Contents

CMBS

Euro CMBS coming alive?

The European CMBS secondary market has been subdued recently, although BWICs have been announced for both today and tomorrow. There is also speculation that primary market issuance could increase.

"Suddenly a couple of decent BWICs have been announced in quick succession, so that should inject some life into the secondary market. The fact that they were announced so close together might just be a coincidence, but it could also mark the start of increased activity," reports one European CMBS trader.

He continues: "The problem so far has been that bonds off BWICs have been going to dealers rather than clients, so it will be interesting to see whether that dynamic changes. Client activity has been picking up slowly, but the Street remains the better buyer."

SCI's PriceABS data confirms that recent activity has been subdued, although it has not stopped. For example, yesterday's session saw the BUMF 3 B1 tranche talked at 104 handle and covered at 100.77.

A few other names were also out for the bid, including ECLIP 2007-2X C, where price talk ranged from the single-digits up to around 30. The bond was also talked in the 30 area last week, but the last recorded cover - from 24 October 2013 - was at 13.

The trader says that spreads have been tightening, with mezzanine bonds in particular trading up over the last few weeks. A number of property sales have also had a positive impact on price action.

Senior bonds tend to move in line with news as events develop, but in a quiet market there has been little to affect pricing, so seniors have continued to grind tighter. Strong interest remains for higher-yielding paper, albeit supply is limited.

"The periphery has rallied significantly over the last few months. We have not seen so much CMBS activity there, but it seems like a safe space and it is probably worth looking at because - if nothing else - there is not much room to fall," the trader says.

He adds that there has been increased talk in the market about new issues. Any new transactions are probably still some way off, but if one could come before summer it might provide a spark.

"Everybody will be at the conference in Barcelona next week and after that summer is just around the corner, so if activity is going to pick up, it will have to be soon. These upcoming BWICs should generate some selling and that is positive, but if the primary market can also pick up, then that would really start a buzz," the trader notes.

JL

RMBS

RMBS secondary supply jumps

US non-agency RMBS BWIC volume picked up yesterday to reach around US$410m. A variety of bonds were out for the bid, including a handful of post-crisis non-performing loan tranches.

Among the Alt-A names circulating during the session, a couple of bonds appeared for the first time in SCI's PriceABS data. The IMM 2007-A M1 tranche was talked at low/mid-90s, for example, while the WMALT 2005-4 5A2 tranche was talked at high-70s.

Also debuting in PriceABS yesterday were the subprime NHEL 2004-1 and NHEL 2004-4 M3 tranches, which were respectively talked at low/mid-90s and 100 area. Meanwhile, the option ARM SAMI 2006-AR8 A1BG was talked at mid/high-70s before being covered at 79 handle. The bond had previously been talked in the high-70s on 5 November.

The NPL RMBS - comprising the VOLT 2013-NPL3, 2013-NPL4, 2013-NPL5, 2013-NPL6, 2014-NPL1 and 2014-NPL2 A1 tranches - were all covered over par. Additionally, the CSMC 2009-2R 2A5 bond was covered north of par during the session.

CS

Structured Finance

SCI Start the Week - 2 June

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

Pipeline
Bank holidays on either side of the Atlantic contributed to a relatively quiet week. Four ABS, four RMBS and four CMBS deals were added to the pipeline.

The newly-announced ABS were US$1bn Fifth Third Auto Trust 2014-2, US$728m MMAF Equipment Finance 2014-A, US$612m PHEAA Student Loan Trust 2014-2 and €1.4bn Sunrise series 2014-1. Fosse Master Issuer series 2014-1, €432m MARS 2600 series V, €752m STORM 2014-II and the re-offered Claris ABS 2011 accounted for the RMBS. Meanwhile, the CMBS comprised US$655m CSMC Trust 2014-ICE, US$1.45bn GCMT 2014-388G, US$350m LCCM 2014-909 Mortgage Trust and US$1.3bn MSBAM 2014-C16.

Pricings
European RMBS dominated the limited list of prints last week. Four RMBS priced, as well as two ABS and one CLO.

The RMBS new issues were €44.07bn BPCE Master Home Loans, €897m Dutch Mortgage Portfolio Loan XII, €342m iArena and US$500m-equivalent RESIMAC Premier Series 2014-1. The €475m A-BEST 9 and €350m RevoCar 2014 transactions accounted for the ABS prints, while the CLO was US$617.5m Jamestown CLO IV.

Markets
US non-agency RMBS BWIC volume picked up mid-week to reach US$410m on Wednesday, as SCI reported on 29 May. That day's session saw a variety of bonds out for the bid, with SCI's PriceABS data recording cover prices for tranches such as the option ARM SAMI 2006-AR8 A1BG.

US CMBS spreads were relatively unchanged last week on fairly low volumes, according to Barclays Capital analysts. "In the legacy sector, 2007 dupers stayed at swaps plus 84bp and 2007 AJ remained at swaps plus 443bp. Agency CMBS spreads were also unchanged and the Freddie K 10-year A2 tranche remains at swaps plus 40bp," they observe.

US CLO secondary market activity was stable, with BWIC volumes amounting to around US$320m for the week. Bank of America Merrill Lynch CLO analysts note that about two-thirds of the line items came from 2.0 deals, with spreads were unchanged on the week.

"Compared to a month ago, 2.0 spread levels are 10bp-25bp wider from double-A to double-B. In the 1.0 space, single-A to double-B tranches did not receive strong bids and a number of them did not trade as sellers' reserve levels were not met," the BAML analysts add.

Meanwhile, European RMBS spreads were marginally tighter across the board, according to European securitisation analysts at JPMorgan. This extended to Italian and Spanish paper, which managed to reverse some of the widening seen over recent weeks.

Deal news
• Green Tree Servicing's failure to meet error rate thresholds for eight of 29 National Mortgage Settlement (NMS) servicing metrics in its first testing period is said to be credit neutral for existing private-label RMBS. Nevertheless, the failure underscores the challenges non-bank servicers face in handling servicing acquisitions from larger banks.
• 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 believed to be securitised in a few deals on which CWCapital is the special servicer.
• Ford Automotive Finance (China) has completed its first auto loan ABS in China, 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.
• 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.
• 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 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.
• New capital invested in reinsurance sidecars reached US$1.92bn in 1Q14, the highest level of quarterly growth in the segment since 2009. 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.
• 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.

Regulatory update
• The Bank of England and the ECB have published their joint discussion paper on the revitalisation of European securitisation, building on the report published in April (SCI 14 April). The paper discusses the reasons for the shortcomings and the opportunities for improvement of the ABS market, and is designed to stimulate discussion among stakeholders on the impediments identified and the suggested policy options aimed at alleviating them.
• The China Bank Regulatory Commission (CBRC) recently issued risk management requirements that should help to establish a better foundation for China's securitisation market. The requirements apply separately to trust companies and financial leasing companies.
• The CFTC has addressed for the first time its definition of a swap as it applies to a specific insurance transaction. No action letter 14-67 allows US life insurers - via a Bermuda cell insurer - to provide a reinsurance hedge to banks active in protecting non-US pensions against the mortality improvements of specified individual beneficiaries.
• 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.

