Contents

Structured Finance

Clean-up call candidates identified

The ECB's TLTRO operation entitles banks to initially borrow up to €400bn for four years at a fixed rate of 25bp. The availability of this low-cost funding increases the likelihood of originators exercising clean-up calls in European ABS and RMBS deals, according to Citi securitised product strategists.

Issuers generally have the right to call outstanding notes at par once the deal balance falls under 10% of the original balance. However, many issuers have not called their deals even after the clean-up call triggers were achieved, possibly because of the high alternative cost of funding the underlying assets. The Citi strategists cite as an example Banca Nazionale del Lavoro's decision not to call its VELAH 1 RMBS for a long time after the collateral balance dropped below the clean-up call threshold.

"ECB's cheap funding should incentivise originators to optimise their wholesale funding by cleaning up such legacy securitisations, leading to good upside in their bonds trading at discounted prices," they observe. "A good portion of the placed securitised universe in Europe comprises of legacy deals that were issued prior to 2008. Many of these deals have amortised significantly and are either passing or approaching their clean-up call triggers."

The strategists identify 62 transactions whose current balance is below or within the five percentage point range of the clean-up call threshold. Spanish RMBS and SME ABS dominate the sample, along with a few Italian and Portuguese RMBS, as well as some consumer ABS deals.

To gauge the likelihood of the clean-up call being exercised, they compare total performing collateral plus reserve fund balance (assets) to the total outstanding note balance (liabilities). Deals with higher net assets relative to liabilities present better economics for originators to exercise clean-up calls.

The analysis shows that 48 of the 62 deals examined have more assets than liabilities and, as such, are good clean-up call candidates for originators. Among these transactions are: Credifarma's ARCOB 2006-1; Banca Popolare di Spoleto's BPSPL1; Agos' SUNRI 2; BBVA's BBVAA 2, BBVAC 2006-2 and BBVAP 3; Caja de Madrid's CIBFT III; and VW's DRVES 2011-1.

CS

Structured Finance

SCI Start the Week - 7 July

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

Pipeline
Several deals joined the pipeline last week as the market prepared for the US Independence Day holiday. The new entrants included four ABS, three ILS, two RMBS, three CMBS and one CLO.

The newly-announced ABS comprised: €800m Bavarian Sky German Auto Loan 2, E-Carat Compartment 7, NZ$150m MTF Valiant Trust 2014 and US$250m Sierra Timeshare 2014-2. The ILS consisted of US$28m Dodeka IV, US$31.825m Market Re Series 2014-2 and US$44.035m Oak Leaf Re Series 2014-1.

£350m Paragon Mortgages No.20 and £240m Precise Mortgage Funding 2014-1 accounted for the RMBS, while the CMBS were C$312m IMSCI Series 2014-5, €198.222m MODA 2014 and US$386.342m VFC Series 2014-2. Finally, the CLO was US$1.036bn Madison Park Funding XIV.

Pricings
As with the week before, last week saw many deals price. The new issuance included six ABS, one ILS, two RMBS, three CMBS and eight CLOs.

The ABS prints comprised: US$640m CIT Aviation Finance III; US$450m Drug Royalty II 2014-1; US$206.3m Edsouth Indenture No.7 Series 2014-3; US$400m Ford Credit Floorplan Master Owner Trust A Series 2014-3; US$1.124bn MBART 2014-1; and €372.3m Monviso 2014.

The ILS pricing was US$30m CCRIF 2014-1 and the RMBS were A$1bn PUMA Series 2014-2 and €101m Rural Hipotecario XXVII. US$550m COMM 2014-SAVA, US$1.264bn JPMBB 2014-C21 and US$635m JPMCC 2014-INN accounted for the CMBS new issues.

Finally, the CLO prints were: US$552.5m Adams Mill CLO; US$415.25m Avery Point V CLO; €1.795bn BPL Mortgages VII; US$521m CVP Cascade 2014-2; US$380m Refinanced Dryden Senior Loan Fund XXIII; US$512m Eaton Vance CLO 2014-1; US$459.75m JFIN CLO 2014-II; and US$414m WhiteHorse IX.

Deal news
• The Hertz Corporation has delayed filing its 1Q14 10-Q financial statement, triggering a potential lease event of default within its US rental car ABS structures that could cause an amortisation event for each series of notes secured by the lease. After applicable grace periods expire and absent a cure, a vote by more than 50% of class A noteholders of a series is required to declare an amortisation event.
• Munich Re has withdrawn its latest catastrophe bond issuance - Queen Street X - due to weak demand. Pushback on the deal's pricing is said to be a sign that investors may be approaching a limit on acceptable catastrophe risks.
• GC Securities has placed the first catastrophe bond directly issued by the World Bank, via member institution the IBRD. The US$30m CCRIF catastrophe-linked capital at risk notes provide three years of annual aggregate protection for hurricane and earthquakes affecting 16 Caribbean countries participating in the Caribbean Catastrophe Risk Insurance Facility (CCRIF), representing the first time that the initiative has tapped the cat bond market.
• MSAC 2006-HE3 and SVHE 2006-WF1 bondholders last month received significant pay-outs related to subsequent recoveries. The trustee for both RMBS is Deutsche Bank and the pay-outs are believed to be due to individual rep and warranty-related settlements with one of the originators or related pay-outs at the loan level.
• US$477m in US CMBS loan allocated balance is slated for sale on Auction.com in July and early August. Unlike previous auctions, most deals have only 1-2 loans up for bid. The largest loan up for sale is the US$67m HSA Memphis Industrial Portfolio securitised in MLCFC 2007-5.
• Canary Wharf Group, the sponsor of the Canary Wharf Finance II CMBS, has sold its interest in the 10 Upper Bank Street property. The building was recently re-valued at £780m, up from an estimated £685m in June 2013.
• Dock Street Capital Management has replaced Strategos Capital Management as collateral manager on the Kleros Preferred Funding II ABS CDO.
• Auctions have been scheduled for: N-Star Real Estate CDO III on 9 July; Longport Funding II CDO on 21 July; and Trainer Wortham First Republic CBO IV on 23 July.

Regulatory update
• US Treasury Secretary Jacob Lew has outlined plans to expand access to credit by boosting the private-label securities market. A new financing partnership between the Treasury and HUD will also support the FHA's multifamily mortgage risk-sharing programme.
• The ECB's TLTRO operation entitles banks to initially borrow up to €400bn for four years at a fixed rate of 25bp. The availability of this low-cost funding could increases the likelihood of originators exercising clean-up calls in European ABS and RMBS deals.
• The Basel Committee and IOSCO are co-leading a task force that will undertake a wide-ranging survey of global securitisation markets. To gain a better understanding of market participants' views, the cross-sectoral Task Force on Securitisation Markets has set up an online survey, which should be completed by 25 July.
• Prime Collateralised Securities (PCS) has introduced the first substantial revision of its criteria in relation to high quality securitisations. The move is designed to raise the standard enshrined in the label, with a few criteria being softened or removed when they proved not to add anything to the quality represented by the label or when the market could demonstrate that very high quality securitisations were being issued without these requirements.
• The EBA has published its technical advice to the European Commission on the use of a prudential filter for gains and losses arising from banks' own credit risk of derivatives. The authority considers as appropriate not to deviate from the current prudential approach applied at the international level under the Basel 3 rules.
• AIMA has launched OTC derivatives clearing guidelines for asset managers. The guide to sound practices provides guidance on the new regulatory framework in the US and EU, which affects most OTC derivatives transactions cleared globally.

