Contents

CLOs

CLO mezz relative value highlighted

CLO spreads are trading in the middle of their post-crisis range, in contrast to most other securitised products, where spreads are at or close to their 12-month tights. While triple-A and double-A CLO bonds do not compare as favourably on a current yield basis, Morgan Stanley CDO strategists note that mezzanine CLO bonds offer a relative value advantage.

"CLO mezzanine debt tranches, particularly US CLOs in the new issue market, offer a compelling relative value opportunity in spread and yield terms compared to several similarly rated credit products," they explain. "Credit curves of both US and European new issue CLOs are steeper and higher relative to those of competing asset classes, such as corporate credit bonds, CMBS and other ABS bonds. Between US and European CLOs, we favour the former, due to wider spread levels at issuance and the steeper US forward rates curve."

A consistently wide positive basis in spreads between CLOs and similarly rated corporate bonds has emerged in the post-financial crisis era. This is in clear contrast to the basis behaviour pre-crisis, when it was much smaller and sometimes even negative.

The post-crisis spread differential persists even when CLO tranches are compared to corporate bonds rated three notches lower, according to the Morgan Stanley strategists. While several factors - including lower liquidity, a narrower investor base and the active management of CLO portfolios - partially justify the wide basis, they suggest that the current basis is still too wide, even after taking these factors into account.

CLOs have a price-to-spread sensitivity similar to that of comparably rated corporate bonds. However, the strategists note that junior mezzanine CLO tranches have shown higher spread volatility than the high yield cash index over the past three years.

Finally, many mezzanine CLO tranches - in particular tranches rated triple-B or below - have call/refinancing upside and benefit from positive convexity potential. This is in contrast to callable high-coupon fixed rate corporate credit bonds trading at a premium, which are negatively convex.

"We argue that as the hunt for yield continues and the relative value disparity in CLO mezzanine tranches becomes more understood, the prospects for spread tightening are significantly greater in the medium term," the strategists conclude.

CS

CMBS

LEMES 2006-1 offer enhanced

IEF, the sponsor of Dutch CMBS Leo-Mesdag, has offered noteholders an enhanced restructuring proposal. The new proposal includes an additional equity contribution of €15m, to be paid out either as additional interest to the class A notes or as loan amortisation.

A proposal made last month failed to gain sufficient approval from class A noteholders (see SCI's CMBS loan events database). Aside from the additional €15m, the terms of the original proposal are unchanged.

The €1bn senior facility A1 loan and €50m senior facility A2 loan are due to mature in August 2016 and August 2017 respectively. Without a restructuring, it is unclear how the €1.05bn balloon will be refinanced.

How and when the €15m is disbursed will depend on IEF's progress on meeting a refinancing target of €500m by May 2016, note Bank of America Merrill Lynch European securitisation analysts. Refinancing and repaying €500m of the A1 loan would result in the repayment of about €446.4m of the €642.5m currently outstanding on the class A notes. The proposal would also see €53.6m of the first €150m refinanced paid pro-rata between the class B, C, D and E notes.

If no portion of the A1 loan is refinanced by May 2016, the €15m will be paid to the class A notes as a one-off interest payment. It would represent 2.3% of the class A note balance outstanding and be equivalent to a step-up in the note coupon of 1.1% per annum.

However, if the €500m refinancing target is reached, there will be no additional interest for the class As. Instead, the €15m would be used towards repaying loan principal.

Should the €500m refinancing target be partially met, then a corresponding portion of the €15m would be used to repay loan principal with the rest paid as interest. "We would be surprised if IEF cannot reach the €500m refinancing target by May 2016 and we think they may already have a good idea where they can refinance this," the BAML analysts observe.

They are confident that the new proposal will be approved by noteholders. Initial noteholder meetings to discuss the proposal are scheduled for 6 June, with an electronic voting deadline beforehand. There are no rebounds if the proposal is not adopted, implying that IEF will not offer any further enhancements.

All classes will be given a chance to vote, but at least two-thirds of the class A noteholders who vote are required to pass the proposal. The class B, C, D, E and Y noteholders all approved the previous proposal.

"Overall, we think the proposal is fair and we see little to complain about. Some Class A noteholders may have objected to the plan to treat the first €150m of refinancing proceeds in the same way as disposal proceeds, meaning it would be shared pro-rata between all classes of notes. However, we suspect the main reason some of the class A noteholders rejected the original proposal was probably because they thought they could extract additional 'ransom value' from a committed sponsor," the analysts note.

If the A1 loan is not fully redeemed by the August 2014 IPD, the A1 loan margin will increase from 65bp to 100bp over three-month Euribor. The A2 loan margin will increase from 185bp to 250bp and then by a further 100bp each year up to a maximum of 450bp.

The first step-up in August 2014 increases the blended margin on the A1 and A2 loans from 71bp to 107bp. All-in borrowing costs would increase from 4.32% to 4.69%, which the analysts believe is lower than the borrower would pay for new debt.

"If the step-up margins are used, the current ICR of 1.72x declines to 1.5x, meaning there should be sufficient cashflow to pay the step-up margins on all the notes and partially amortise the class A notes after August 2014, in our analysis. Assuming rental income does not change, we project the class A note amortisation from excess rental income could be €24.1m per annum from August 2014 - reducing to €23.6m and then €23.1m per annum from the subsequent A2 loan step-up dates in August 2015 [and] August 2016 respectively, if the debt is not refinanced," they suggest.

