids of a threshold amount of proceeds at least equal to the auction call redemption required amount of approximately US$168.14m.

CDS

Ukraine concerns contained

The five-year credit default swap spread for Russia has widened by 13bp to 212bp over the past 30 days, according to S&P Capital IQ, reflecting the credit market's concern over the country's intervention in Ukraine. At the same time, the Ukraine protection premium widened by 58bp to 1,116bp - a level that indicates an imminent risk of default.

Rising premiums for both Russia and Ukraine are a matter of course, given the political situation, but S&P's global markets intelligence research team investigated further to find out if credit market concerns are spilling over to surrounding countries. It searched the S&P Capital IQ database for default premiums for a number of countries, including those sovereigns that surround Ukraine. Turkey's CDS spread has tightened by 40.2bp to 227.7bp over the last 30 days, for example, while China's has tightened by 6.2bp to 90.3bp.

Based on its findings, S&P suggests that the credit market views the situation in Ukraine as largely confined to that nation at present. However, it warns that this situation could quickly reverse if tension heightens or falls.

CMBS

Further CWCapital outcomes reported

A further three CMBS with significant exposure to the CWCapital bulk sales have reported US$146m in liquidations, based on March remittance reports. The deals are BACM 2008-1, GMACC 2006-C1 and GMACC 2004-C3.

Overall proceeds from the sales beat appraisals, with US$142m in gross proceeds compared to appraisals of US$134m, according to Barclays Capital CMBS analysts. Losses came in at a 56% severity.

The largest property liquidated was the US$49.5m Executive Centre portfolio, securitised in GMACC 2006-C1, which sold for US$43.2m. That represents a US$26.6m loss at a 54% severity.

The GMACC 2006-C1 liquidations wrote off the G to H tranches. Interest shortfalls were repaid on the D to F tranches.

The US$32.5m International Tower office building in GMACC 2004-C3 sold for US$30.3m, which is above its most recent appraisal value of US$22.3m. The sale still led to US$21.6m in losses for a 67% severity.

The GMACC 2004-C3 liquidations wrote off tranches G to J, as well as most of the F tranche. Interest shortfalls were repaid on the D to J tranches, with enough excess interest proceeds to repay losses on the J tranche, which totalled US$1.8m.

The largest property liquidated from BACM 2008-1 was the US$16.4m North Bergen Center. This represented a US$15.7m loss.

BACM 2008-1's sales wrote off the M to S tranches, as well as a quarter of the L tranche. Interest shortfalls were repaid on the G to K tranches.

One additional property was also liquidated in each trust, most likely outside of the auction process, for a balance of US$27m. The Barcap analysts expect another US$1bn of liquidations to be reported from the remainder of the CWCapital bulk sales (SCI passim).

CMBS

Pay-offs continue to decline

The percentage of US CMBS loans paying off on their balloon date was 68.8% in February, marking the third straight month in which the rate declined, according to Trepp. The firm notes that last month's pay-off percentage is the same as the 12-month moving average of 68.8%.

By loan count as opposed to balance, 74.6% of loans paid off in February, up from a rate of 63.2% in January. The 12-month rolling average by loan count now stands at 70.1%.

CMBS

Annual loss severity hits highs

The annual loss severity for US CMBS loans was 46.3% in 2013, the highest since the inception of Moody's update report on the segment. Driven by a number of large loans that were liquidated at high losses, this figure compares to 40.1% for loans liquated in 2012.

From 1 January to 31 December 2013, US$14.2bn of CMBS loans were liquidated, compared with US$16.4bn during the same period the previous year. Three liquidations with both high dollar and percentage losses took place in the fourth quarter (see SCI's CMBS loan events database): Gwinnett Place loan liquidated with a US$107.6m loss (at a 93.5% loss severity); Granite Run Mall liquidated with a US$104.7m loss (95.7%); and the Babcock & Brown FX4 portfolio liquidated with a US$90m loss (88.8%).

The losses for these loans are respectively the sixth-, eighth- and ninth-highest recorded. Loans secured by malls or lifestyle centres now account for seven of the 10 highest-loss loans, with a weighted average severity of 94.5%, Moody's notes. Meanwhile, loans backed by retail properties had the highest weighted average loss severity at 49.4%, while loans backed by self-storage properties had the lowest at 34.4%.