CMBS

Location boosts CRE performance

Over 26,000 loans collateralising US conduit CMBS deals issued since 2005 - representing US$363bn or about 80% of the conduit universe - have so far reported full-year 2013 cashflow data. Bank of America Merrill Lynch CMBS analysts have aggregated this data across vintages, property types and property locations to glean a better understanding of commercial real estate performance over the past few years.

First, the BAML analysts aggregated NCF data for conduit loans originated in 2005-2012 that reported 2012 and 2013 financials to analyse the year-over-year change in performance. The results showed 2.2% year-over-year NCF growth across the universe, with hotels registering the largest year-over-year increase of 5% and legacy suburban office loans primarily responsible for declines in performance.

Among vintages, loans collateralising 2012-vintage CMBS experienced the highest, most uniform year-over-year changes in NCF, while 2010-vintage deals exhibited the worst YOY. Aggregate NCF decreased by 0.5% across all property types in this segment and appears to have been skewed lower by a small sub-set of larger-sized CBD office and 'other' office loans.

Although their year-over-year cashflow growth was still positive, conduit loans collateralising 2005, 2006 and 2008 vintage deals also exhibited below-average performance. The analysts believe that this is likely due to adverse selection, in which many of the higher-quality assets may have already refinanced, and a lower percentage of hotel loans (which had the best performance across property types) in these vintages compared to 2011 and 2012 vintage deals.

They also suggest that the broader economic cycle and a property's location remain the predominant drivers of whether cashflows increased. For example, properties located in cities such as Denver, Austin, Houston and San Jose - which have significant technology and energy industry presence - enjoyed year-over-year cashflow increases of over 7%.

Although NCF growth was broadly positive in 2013, in many instances it still hasn't returned to underwritten levels, according to the study. This is particularly true for 2006 to 2008 vintage deals, whose loans were underwritten fairly aggressively and - despite recent improvements in commercial real estate fundamentals - the expectations that were set at origination have yet to materialise.

To analyse cashflow growth for loans collateralising 2013-vintage conduit deals, the analysts used the available 2012 full-year NOI cashflows from the original deal documents and compared the changes between 2012 and 2013. Overall, the results were positive, with 4% year-over-year growth in NOI across the sample.

Assets in primary markets registered the largest year-over-year increase of 5.6%, with most of the growth due to industrial and office properties that aren't categorised as CBD or suburban, such as data centers. While assets in primary markets realised the largest overall growth, multifamily properties in secondary markets and retail and hotel properties in tertiary markets also performed well.

However, primary markets also showed the largest decrease from underwritten levels, implying that assets in better-quality locations were likely underwritten more aggressively.

On the other hand, among conduit transactions issued in 2010-2012, debt yields registered an upward trend compared to their underwritten levels. Of the five major property types, loans collateralised by hotel properties saw NOI debt yields increase by 2.5 percentage points on average since origination.

"We believe this is due to the combination of stricter underwriting standards and the economic recovery, which passed through to hotel properties more quickly than it did to other asset types since hotels can effectively change their rental rates on a daily basis. On the other hand, given the longer-dated lease structure among office properties, we weren't surprised to see that NOI debt yields were only marginally higher since the loans were originated," the analysts observe.

Segmented by market tier, loans collateralised by properties located in secondary and tertiary markets registered the largest increases in debt yields since origination.

CMBS

Pricing in prepayment protection

Tightening loan margins and note spreads have increased the likelihood of European CMBS 2.0 prepayments. However, prepayment protection appears not to have been fully priced in for certain bonds.

CMBS prepayment protection affects how much bond prices can rise above par when spreads tighten. Barclays Capital CMBS analysts note that deals have employed various ways to treat early redemptions at the loan level and distribute prepayment fees to the CMBS notes.

At the loan level, borrowers often have to pay a fixed percentage of the prepaid amount as a penalty, with that percentage differing from loan to loan. For other transactions, there is a present value concept, under which borrowers would have to pay the lender the present value of future loan margins up to a certain date if the prepayment occurred early in the loan term, or pay a fixed percentage in the later years of the loan term.

Loan-level prepayment fees were common in most CMBS 1.0 transactions, but were generally paid to the originator rather than noteholders. In most CMBS 2.0 deals, the bondholders benefit from early refinancing - albeit to differing extents, as deals allocate fees in varying ways.

For example, the loan-level prepayment fee in FLORE 2012 is lower than for TAURS 2013 (GMF1) - although that is offset by a more favourable treatment at the issuer level, the Barcap analysts suggest. This is partly because part of the fee payable by the TAURS 2013 (GMF1) borrower would be paid to the class X.

In Gallerie 2013, the effect is similar to TAURS 2013 (GMF1), with high loan-level prepayment fees at the borrower level. However, CMBS bondholders only benefit from the part of the prepayment fee that is related to the weighted average CMBS margin.

The analysts identify FLORE 2012 as the CMBS transaction for which prepayment protection is most imminent. Deutsche Annington announced a takeover of the sponsor behind the deal earlier this year, which is scheduled to be completed in Q4, with the deal being redeemed early soon afterwards.

A January 2015 prepayment would translate into DMs of 115bp to 505bp, which is higher than for comparable German multifamily bonds. An earlier redemption just before the October 2014 IPD would see the class A DM drop to 55bp and DMs would also drop considerably if a prepayment occurred after September 2015.

An early 2015 prepayment is believed to be the most likely outcome, suggesting that prepayment protection is not fully priced in and FLORE 2012 therefore looks cheap compared with Gagfah-sponsored German multifamily deals. Meanwhile, the Italian Gallerie 2013 CMBS has prepayment protection until April 2016 and has a loan margin of 5.25%, so a prepayment after that date is possible.

If repayment of Gallerie 2013 occurs at expected maturity in October 2018, then all classes of notes price wider than those of DECO 2014 Gondola. However, that would change if Gallerie 2013 prepays in 2016 or 2017.

An April 2016 prepayment for Gallerie 2013 would see the class A DM fall to 100bp. In fact, the analysts calculate that class A DM only increases above the 149bp issuance spread of DECO 2014 Gondola if a prepayment after April 2017 is assumed.

The Gallerie 2013 classes B and C are in the same position, so prepayment risk means Gallerie 2013 appears overvalued compared with recent pricing provided by DECO 2014 Gondola. The analysts also believe that the Gallerie 2013 class B notes are expensive compared to the A and C classes, as well as compared to DECO 2014 GNDL class C.