Prepayment charges would have applied on any prepayments on the A1 and A2 loans before this month's IPD. That left the sponsor with only three months in which to refinance both loans without incurring any prepayment fees or step-ups.

IEF is seeking a series of partial refinancings rather than looking to refinance the €1.05bn in one go. Ticket sizes of €100m-€200m should provide greater flexibility and create more competition between lenders and thus be cheaper for the sponsor.

JL

Insurance-linked securities

Sidecars proliferating

New capital invested in reinsurance sidecars reached US$1.92bn in 1Q14, the highest level of quarterly growth in the segment since 2009, according to Moody's. New capital has surged even as reinsurance rates fall, suggesting that reinsurers have different motivations for sponsoring sidecars now than they did the last time there was a sharp increase in new capital in 2005-2006.

Following Hurricane Katrina in 2005, rising demand for coverage pushed premiums higher and sidecars allowed reinsurers to move some of their assumed risk off their balance sheets and therefore offer more capacity. In contrast, over the past year an influx of alternative capital in the form of insurance-linked securities and catastrophe bonds pushed reinsurance prices down, driving reinsurers to sponsor sidecars as a means of preserving their own market share.

As of December 2013, catastrophe bonds, structured industry loss warranties and collateralised reinsurance accounted for US$50bn of capacity, or around 16% of the global property catastrophe limit purchased. The cat bond market alone is projected to reach US$23bn by end-2016.

As of 1 April 2014, total capital outstanding invested in sidecars exceeded US$6bn. The primary driver of growth so far this year has been a single sidecar sponsored by Arch Capital Group. At a reported US$1.1bn equity, Arch's Watford Re - a joint venture with JPMorgan's Highbridge Principal Strategies - is the largest sidecar in history.

Eden Re, sponsored by Munich Re, is another new entrant to the market. Meanwhile, Catlin Group launched its first sidecar-like instrument - the Portfolio Participation Vehicle - in March (SCI 4 March).

The remainder of the new capital went into renewed sidecars, including Blue Capital, Altair Re, Harambee Re and AlphaCat. Validus Holdings has offered its AlphaCat series for four consecutive years since 2011.

ACE renewed its Altair Re vehicle to receive additional quota share capacity. And Moody's suggests that the final new capitalisation figures for the first quarter are likely to be revised up from US$1.92bn, since Argo Group has not yet disclosed the size of its renewed sidecar, Harambee Re.

Most sponsors capitalise their sidecars with a maturity of one year and then upon success of the vehicle renew it in the following years. However, this season two sponsors have three-year commitments: the recently launched Atlas Re and Eden Re (Munich Re) will both mature in April 2017. Lorenz Re, launched in early 2013, is a multi-year sidecar that allows PartnerRe to leverage third-party capital without launching a full management fund.

Moody's believes that more reinsurers will sponsor sidecars and that the capital in these entities will continue to grow and their focus will broaden as the market continues to evolve. In addition to retaining market share, management of third-party capital through sidecars complements the range of reinsurance products sponsors offer, ensures a relatively steady revenue stream through fees and risk-free profit commissions and helps them to adapt alongside an evolving market. Sidecar arrangements can also reduce earnings volatility and offer more efficient capital.

In terms of risk coverage, the majority of sidecars capitalised since 2009 embrace property catastrophe reinsurance coverage. But Arch Capital capitalised Watford Re with a diversified multiline reinsurance portfolio, including property and casualty. Everest Re's Mt Logan vehicle offers further diversification potential in that it features a segregated account structure, which provides flexibility to cover various risks for different types of investors.

CS

Structured Finance

Natixis promotes SF trio

Natixis has made a couple of appointments to its global structured credit solutions (GSCS) team. Emmanuel Lefort becomes GSCS global head, while Hank Sandlass becomes GSCS Americas deputy head.

Additionally, Kevin Alexander has been named head of fixed income for the global markets group in the Americas. He will supervise all debt platforms and GSCS teams based in New York.

Alexander will report to Denis Prouteau, Guillaume Couzineau and Alain Gallois. He has held several roles at Natixis over the last 15 years and was most recently global head of GSCS, the role Lefort is assuming.

Lefort will remain in London and report to Gallois. He has spent 13 years at Natixis, including as head of structuring within its GAPC bad bank.

Sandlass will take responsibility for US-based GSCS operations. He will report to Lefort and Alexander and will continue to manage Natixis' US asset-liability management and conduits group, as he has done for 11 years.

Structured Finance

Capital markets deputy steps up

DBS has named Eng-Kwok Seat Moey as its next head of capital markets. She was appointed deputy head last year in preparation for the transition.

Seat Moey replaces Eric Ang, who will stay at the firm as a senior executive advisor, effective from next month. Seat Moey has more than 20 years of experience in capital markets advisory and funds management, and has been heavily involved in the asset-backed structured products unit at DBS.

Structured Finance

Islamic finance group formed

Moody's has formed a dedicated global Islamic finance group (IFG) to meet the growing demand for Islamic finance credit ratings and research, as both Islamic capital markets and Islamic banking continue to register double-digit growth rates. The unit will deliver independent analysis of Shari'ah-compliant products, financial institutions and takaful insurers to support an improved understanding of the credit risks and market trends across the sector.

The IFG will be chaired by Dubai-based Khalid Howladar, the agency's recently-appointed global head of Islamic finance, and draws expertise from Moody's sovereign, banking, corporate, insurance and structured finance analytical teams worldwide. Howladar has held various positions at Moody's since 2001 - spanning both the structured finance and financial institutions groups - and will continue to provide coverage for GCC conventional banks with the Dubai-based banking team.