Deals added to the SCI New Issuance database last week:
Arbour CLO; Armor Re Series 2014-1; Barclays Dryrock Issuance Trust 2014-2; Carlyle Global Market Strategies CLO 2014-2; CAS 2014-C02; Chestnut Financing; COMM 2014-UBS3; Exeter Automobile Receivables Trust 2014-2; Gallatin CLO VII 2014-1; Globaldrive Auto Receivables 2014-A; Golub Capital BDC CLO 2014; GRACE 2014-GRCE; Navient Student Loan Trust 2014-1; OCP CLO 2014-6; PYMES Santander 8; Spirit Master Funding series 2014-1; Spirit Master Funding series 2014-2; Spirit Master Funding series 2014-3; STORE Master Funding series 2014-1; Westlake Automobile Receivables Trust 2014-1; WFCM 2014-LC16.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2004-3; BACM 2005-4; BACM 2006-1; BACM 2007-3 & JPMCC 2007-LDP11; BSCMS 2005-PWR9; BSCMS 2006-T22; BSCMS 2007-T28; CGCMT 2007-C6; CSFB 2004-C5; CSMC 2007-C1; DECO 2007-E5; ECLIP 2006-2; EPICP BROD, EPICP CULZ, EPICP DRUM; GECMC 2005-C4; GECMC 2007-C1; GMACC 2002-C3; GSMS 2005-GG4; GSMS 2007-GG10; INFIN SOPR; JPMCC 2006-LDP7; JPMCC 2006-LDP9 & JPMCC 2007-CB18; JPMCC 2007-LD12; LBUBS 2003-C7; LBUBS 2004-C7; LBUBS 2007-C6; LEMES 2006-1; MLMT 2005-LC1; MSC 2005-HQ7; SOVC 2007-C1; TAURS 2006-2; TITN 2006-3; TITN 2007-1; TITN 2007-CT1; TMAN 7; WBCMT 2005-C17; WBCMT 2006-C23; WBCMT 2006-C27; WINDM X; WTOW 2007-1.

CMBS

CMBS delinquencies 'idiosyncratic'

An increasing number of US CMBS 2.0 and 3.0 loans have begun to enter special servicing or show initial signs of distress. Since the beginning of the year, 14 loans - with US$164m in outstanding balance - have moved into special servicing or delinquency, although this seems to reflect idiosyncratic issues rather than sector-level weakening.

Barclays Capital analysts note that 23 loans across the 2010-2014 vintages - with US$285m of outstanding balance - are delinquent or in special servicing. That is still a small percentage for each of the new issue vintages but it is growing.

The vintage with the largest amount of defaults is 2011, where there is US$122m in delinquent loans. While the consensus is that CMBS credit quality has weakened each year since issuance restarted in 2010, the analysts note that performance trends are yet to bear this out and attribute the concentration in the 2011 vintage to that fact that 2011 loans have had more time to season than other vintages.

By property type, multifamily represents the largest share of distressed loans. Over 45% of loans in special servicing or delinquency are multifamily properties despite multifamily loans only representing about 9% of new issue collateral.

While the Barcap analysts note that the sample size of 3.0 distressed loans is too small to come to definitive conclusions, initial trends suggest apartment properties may be underperforming. This may be because of the likelihood of adverse selection in conduit CMBS as the better properties gravitate towards cheaper agency funding.

Delinquencies may also be being driven by unusually structured or niche subsectors of the multifamily sector. These subsectors include student housing and military housing, both of which had had recent performance pressures.

Some atypical multifamily properties also appear to be underperforming, such as the US$23m Strata Estate Suites in North Dakota in COMM 2013-CR10 where DSCR is down to just 1.07x only a few months after issuance. The property had an unusual structure with potentially volatile occupancy.

Other delinquencies appear to be for reasons which are not necessarily related to the properties themselves. The US$8m Brooksedge Apartments, US$11m Retama Ranch Apartments and US$12m Stonebridge Apartments, for example, were moved to special servicing because of court proceedings against the borrower, which was accused of an unrelated Ponzi scheme.

Several loans appear to be in default because of borrowers failing to pay in a timely manner and follow lockboxes properly. These loans may return to current status and the analysts estimate half of the defaults can be attributed to these idiosyncratic factors or payment issues.

The other half of loans in default seem to be due to a sharp drop in financials of the underlying asset. The poor performance can be traced to tenant departures for some of the office or retail properties or a decline in occupancy for multifamily assets, but these default volumes are still too small to identify a sector-wide pattern of weakness.

Losses are expected to be minimal and despite the growing number of specially serviced new issue loans, only four properties appear to be underwater; of those four, losses for three should be under 10%. The US$5m The Cove at Southern loan looks the most likely to take losses, with the most recent appraisal indicating an 18% haircut.

"Of the US$285m of loans in special servicing, we estimate losses of about US$18mn, or 6% severity, after applying estimated valuations for loans without updated appraisals. Most of the losses are likely to be concentrated in a handful of small loans," say the analysts.

Delinquencies for 2011 and 2012 vintages appear roughly in line with where 2004-2005 collateral was after the same period of seasoning. Without a slowdown similar to 2008-2009, the analysts expect the new issue vintages to outperform.

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Structured Finance

Fixed income analyst added

Aite Group has appointed John Mangano as an analyst in its institutional securities and investments team. He is based in Boston and will focus on fixed income products, technology and market structure.

Mangano spent 15 years at Fidelity Capital Markets, where he held a range of fixed income sales and trading roles, including in structured debt. More recently he was a managing partner at Nantucket Absolute Capital.

Structured Finance

Rating agency adds industry vet

Moody's has appointed Jim Ahern as its next head of structured product ratings and surveillance in the US, Canada and Latin America. He will replace Claire Robinson, who has retired from the rating agency.

Ahern joins from Société Générale, where he was global head of securitisation. The new role will see him leave London to be based in New York, where he was previously based until 2011.

Ahern has also worked for Commerzbank, Mizuho and UBS. He will report to global structured product rating head Michael West.

Structured Finance

Markit IPO underway

Markit has commenced its initial public offering: the firm's shareholders intend to sell 45,707,965 common shares at a price that is expected to be between US$23 and US$25 per share. The underwriters will have a 30-day option to purchase up to an additional 6,856,195 common shares from certain of the selling shareholders. Bank of America Merrill Lynch, Barclays, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley, UBS, BNP Paribas, Jefferies, RBC, RBS and TD Securities are joint book-running managers for the IPO.

CMBS

CMBS surveillance product added

Trepp is set to integrate Kroll Bond Rating Agency's new CMBS surveillance product KBRA Credit Profile (KCP) with its own product suite. The KCP reports provide valuations and losses for the collateral securing credit-impaired loans.

Authorised Trepp clients will be able to access the KCP reports, enabling forecasting of both the probability of default and resolution timing. The reports will also add functionality and increase transparency around Trepp's assumptions, along with colour and commentary on loan and transaction performance.

ABS

Auto ABS structuring trends surveyed

Moody's notes in the second report of its four-part series on the global auto ABS sector that transactions in North America, Europe, Asia Pacific and South America benefit from the use of common legal and operational protections, such as back-up servicing arrangements and true sale mechanisms. While new deals will continue to feature similar types of capital structures and credit enhancement, some issuers in the US are bringing back structural features that present incremental risk in transactions, according to the agency.

"Features such as prefunding and revolving periods fell out of favour during the recession in the US because they add incremental risk, but they are showing up in new ABS transactions," says Sanjay Wahi, Moody's vp and senior analyst. "The use of floating rate rather than fixed rate securities in transactions is also making a comeback in the US."

Because these securities are no longer hedged, they add interest rate risk to these transactions. These features require more credit enhancement because of the additional risk that they pose to ABS investors, Moody's observes.

"In contrast, some issuers in Europe are increasingly using more static pools in response to investor demand for simpler structures and shorter maturity," says Mehdi Ababou, Moody's vp and senior analyst. French captive finance companies, who have historically used a master trust type of structure, recently added auto ABS backed by discrete static pools to their existing offering to cater to investor demand.

Meanwhile, as China's securitisation market develops further, new auto loan ABS deals will rely on structural protections that resemble those in more developed markets. However, because the sector is still very young, deals have untested legal and operational risks. Risks related to potential servicer default are one area of concern.

"It is unclear whether Chinese securitisations would be able to transfer servicing duties in an orderly fashion to a successor in the event of a servicer default, because there is no precedent for such transfers," says Elaine Ng, Moody's vp and senior analyst.

South America has strengthened capital market regulations to further protect auto ABS investors. For instance, in Argentina all issuers are required to hire a master servicer, meaning that an independent third party verifies pool balances.