The three loans securitised in Gagfah's Taurus 2013 (GMF1), GRF 2013-1 and GRF 2013-2 transactions mature in 2018, although at least one of those is expected to prepay early. Lower coupon spreads and consequent lower premium to par should make the three transactions less sensitive to early redemption than FLORE 2012 or GALRE 2013, with Taurus most likely to be prepaid as it features the highest loan spread.

If TAURS 2013 prepays in 2017, the expected DM would reduce by between 5bp for the class A and 10bp for the class C notes. The transaction with the highest note spreads and premium to par is GRF 2013-1 and the analysts note that its sensitivity to early redemption in 2017 is 10bp for class A to 30bp for class E, making GRF 2013-1 expensive relative to TAURS 2013.

JL

Structured Finance

Structuring pro brought in

Natixis has appointed Sachin Patel as a senior structurer in London. He joins from Credit Agricole, where he was a senior portfolio manager and focused on the workout of distressed US and European structured credit assets. Patel has also worked at Moody's Wall Street Analytics and Morgan Stanley.

CDO

ABS CDO manager replaced

Dock Street Capital Management has replaced Strategos Capital Management as collateral manager on the Kleros Preferred Funding II ABS CDO. Moody's confirms that the move won't impact the deal's ratings, noting that the amended and restated management agreement does not alter the responsibilities, duties and obligations of the manager in a meaningful way. In reaching its conclusion, the agency considered the experience and capacity of Dock Street to perform collateral management duties.

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

CLOs

CLO lawyer becomes partner

Appleby has promoted Benjamin Woolf to partner. The structured finance specialist is a member of the corporate and commercial practice group.

Woolf has particular expertise in CLOs. Before joining Appleby in 2011 he worked at Clifford Chance and Mayer Brown, where he focussed mainly on securitisation and asset-backed financing.

CLOs

Manager adds CLO pair

Apollo Capital Management has strengthened its team with two appointments. Albert Huntington and Matt Roesler will both be based in New York.

Huntington joins as principal. He was previously at Bank of America Merrill Lynch and Narricot Industries, while Roesler joins from Citigroup.

CLOs

Six European CLOs transferred

BNP Paribas Asset Management has replaced BNP Paribas as collateral manager on six CLOs. The affected deals are Leveraged Finance Europe Capital I, Leveraged Finance Europe Capital II, Leveraged Finance Europe Capital III, Leveraged Finance Europe Capital IV, Neptuno CLO I and Versailles CLO M.E. I.

Moody's says the move will not impact the CLOs' ratings but does not express an opinion as to whether the amendment could have other, non credit-related effects. For other recent manager transfers, see SCI's database.

CMBS

FirstKey set up CRE platform

FirstKey Lending has established a commercial real estate lending programme - FirstKey Commercial. The new unit will offer bridging loans of up to US$25m to clients looking to purchase, refinance or reposition commercial properties and will be led by ceo Randy Reiff.

Reiff was previously global head of CRE finance and CMBS at JPMorgan and global co-head of CRE finance and CMBS at Bear Stearns. Most recently he led the global CRE and CMBS business within Macquarie's fixed income currencies and commodities division.

CMBS

Broker-dealer adds CMBS pair

Cross Point Capital has announced the appointments of Tim Martin and Sudeep Walvekar. Martin is head of CMBS sales and trading at the firm, while Walvekar is also part of the CMBS sales and trading team.

Martin has extensive real estate experience, having joined Salomon Brothers in 1986 and since holding several mortgage origination and CMBS trading positions, including as a portfolio manager at Oppenheimer Funds. He has also worked for Tejas Securities Group (SCI 30 June 2011).

Walvekar was previously a vp at National Alliance Capital Markets. He too has worked at Tejas where he covered a variety of fixed income products including distressed debt, high yield, RMBS and CMBS.

Insurance-linked securities

Amlin ups interest in ILS manager

Amlin has reached a non-binding agreement in principle to increase its existing interest in Leadenhall Capital Partners (LCP), which Amlin established in joint venture with LCP's individual partners in 2008. Under the terms of the agreement, Amlin will increase its current 40% interest in the business to 75%.

The consideration will be determined by the profitability of the business, subject to a cap, and will be payable in three installments from 2014 to 2016. The remaining 25% interest will continue to be held by the individual partners of LCP on an ongoing basis.

RMBS

Rating agency names mortgage head

S&P has promoted Waqas Shaikh to lead analytical manager for mortgage-bond ratings and surveillance in the US. He is based in New York and reports to Mike Binz, head of North American ABS and RMBS ratings.

Shaikh will focus on new issues and on-going deal surveillance. He was previously part of the global risk management group and has been with S&P since 1999 and succeeds Sharif Mahdavian.

RMBS

Alternative asset manager adds two

Premium Point Investments has appointed Ivan Chee to oversee trading in non-agency mortgage bonds. He is based in New York.

Chee was previously at Morgan Stanley, where he was most recently desk strategist for agency RMBS. Before joining Morgan Stanley he was a software design engineer for Expedia and has also worked at IBM.

Premium Point has also appointed Mark Ginsberg. He will serve as portfolio manager for the firm's flagship fund.

ABS

Green light for ABS, RMBS ratings

Morningstar Credit Ratings' designation on the NAIC credit rating provider (CRP) list has been extended to cover all ABS and MBS. Previously the designation only covered CMBS.

The amendment became effective last month and provides insurance companies with an extra option among rating providers for determining risk-based capital under NAIC guidelines. Investors using a designated CRP are exempt from making a filing for the respective securities with the NAIC's security and valuation office.

ABS

Hertz delay to trigger lease EOD?

The Hertz Corporation has delayed filing its 1Q14 10-Q financial statement, triggering a potential lease event of default within its US rental car ABS structures that could cause an amortisation event for each series of notes secured by the lease. After applicable grace periods expire and absent a cure, a vote by more than 50% of class A noteholders of a series is required to declare an amortisation event, according to securitised products analysts at Citi.

A lease EOD would discontinue the lessee's right to lease additional trust vehicles, with the trust retaining any cash generated by ongoing vehicle sales or programme vehicle turn-backs. The lessee is obliged to continue making lease payments to the trust, however.

The Citi analysts suggest that three courses of action are possible. First is for bondholders to do nothing, with the potential amortisation event continuing until cured.

The second course of action is to vote for trust amortisation, whereby the trust applies cash from ongoing vehicle sales or programme vehicle turn-backs to repay bondholders. A third possibility is to seek a waiver, but Hertz has not announced any intention to do so.

The analysts note that the ABS market is not accustomed to evaluating intercreditor complexities. "It is unusual for a voting event to occur in non-distressed ABS and the market may not be the ideal venue for navigating corporate financing twists and turns. While the structure has significant credit enhancement, the principal cashflows derive from the lessee and the structure is essentially a secured corporate financing for one lessee," they observe.