CDS

ICE transition accelerated

Duncan Niederauer, ceo of NYSE Group and co-president of ICE, has accelerated his planned departure in light of the rapid integration of the two exchanges. He will continue as president of ICE until the end of August.

Niederauer served as ceo of NYSE Euronext from 2007 through late 2013, when the acquisition by ICE was completed. He will be succeeded by Thomas Farley, coo of NYSE and former ICE Futures US president, who takes the title of president of NYSE Group.

Niederauer comments: "The transition to ICE ownership has gone smoothly and, with our integration well on track, accelerating the final stages of my transition will only extend that progress and provide clarity on future leadership."

CMBS

CMBS chief makes move

Goldman Sachs has hired Jonathan Strain as an md in its commercial mortgage bond business. He will become co-head of the US real estate finance group, alongside Ted Borter, and be based in New York.

Strain joins from JPMorgan, where he was head of CMBS capital markets. He has also worked at Dillon Read Capital Management, UBS and Morgan Stanley.

Insurance-linked securities

Insurance banker recruited

Willis Capital Markets & Advisory (WCMA) has appointed Rafal Walkiewicz as md of its insurance investment banking division. Walkiewicz, who will be based in New York, will play a key role in developing further the firm's capital raising and M&A business. He will report directly to WCMA ceo Tony Ursano.

Joining from Goldman Sachs, Walkiewicz has spent the past 10 years in the bank's financial institutions group, focused on the insurance space. Before that, he was president and ceo of BMT Financial Services, a Polish SEC-registered stockbroker, asset manager and investment banking boutique.

Insurance-linked securities

Longevity solutions team beefs up

Legal & General has made a number of key appointments to its bulk annuity & longevity insurance business in response to continued growth in pension scheme de-risking activity. Alyssa Manning and Kai Hoffmann have joined the team as business development directors, while Dominic Moret and Vanessa HoVon have joined as senior commercial underwriters.

Manning was previously a vp in Credit Suisse's longevity markets group and portfolio management group, during which time she worked closely with clients to provide tailored solutions through longevity derivatives. Hoffmann was most recently a member of Swiss Re's longevity solutions team, where he worked with pension schemes and their advisers to implement longevity insurance solutions.

Moret previously worked at Towers Watson, advising both pension scheme trustees and sponsors on a wide range of issues, including liability tracking and risk management. HoVon also comes from Towers Watson, where she was a pensions consultant.

RMBS

RMBS trading vet recruited

Prudential Fixed Income has hired John Vibert as md, structured products. Vibert will work closely with Richard Rogers to co-lead the firm's structured finance team. He was most recently a lead portfolio manager for BlackRock's mortgage credit portfolios and lead trader for its non-agency RMBS trading team.

Before joining BlackRock, Vibert was an md at Credit Suisse, where he was head of adjustable-rate mortgage trading and co-head of non-agency RMBS trading. He has also worked at Morgan Stanley and Salomon Brothers.

ABS

Litigation risk mitigated

Harley-Davidson's most recent ABS issuance - the US$850m Harley-Davidson Motorcycle Trust 2014-1 - includes language allowing the company to buy back motorcycle loans from the SPV, should it determine that their repurchase would better serve consumer lending laws. Moody's notes in its recent ABS Spotlight publication that these new representations and warranties differ from the language in the company's prior securitisations and are unique in the auto loan ABS sector.

The new language gives Harley-Davidson the flexibility to repurchase problem loans and retain ownership if it needs to modify them. Under the transaction documents of the company's earlier securitisations, contract modifications such as changes to the annual percentage rate could breach the servicing agreement.

The revision to the R&Ws also insulates the SPV from litigation risk. The facts stated in the R&W relating to compliance with laws including consumer protection, if incorrect or alleged to be incorrect, could give rise to a lawsuit against the SPV as the owner of the asset.

The deal documents state that the issuer can buy back only up to 10% of the total value of the receivables pool, a limitation designed to maintain the SPV's true sale status.

The new language comes on the heels of a consent order between Ally Financial and the Consumer Financial Protection Bureau (CFPB) in December, stemming from allegations that Ally engaged in discriminatory auto loan pricing. Separately, the CFPB has issued public guidance regarding compliance with the fair lending requirements of the federal Equal Credit Opportunity Act.

Moody's believes that other auto issuers are likely to adopt methods to address regulatory risk, even before they become aware of the nature and scope of any regulatory inquiry.

ABS

P2P credit considerations outlined

Moody's highlights in its latest 'ABS Spotlight' four main credit considerations for peer-to-peer (P2P) loan securitisations. These are: historical performance of the loans; underwriting and origination practices; servicing arrangements; and regulatory oversight and compliance.

The agency notes that performance history is a key credit consideration for P2P ABS transactions. "As with other types of new consumer lending programmes, forecasting performance of P2P loans is challenging because of limited performance data," it explains. "However, potential issuers of P2P loan ABS could mitigate some of the concerns over lack of historical data by selecting and securitising a P2P company's loans that have the most favourable and predictable credit characteristics. Potential ABS issuers can also provide more details of borrower attributes than what consumer loan ABS transactions typically disclose."

The challenge in forecasting loan performance stems from the short history of the P2P companies and their limited exposure to periods of economic turmoil. P2P companies originated most loans over the past several years; therefore, only a small number of loans have fully amortised.