"Brazil has also adopted regulations to reduce operational risk in auto loan ABS transactions," says Rodrigo Conde, a Moody's analyst. "Rules governing commingling risk improve custody of assets, increase the responsibility of trustees and master servicers, and decrease the likelihood of fraud in financial institutions."

ABS

Timeshare delinquencies normalising

Total US timeshare ABS delinquencies for 1Q14 stood at 3.19%, down from 3.27% in 1Q13 and 3.38% in 4Q13, according Fitch's latest index results for the sector. This marks the seventh straight quarter of year-over-year improvement, with delinquencies having largely normalised at their historical levels, following the dramatic increases of 2008 and 2009.

The quarterly and year-over-year improvement is also evident in default performance. Defaults for 1Q14 at 0.65% decreased slightly from 4Q13 at 0.66% and are down from the 0.72% observed a year ago. But Fitch notes that while quarterly and year-over-year improvement is evident, default levels remain somewhat elevated compared to pre-recessionary levels.

On an annualised basis, defaults were 7.73% for 1Q14, down from 7.93% for 4Q13. This represents the eighth consecutive quarter of improvement, as well as the lowest level of defaults for timeshare ABS in over four years.

ABS

Driver China One rated

Further details have emerged about Volkswagen's much-anticipated debut Chinese auto loan ABS, the RMB799.7m Driver China One Trust (SCI 1 April). The deal - arranged by CICC - is structured under the China Banking Regulatory Commission's credit asset securitisation regime.

Provisionally rated by Fitch and Moody's, Driver China One Trust comprises three tranches: RMB699m class A notes (Aa3/AA), RMB44m class Bs (Baa2/A-) and RMB52.72m unrated subordinated notes (to be retained by the originator). There is also a junior initial OC tranche sized at RMB4m.

The portfolio consists of 13,696 loans made to 13,536 obligors, with what Moody's describes as a good level of geographic diversification across China. Almost half of the pool balance relates to borrowers located in provinces that were ranked top 10 by GDP per capita in 2012.

At 98.6%, the pool has a higher proportion of loans for the purpose of purchasing new vehicles with fully amortising repayment terms, compared to recent European VW auto ABS. The weighted average down-payment rate is about 35%; all loans have a minimum down-payment of 20%.

Six auto brands are included in the pool: VW, Audi, Porsche, Skoda, Bentley and SEAT.

ABS

Record results for credit card indices

After hitting a record low in April, Fitch's Prime Credit Card 60+ Day Delinquency Index decreased by another 2bp to 1.15% in May, reaching the lowest level since its launch in 1991. The index has declined by 22% year-over-year and now stands 75% below its peak level reached at the end of 2009.

Meanwhile, Fitch's Prime Credit Card Charge-off Index increased by 7bp to 3.11% in May, albeit the index remains down nearly 21% YOY. It now stands at 73% below its historic high of 11.52% reached in September 2009.

Consistent with seasonal trends, Fitch's Prime Credit Card Monthly Payment Rate Index declined to 26.23% in May. This index is now 12% higher YOY and well above its historical average of 17.18%.

Similarly, Fitch's Prime Credit Card Gross Yield Index decreased by 87bp month-over-month (MOM) to reach 18.25% in May. Prime gross yield has declined every May since Fitch created its credit card ABS index back in 1991.

The Prime Credit Card Three-Month Average Excess Spread Index also set a new record last month, increasing by 24bp MOM to a new high of 13.27%.

Fitch's Retail Credit Card 60+ Day Delinquency Index decreased by 2bp MOM to 2.44% in May. During the same period, the Retail Credit Card Charge-off Index increased by 30bp to 6.95%, increasing by 4.51% MOM, albeit the index remains 50% lower than its peak of 13.41% reached in March 2010.

Fitch's Retail Credit Card Gross Yield Index decreased by 87bp to 27.52% from the previous month, a 3.06% decrease. However, the Retail Credit Card MPR Index increased by 57bp MOM to 15.91%, while the Retail Credit Card Three-month Average Excess Spread Index increased by 12bp MOM to 18.6% - an all-time high for the index since its inception in 2004.

ABS

Global auto credit quality examined

Moody's expects the credit quality of global auto loan ABS to remain steady, except for in North America, where lenders are easing underwriting standards and borrower credit is declining modestly. Auto ABS pools will continue to consist primarily of loans to prime borrowers, with the US continuing to have a sizable market for securitisations backed predominantly by near-prime and subprime borrowers.

Lenders in the US are offering easier repayment terms in response to low default levels, strong consumer demand and easier access to capital. Even though these same dynamics will likely occur in other regions, the impact will be muted because of the predominance of prime borrowers in the underlying pools. In addition, underwriting remains tight in Europe compared with pre-crisis standards, reflecting cautious expectations about economic activity.

Geographic diversification across loan pools protects investors from regional economic shocks. However, in many regions, the presence of auto loans to SMEs increases volatility because the pools are more vulnerable to economic downturns. Pools in Australia also typically have a small exposure to commercial equipment loans, such as in the agricultural or construction segments, which also can increase performance volatility.

Offsetting the general stability in global auto ABS is the variation in loan terms by region. Longer maturities and lump sum or balloon payments at the end of a loan term make some auto loan pools riskier than others, Moody's observes. Longer loan terms can attract borrowers with lower credit profiles and the loss severity will be higher if a loan with a longer term defaults.

Loans in Chinese ABS pools will continue to have higher credit quality than in many other markets because lenders use cautious underwriting criteria, such as a minimum 20% down payment, fully amortising loans and shorter tenors.

Structured Finance

Central bank discussion paper welcomed

AFME has welcomed the Bank of England and ECB's discussion paper on revitalising the European securitisation market (SCI 30 May), noting that the report "helpfully acknowledges" the strong performance of high‐quality transactions in the region. The association adds that the concept of 'qualifying securitisations' fits well with recent calls by the European Commission to revive a sustainable market for high‐quality securitisation in Europe, as well as the analysis currently being undertaken by the European Banking Authority.

Simon Lewis, chief executive at AFME, comments: "AFME and the industry are keen to continue our constructive engagement with the Bank, the ECB, the Commission and other policymakers to continue to develop this concept. Much work remains to be done and there remain difficult challenges to resolve - for example, how to avoid cliff effects; how to address the different motives behind any single definition of 'high quality'; and how to strike the right balance between meeting the needs of the real economy, while maintaining high quality."

AFME believes that it is crucial for industry and policymaker discussions to converge in a single forum, where work can be undertaken in a coordinated way.

Structured Finance

SFR snapshot debuts

Kroll Bond Rating Agency has published the inaugural issue of its Single-Family Rental Performance Snapshot, which aims to provide the market with a timely synopsis of the performance of securitised transactions in this emerging asset class. The move is part of an effort to provide more transparency around the performance of SFR transactions.

This first report highlights the Invitation Homes 2013-SFR1 (IH 2013-SFR1) transaction, which is collateralised by a single loan with a current balance of US$479.1m. The loan - which is secured by mortgages on 3,207 SFR properties - continues to perform in line with KBRA's expectations.

The average monthly vacancy rate since issuance and in 2014 is 5.1% and 6.3% respectively. The vacancy rate has been declining through 2014 and for April stands at 4.2%.

The average number of days vacant for April 2014 was 43. Vacancy times have been stable in the low-40 day range this year.

The average lease renewal rate since issuance and in 2014 is 6.3% and 7.5% respectively. The April lease renewal rate is 5.4%.

Contractual in-place rental revenue is, as expected, 3.6% lower than at issuance due to vacancy rising from zero. The rental income has risen by 4.5% and 2.7% since January 2014 and March 2014 respectively, reflecting the occupancy rate in recent months. The average tenant delinquency rates on the occupied properties since issuance, year-to-date 2014 and in April 2014 were 0.40%, 0.57% and 0.58% respectively.