ABS

Covenant waive requested

Further details have emerged about the delay in Hertz's 1Q14 Form 10-Q filing (SCI 4 July). Due to a number of accounting errors, the firm is to restate its 2011 financial statements and review the corporate financial statements for 2012 and 2013.

The nature of the accounting issues appear to be primarily non-cash items and do not seem to be related to Hertz's core rental fleet operations funded in the ABS market, according to structured product strategists at Wells Fargo. Neither does it seem to be related to a deterioration of credit fundamentals in the ABS deals, they suggest.

However, given the trigger of a potential amortisation event for the ABS, Hertz has sent ABS investors a solicitation to waive the covenant breach due to the delayed financial statements. The solicitation expires on 14 July.

"Credit fundamentals do not seem to warrant an early amortisation of the ABS, in our opinion. Furthermore, the economics of voting for an amortisation would seem to work against investors, in our view, because of the premium prices of most class A bonds," the Wells Fargo strategists observe.

ABS

Record low for card delinquencies

US credit card ABS delinquencies closed June with another record low, while excess spread remained at historical highs. Fitch's 60+ Day Delinquency Index decreased by another 6bp to 1.09% and now stands 76% below its peak level registered at end-2009. At the same time, Fitch's Prime Credit Card Three-Month Average Excess Spread Index maintained its record high of 13.27% for a second straight month and now stands at over twice its lifetime average of 6.51%.

Meanwhile, Fitch's Prime Credit Card Chargeoff Index declined by a further 4bp to 3.07% in June and is now 73% below its historic high of 11.52% reached in September 2009. Consistent with seasonal trends, monthly payment rate performance increased to 26.99% last month, while Fitch's Prime Credit Card Gross Yield Index increased by 9bp month-over-month (MOM) to 18.34%.

Fitch's retail credit card indices also registered positive momentum in delinquencies and charge-offs in June. However, gross yield, MPR and three-month average excess spread faired less favourably.

Structured Finance

Stable outlooks dominate APAC

Fitch affirmed 195 Asia-Pacific structured finance (SF) tranches in 2Q14. The agency also upgraded seven tranches and downgraded three others.

Of the total affirmations, 77 were from Australia, which also contributed five of the upgrades during the quarter. The upgrades were made to prime RMBS and unsecured consumer loan ABS bonds, where a build-up of credit enhancement supports the higher ratings.

Two Japanese prime RMBS tranches were also upgraded by one notch each. However, all three downgrades in the region involved Japanese CMBS tranches that defaulted and the ratings were simultaneously withdrawn.

Additionally, Fitch's SF team in Tokyo affirmed seven Japanese prime RMBS tranches, two ABCP programmes, one multi-borrower CMBS tranche and one Thai credit card tranche. A total of 33 publicly rated tranches from non-Japan Asia SF transactions were affirmed in 2Q14 as asset performance continued to be within the agency's expectations.

Five Korean ABS tranches, one Singapore CMBS tranche and one structured credit tranche were affirmed during the quarter. The outlook on the latter was revised to negative from stable, reflecting a previous rating action on a transaction counterparty.

Indian auto loan ABS accounted for most of the quarter's rating actions at 26. Delinquencies had risen markedly between end-2013 and early 2014, a factor that resulted in the outlooks assigned to four tranches being revised to negative from stable during 2Q14.

Stable outlooks continued to dominate, as of 30 June. There were also nine positive outlooks and six negative outlooks.

Structured Finance

Ratings sensitivity analysis released

S&P has outlined five of the top macroeconomic factors that it believes are most relevant to the credit quality of European structured finance securities and, therefore, to its rating actions. These factors include GDP growth, the unemployment rate, property prices, bank equity returns and corporate credit risk premia.

The report is an update of a study the agency published in 2012, which explored the links between macroeconomic factors and structured finance rating movements worldwide. "As with the previous European study, we selected our top five factors by examining correlations between macroeconomic variables and European structured finance rating movements," comments S&P credit analyst Arnaud Checconi.

He continues: "We then conducted a sensitivity analysis to gauge what degree of change in the top five factors might be linked to average ratings migration of a full rating category (that is, three notches). We also explored three distinct scenarios - using our base-case economic assumptions for 2014, the benign market conditions of 2003-2007 and a severe downturn equivalent to the US Great Depression - to assess their potential rating implications."

The worst-case scenario would likely result in substantial downward rating migration. For example, a hike in the European unemployment rate to 25%, a 50% drop in real estate prices or a 26.5% decline in the EU-28 GDP would result in roughly a 10-notch average downgrade for European structured finance tranches, according to S&P's analysis.

By contrast, a repeat of the benign period from 2003-2007 could spur an average 0.4-0.6 notch rise. In the base-case scenario there is minimal change in the underlying economic variables and therefore credit quality and ratings would not change significantly.

While the study focuses solely on the historical relationship between certain macroeconomic factors and European structured finance rating movements, S&P notes that many other factors affect rating trends and some are likely to be transaction-specific. The agency also notes that while there may have been a correlation between certain economic factors and rating movements in the past, there may not be a causal relationship and so the link may not hold up in different future circumstances.

Structured Finance

SRT guidelines released

The EBA has published a final set of guidelines designed to support both originator institutions and competent authorities in the assessment of significant risk transfer (SRT) for securitisations. The guidelines aim to ensure a more consist approach in the assessment of significant risk transfer across the EU and to achieve a level playing field in this area.

The EBA says it recognises that securitisation in a well-defined prudential framework is beneficial to banks and is a key funding tool for the real economy. Further, it is a useful tool for achieving credit risk transfer and risk-sharing in the financial system and for supporting the current deleveraging and de-risking process of EU banks without inducing an excessive contraction in the real economy.

The guidelines include: requirements for originator institutions when engaging in securitisation transactions for SRT; requirements for competent authorities to assess transactions that claim SRT; requirements for competent authorities when assessing whether commensurate credit risk has been transferred to independent third parties; and a standard template on how competent authorities should provide information to the EBA for approved transactions claiming SRT. The guidelines have been developed in accordance with Article 243 or Article 244 of the Capital Requirements Regulation (CRR).

Structured Finance

Investor confidence underscored

Efforts to improve the functioning of the European securitisation market will not be successful without a confident investor base, Fitch suggests. The agency says that investor confidence is limited by the lack of clarity and consistency in the regulatory treatment of securitised paper and that issuing additional or alternative ratings which ignore some credit risks present in securitisations could ultimately reduce confidence in securitisation investments.

"Investor confidence was badly shaken by the underperformance of certain asset types during the financial crisis, with many investors reluctant to resume investing in any form of securitisation," comments Marjan van der Weijden, head of EMEA structured finance at Fitch. "The sector has benefited from various industry initiatives in recent years. Additional and more granular information, including from rating agencies, now gives investors an improved ability to distinguish the credit quality between securitisations."