Like other new consumer lenders, P2P companies have modified their underwriting criteria in an effort to better predict loan performance. However, they lack the scale and operating history of more established underwriters and face risks when doing business with borrowers who are already in debt and need to borrow more to keep afloat. Fraud and misrepresentation risks are also inherent in P2P platforms, but focusing on fraud detection during the underwriting process and including seasoned loans in the ABS pools would help mitigate these risks.

Meanwhile, loan servicing by P2P companies poses high operational risk because these companies are weak financially, owing to their relatively small size and short operating histories. Issuers in other ABS asset classes have mitigated some servicing risk by arranging for a strong third-party servicer, or by setting up an effective back-up servicing arrangement.

An issuer could also set up a servicing arrangement specific to a securitisation, as opposed to an arrangement covering the P2P company's entire portfolio, to make it easier for ABS investors or the indenture trustee to replace a non-performing servicer.

In addition, P2P companies face the risk of regulatory uncertainty as they grow and evolve. Although P2P lending - specifically when funded through a bank - must comply with a variety of regulations, P2P companies themselves are not currently subject to explicit oversight by any one federal or state agency. As loan origination in this industry grows rapidly, however, P2P companies could face additional oversight and regulatory requirements in the future by the Consumer Financial Protection Bureau or other federal agencies.

P2P loan origination has increased significantly, with year-over-year growth rates of over 100%. Outstanding loans for the two largest P2P companies, LendingClub Corp and Prosper Marketplace, totalled approximately US$2.5bn combined at end-2013.

ABS

Global auto ABS performance 'steady'

Moody's expects improving global labour markets to result in steady auto loan ABS performance this year. This is based on the findings of its first report in a four-part series that examines auto loan ABS credit performance trends in North America, Europe, Asia Pacific and South America. The other articles in this series will examine: structural, operational and legal issues affecting the sector globally; composition of collateral pools and underwriting practices in each region; and rating migration throughout different economic cycles.

"Securitisations backed by pools of auto loans are a cornerstone of the structured finance markets in many regions and the sector is drawing increasing interest in markets such as China," says Sanjay Wahi, Moody's vp and senior analyst. "The Chinese government is encouraging further development of the securitisation industry and consumer demand for automobiles and auto financing options is growing rapidly."

"In China, stable employment and strong lending criteria mean that the majority of auto loans will be to prime borrowers, boosting performance in the loan pools," adds Elaine Ng, Moody's vp and senior analyst.

Trends vary by region. Performance in Australia and Japan - which remained strong, even during the financial crisis - is expected to continue performing steadily, given the predominance of loans to prime credit borrowers in the ABS pools in both countries.

However, underwriting standards in the US have loosened as a result of the improving economy, causing delinquency and default rates to rise marginally. As a result, performance of more recent transactions will be weaker, Moody's notes.

"Losses on prime pools will remain at all-time lows in North America though, because the majority of loans in the pools are still to very strong borrowers," explains Wahi.

Auto loan ABS performance is expected to be mixed in South America. "Securitisations in Argentina will continue to perform well because high inflation will lower LTVs over time, boosting recovery rates on repossessed vehicles," says Rodrigo Conde, a Moody's analyst.

However, in Brazil, credit performance of non-prime loans should decline moderately, given rising interest rates and the slowing pace of economic expansion. Performance of prime deals should remain stable.

In Europe, meanwhile, auto loan ABS performance will remain steady overall. However, Spanish auto ABS will continue to be weak due to the high unemployment rate, according to Moody's vp and senior analyst Mehdi Ababou.

ABS

Punch restructuring alternative proposed

A stakeholder group comprising seven investors in the Punch A and Punch B whole business securitisations has proposed alternative restructuring terms to those launched by Punch Taverns at the beginning of the year (SCI 15 January). The proposal would result in a reduction in total net debt of £600m.

Under the proposal, junior notes in Punch A and Punch B would be exchanged for a combination of not only cash and new junior notes, but also ordinary shares in the company in a debt-for-equity swap. In addition, a group of junior creditors would subscribe for ordinary shares in the company at a significant discount to the current market price to raise additional funds to be applied to repay junior notes in the Punch A transaction.

Should the proposal be implemented, the reduction in net debt would result in the pro-forma net debt to EBITDA leverage of the Punch group falling to around 7.7x, at August 2014. Gross securitisation debt of £1.58bn would have an effective interest rate of around 7.9%, including PIK interest.

In consideration for the debt reduction, the debt-for-equity swap and share placing contemplated by the proposal would result in significant equity dilution for existing shareholders, such that the company's currently issued share capital would represent 15% of its total enlarged issued share capital following the restructuring.

The stakeholder group owns or controls circa 34% of the notes across Punch A and Punch B, over 50% of junior notes in both securitisations and the equity share capital of Punch. While the ABI Special Noteholder Committee is not currently signed up to the proposals, substantial progress is said to have been made in addressing their issues.

Implementation of a consensual restructuring would require the consent of other parties outside of the stakeholder group, including shareholders, all classes of noteholders in Punch A and Punch B and other securitisation creditors. But implementation of the proposal - or any consensual restructuring involving a significant equity component - would result in additional execution complexity, according to the company.

Accordingly, it believes that it will not be possible to launch any such restructuring prior to the deadline of 30 June included in the covenant waivers obtained by Punch A and Punch B on 13 May. It is therefore likely that an extension to the covenant waivers will be necessary to provide sufficient time to implement a consensual restructuring.