The weighted average loss severity for all loans backing CMBS in the US that liquidated at a loss was 41.5% in 4Q13, up from 41% in the third quarter. Discounting loans with losses of less than 2%, the weighted average loss severity for liquidated loans was 52.8%, essentially the same as in the third quarter. Loans with losses of less than 2% account for 21.7% of the sample size by balance and 19.5% by number.

The vintages with the highest loss severities are 2008 (at 52.5%), 2006 (50.1%) and 2007 (41.3%). As of December 2013, these vintages constituted 53.6% of CMBS collateral and 76.2% of delinquent loans.

Of the 10 metropolitan statistical areas (MSAs) with the highest dollar losses, New York had the lowest severity at 25.3% and Detroit the highest at 60.5%.

"We expect aggregate conduit losses - inclusive of realised losses - on deals we rate of 8% of the total balance at issuance for the 2005 vintage, 11.8% for the 2006 vintage and 14.0% for the 2007 vintage, with most of the losses yet to be realised. The aggregate realised loss for these three vintages is currently 3.4%," comments Keith Banhazl, a Moody's vp and senior credit officer.

Cumulative realised losses for all liquidated loans also rose - to 3% - from 2.8% in the third quarter. For all liquidated loans, the 2008 CMBS vintage had the highest cumulative loss rate (5.3%) in 4Q13, essentially the same as in the third. The 2000 CMBS vintage had the second-highest cumulative loss rate (4.6%), the same as in the third quarter.

"Cumulative loss rates will continue to rise because of the significant share of recent vintage loans currently in special servicing," Banhazl concludes.

CMBS

CMBS upgrades to increase

Fitch expects US CMBS upgrades to increase in 2014. As the market stabilises, delinquencies decline and loans continue to be resolved, downgrades have already lessened.

The agency expects upgrades to increase overall from the last several years as property values stabilise and its pool-level loss expectations decline. Through February 2014, Fitch has upgraded 44, downgraded 43 and affirmed 964 tranches.

At this rate, upgrades will exceed the 58 in 2013 and 92 in 2012. Downgrades declined in 2013 to 864, from 1,299 in 2012.

"The continued favourable lending environment will lead to ongoing refinancing of stronger performing loans and increasing credit enhancement in 2004 vintage and prior deals. The combination of pay-down - either through liquidation of non-performing loans or scheduled principal - and losses from liquidated loans will have a barbell effect on seasoned transactions," Fitch notes.

The agency expects some AM classes - which were previously downgraded to below single-A - to be upgraded, due to better-than-expected recoveries on specially serviced loans. These ratings may be capped at single-A, as the risk of future interest shortfalls from fees and expenses associated with specially serviced or previously specially serviced loans are passed through.

Upgrades to double-B and triple-B categories in older vintages are likely to occur as the pools pay down and delinquency levels stabilise or decline. Fitch points out that although increased credit enhancement is a key factor to upgrades, the increased credit enhancement is often needed to offset adverse selection as the pool becomes more concentrated.

Before considering upgrades, the agency says it will often apply additional stresses to avoid excessive ratings volatility. These may include deterministic tests on the largest loan concentrations, increased adjustments to in-place cashflow and higher cap rate scenarios. Future amortisation over the life of the remaining loans may also be taken into consideration.

In the longer term, Fitch anticipates that some modified loans will re-default. The agency's loss expectations for these loans - and thus current ratings - already take these losses into account. Downgrades on distressed classes (those below single-B) are likely to continue, as losses are incurred.

Risk Management

Risk-based capital shortfalls shrinking

The Basel Committee has published the results of its latest Basel 3 monitoring exercise. A total of 227 banks participated in the study, comprising 102 large internationally active banks (Group 1 banks) and 125 Group 2 banks.

Data as of 30 June 2013 show that shortfalls in the risk-based capital of large internationally active banks generally continue to shrink. At the Common Equity Tier 1 (CET1) target level of 7% (plus the surcharges on G-SIBs as applicable), the aggregate shortfall for Group 1 banks is €57.5bn, compared to €115bn on 31 December 2012.

However, the aggregate shortfall of CET1 capital with respect to the 4.5% minimum has increased to €3.3bn, which is €1.1bn higher than previously. As a point of reference, the sum of after-tax profits prior to distributions across the same sample of Group 1 banks for the year ending 30 June 2013 was €456bn.

The capital shortfall for Group 2 banks included in the sample is estimated at €12.4bn for the CET1 minimum of 4.5% and €27.7bn for a CET1 target level of 7%. This represents an increase compared to the previous period of €1bn and €2.1bn respectively, which is caused by a small number of Group 2 banks within the sample. The sum of Group 2 bank after-tax profits prior to distributions in the year ending 30 June 2013 was €26bn.