She adds that post-crisis securitisations generally benefit from increased credit enhancement, particularly in asset classes and countries where loss expectations are now higher than originally envisaged because of poor asset performance during the crisis. This increased credit support has been driven by both investor demand and rating agency criteria developments, and should support investor confidence in loss protection and rating stability when determining whether to invest in securitisations.

However, Fitch notes that the gap between capital requirements and actual transaction performance remains wide for European securitisation, despite modest reductions in the capital charges envisaged for certain sectors in the most recent Basel 3 and Solvency 2 proposals.

The recent Bank of England and ECB paper suggests that sovereign-related rating caps have had a material impact in constraining the market's revival (SCI 30 May). But Fitch points out that most of its European securitisation ratings relate to transactions from countries that can achieve triple-A ratings.

"Double-A plus ratings remain achievable in Spain, Italy and Ireland. Only Greece and Portugal have a rating cap below double-A, affecting only 3% of Fitch-rated notes by balance. Investors are showing renewed interest in peripheral European securitisations regardless of rating caps," the rating agency says.

It adds that ignoring risks such as sovereign and counterparty credit risks would result in ratings presenting only a partial view of the credit quality of securitisations and would undermine Fitch's aim for the long-term comparability of ratings across sectors. This could ultimately reduce confidence in securitisation ratings.

Rather than a matrix of additional or alternative ratings that exclude such risks, investor feedback suggests that more granular information regarding underlying asset performance would be of greater use. To this end, Fitch is rolling out what portfolio loss metrics, which aim to provide specific insight into the agency's expectations for asset performance and the credit protection available to securities, without taking sovereign or counterparty rating caps into consideration.

Structured Finance

FIGSCO rating approach explained

The rating of Goldman Sachs' latest secured funding product - dubbed Fixed Income Global Structured Covered Obligation (FIGSCO) - would most likely be equalised with that of the total return swap provider, says Fitch. The transaction is secured by a wide range of fixed income assets, including securitised debt, with overcollateralisation (OC) levels that are marked to market daily.

Fitch notes that in principle this style of transaction could receive a rating uplift above the rating of the swap provider if the structural protections led to stressed recoveries from the portfolio that were above average unsecured recovery levels, since the FIGSCO structure provides investors with recourse to both the swap counterparty and a segregated pool of assets. However, in this case, the agency says the structural protections and collateralisation levels are too low compared with its market value rating criteria.

Fitch's market value criteria also analyse the level of OC based on frequent mark-to-market valuations of various types of assets to arrive at the stressed, or discounted, value of assets available to repay rated liabilities and could be used to assess FIGSCO's portfolio. By contrast, the agency's covered bond rating criteria do not offer a suitable framework for FIGSCO, as the diversity of assets, daily marking-to-market and potentially high debtor concentrations are not typical features of covered bond programmes.

The collateralisation thresholds commensurate with triple-A and double-A ratings in Fitch's market value rating criteria are materially higher than the percentages contained in FIGSCO's portfolio guidelines. For example, the deal prescribes 105% collateralisation for double-A plus to single-A minus rated bonds and 107% for bonds in the triple-B category.

In comparison, in Fitch's criteria the equivalent standalone triple-A collateralisation level for a structure backed by investment grade corporate bonds would range from 130% to 165%. For a double-A rating backed by corporate bonds, the collateralisation would range from 120% to 150%. The differences are higher for high yield debt.

In order for FIGSCO to achieve a ratings uplift, OC levels would need to be materially higher, although not necessarily at these standalone levels. In addition, the selling agent has six months to sell the collateral in the event that a trigger is breached, compared with 45-60 business days typically seen in most market value structures.

"The longer deleveraging period could lead to further market value erosion, reducing recoveries for bondholders. We would also need to assess the selling agent's ability to liquidate the range of security types and conduct ongoing surveillance of marked-to-market prices," Fitch observes.

Goldman Sachs recently roadshowed a potential issue of a secured funding product that it has designated as FIGSCO. The issuer is an SPV backed by Goldman Sachs Mitsui Marine Derivatives Products (GSMMDP), a joint venture guaranteed by Goldman Sachs (rated single-A) and Mitsui Sumitomo Insurance (single-A plus).

In the transaction structure, issuance proceeds would be used to buy assets, and the issuer would exchange payments on these for payments matching the terms of the notes via a total return swap with GSMMDP. Fitch does not rate GSMMDP and believes that triple-A ratings are not attainable for DPCs.

Structured Finance

Securitisation task force established

The Basel Committee and IOSCO are co-leading a task force that will undertake a wide-ranging survey of global securitisation markets. To gain a better understanding of market participants' views, the cross-sectoral Task Force on Securitisation Markets has set up an online survey, which should be completed by 25 July.

Established in consultation with the International Association of Insurance Supervisors (IAIS) and the IASB, the Task Force will: survey securitisation markets, with the aim of understanding how they are evolving in different parts of the world; identify factors that may be hindering the development of sustainable securitisation markets; assess whether there are factors inhibiting the participation of investors, particularly non-bank investors; and develop criteria to identify and assist in the development of simple and transparent securitisation structures. The Basel Committee and IOSCO encourage market participants to participate in the survey as "their experience and views will be a useful and important input into this review".

Structured Finance

Hedge fund assets top US$3trn

Total assets in hedge funds surpassed US$3trn for the first time in May, according to eVestment. The US$22bn of new capital added brings year-to-date flows to US$93.3bn, the largest five-month total to begin a year since 2007.

Performance gains added US$37.8bn to total AUM for an estimated asset-weighted return of 1.28% in May. This compares to the 1% the industry produced on an equal-weighted basis during the month.

Investors allocated US$8.4bn to alternative credit strategies during the month. MBS strategies also saw strong inflows in May of US$1.5bn, as positive sentiment appears to have returned to the sector.

CDS

HY single-name clearing introduced

ICE Clear Credit has launched clearing for non-investment grade single name CDS constituents of the Markit CDX.HY index. The move means that the clearing house will clear nearly 500 CDS instruments through ICE Clear Credit and ICE Clear Europe, including North American, European and emerging market indices, as well as sovereign and corporate single names. Since launching CDS clearing five years ago, ICE has cleared over US$53trn in gross notional value of CDS, with open interest of approximately US$1.7trn.

CDS

Protocol timeline released

ISDA has announced the timeline of the protocol to upgrade 2003 credit derivative trades to the new 2014 Definitions. The protocol adherence period is expected to begin on 18 August and close on 12 September, with clearing and confirmation in the trade warehouse available from the index roll on 22 September.

A list of names excluded from the protocol will be provided at the time of publication. North American financial CDS will be included in the protocol, but the new governmental intervention (GI) and asset package settlement provisions won't.

Contingent convertible (CoCo) bonds similarly will not trigger, nor are they deliverable into the new CDS contracts, according to JPMorgan credit derivatives analysts. But ISDA is expected to publish a CoCo Supplement that will allow market participants to trade CDS on financials with CoCo bonds as deliverable obligations.