ABS

Ford debuts Chinese ABS

Ford Automotive Finance (China) has completed its first auto loan ABS in China to support the financing of Ford-brand vehicle sales in the country, becoming the first wholly foreign-owned auto finance company to complete a transaction under the most recent ABS pilot programme governed by the China Banking Regulatory Commission and the People's Bank of China. Sized at RMB800m, the deal is called Fuyuan 2014-1 Retail Auto Mortgage Loan Securitization Trust.

"Ford Automotive Finance (China) is adding both dealers and retail customers quickly in China, and we will support Lincoln when the brand arrives later this year," comments Nu Tran, president of Ford Credit Asia Pacific. "We now have another funding tool to support their financing needs."

Ford Credit's Chinese subsidiary began operations in 2005. It provides wholesale financing for more than 400 dealers and retail financing through nearly 500 Ford dealerships in 290 cities across China.

Structured Finance

Pre-crisis losses decline

The turnaround of the US housing market has led to a sizeable decline in pre-crisis global securitisation losses, Fitch reports. At the same time, loss expectations for pre-crisis EMEA securitisations have remained constant.

Total losses on US bonds issued between 2000 and 2008 fell to 5% from the 5.4% recorded in Fitch's study last year. Total losses include both realised and expected future losses.

"Loss performance on US RMBS improved significantly for 2000-2008 deals to 8.7% from 9.6%, thanks largely to the stronger-than-expected housing market recovery," says Fitch senior director Gioia Dominedo.

Despite the improvement, US RMBS losses still account for over half (54.3%) of global losses across all 2000-2013 vintages. Losses on prime deals (3.4%) are considerably lower than on Alt-A (16.1%) and subprime deals (10.7%), however.

"Improved loss performance for both global structured credit and US CMBS deals also contributed to the lower loss rates overall, albeit to a lesser extent," Dominedo adds.

Nevertheless, structured credit still accounts for 28.7% of global securitisation losses. Fitch projects total losses of 11.1% on global structured credit, which drop to 3.5% when excluding ABS CDOs.

Meanwhile, total losses on EMEA bonds issued between 2000 and 2008 have remained flat at 1% for three consecutive years. This includes realised losses of 0.3% (unchanged from the previous year) and expected future losses of 0.7%.

"Total losses of 1% on pre-crisis EMEA securitisations compare favourably with 7.6% on US transactions from the same vintages," observes Dominedo. The strongest performance is visible in consumer assets, such as mortgages, credit cards and auto loans, with total losses of 0.3% on EMEA RMBS and 0.1% on EMEA consumer ABS from the same vintages.

"No losses are expected on UK and Dutch prime RMBS, which account for over a third of the bond balance issued pre-crisis," Dominedo continues.

EMEA RMBS losses are mainly driven by Spanish and UK non-conforming deals. However, total losses in these sectors remain below 2%. Similarly, EMEA ABS losses are concentrated in underperforming Spanish transactions.

Fitch expects total losses of 4.1% of the global bond balance issued between 2000 and 2013. Deals issued after 2008 thus far account for only 0.1% of loss estimates.

Structured Finance

APAC positive rating actions continue

Fitch says that over 99% of Asia-Pacific structured finance (SF) tranches maintained their ratings, were upgraded or paid in full (PIF) last year, compared with the 95% reported in 2012. The ratio of ratings maintained, upgraded and PIF in 2013 was higher than the average over 1998-2013 for all rating categories.

Asia-Pacific SF upgrades outnumbered downgrades by a ratio of 4.7 to one, marking the first time since the onset of the financial crisis that there were more positive rating actions than negative, according to Fitch. The agency adds that the number of upgrades (14) and downgrades (three) is low because over 55% of the portfolio was rated triple-A at the beginning of 2013 and so high rating stability is expected.

The limited number of downgrades reflects the fact that work-outs in Japanese CMBS - the major contributor to downgrades in previous years - are in their final stages. All investment grade CMBS were maintained, upgraded or PIF during 2013, which is the highest level of stability since the crisis. Over the same period, all ABS and RMBS were also maintained, upgraded or PIF.

At end-1Q14, the rating outlook for Asia-Pacific SF remained largely stable, with a negative outlook outstanding for one Japanese CMBS tranche. Positive outlooks were outstanding for two Australian auto ABS tranches and five Japanese CMBS tranches backed by multi-family apartment assets.

Fitch assigned negative outlooks to four Indian auto loan transactions in May due to deteriorating collateral performance, as increased fuel costs reduced margins for operators (SCI 17 April).

Structured Finance

BPO assessments examined

Moody's notes in its latest ResiLandscape publication that broker price opinions (BPOs) can provide fair assessments of home values for single-family rental (SFR) securitisations, if BPO providers follow detailed and thorough processes and procedures. An analysis undertaken by the agency of data from two BPO providers showed that, on average and in the current environment, BPO values approximated the eventual property sales prices.

The BPO procedures included: in-depth documentation to validate their valuation; use of multiple comparable properties within close proximity to the subject property; and well-defined comparable property parameters. Vendors employed a detailed broker selection process and quality control mechanisms, including independently validating BPOs with an automated valuation model or with other comparable properties from multiple listing services.

The sample comprised BPOs performed between 2011 and 2014, where the related property sold within six months of the BPO date. The average BPOs for the top-20 metropolitan statistical areas (MSAs) commonly found in SFR securitisations were shown to be marginally lower than the average sales prices for those houses.