KBRA analysed the change in home price indexes at the zip code level for the property pool and found the weighted average home price index growth since the original valuation of the properties to be 4.3%. The agency also compared the rent per square-foot for the properties to single-family rental property indices, which indicated that the April 2014 rents average approximately 94% of market rents.

Structured Finance

Euro ABS policy options outlined

The Bank of England and the ECB have published their joint discussion paper on the revitalisation of European securitisation, building on the report published last month (SCI 14 April). The paper discusses the reasons for the shortcomings and the opportunities for improvement of the ABS market, and is designed to stimulate discussion among stakeholders on the impediments identified and the suggested policy options aimed at alleviating them.

The paper notes that the banking system is likely to need access to a wider range of funding sources going forward and that the revival of the ABS market can play a useful role in ensuring that there is not a renewed build-up of systemic risk, including from excessive reliance upon any single source of financing. It also argues that well-functioning securitisation markets enable non-bank financial institutions to raise funding for their real economy lending, thereby providing an alternative to bank lending.

Further, the central banks notes that credit risk transfer via securitisation can free up bank capital, allowing banks to extend new credit to the real economy and supporting the transmission of accommodative monetary policy. It may also reduce the dependency of banks' lending decisions on business cycle conditions and lower the exposure of real economy borrowers to refinancing or liquidity risk.

"More generally, securitisation can contribute to enhancing the issuer's risk management culture through the discipline the process of securitising assets imposes," the paper observes. "Some securitisations may further provide long-term investors, such as insurance companies and pension funds, with a broader pool of assets that are genuinely low-risk from a credit perspective. In principle, greater issuance of low credit risk ABS may also deepen the supply of high-quality collateral - which could be particularly useful, given the post-crisis trend towards greater collateralisation of financial transactions, with regulatory reforms headed in a similar direction."

The report goes on to outline the potential impediments that may be preventing securitisations from being priced in a way that meets the demands of both investors and issuers. First, some types of investor may currently be deterred from holding ABS due to changes in regulatory capital charges to be held against these investments and uncertainty about the final outcome of post-crisis reforms. In particular, the proposed treatment for higher-quality ABS may still be perceived by investors as conservative, particularly when compared with similar asset types.

Second, post-crisis investors appear to have been more cautious in their risk assessment of assets, which in the short term may represent an impediment to the quick revival of the securitisation market. The paper suggests that such hurdles for securitisation may be higher compared to other assets due to the paucity of available data for some ABS, for example, those backed by SME loans. The difficulty of assessing market liquidity may add additional challenges to the assessment and management of risk.

Third, there may be deterrents to potential issuers, including uncertainty around capital relief available under future securitisation capital rules and inconsistent implementation of retention requirements globally. Issuers may also be unable or unwilling to offer sufficiently attractive spreads to investors, given cheaper alternative funding opportunities or consideration of other cost pressures.

Fourth, the central banks suggest that imposition of structured finance credit rating caps on ABS has had a negative impact on the securitisation market in certain EU countries where it is no longer possible to achieve a triple-A rating, regardless of the extent of credit support in the structure. This results from the imposition of a hard sovereign rating cap, which may undermine transparency around the inherent credit quality of securitisations.

Fifth, concerns around the continuing availability of the infrastructure necessary to arrange and service a securitisation can further raise risks and/or increase direct costs to issuers. One specific issue highlighted by the report relates to rating agencies' requirements that providers of ancillary facilities - such as swaps and bank accounts - meet a certain credit rating criterion. The universe of such providers is significantly smaller and more concentrated than before the financial crisis.

Finally, historical trading volumes of securitisations have been relatively low. This is not necessarily a sign of an instrument being fundamentally illiquid, though actual or perceived illiquidity is an important determinant of pricing and investor demand.

The report notes that robust securitisation markets require investors that are resilient to changes in economic conditions. "It would therefore be desirable for risks to be distributed across the financial system in a transparent and diverse manner, to an investor base that is not excessively leveraged or dependent on short-term funding. Equally, securitised assets should embody features that improve the ability of investors to predict their performance in different economic environments, which in turn should support demand."

The central banks indicate that involvement in the market by the authorities may be desirable to support its revitalisation in a more robust form. For example, by lending credibility and maximising the broader benefits of well-functioning securitisation markets.

A number of options are outlined for competent authorities to consider, including the development of high-level principles for 'qualifying securitisations' - to be applied to an entire transaction and not to individual tranches - which could aim to identify securitisations that are simple, structurally robust and transparent. This would enable investors to model risk with confidence and provide originators with incentives to behave responsibly.

The paper outlines a number of characteristics that a qualifying securitisation should embody: its assets must be credit claims or receivables with defined terms relating to rental payments or principal and interest payment and be current in payment; it will have recourse to the ultimate obligors for the underlying receivables; originators must demonstrate that assets are homogenous and consistently originated in the ordinary course of their business; obligors must have satisfied prudent and consistent underwriting criteria and have been assessed as having ability and volition to make timely payments; and verifiable loan loss performance should be made available for substantially similar receivables to those being securitised. Where underlying receivables are secured on specified tangible assets, such security must be first-ranking or, if lower ranking, rights associated with all prior ranking security shall also be transferred to the securitisation. Finally, the securitisation should effect a true sale.

Such an initiative would aim to promote securitisations for which the risks and pay-offs could be consistently and predictably understood, making such due diligence more straightforward as uncertainty and model risk are lower. Consequently, qualifying securitisations could benefit from improved secondary market liquidity and may also warrant a specific regulatory capital treatment.

In terms of data availability, based on loan level and credit register information, authorities could consider encouraging the industry to develop benchmark indices of borrower, loan and tranche performance to assist issuers in structuring transactions and investors in managing risk. Finally, to provide investors with greater visibility and understanding of the impact of sovereign and ancillary facility debt rating caps on ABS ratings, rating agencies could publish additional information to complement their overall rating. This could include a matrix showing the implied rating of the various tranches if the sovereign and ancillary facility rating caps were to be set at higher levels than currently.

The central banks welcome comments and views on the material set out in their paper. Comments should be submitted by 4 July.

Structured Finance

Portuguese ratings upgraded

Moody's has upgraded to Baa1 six notes in five Portuguese ABS and eight notes in seven RMBS transactions. At the same time, the agency placed on review for upgrade three notes in three ABS and 42 notes in 22 RMBS. It has also placed on review direction uncertain one note in one RMBS deal.

The rating actions follow the upgrade of the Portuguese sovereign rating from Ba3 to Ba2 on review for upgrade and the resulting increase of the local-currency country ceiling to Baa1 from Baa3. The move reflects improvements in institutional strength and reduced susceptibility to event risk associated with lower government liquidity and banking sector risks, Moody's says.

Performance issues that the reduced country risk may not mitigate prompted the rating review action direction uncertain on the class C tranche of Lusitano Mortgages No. 6.

Structured Finance

Risk management requirements welcomed

The China Bank Regulatory Commission (CBRC) recently issued risk management requirements that should help to establish a better foundation for China's securitisation market. The requirements apply separately to trust companies and financial leasing companies.

"The new rules provide additional support to China's developing securitisation market because trust companies often provide trustee services to securitisation transactions and there is growing interest in having financial leasing companies securitise their leases," Moody's notes in its latest Structured Thinking: Asia Pacific publication. "The additional requirements are therefore aimed at controlling risks in these institutions. They will also help improve the operational strength of securitisations and the credit profile of the underlying assets in securitised loan portfolios - two factors which are important for the success of China's securitisation market."

The agency expects new requirements regarding the management of trustees to strengthen the operational stability and quality of trustee services through the improvement of trustee operations and the better identification of trustee responsibilities. The stability of the trustee's operations should also improve because the new rules require shareholders to provide capital and liquidity support to trust companies, if and when needed.

The rules also clarify and impose various responsibilities on the trustee, the consequences of which will have a direct impact on securitisations. The responsibilities include requirements on due diligence, risk management, post closing operations and asset enforcements.