The CoCo Supplement will define a level, such that if a bank's capital ratio falls below this level and the obligation is either permanently or temporarily written down or converted into another instrument, then a GI event will have occurred. CDS trading with the CoCo Supplement will therefore allow impairment of CoCo bonds to trigger CDS and also allow the resulting asset package to be deliverable.

Initially, this provision is expected to apply to Swiss banks that have no or limited non-CoCo Subordinated Tier 2 obligations. CoCo CDS will therefore likely be the standard subordinated CDS for these entities.

"Due to the likely higher cost of buying CoCo versus non-CoCo subordinated CDS, these provisions will likely not be the standard for most CDS entities. However, we expect that issuers that have both CoCo and non-CoCo Tier 2 debt to have both CoCo and non-CoCo subordinated CDS," the JPMorgan analysts observe.

CDS

Insurance CDS spreads tighten

All insurance sectors saw CDS spreads tighten during the last quarter as fundamentals point to an improvement in global growth, says Moody's. A review of Moody's global insurance CDS index during 2Q14 shows Travelers is the company with the most positive CDS-implied rating gap movement in the quarter.

CDS five-year mid-spreads tightened across all insurance sectors, while the median CDS-implied ratings gap of companies in the index was negative 1.1 notches at the end of the second quarter, compared with negative 1.4 notches at the end of the first quarter. This implies that the CDS market continues to have a more negative view of the insurance sector than Moody's, but slightly less so than previously.

The CDS-implied rating gap of Travelers improved by 1.7 notches during the second quarter, from 1.4 notches to 3.1 notches, implying that the CDS market has a more positive view than Moody's. The agency believes the movement was partly due to Travelers' strong reported first quarter earnings and optimism about future earnings.

CLOs

Volcker changes bring benefits

CLOs which amend sooner than others may improve managers' relationships with key investors, make their debt and equity more attractive sooner and be more liquid in the broader market as the deadline for Volcker compliance approaches, says Fitch. However, amendments will be difficult in certain circumstances.

US banks currently hold around US$70bn of CLO debt that may eventually fall foul of the Volcker Rule. The OCC has published procedures for examiners to determine whether or not banks have business activities or investments that are subject to the regulation and is working on more detailed procedures, which should accelerate amendment activity as the market gains an agreed-upon set of changes to rely on.

The most common way to bring a CLO into compliance is to remove its ability to invest in bonds. As the indentures continue to allow for some exposure to unsecured collateral in the form of second-lien loans, Fitch does not consider this to impact a transaction's creditworthiness.

Amending a CLO generally requires the approval of the majority of both the equity and senior debtholders. The most onerous structures require active approval rather than just lack of dissention.

The logistics of obtaining positive consent from a majority can be a challenge where debt or equity tranches are widely held across the investor community. Fitch suggests there may also be challenges where bond investments are important to the CLO manager's investment thesis, although most pre-crisis CLOs are expected to have matured or been called before the Volcker Rule is implemented.

CLOs

'Core' arrangers dominate US CLOs

Underlining the flourishing market, 119 US CLOs priced in 1H14 for a total value of US$63.2bn, according to Appleby's latest 'CLO Insider' report. Volumes surpassed the total for 2H13 by US$22bn.

"The first half of 2014 not only marked the biggest dollar amount in terms of CLOs priced since the market started picking up in 2010, but the average deal size is also well above previous six-month periods in recent years," comments Julian Black, Cayman-based partner and global head of structured finance at Appleby. "Investors continue to recognise that CLOs are unlike ABS CDOs in that they are diversified, have strong performance history and a reassuring level of transparency and oversight by third parties."

At US$531m, the average deal size was up by 14% over 2H13 and by 12% when compared to the average for full-year 2013. Meanwhile, total value of CLOs priced in the first half of the year was up by 53% when compared to the last half of 2013. Appleby expects the full year to round-out in the US$100bn-US$120bn range.

The report finds that a core set of arrangers continue to dominate the CLO market, with Citi taking the top position again for the six-month period, closing 18 deals valued at US$9bn. The top-10 arrangers account for 86% of the total for CLOs priced during January-June 2014.

The top-10 managers for 1H14 have closed 18% of the total CLOs priced. Of the 119 transactions, 87 individual managers have participated - of which 58 have issued one deal, 26 issued two deals and three issued three deals. A number of the big private equity houses have also launched their debut deal during the period.

The top-10 deals by value in the first half represent 15% of the value for all deals for the period. Average deal size for this group was US$927m.

Finally, the average triple-A spread for deals closed between January and June 2014 was 149bp, compared to 143bp for the previous period.

CMBS

Maturity repayment index inches up

Fitch reports that six of the 10 EMEA CMBS loans maturing in 3Q14 have a Fitch loan-to-value ratio above 100%. The agency further observes that the percentage of loans formally in default and/or special servicing continues to increase as loans hit maturity.

"Among the loans maturing in the third quarter, losses will likely be incurred, barring restructuring or injection of sponsor equity," comments Mario Schmidt, associate director in Fitch's structured finance team.

Two maturing loans, both with Fitch LTVs in excess of 100%, are already in special servicing as a result of technical or payment default. Three maturing loans were extended previously, for between six and 18 months. In two of these cases, Fitch believes that the exit position has improved sufficiently to envisage full repayment.

Six loans are in CMBS transactions that have tail periods of three years or less, thus restricting the range of options available to servicers in case of loan default.

Fitch's maturity repayment index improved to 59.8% for 2Q14 from 59% during the previous quarter.

CMBS

German MFH performance to remain strong

German multifamily (MFH) CMBS performance has been strong since transaction origination in 2012 and 2013, Fitch notes. The agency expects this trend to continue in the coming quarters, due to the stable economy in Germany.

"The collateral performance of the largest MFH transactions has remained stable to positive over the last 12 months, visible through increasing rental levels, stable vacancy rates and cost ratios within our expectations," comments Tuuli Krane, director in Fitch's European structured finance team.

Three new MFH CMBS transactions - Taurus 2013 (GMF1), German Residential Funding 2013-1 and German Residential Funding 2013-2 - were issued in 2013. Together with Florentia, issued in 2012, these deals account for over 80% of the total outstanding securitised German MFH debt balance.

"The new issuances are proof of investor interest returning in CMBS, albeit to a small sub-section of the overall CMBS market," says Mario Schmidt, associate director in Fitch's European structured finance team.

CMBS

Auction.com sales continue apace

US$477m in US CMBS loan allocated balance is slated for sale on Auction.com in July and early August. Unlike previous auctions, most deals have only 1-2 loans up for bid.

The largest loan up for sale is the US$67m HSA Memphis Industrial Portfolio securitised in MLCFC 2007-5, with the final nine assets in the portfolio listed (see SCI's CMBS loan events database), according to CMBS analysts at Barclays Capital. They suggest that loss severities are likely to be high, at around 80%-85%, as the assets are appraised at just US$9.25m as of September 2013 and CWCapital has indicated that the properties' values have fallen since then.