The average CET1 capital ratios under the Basel 3 framework across the same sample of banks are 9.5% for Group 1 banks and 9.1% for Group 2 banks. This compares with the fully phased-in CET1 minimum requirement of 4.5% and a CET1 target level of 7.0%.

Meanwhile, the weighted average LCR for the Group 1 bank sample was 114% on 30 June 2013, down from 119% six months earlier. For Group 2 banks, the average LCR has increased from 126% to 132%. For banks in the sample, 72% reported an LCR that met or exceeded a 100% minimum requirement, while 91% reported an LCR at or above a 60% minimum requirement.

The Committee's next Basel 3 monitoring exercise, which will be based on financial data as of December 2013, will include data related to the proposed revisions to the NSFR.

Risk Management

Leverage ratio examined

The EBA has published a report on the leverage ratio that provides a policy analysis and a quantitative assessment of the impact that would derive from aligning the current Capital Requirements Regulation (CRR) definitions of the leverage ratio's exposure measure to the revised Basel 3 standard published by the Basel Committee on 12 January. The report uses data collected for the Basel 3 monitoring exercise as of 30 June 2013 through a sample consisting of 173 EU institutions from 18 member states.

Overall, the assessment indicates that the revised Basel 3 framework leads to leverage ratios that are broadly in line with or possibly slightly higher than leverage ratios calculated according to the current CRR. On this basis and considering that the revised Basel 3 framework represents a more accurate measure of leverage, the EBA recommends - in the interest of consistency between the leverage ratio calculation within the EU and the other jurisdictions that implement Basel 3 - aligning the CRR definition of the leverage ratio's exposure measure to the Basel 3 framework.

Furthermore, the EBA notes that with respect to securities financing transactions (SFTs), the current CRR text may allow for different interpretations. Therefore, in the event the European Commission delegated act does not align the treatment of SFTs with that of Basel 3, the EBA recommends that the treatment in the current CRR be clarified in accordance with the interpretation that is more prudent and closer to the Basel 3 treatment.

Risk Management

IOSCO examines prudential standards

IOSCO has published a consultation report on prudential standards in the securities sector, looking at key capital frameworks for securities firms. While many key themes are covered by previous reports, the organisation highlights prudential regulatory and supervisory areas that might be updated.

The report's comparative analysis focuses on the net capital rule (NCR) approach and capital requirements directive (CRD). It updates IOSCO's 1989 report on capital adequacy standards for securities firms.

IOSCO's existing reports already cover themes such as minimum capital requirements that reflect the type of business being conducted, but the organisation also identifies areas that could be updated. One such update could relate to opportunities for regulatory capital arbitrage that might have materialised from differences in prudential regulations across jurisdictions.

Another area to update concerns the increasing use of internal models. This would also include the commensurate increase in infrastructure, systems and controls that are necessary for firms to ensure they are not undercapitalised.

RMBS

ESAIL 2007-6NCX restructured

First stage restructuring proposals have been affected for the Eurosail-UK 2007-6NC RMBS, following the sale of the remaining Lehman Brothers claims, as per the extraordinary resolution passed by all noteholders on 10 February (SCI 10 January). The claims were sold to the winning bidder for US$32.88m.

The first stage restructuring proposals include: the conversion of the realised termination amounts from US dollar to sterling; the conversion of each class of notes from euro to sterling; amending the outstanding principal amount of the class B, C and D notes; increasing the margin applicable to the junior notes by 25bp; distributing the converted realised termination amounts by the March IPD as partial redemptions to the class A3A, B, C and D notes; and reducing the reserve fund to £1.78m. Additionally, RBS European asset-backed analysts note that a liquidity reserve fund will be created, initially at 80bp of the outstanding notes for the benefit of the class A2A notes and - following redemption of the class A2A notes - the A3A notes.

RMBS

Declining advance rates eyed

Moody's expects delinquent loan advance rates to continue declining for loans transferred to Nationstar Mortgage from Aurora Loan Services and Bank of America servicing portfolios. Declining servicer advancing is particularly credit negative for fast-pay US RMBS bonds that are more likely to be outstanding when credit support is depleted, at which point they might have to share principal payments and losses with other bonds.