For instance, the trust companies must identify designated staff to monitor transactions, particularly for high-risk projects. For transactions in which risks have surfaced, trust companies must take remedial actions, including asset divestment, security enforcement, debt restructuring and enforcement actions against the guarantor. Additionally, the rules require various regulators and their local offices to better coordinate with one another to ensure an effective supervision of trust companies.

Meanwhile, the guidelines are anticipated to lower financial leasing companies' operational and bankruptcy risks through the introduction of various shareholding and management requirements. For instance, financial leasing companies are required to have at least one founding shareholder who is a licensed international or domestic bank, a large domestic manufacturer of equipment suitable for financial leasing or a licensed international leasing company. This shareholder must hold no less than 30% of the financial leasing company's shares.

The guidelines further impose additional requirements on founding shareholders, such as meeting requirements on its own financial and operational strengths, investing with its own fund and agreeing not to divest or pledge its shares for the next five years. Shareholders must also provide capital and liquidity support to the financial leasing company if required to support its operations.

Other requirements include corporate governance, credit management, liquidity, market and operational risks, and portfolio composition. Moody's suggests that all these changes and additions can strengthen the continuity, stability and robustness of financial leasing companies.

CDO

ABS CDOs on the block

Auctions for the Kleros Preferred Funding and Trainer Wortham First Republic CBO V deals have been scheduled for 20 June. The collateral shall only be sold if the proceeds, together with other available redemption funds, are at least equal to the total senior redemption amounts. The collateral manager for the former transaction, although it may not have been the highest bidder, has the option to purchase the securities for a purchase price equal to the highest bid.

CDO

ABS CDO auction due

An auction will be conducted for Belle Haven ABS CDO 2006-1 on 20 June. The collateral shall only be sold if the proceeds are at least equal to the auction call redemption amount, plus an amount sufficient to provide subordinated noteholders with an IRR of at least 5%.

CDO

ABS CDO auction set

Dock Street Capital Management has been retained to act as liquidation agent for RFC CDO IV. A public sale of the collateral is scheduled for 12 June. The move follows the acceleration of the transaction after an EOD occurred (SCI 13 May).

CDO

CBO tender offer amended

HoldCo CDO Opportunities Fund has amended its tender offer for SKM-Libertyview CBO I class C and D notes (SCI 27 May). Under the amendments, the deadline for receiving an early tender premium has been extended to 13 June and the expiration date has been extended to 7 July. The purchase price per US$1,000 outstanding principal amount of the class C notes has also been increased to US$987.50, while the early tender premium has been reduced to US$7.50.

Additionally, the offeror has commenced a tender offer to purchase for cash the remaining class D notes that were not included in the original offer. While the purchase price and early tender premium for these notes is the same as in the original offer, this additional offer will expire on 2 July.

As of 2 June, none of the outstanding class C notes and US$1m of the outstanding class D notes had been validly tendered.

CDS

Improved sentiment seen for Gazprom

OJSC Gazprom five-year CDS spreads have tightened by 27% since 5 May, dropping to the lowest spread levels since early March this year, according to Fitch Solutions latest CDS case study. CDS liquidity has continued to increase for Gazprom, moving up by eight percentile rankings since 1 May to trade in the 16th regional percentile, making it more liquid than 84% of the CDS reference entities in the region.

"Improving CDS market sentiment for Gazprom is likely attributed to a recent deal between Russia and China for Gazprom to supply 38 billion cubic metres of gas a year to China National Petroleum Corporation," comments Diana Allmendinger, director, Fitch Solutions. "Earlier this week, Gazprom confirmed it received a payment of US$786.3m from Ukraine's Naftogaz for February and March supplies, which is potentially perceived by the CDS market as a sign of renewed stability and mending relations between the company and Ukraine's new government."

CDS

CDS notionals decline further

The BIS has released its quarterly review, summarising the latest data for the international banking and OTC derivatives markets to end-2013. Of note, credit derivative notional amounts fell to US$21trn at end-2013 from US$29trn at end-2011 and a peak of US$58trn at end-2007.

The gross market value of CDS fell to US$700m at end-2013, from US$1.6trn at end-2011. The net market value fell to US$139bn from US$417bn over the same period. This net measure takes account of bilateral netting agreements covering CDS contracts but, unlike gross credit exposures, is not adjusted for cross-product netting.

The decline in overall CDS activity was driven mainly by a contraction in inter-dealer activity, according to the BIS. The notional amount for contracts between reporting dealers fell to US$11trn at end-December 2013 from US$14trn at end-2012.

Notional amounts with banks and securities firms also fell, to less than US$2trn from US$3trn over the same period. Trade compression continued to eliminate redundant contracts, although the volume of compressions appears to have slowed from the peaks of 2008-2009.

Central clearing made further inroads in the CDS market in 2013, as contracts with CCPs accounting for 26% of all CDS contracts at year-end. The share of CCPs is highest for multi-name products (at 37%) and much lower for single-name products (at 17%). Contracts on CDS indices in the multi-name segment tend to be more standardised than those in the single-name segment, which thus makes the former more amenable to central clearing, the BIS notes.

Owing in part to the shift towards central clearing, the CDS market has seen an increase in netting. Net market value as a percentage of gross market value fell to 21% at end-2013 from 24% at end-2012 and 26% at end-2011.

The prevalence of netting is greatest for CDS contracts with CCPs and other dealers, where it reduced the ratio of net to gross market value to 9% and 15% respectively at end-2013. It is lowest for those with insurance companies (83%) and special purpose vehicles (57%).

Meanwhile, the distribution of underlying reference entities indicates that contracts referencing non-financial firms have declined at a somewhat more rapid pace than those referencing other sectors. Outstanding CDS contracts referencing non- financial firms stood at US$7trn at end-December 2013, representing 34% of all CDS. This is down from 37% at end-2012 and 40% at end-2011.

Contracts referencing financial firms stood at US$6trn at end- 2013, followed by securitised products and multiple sectors at US$5trn and sovereigns at less than US$3trn. By rating, contracts referencing investment grade entities equalled US$13trn and those referencing lower-rated or unrated entities were US$8trn.

CLOs

Strong performance continues for Euro CLOs

Fitch reports in its latest European Leveraged Loan CLO Tracker that CLOs continue to demonstrate stable ratings and strong performance. The average net loss across all transactions the agency monitors was -1.56% at end-April 2014, up from -1.49% at end-April 2013.

The increase is due to the continued workout of defaulted or credit risk names. However, one of the most significant drivers of net portfolio losses in 2014 has been the default of the Vivarte transaction.

In the past 12 months, Fitch has rated 11 transactions that have become effective and a further seven transactions have closed but have not yet become effective. The average time to ramp-up was 3.4 months and the average percentage ramped at closing was 66%.

CLO 1.0 deals rated by Fitch have performed in line with investor expectations, with an annual average cash return of approximately 14% and an average cumulative distribution near 90% of the equity balance. Of the CLO 1.0s rated by Fitch, 80% made an equity payment on the most recent payment date, with an average annualised cash return of more than 17% and a median annualised cash return above 20%.

Amend-and-extend activity has diminished as refinancing options have become available through the high yield bond market and on the back of new CLO issuance. On average, transactions that are one year from the end of their reinvestment period have paid down their senior liabilities by 10% and 22% after two years.

Loans with a recovery rating of RR3 represent 44% of assets in CLO portfolios, compared to 35% of credit opinions for senior secured loans. However, covenant-lite loans have increased as part of CLO portfolios and CLO 2.0 transactions typically now have cov-lite buckets ranging from 20% to 50%.

The credit quality of recent vintage cov-lite loans has migrated from single-B to B/B-. This trend shows a growing appetite for risk among leveraged loan investors, Fitch suggests.

CMBS

CMBS loss projections forecast

S&P has published its expected loss projections for US and Canadian conduit/fusion and single-borrower/large-loan CMBS transactions that it rates. The report addresses losses by transaction, vintage, property type and metropolitan statistical area.