The US$38m Marriott - Memphis loan securitised in JPMCC 2007-CB19 is also likely to take large losses, if it is liquidated in the auction based on its latest appraisal of US$14.9m, as of August 2013. With US$5.4m of ASER and advances outstanding, loss severity could approach 75% for the asset.

Also slated for auction is the Simon - DeSoto Square Mall asset in MLMT 2005-MKB2, which backs a performing loan that was modified via a US$21.5m/US$20m A/B-note split (with an additional US$20m written off) in November 2012. The Barcap analysts note that the property's performance appears to have stabilised since then, with occupancy standing at 76%. They expect the B-note to see some recoveries (likely about 25%), as excess cashflow should have paid down a portion of the US$4.25m in contributed equity ahead of the B-note.

In addition, two loans representing US$47m from the seasoned CMAT 1999-C1 transaction are up for auction, including the non-recoverable US$38.5m Baldwin Complex office building.

CMBS

BAML preps single-sponsor CMBS

Details have emerged on the BAMLL 2014-ICTS single-sponsor CMBS. The US$188m transaction is backed by a non-recourse mortgage loan secured primarily by a first mortgage on the borrower's fee simple interest in a luxury hotel in New York City.

The interest-only loan has an initial term of 25 months but allows for four one-year extensions. Interest is accrued at a variable rate equal to 2.17% over one-month Libor, with a Libor cap of 3%.

Metropolitan Life Insurance Company and certain affiliates hold a preferred equity interest in the borrower's sole member in the aggregate amount of US$177m. The preferred equity accrues interest at one-month Libor plus 6%, is payable on a current basis to the extent of available cash and, subject to two successive one‐year extension options, is required to be redeemed when the mortgage loan is repaid or refinanced, or on 1 June 2020 if that is earlier.

The real estate collateral for the transaction is the Intercontinental New York Times Square, a 36-storey luxury hotel in New York City, built in 2010 within the Times Square district of Manhattan. The property is managed by an affiliate of InterContinental Hotels Group.

CMBS

CMBS pay-offs drop

The percentage of US CMBS loans paying off on their balloon date slipped noticeably in June to 67.3%, about 10 points lower than the May reading of 77.1%, according to Trepp. In comparison, the 12-month moving average stands at 71.7%.

By loan count as opposed to balance, 74.1% of loans paid off last month - marking a slight decrease from May's level, with 74.8% paying off on this basis. The 12-month rolling average by loan count is now 70.8%.

Insurance-linked securities

Jumbo cat bonds drive record issuance

Last quarter saw the largest-ever issuance volumes in the history of the non-life catastrophe bond market, with US$4.5bn of capacity issued through 17 tranches, according to Willis Capital Markets & Advisory's latest ILS market update. This compares with US$3.3bn issued via 17 tranches in 2Q13 and the previous quarterly record of US$3.5bn issued in 2Q07.

The record issuance volume was driven by two of the largest-ever catastrophe bond transactions - Everglades Re 2014 and Sanders Re 2014. The former, sponsored by Florida Citizens, was brought to market in part to replace the maturing US$750m Everglades Re 2012 transaction.

The deal was initially marketed with a size of US$400m and a pricing range of 6.50%-7.75%. While changing the trigger basis from per occurrence to annual aggregate, Citizens chose to upsize the transaction to US$1.5bn, making it the largest single catastrophe bond on record. It closed with a final issuance spread of 7.50%.

Meanwhile, Sanders Re 2014-1 initially launched with three classes of notes covering US named storms (excluding Florida) and US earthquake on a per occurrence industry index basis. The transaction was launched with an aggregate size of US$600m and upsized to US$750m with pricing at the midpoint or near the top of each of the announced pricing ranges (3%-3.90%).

Allstate immediately thereafter sponsored an additional 2014-2 take-down, securing named storm, earthquake and severe thunderstorm protection for its Florida subsidiaries on an indemnity basis. The deal upsized from US$150m to US$200m and priced at 3.90%, which was the upper end of the initial pricing range.

Four first-time sponsors tapped the market in Q2, after two new sponsors came in Q1. Heritage P&C issued the first transactions of the quarter via Citrus Re 2014-1 and 2014-2, securing US$200m of limit for named storms in Florida on an indemnity basis. Everest Re was another new entrant, with the US$450m Kilimanjaro Re 2014-1 transaction through two classes of notes.

Willis notes that a further two sponsors brought diversifying perils in Q2, incorporating new structural features and pushing the lower boundaries of the margin cat bond investors require. Generali sponsored the first indemnity triggered European wind transaction since 2008 through Lion I Re, securing €190m of protection at 2.25%.

Group Sompo issued the first-ever Yen-denominated transaction, purchasing ¥10.13bn of protection at 2%. This was the sponsor's first indemnity deal since 1998's Pacific Re.

The Texas Windstorm Insurance Association (TWIA) last quarter became the latest residual market entity to issue catastrophe bonds. Alamo Re upsized from US$300m to US$400m, with a final spread below the initial price guidance range at 6.35%.

Indeed, the first half of 2014 saw 50% of transactions price below the initial guidance range and 21% price above the midpoint of initial guidance. "We can interpret this trend in many ways, including but not limited to overly aggressive initial ranges, disparity in the number of transactions and capacity issued between the two periods, pushback from investors to ever-compressing risk spreads and dampened investor demand in the wake of the US$1.5bn Everglades deal," Willis observes.

Three-quarters of 2014's transactions were upsized, compared to 63% for the first half of 2013. This could reflect the diversity of deals brought to market, as well as new capital and investor participants.

Diversifying bonds were more likely to experience favourable price and size changes, as demonstrated by the Lion I and Kizuna deals.

Insurance-linked securities

CCRIF sees cat bond firsts

GC Securities has placed the first catastrophe bond directly issued by the World Bank, via member institution the IBRD. The US$30m CCRIF catastrophe-linked capital at risk notes provide three years of annual aggregate protection for hurricane and earthquakes affecting 16 Caribbean countries participating in the Caribbean Catastrophe Risk Insurance Facility (CCRIF), representing the first time that the initiative has tapped the cat bond market.

The unrated bond matures in June 2017 and features a parametric trigger. GC Securities served as sole placement agent and co-structuring agent with Munich Re.

The World Bank's cat bond issuance programme is expected to open up new markets for public sector sponsors and significantly streamlines the issuance process in terms of time and cost. GC Securities says that the platform is fully customisable for other entities, with investors' receptivity indicating the untapped potential in the capital markets for public sector sponsors.

CCRIF is a risk-pooling facility that is designed to limit the financial impact on its 16 Caribbean member governments resulting from catastrophic earthquakes and hurricanes by providing financial liquidity when a policy is triggered.

Insurance-linked securities

Cat bond pricing floor emerging?

Munich Re last week withdrew its latest catastrophe bond issuance - Queen Street X - due to weak demand. Pushback on the deal's pricing could be a sign that investors are approaching a limit on acceptable catastrophe risks, according to Fitch.