Among all MSAs, about 13% of the 6,991 BPOs sampled were 15% higher than the sales price. In comparison, of the full appraisals available for 3,494 of the properties in the sample, about 19% were 15% higher than the sales price. Of the same sample, about 15% of the BPOs had values that were 15% higher than the sale price.

"Although a significant number of individual BPOs deviated from the sales price, the volatility was no greater than in a similar comparison of full appraisals to sales prices. Nevertheless, these outliers - as well as having less comprehensive procedures than appraisals - justify a moderate haircut to the BPO when relying on BPOs to estimate recovery values," Moody's observes.

For SFR securitisations Moody's has rated so far, it has applied a 15% haircut to BPOs. In addition, in determining the property value, the agency took into account the issuer's acquisition cost plus portions of renovation costs and home price appreciation.

For future transactions, Moody's says it will assess the type of valuation product supplied, the available data and the processes and procedures used to reach the valuation to determine whether and how much to haircut the valuation. For example, if a BPO vendor's processes and procedures are not as stringent and data shows a significant divergence between BPO and sales price, an additional haircut may be warranted.

Structured Finance

MBIA upgrades lift SF ratings

Moody's has upgraded the ratings of 199 structured finance securities wrapped by MBIA Insurance Corp and two structured finance securities wrapped by MBIA UK Insurance. The action is driven by Moody's upgrade of the insurance financial strength (IFS) ratings of MBIA Corp to B2 (from B3) and MBIA UK to Ba2 (from B1).

The agency has also upgraded the IFS rating of National Public Finance Guarantee Corp to A3 (from Baa1), the senior debt rating of MBIA Inc to Ba1 (from Ba3) and MBIA Mexico to B2 (from B3). The outlook for all the ratings is stable.

Moody's says that the rating actions reflect the positive effect that recent settlements of significant commercial real estate exposures and ongoing portfolio run-off has had on the group's capital adequacy and liquidity profile. National's improving prospects for generating new insurance within the municipal market was also a positive consideration in the rating actions for National and for MBIA Inc, it adds.

The rating actions on MBIA Inc, MBIA Corp, MBIA Mexico and MBIA UK conclude reviews for upgrade initiated earlier this year (SCI 17 February).

Structured Finance

SFR criteria released

Kroll Bond Ratings has published its single-family rental (SFR) securitisation methodology. Given the hybrid nature of the underlying collateral, KBRA will employ elements from both its CMBS and RMBS methodologies to analyse SFR transactions.

When considering the probability of default of a SFR loan, KBRA determines the estimate of sustainable net cashflow, known as KBRA Net Cash Flow (KNCF). KNCF is based on an analysis of the underlying collateral properties' financial and operational performance, as is typically undertaken for CMBS collateral. When determining recovery on a defaulted SFR loan, KBRA calculates the recovery upon a liquidation of the pool under various stressed home price scenarios, as is typically undertaken for a pool backing an RMBS transaction.

However, the agency notes that the assessment of an SFR transaction also involves analytical considerations that are distinct from both CMBS and RMBS. Specifically, the SFR securitisation market is currently characterised by large institutional sponsors that have engaged in the volume purchasing and refurbishing of single-family homes in distressed markets over relatively short periods of time. Simultaneously, many of these institutions have established property management companies to oversee the leasing and maintenance of the property portfolios.

KBRA anticipates that the SFR market will become more fragmented over time, featuring smaller loans from multiple sponsors, and also sponsors who elect to employ third-party managers.

Structured Finance

LCC ceiling sensitivities examined

Moody's has adjusted its parameter sensitivity analysis to clarify the rating impact of sovereign risk on structured finance transactions, specifically following a change in the local-currency country (LCC) risk ceiling. The update shows that the raising of the LCC ceiling does not necessarily mean a rating upgrade.

"Because the credit performance of a note relies heavily on counterparty performance, risks related to the servicer, swap counterparty and account bank can limit the benefit of a rise in the LCC ceiling," says Pier Paolo Vaschetti, a Moody's vp-senior analyst. Thus, the sensitivity analysis also adjusts either the servicer rating, the swap counterparty rating or the account bank rating, depending on which of these factors limits transaction ratings.

The analysis examines two examples: one where counterparty risks do not limit the ratings on notes when the LCC ceiling rises; and one where counterparty risks prevent a rating upgrade on the most senior notes, despite a rise in the LCC ceiling. "We note that our parameter sensitivity analysis is purely quantitative and so is only one of many inputs to our rating process," adds Paula Lichtenszten, a Moody's avp-analyst. "Because we have also taken qualitative factors into consideration, the actual ratings that we assign to a transaction could differ from the ratings that the parameter sensitivity analysis implies."

Structured Finance

MiFID II consultation underway

ESMA has launched the consultation process for the implementation of the revised Markets in Financial Instruments Directive (MiFID II) and Regulation (MiFIR). This is the first step in the process of translating the MiFID II/MiFIR requirements into practically applicable rules and regulations.

MiFID II/MiFIR introduces transparency requirements for a broader range of asset classes; the obligation to trade derivatives on-exchange; requirements on algorithmic and high-frequency-trading; and new supervisory tools for commodity derivatives. It is also designed to strengthen protection for retail investors through limits on the use of commissions; conditions for the provision of independent investment advice; stricter organisational requirements for product design and distribution; product intervention powers; and the disclosure of costs and charges.