"Our estimates of projected losses focus on our observed performance for US and Canadian CMBS transactions over time," comments S&P credit analyst Barbara Hoeltz. "They incorporate up-to-date performance information provided by the master and special servicers and our most recent analysis of the individual transactions. In addition, the projections reflect our view of the migration of delinquent loans and our current expectation of realised losses."

The study shows that the conduit/fusion 2006, 2007 and 2008 vintages continue to experience the highest total transaction projected losses, exceeding 10%, with the 2005 vintage standing at just over 6%. Although the office segment currently has one of the lowest realised losses to date (at 3.4%), S&P expects this property type to have the highest total projected loss (at 9.4%), as office collateral performance is likely to continue struggling. The agency also expects lodging to experience the second-highest total projected loss (at 9.1%).

The metropolitan statistical areas that S&P designates as secondary markets will experience higher near-term and total transaction projected losses than primary and even tertiary markets, according to the agency.

CMBS

Servicer replacement request queried

Hatfield Philips International (HPI) has outlined its credentials and performance as servicer and special servicer on the Windermere X CMBS portfolio. The move appears to be in response to efforts by the controlling class representative (Brookland Partners) to replace HPI with Mount Street Loan Solutions as special servicer of the Bridge, Built, Lightning Dutch and Tresforte loans (see also SCI's CMBS loan events database).

In particular, HPI notes the success of its ongoing efforts to maximise the recovery on the Bridge, Lightning Dutch and Built loans. For example, as a result of the change in asset management (to Valad) and the enforcement on the shares under the Bridge loan, the new directors will be able to make all decisions related to the leasing and sale of the properties without the burden of negotiating with the previous sponsorship.

With regards to the Lightning Dutch loan, HPI notes that a new asset manager has taken control of the property and stabilised individual tenancies after the bankruptcy of TCN, the previous head tenant. The special servicer is now evaluating different solutions to maximise the recovery, including a hold-and-sell strategy or a sale through enforcement or on a consensual basis.

For the Built loan, HPI points to the stabilisation of the existing tenancies through lease negotiations and preparation of the properties for sale. It states that the size of the loan and the structure of the borrowing entities did not lend themselves to an efficient enforcement of the security.

Meanwhile, HPI says that it worked with the existing borrower to extend the Italian loans securitised in WINDM X - IFB & Pavia and Enel Tower - in return for meeting specific milestones for leasing and sales. The extensions were completed in primary servicing, but had the loans been transferred to special servicing, HPI says that the fees would have been greater.

HPI says that it is best suited to continue acting as special servicer on the transaction, given its current performance and track record of success working on behalf of all noteholders to maximise recovery. The firm suggests that changing special servicers - per the request of an entity that it "believes is no longer the controlling class representative" - could jeopardise the considerable progress made on the portfolio to date.

Furthermore, HPI notes its considerable experience and exposure servicing loans backed by German, Dutch and Italian properties. In contrast, its proposed replacement currently has no operations in Germany and a limited track record of success in Italy, according to HPI.

Brookland was appointed controlling class representative in respect of the Bridge, Built, Lightning Dutch and Tresforte loans (as well as any other loans that become subject to a servicing transfer event) by a class E noteholder extraordinary resolution on 24 March and subsequently acceded to the servicing agreement on 9 April. The firm issued a letter to the special servicer and trustee on 14 April 2014 requiring the termination of HPI and the appointment of Mount Street as successor special servicer. As of a 30 May investor notice, the formal process for replacement of the special servicer had yet to be effected.

HPI requests that all noteholders examine what it describes as the "flawed directive" to replace it as special servicer and to query the relationship between the former controlling class and the proposed replacement special servicer. It also indicates that the conditions for its termination as special servicer have not been satisfied.

Brookland has convened an informal meeting of class D noteholders (the controlling class) for tomorrow (5 June).

CMBS

CMBS surveillance shared

Morningstar Credit Ratings has made its CMBS DealViewSM surveillance reports available to investors, analysts and traders via its website. The reports are updated monthly and include a comprehensive credit review, in-depth loan and property analysis, applicable letter ratings and rating outlooks for CMBS transactions. Its ratings and surveillance process involves detailed loan- and property-level analyses, a review of operating cashflow, tenant base, property condition and market performance, as well as timely reviews of credit events affecting the CMBS market.

"We're addressing investor demand for more transparency and access to our industry-leading surveillance coverage of CMBS transactions through this initiative," comments Vickie Tillman, president of Morningstar Credit Ratings. "Since 2001, we've provided subscribers of our CMBS ratings and surveillance product with comprehensive monthly reports for the vast majority of secondary market CMBS transactions. We are now expanding the availability of our industry-leading DealViewSM surveillance reports, for transactions we are selected to rate at issuance, to a significantly larger number of CMBS investors."

CMBS

Single-borrower execution broadening

Single-borrower US CMBS issuance has picked up in recent months, after a slow start to the year. Barclays Capital CMBS analysts suggest that the funding advantage enjoyed by banks and insurers has lessened due to the sharp rally in rates, resulting in more borrowers opting for CMBS execution.

Hotel properties dominated single-borrower CMBS issuance over the past 6-9 months, as insurers and banks tended to stay away from this sector, given the elevated volatility of cashflows for these assets. But the Barcap analysts note that tier 1 office properties in gateway cities are increasingly being securitised in CMBS deals, reflecting the move towards CMBS execution in this segment. For instance, the Grace Building and 388 Greenwich Street office properties in New York City were securitised in single-borrower transactions last month.

Nevertheless, total CMBS deal volumes are running below last year's levels, at about US$27.7bn year to date. The analysts forecast US$90bn-US$95bn of issuance for 2014, with volumes picking up towards the end of the year, driven by an increasing volume of maturing loans from the 2004-2005 vintages.

CMBS

CMBS delinquency improvements continue

The Trepp US CMBS delinquency rate improved for the twelfth consecutive month in May, with a 17bp decline. It now stands at 6.27%, 280bp lower than the May 2013 rate. The delinquency rate has fallen by 407bp since the all-time high of 10.34% in July 2012.

Loan resolutions totalled over US$1bn in May, up from about US$850m in April. Removing distressed loans from the delinquent loan pool put 20bp of downward pressure on the delinquency rate. Loans that cured totalled over US$800m in May, which took 16bp off the delinquent loan percentage.

New delinquencies totalled about US$1.3bn this month, which pushed the rate up by 24bp. Loans that had been delinquent but were resolved without losses (accounting for US$120m) put another 2bp of downward pressure on the rate in May.

CMBS

CMBS liquidations, loss severity up

US CMBS liquidated loan volume reached US$1.02bn in May, up from US$844.16m the previous month, according to Trepp. Of the loans that were liquidated, 84% by balance fell into the greater than 2% loss severity category.

Loss severity registered 48.94% in May, up by nine percentage points from April's 39.77% and just above the 12-month moving average of 47.62%. The number of loans liquidated in May was 78, resulting in US$501.18m in losses. The average disposed balance was US$13.13m - below the 12-month average of US$14.57m.

Servicers have been liquidating at an average rate of US$1.21bn per month since January 2010.

Insurance-linked securities

Longevity swap relief granted

The CFTC has addressed for the first time its definition of a swap as it applies to a specific insurance transaction. Law firm Sutherland notes in a recent client memo that no action letter 14-67 allows US life insurers - via a Bermuda cell insurer - to provide a reinsurance hedge to banks active in protecting non-US pensions against the mortality improvements of specified individual beneficiaries.

NAL 14-67 addresses a four-part transfer of the longevity and related inflation risk of a pool of plan beneficiaries under a non-US defined benefit pension plan. The move follows a US insurer's request for no-action relief out of concern that reinsurance agreements between a cell insurer and the insurer's New Jersey and Connecticut subsidiaries might be characterised as swaps under the Commodity Exchange Act or as guarantees or insurance of CFTC-regulated swaps.