The declining advance rates result from Nationstar's more conservative advancing policies, common among non-bank lenders, according to Moody's in its latest ResiLandscape publication. More delinquent loans are being deemed unrecoverable, also contributing to declining advance rates and increasing reimbursements of prior advances. Decreasing advances and increasing reimbursements raise volatility in RMBS cashflows.

Advance rates for the loans transferred from Bank of America declined sharply after the transfer. Nationstar advanced payments on 32% of the delinquent loans in the portfolio as of January, down from the 46% advance rate in June 2013, when Bank of America began the transfer. The advance rate on Aurora's transferred portfolio dropped to 37% in January from 57% just prior to the June 2012 transfer announcement.

At the time of the Aurora transfer, Nationstar stated that it would postpone for two years the reimbursement of outstanding advances if recovering those advances would cause investment grade bonds to default on interest payments. Moody's expects that after this two-year period expires in June, the servicer will recoup prior advances at a higher rate and further decrease advance rates.

Non-bank servicers tend to have lower advance rates than banks due to their higher costs of funds. The agency anticipates that Nationstar's advance rates for these portfolios will ultimately converge towards those of Ocwen Financial Corporation.

Servicers are unlikely to advance amounts that they expect will be difficult to recover. Although loan-to-value ratios of the delinquent Aurora and Bank of America transferred loans decreased to 88% from 122% over the past two years, they have been delinquent for 37 months on average, up from 30 months one year ago. Over half (52%) of these delinquencies are now in judicial states, up from 48% one year ago.

As Nationstar deems more loans unrecoverable, there has been an increase in reimbursements of previously advanced funds in deals transferred from Aurora and Bank of America. "These reimbursements increase the likelihood of missed interest payments and permanent interest shortfalls on the bonds, since the reimbursements are drawn from the top of the cashflow waterfall. In many cases, weak structural mechanisms prevent these missed interest payments from being recovered. Fixed-rate RMBS are at a higher risk of interest shortfall because - in the absence of advancing - interest is available only from the non-delinquent collateral to meet the fixed interest due on the bonds," Moody's concludes.

RMBS

Sentiment drives ABX prices higher

Markit ABX triple-A index prices have climbed modestly over the last six months, due to improving investor sentiment on subprime RMBS. Moody's expects recovery values to improve gradually over the next few years, driven by further strengthening in the housing market and better macroeconomic conditions.

Last cashflow (LCF) triple-A prices have since July 2013 increased by four points for ABX 2006-2, 10 points for ABX 2007-1 and seven points for ABX 2007-2. Additionally, ABX 2006-1's double-A prices now nearly match the penultimate triple-A prices because 16 of the 20 PENAAA bonds have paid down in full and brought double-A bonds closer to receiving payments.

Stronger performance of the underlying subprime collateral has led to improving market sentiment on the sector, Moody's notes. "Loan default rates have slowed, reflecting declining loan-to-values among still-current borrowers, as a result of housing market improvements and an improving broader economy. Serious delinquencies have declined across all indices as servicers continue to work through the backlog of delinquent borrowers. Meanwhile, there has been a modest increase in realised losses."

Moody's expected principal recoveries for the cash bonds backing ABX triple-A indices have generally stabilised since July 2013, consistent with the improving market sentiment about the sector and, in turn, higher ABX prices. The differential in recoveries between LCF triple-A and PENAAA is narrowing, due to the impending shift in principal priority after the mezzanine certificates are written down, subsequent to which the last cashflow bonds will start receiving principal pro-rata with PENAAA bonds.

RMBS

RFC issued on Turkish methodology

Moody's is seeking comments on the methodology it is proposing for analysing the credit risk of residential mortgage pools in Turkey. The agency plans to use the proposed approach in conjunction with its existing methodologies to rate RMBS and covered bonds backed by such pools.

To derive the calibration of country-specific values and assumptions for Turkey, Moody's benchmarked the Turkish residential real estate market to other jurisdictions. The agency has adapted many parameters from its emerging securitisation markets implementation of the methodology.

It says these parameters are a highly relevant benchmark for Turkey, due to: similarities in developing macro economies; nascent banking sectors; positive demographics trends; and real estate markets characterised by robust house price appreciation in recent years. Additionally, a limited time series of relevant historical data is available, due to the lack of reliable data sources and the fact that the Turkish economy has yet to experience severely stressed economic cycles.

Moody's does not expect any rating changes to result from the publication of the methodology, if it's adopted as proposed. Comments should be submitted by 11 April.