In order to ensure that MIFID II achieves its objectives in practice, ESMA has published a 'Consultation Paper on MiFID/MiFIR Technical Advice' and a 'Discussion Paper on MiFID/MiFIR draft RTS/ITS'. The latter will provide the basis for a further consultation paper on the draft RTS/ITS, which is expected to be issued in late 2014/early 2015. The closing date for responses to both papers is 1 August.

CDO

Trups CDO defaults, deferrals decline

The number of combined defaults and deferrals for US bank Trups CDOs declined to 24.4% at end-April, compared with 24.5% at end-March, according to Fitch's latest index results for the sector.

Four banks deferring interest on a total notional of US$27m in six CDOs cured in April. Two of these banks, or US$9m in notional, were due to reach the end of the maximum allowable five-year deferral period in 2014.

Additionally, one issuer representing US$21m of collateral in three CDOs re-deferred interest payments on its Trups. A discount sale of a previously defaulted issuer representing US$7.5m of notional from one CDO with recovery of US$0.07 resulted in a reduction of the cumulative defaulted notional of the banks.

Across 78 Trups CDOs, 229 bank issuers have defaulted and remain in the portfolio, representing approximately US$6.6bn of collateral. Additionally, 224 issuers are currently deferring interest payments on US$2.6bn of collateral.

CDO

CBO tender launched

HoldCo CDO Opportunities Fund has commenced a tender offer to purchase for cash all of the outstanding class C (US$8.14m principal amount) and D (US$35m) notes of SKM-Libertyview CBO I. The purchase price per US$1,000 outstanding principal amount is US$965 and US$23.57 respectively, with early tender premiums of US$20 and US$11.79 offered to holders that tender their notes by 30 May.

The offer will expire on 23 June, unless it is extended. BMC Group is the tender agent for the offer.

The offeror has disclosed that it currently owns US$3m (equivalent to one-third) of the class C notes outstanding, having acquired them in April for a price of US$863.54 per US$1,000.

CDS

EFH CDS, LCDS settled

The final results of the Energy Future Holdings CDS auctions have been published (SCI 16 May). The final price for Texas Competitive Electric Holdings Company LCDS was determined to be 78.75, after seven dealers submitted initial markets, physical settlement requests and limit orders to the auction. However, the final price for the entity's CDS was determined to be 8.5.

Meanwhile, the final price for Energy Future Intermediate Holding Company LLC/EFIH Finance Inc CDS is 105.75. Due to zero net open interest, there was no subsequent bidding period to the auction and so the inside market midpoint value is the final price.

Finally, Energy Future Holdings Corp CDS were settled at 56.125. Eleven dealers submitted initial markets, physical settlement requests and limit orders to the CDS auctions.

CDS

DIRECTV CDS hits all-time tights

Credit protection on DIRECTV is now pricing at its all-time tightest level, driven by news that AT&T Inc intends to purchase it, according to Fitch Solutions. At 48bp, five-year CDS spreads on DIRECTV Holdings LLC (DTVH) have tightened by 52% since 30 April and are outperforming AT&T for the first time. AT&T CDS firmed by 4% during the same period to trade at their lowest levels since May of last year.

Market sentiment has been improving for both companies, leading up to announcement that AT&T intends to buy DIRECTV in a deal valued at approximately US$48.5bn. CDS liquidity has increased for both issuers since the beginning of May, most notably for AT&T, where CDS went from trading in the 26th regional percentile to the 14th.

CMBS

New issuance dampens default rate

Fitch's US CMBS cumulative default rate declined by 20bp in the first quarter to 13.5%, due to US$8.3bn in new issuance. In 1Q14, 91 loans totalling US$1.1bn were newly defaulted, up considerably from 42 loans (US$340.3m) in 4Q13 and 72 loans (US$781.2m) in 1Q13.

The increase in the quarterly default amount was driven by larger loans over US$20m, according to Fitch. Nineteen large loans accounted for nearly half of the total newly defaulted loans by balance.

Office properties were the largest contributor by original loan balance to new Q1 defaults, with 28 loans comprising 40.1% of newly defaulted loans. Retail properties were the second largest contributor, with 32 loans at 29.2% of newly defaulted loans, followed by six hotel loans at 12.5%.

The two largest defaults were both on office properties. The first was a US$95m loan secured by Gateway One, which is the second largest loan in MSCI 2007-IQ13. The property has reportedly suffered due to declining lease rates and high vacancy in the market.

The second largest default was a US$78m office loan secured by One HSBC Center, securitised in GSMSC 2005-GG4. The largest tenant occupying 77% of the space vacated at lease expiration.

Retail defaults for 1Q14 totalled US$320.4m (29.2%). Newly defaulted retail loans ranged in size from US$617,000 to US$39.5m.

The largest two defaults were both malls. The first was the US$39.5m College Square Mall, securitised in BSCMSI 2005-PWR10. Occupancy at the property has been low for some time and the borrower decided to stop funding operational shortfalls.

The second largest was the US$36m Mall at Yuba City, securitised in CSFB 2005-C1. The loan has struggled since 2010 with declining lease rates and increasing expenses.

Meanwhile, three hotel loans over US$20m defaulted for the first time in 1Q14, after struggling since the downturn. They consist of the US$59.8m Sheraton Newark Airport (JPMCC 2006-CIBC17), the US$30m Marriott Hotel Huntsville (JPMCC 2007-LDP10) and the US$20.3m Chantilly Residence Oxford (MLCFC 2007-5).