In granting the US insurer's no-action request without expressly confirming whether the reinsurance agreements qualified for the insurance safe harbour, the CFTC concluded that the reinsurance agreement was a traditional reinsurance contract. According to the Commission, the longevity swap was merely a conduit for the longevity risk coverage.

Risk Management

Pre-trade platform enhanced

Traiana has enhanced its CreditLink platform with new functionality designed for buy-side market participants trading on swap execution facilities (SEFs). The service now includes streamlined post-trade processing of SEF trades, management of the allocations process for bunched orders and the ability to monitor limits across the entire trade lifecycle.

Over 6050 buy-side client organisations have managed their pre-trade clearing certainty using CreditLink and over 72,000 accounts from both buy-side and OTC clearing FCMs have connected to the platform. The service is now connected to the major SEFs, clearing houses and 16 FCMs.

Risk Management

Collateral management trends surveyed

Sapient Global Markets has released the results of a new survey examining trends, issues and requirements for efficient collateral management across global market participants. The research - conducted throughout March - reveals three significant trends: evolution towards the front office; efficiency gains required to deliver increased automation; and the systems and processes needed to support these substantial structural changes.

The evolution of collateral management business models is leading many firms to view collateral management as a potential new revenue stream, according to Sapient. While 66% of firms polled still view collateral management as a cost centre, 39% plan to make collateral a profit center and use it to generate additional revenue. The increasing focus on collateral as an additional revenue stream is prompting a migration of optimisation functions to the front office and will require significant changes to established processes and systems to enable firms to manage margin and risk calculations within compressed timeframes across all available collateral inventory pools.

The survey highlights that cost efficiency is one of the main drivers of change in collateral management, requiring more effective client communication, responses to margin calls, dispute management and settlement of non-cash collateral. However, most survey participants do not consider their dispute management processes to be efficient enough and regard their counterparties' processes as an area for improvement.

Collateral booking, for example, is performed manually in more than 60% of firms due to the lack of standardisation and automation in client communication. Increasing automation would lead to cost reduction in these functions and allow knowledgeable staff to be re-deployed, Sapient suggests.

Increasing efficiency and removing internal bottlenecks is leading firms to examine transformation or optimisation strategies to efficiently manage their collateral. Respondents see the value in creating a consolidated view of available collateral; however, this will require changing their operating model, architecture and collateral management system, removing existing siloed approaches and establishing a centralised collateral management platform. This platform will need to consolidate the collateral management function across all asset types that are subject to collateral or margin and provide an entity-wide overview of all available and eligible collateral.

"To date, firms have implemented tactical solutions to meet specific regulatory mandates," comments Robert Binder, vp at Sapient. "But, as these regulations solidify, they will begin to adapt more strategic approach in order to remain competitive. An increase in STP rates through automation will be critical in order to stay competitive, especially as many of the firms surveyed expect the volumes of margin calls, transferred collateral, reconciliations and disputes to increase significantly."

RMBS

UK RMBS criteria updated

Fitch has updated its criteria assumptions for assessing credit risk in UK residential mortgage loan pools. The updated assumptions are expected to have a limited impact on existing UK RMBS ratings and no effect on covered bond or SME CLO ratings. Potentially affected ratings will be reviewed within six months.

Under the updated assumptions, Fitch applies the sustainable loan-to-value ratio (sLTV) as a predictor of default instead of the original loan-to-value ratio (OLTV). sLTV is the ratio of the current loan balance to the agency's estimated sustainable house price (SHP) level.

Fitch identified that sLTV is a stronger predictor of default probability for the UK market than OLTV, based on regression analysis of performance data for 2.9 million UK mortgages. The UK SHP is based on the assumption that in the long term house prices will move in line with income level. UK house prices in 1Q14 were assessed at 16.3% higher than the long-term sustainable value.

The sLTV approach results in lower default assumptions for seasoned loans that have benefited from favourable house price movements and for loans with a reduced LTV through partial repayment. Mortgage pools originated around the peak of the market that have suffered from house price declines without offsetting amortisation are likely to have higher loss expectations.

Fitch has also lowered its long-term default expectations for prime mortgage loans as a result of the improved economic outlook and mortgage performance remaining well within expectations. For a typical prime mortgage portfolio, the foreclosure frequency (FF) at single-B has been reduced to 4% from 5%. There have been no FF assumptions at triple-A for prime loans.

Additionally, the stressed Libor rate for calculating debt-to-income and interest-coverage ratios has been reduced to 4% from 5.5%. The agency has also revised its treatment of interest-only loans to reflect the increased risk of borrowers being unable to repay the outstanding principal at maturity.

Fitch will consider both the remaining loan term and the indexed current loan-to-value ratio (CLTV) in determining this risk. It says that the revised approach may lead to increased FF for interest-only loans.

Analysis of loan-by-loan repossession data showed that buy-to-let (BTL) loans on flats experience higher quick sale adjustments (QSAs) compared with the market average for residential mortgage loans. Fitch has therefore increased the QSAs for these segments, leading to increased loss severity levels.

The approach for treating standard variable rate (SVR)-linked loans in its cashflow analysis has also been amended to help differentiate between high and low SVR lenders. For the purpose of cashflow modelling, the haircut margin on these loans is now 2%-3% instead of 2%-2.5%. In addition, Fitch applies a lower haircut to SVR loans in declining interest rate scenarios.

The assumptions aim to create more differentiation between transactions backed by non-conforming mortgage loans: portfolios of loans with more adverse credit characteristics will result in higher loss expectations, while loans with fewer adverse characteristics are treated more favourably. As a result, non-conforming RMBS tranches may be subject to upgrade or downgrade depending on the effect of the assumptions on the analysis of individual portfolios and the credit enhancement available.

The move follows the publication of an exposure draft on the proposals (SCI 26 March). Fitch says it received comments on the exposure draft from four respondents, three of whom requested confidentiality.

RMBS

Canadian private-label RMBS discussed

A number of changes have been made to Canada's housing finance system over the last few years, but how they might influence mortgage lender financing strategies and borrower behaviour in the medium- to long-term remains unclear. Given the potential for a private-label RMBS market to emerge in the country, S&P notes that there are some unique features to consider when evaluating the relative credit risk of RMBS backed by uninsured Canadian mortgage loans.

There have been calls from numerous stakeholders to reduce the Canadian government's role in the mortgage market and transfer risk to the private sector, which may reduce the availability of mortgage portfolio insurance and funding through the National Housing Act Mortgage-Backed Securities (NHA MBS) and Canada Mortgage Bond (CMB) securitisation programmes. While banks have a diverse range of funding options for residential mortgages, non-bank mortgage lenders have generally relied more on wholesale financing strategies, including ABCP warehousing and the NHA MBS and CMB programmes.

"The questions about uninsured term securitisations as a source of permanent funding for non-bank lenders have grown louder as the NHA MBS and related CMB programmes' growth rates have plateaued and since the 2013 federal budget restrictions on using insured mortgages as collateral in private-label RMBS and ABCP conduits. We believe that standalone, uninsured amortising term RMBS securitisations in Canada will be considered with increasing frequency in the near future," S&P observes.

The agency notes that some noteworthy areas of focus for uninsured Canadian RMBS include: renewal/balloon risk; considerations related to the originator; potential housing market imbalances; and household debt levels at historical highs. A typical Canadian residential mortgage has a loan term of up to five years with a 25- to 30-year amortisation period. At the end of each loan term, the remaining principal balance is due as a balloon payment that is generally paid by the lender renewing the mortgage for an additional term while maintaining the original amortisation schedule.

However, the lender is not legally obligated to renew. Alternatively, the borrower may switch lenders at renewal and use the proceeds from the new lender to repay the initial lender.

If borrowers are current on their mortgages, lenders have historically renewed without verifying updated income or employment status or requesting updated appraisals. However, there have been instances where lenders were unable or unwilling to renew loans to borrowers who were current on their mortgages, such as when Xceed Mortgage Corp experienced funding challenges following the ABCP market disruption.

"While historical experience of non-renewal is generally associated with non-prime borrowers, we believe that - under more stressful economic scenarios - renewal risk should be contemplated even for prime borrowers," S&P says. "The inability or unwillingness of an originator to renew could affect the securitised pool's collateral performance and create event risk in the transaction, even with prime collateral."

A mortgage originator's financial strength may indicate how likely renewals will be offered in a given economic environment. However, if the originator no longer has the ability or willingness to renew under a stress scenario and the borrower is otherwise unable to secure mortgage financing from another lender, it could potentially result in a significantly higher foreclosure frequency for the securitised pool.

The ability and willingness of other lenders to renew the loan could be affected under economic stress, such as certain institutions being limited by prescribed maximum LTVs or DSRs. S&P says it queries whether mitigants to this risk might exist in future securitisation structures.

Meanwhile, two measures of housing valuation - home price-to-income and price-to-rent ratios - show that Canadian housing prices remain among the highest relative to income and rental costs compared with other major real estate markets around the world. According to the home price-to-income ratio, Canadian home prices may be 30% overvalued relative to their historical average between 1988 and 2013, up from 20% before the recession in 2008. Nevertheless, S&P notes that its base-case scenario envisions flat-to-modestly lower home prices (down y 3%-5% in 2014) as the most likely outcome from slower housing demand.

"Significant changes to Canada's mortgage finance system during the last several years could help spur the development of a private-label RMBS market and gradually reduce reliance on government-related securitisation programmes for mortgages with LTVs of less than 80%," the agency observes. "However, we believe that this market's growth will be slow while market participants evaluate features unique to Canada's mortgage market, particularly for originators with relatively lower financial strength compared with the desired RMBS ratings. It will be interesting to observe how securitisation structures may evolve to mitigate these features unique to Canada, such as the mismatch between the amortisation period of the mortgages and the shorter mortgage loan terms."

Last month saw Canadian homeowner mortgage loan insurance premiums rise by approximately 15% and Canada Mortgage Housing Corp (CMHC) insurance discontinued for second homes or self-employed borrowers without third-party income verification. In April, the Office of the Superintendent of Financial Institutions proposed new guidelines (B-21) regarding its expectations for residential mortgage insurance underwriting.

RMBS

Aussie soft-bullet bonds gaining traction

Recent exploration of a broader range of bullet-payment structures - including master trust structures - by issuers of Australian RMBS may pique the interest of investors, particularly offshore accounts, according to S&P. These structures offer issuers the potential to diversify their funding options, reduce swap and funding costs, and appeal to a wider investor base.

S&P notes that there are two types of bullet-payment bonds: 'hard-bullets', where the maturity of the bond has a fixed repayment date and failure to repay on that date results in an event of default; and 'soft-bullets', where the maturity date of the bond can be extended, thus either offering the issuer more time to refinance the debt or matching the ultimate repayment date of bond to the pay-down profile of the assets. The latter option eliminates asset and liability mismatch risk altogether.

Australian RMBS that have incorporated hard-bullet tranches are usually dependent on a bank for redemption, with the rating of the hard-bullet tranche usually capped at the rating of the redemption-facility provider. Alternatively, some transactions rely on the accumulation of principal collections within the transaction structure to facilitate repayment on the hard-bullet tranche. However, this usually results in a hard-bullet tranche that is a relatively small percentage of the total mortgage pool size.

In the past, some investors preferred the repayment timing 'certainty' offered by hard-bullet structures. But S&P suggests that increasingly investors recognise that this certainty may be somewhat illusory if the issuer or the market is experiencing significant stress. Consequently, there appears to be growing favour towards soft-bullet structures and their ability to offer a preordained path to orderly dissolution, with the ability to preserve value.

Examples of RMBS that have already incorporated bullet features include Series 2010-2 SWAN Trust (issued by Commonwealth Bank of Australia subsidiary Bankwest), IDOL Trust Series 2011-2 (ING Bank Australia), Series 2012-1E REDS Trust (Bank of Queensland), Premier Series 2013-1 (Resimac), Pepper Residential Securities Trust No. 12 and Compass Master Trust. However, the total volume of bullet-payment notes remains low.

Whether these additional bullet-payment options are successfully implemented may depend on final regulatory settings and ensuing operating rules and guidelines. In addition, investor interest in bullet-payment bonds to manage their funding maturity profiles and foreign-currency risk will also determine growth in these funding options.

Overall Australian RMBS issuance volumes have been cautiously solid in 2014, following strengthening investor and issuer participation in 2013. But issuance levels remain significantly lower than those before the financial crisis, declining to about 8% of total mortgages outstanding in Australia, after a peak of just below 24% in 2007.

RMBS

Green Tree test failures eyed

Moody's says in its latest ResiLandscape publication that Green Tree Servicing's failure in its first testing period to meet error rate thresholds for eight of 29 National Mortgage Settlement (NMS) servicing metrics is credit neutral for existing private-label RMBS. Nevertheless, the failure underscores the challenges non-bank servicers face in handling servicing acquisitions from larger banks, according to the agency.

"The test results could hamper Green Tree's ability to grow its business through mortgage servicing rights purchases in the short term and could also give the government-sponsored enterprises pause when approving future transfers of servicing to Green Tree, depending on the success of its corrective action plan," it observes.

According to the Office of Mortgage Settlement Oversight, Green Tree failed to meet error rate thresholds for metrics regarding loan modification documentation, complaint response timeliness and bankruptcy filings. In contrast, the other five mortgage servicers that the OMSO monitors - four of which are banks that have been tested multiple times since 2012 - passed all requirements tested in the period. The fifth is Ocwen Financial, which also took over servicing for a portion of ResCap loans and acquired ResCap's servicing platform and NMS infrastructure.

The eight test failures will not directly affect RMBS cashflows or credit quality because the scope of the review pertained only to certain GSE loans for which Green Tree acquired servicing rights from Residential Capital in 2013. However, from operational and regulatory perspectives, Green Tree's failures raise concerns about its ability to service loans subject to the NMS.

The servicer must now submit corrective action plans regarding these failed metrics to the OMSO and could face fines if it fails to adequately address the issues. The OMSO's review and approval of corrective action plans can include a determination of whether any of the errors are widespread.

Moody's notes that other servicers also failed a number of the settlement's requirements the first time through the testing process and were able to address the issues by establishing corrective actions plans approved by the OMSO monitor.

RMBS

ResCap proceeds materialise

An estimated third of affected RFC/GMAC RMBS deals saw settlement proceeds of US$17.65 per unit from the ResCap Liquidating Trust flow through to bondholders during the May remittance period. Some trusts expecting distributions are yet to receive proceeds, possibly due in part to the lack of clarity around how to handle subsequent recoveries, with trustees seeking advice on how to proceed.

The final version of the ResCap RMBS trust claims was submitted to the court at end-March (SCI 30 April). Based on their allocated units, investors in ResCap deals will receive a cash payment and then continue to receive additional proceeds over time as the remaining estate assets are liquidated. Additional proceeds could arise from rep and warranty claims by ResCap to other originators in ResCap-sponsored transactions.

The ResCap Liquidating Trust is expected to make another distribution of US$1.15 per unit on 9 June. Bank of America Merrill Lynch RMBS analysts expect trusts that made distributions in May to pass on the June dividend payment in either the June or July remittance.

RMBS

Servicer analytics offered

BlackBox Logic has released a new loan-level RMBS performance dataset, dubbed BBx Premium Non-Agency RMBS, which aims to allow users to more effectively analyse servicer behaviour in the private label security market. Key features of the offering include: estimated forbearance values and confidence levels; modification flags, amounts and percentages broken into capital, balance reduction and rate modification categories; and total servicer advances amounts, percentages and statuses. The data can be accessed through Crystal Logic, BlackBox's web-based historical RMBS analytics tool, or as a standalone dataset.