Four loans from the 2011-2013 vintages defaulted during the quarter, the largest of which is the US$19.5m Acropolis Gardens Realty Corp loan in WFRBS 2013-C15. The loan transferred to the special servicer in March for monetary default.

Undisclosed ongoing litigation emerged in federal court claiming fraud and breach of fiduciary duty on the part of the board of directors of the building's cooperative. The loan is now 90-plus days delinquent.

The remaining three loans are all secured by multifamily properties that have seen occupancies decline since issuance.

CMBS

Further CMBS auctions listed

A further 64 properties backed by US$403m in US CMBS loans have been added to the Auction.com sales listed for June (see also SCI's CMBS loan events database). A large portion of these loans are from a few deals on which CWCapital is the special servicer, according to Barclays Capital CMBS analysts.

They note that the largest deal exposure to the new listings is JPMCC 2007-LD11, representing US$90.1m in loans encumbered by 17 properties. JPMCC 2006-LDP9 also has a large exposure, with US$79m out for bid. Both of these deals are serviced by CWCapital.

The largest loan listed for auction is the US$25.9m Renaissance West Retail Center, securitised in WBCMT 2005-C17. The loan was appraised at US$19.6m in February, which would imply a 38% loss, the Barcap analysts observe.

Risk Management

End-user trading promoted

The CFTC has announced two actions designed to benefit utility special entities and promote end-user trading on swap execution facilities (SEFs) and designated contract markets (DCMs). To incentivise trading on SEFs and DCMs, it has issued a no-action letter that provides relief with respect to compliance with certain recordkeeping provisions of Regulation 1.35(a) to members of designated contract markets or swap execution facilities that are not registered or required to be registered with the Commission.

The Commission has also issued a proposed rule amendment to adjust the de minimis threshold for determining if an entity that enters into swaps with utility special entities must register as a swap dealer. The proposal would amend the Commission's swap dealer definition to permit a person dealing in 'utility operations-related swaps' with 'utility special entities' to exclude those swaps in determining whether that person has exceeded the de minimis threshold specific to dealing with special entities. Under the proposal, however, such swaps would be counted for determining whether the general dealing de minimis threshold applies.

The Commission is seeking comments from the public on the proposal. The comment period will close 30 days after the proposal is published in the Federal Register.

RMBS

DSB compensation to rise?

The Amsterdam court has passed an interim ruling on the framework agreement that sets out the compensation process on due care claims of clients of the now bankrupt DSB Bank (SCI passim). The court believes that the framework is broadly adequate, but raised concerns about some aspects that apply to certain types of claims and suggested that improvements are made.

The due care claims arise from borrower complaints about DSB's lending practices, with the bank's Chapel 2003-1, Chapel 2007, Monastery 2004-I and Monastery 2006-I RMBS bearing the associated losses. The framework agreement governing borrower compensation resulted from negotiations between DSB and consumer organisations in September 2011. Many borrowers have already submitted their claim and received compensation under the current terms of the framework.

Moody's notes that although the bankruptcy trustees must still carry out a full assessment of the impact of the court's suggested improvements on the potential compensation amounts, such improvements would apply to only a limited number of borrowers and result in a moderate increase in the compensation amounts. It adds that an increase in due care losses resulting from the court's suggested improvements would not negatively affect the ratings on the notes in the four securitisation transactions.

The due care loss assumption underlying the current ratings on the notes is based on the maximum compensation estimates provided by the bankruptcy trustees in 2011, given that all borrowers submit their claim, choose to settle their claim through the framework agreement and not through individual court verdict, and can prove the validity of their claim. These maximum compensation estimates amount to €75m for Chapel 2003-1, €85m for Chapel 2007, €10m for Monastery 2004-I and €15m for Monastery 2006-I.

However, Moody's suggests that the due care losses ultimately realised are likely to fall short of these values, with the borrower claims processed up until end-2013 amounting to only around 41% of the maximum estimates on average in the securitisations. The current ratings therefore already account for the potential moderate increase in due care losses.

It was previously expected that the court would ratify the framework in its current form in 1H14, but the resolution is now unlikely to take place until late this year, further delaying the compensation process and the full crystallisation of the due care losses. This delay will also prolong the involvement of the bankruptcy trustees in the servicing of the transactions, according to Moody's. The day-to-day servicing of the loans has been sub-delegated to Quion since June 2013, but handling of due care claims has remained the responsibility of the bankruptcy trustees.

Moody's says that significant increases in borrower compensation compared with those established under the current framework could lead to a possible downgrade of the ratings on the outstanding notes.

RMBS

Bidding criteria switched

The seller of yesterday's US$1.1bn non-agency RMBS BWIC (SCI 20 May) switched on the morning of the sale from only soliciting all-or-none bids for the entire portfolio to entertaining single security bids. Given that nearly one-quarter of the list comprises Re-REMIC bonds that tend to be less liquid, Interactive Data suggests that the seller may have feared poor execution and thus changed the bidding criteria to be more accommodative.

The list originally consisted of 47 individual line items, but one - SASC 2006-NC1 A4 - was said to have traded early. The bulk of the bonds out for bid on the list were split between Alt-A and subprime collateral.

SCI's PriceABS data picked up a range of Re-REMIC names circulating yesterday, including BCAP 2009-RR10 7A2, BCAP 2010-RR4 5A14 and BCAP 2011-RR11 3A7. Covers of low/mid-90, 50 area and mid-80 were recorded for the respective tranches.