Ratios of risk premiums to expected loss have fallen dramatically in the cat bond market over the past several years as investor demand has greatly exceeded the available supply. Fitch cites the last four Queen Street issuances as an example: ratios have dropped to 2.02x for Queen Street IX from 4.72x for Queen Street VI, issued in 2012. Although the perils were different, the underlying expected loss remained relatively constant at 2.7%, while the risk premium declined to 5.50% from 10.35%.

The agency notes that if Queen Street X had been placed at the lower end of a price range between 4.75% and 5.50%, it would have been one of the first bonds for which the risk premium/expected loss ratio fell below 2x.

Through first-half 2014, nearly two-dozen catastrophe bonds with varying risk levels were issued globally with an average risk premium of approximately 4.3%. This compares to an average of 5.7% for the same period in 2013.

Of the bonds issued in 2014, four individual tranches were issued at a risk premium to expected-loss multiple of less than 3x. They include Residential Reinsurance 2014 class 10 tranche (at a 15% risk premium), Queen Street IX Re (5.5%), Lion I Re (2.25%) and Kilimanjaro Re class A notes (4.75%).

Residential Reinsurance 2014 included an US$80m tranche with a premium/expected loss ratio of 1.52x, but also included one of the largest risk premiums the market has seen in recent years at 15% - exemplifying the increased risk that investors have been willing to accept for deals that include significant risk premiums. The record US$1.5bn Everglades Re 2014 offered the second-largest coupon rate of any bond issued this year, at 7.5%, and a risk premium/expected loss ratio of 3.26x.

As the hurricane season runs from June to November, Fitch believes that the catastrophe bond market will see fewer US named-storm peril issuances coming to the market for the next couple of months. Other perils are likely to continue to be issued at relatively low risk premium/expected loss multiples throughout the year, however.

"As the market approaches a floor for cat bond pricing, the risk premiums paid to investors will be an important factor in determining the demand for cat bond transactions," the agency concludes.

NPLs

HUD auction sees three firsts

Lone Star on 11 June became the first single bidder to win each of the pools offered in a HUD single family loan sale. The 2014-2 Part 1 auction comprised 16 different pools of geographically diverse non-performing FHA loans, with US$3.9bn of aggregate UPB and a US$3.3bn aggregate BPO.

Loan Star's weighted average bid was 77.6% of BPO (65.8% of UPB), representing the highest-ever bid among all HUD auctions conducted since the programme began in 2010, according to Barclays Capital research. The sale was also the most competitive auction to date and attracted bids from 27 entities, underscoring the increased interest in NPLs among investors.

Risk Management

MPOR standards published

The EBA has published its final draft regulatory technical standards (RTS) specifying the minimum margin periods of risk (MPOR) that institutions acting as clearing members may use for the calculation of their capital requirements for exposures to clients. To incentivise the use of CCPs, the Capital Requirements Regulation (CRR) introduces special treatment for centrally cleared derivatives.

In particular, these draft RTS specify the level of a particular parameter and the MPOR that clearing members may use to calculate the regulatory requirements for counterparty credit risk (CCR) when they apply the internal model method (IMM) or other non-internal methods. In the case of the IMM, the MPOR will be an input into the model; for non-internal methods, the MPOR will determine a multiplier of the exposure value that is less than one.

These draft RTS specify the MPOR for different classes of derivatives, covering the full spectrum of derivative types and all the methodologies for the calculation of capital requirements against CCR. The proposed methodology aims to properly capture the risk arising from derivatives exposures to clients, adding very limited operational burden on institutions. This is achieved by identifying the liquidation periods estimated by CCPs for margin purposes as proxies for the margin periods of risk.

Risk Management

DVA approach published

The EBA has published its technical advice to the European Commission on the use of a prudential filter for gains and losses arising from banks' own credit risk of derivatives. The authority considers as appropriate not to deviate from the current prudential approach applied at the international level under the Basel 3 rules.

The EBA's analysis highlights that at present it is challenging to measure own credit risk in a robust way. In addition, it points to the difficulty in isolating in a consistent way the changes in own credit risk that stem only from changes in an institution's own credit standing.

In its advice, the EBA notes that the Basel approach ensures a conservative outcome and a level playing field at the international level, as well as addressing this "complex and ongoing issue in a rather simple way".

The authority adds that prudential requirements could potentially be revised in the future, if necessary and if an agreement is reached on the current issues under debate. In the meantime, it says that a close monitoring of institutions' practices related to own credit risk from derivatives seems appropriate.

RMBS

Further settlement deadline extended

The trustees for the RMBS that fall under Citibank's US$1.125bn rep and warranty settlement have exercised their right to extended by 45 days the deadline to respond to the offer. The new deadline is 14 August.

Barclays Capital RMBS analysts note that the trustees for the 68 deals that are part of the Citibank settlement - Deutsche Bank, HSBC,US Bank and Wells Fargo - are also the trustees for a number of transactions that fall under JPMorgan's similar R&W settlement, where the acceptance deadline has been extended three times without a response to JPMorgan's offer announced on 15 November 2013. "Given that Citibank's announcement was almost six months after JPMorgan's and that the settlement agreement allows trustees to request even more time, extensions beyond 14 August 2014 cannot be ruled out. Furthermore, even if the trustees were to accept the offer, getting court approval for this settlement could be a drawn-out affair if the Bank of America/Countrywide settlement is anything to go by. As such, the timing of any eventual pay-out is uncertain," they observe.

RMBS

Rating actions for Irish RMBS

Fitch has upgraded ten, affirmed 23 and downgraded four tranches across 12 Irish RMBS. At the same time, outlooks on 14 tranches were revised to stable from negative and the rating watch positive on five tranches has been resolved.

Fitch placed five tranches of Irish RMBS on RWP in April, following a revision in the rating cap on structured finance ratings to align them with the country ceiling of Ireland (double-A plus), six notches above the sovereign issuer default rating. With the publication of its updated criteria assumptions for Irish RMBS last month, Fitch's analysis showed that the credit enhancement available to the senior notes of Kildare Securities, Fastnet 9, Emerald 5 and the senior and mezzanine notes of Emerald 4 are sufficient to support higher ratings - resulting in an upgrade of these notes.

The assumptions also included the revision of foreclosure frequency expectations and reduction in house price decline assumptions, along with other adjustments to better reflect an improved view on the future performance of the Irish mortgage market. This improved outlook has led to the revision of the outlook to stable from negative on 14 tranches.

Loans in arrears by more than three months remain high across most seasoned Irish RMBS. However, in recent months some deals have reported a decline in the number of borrowers in arrears for several reasons.

In Emerald 5, for example, approximately €40m of loans in arrears by more than 12 months were repurchased out of the portfolio by the originator. The decline in arrears by more than three months in Celtic 11 to 12.7% from 13% was caused by properties backing late-stage arrears loans being re-engaged with the servicer and cured, as well as those entering repossession but not being replaced by new borrowers falling into arrears.

Fitch expects this latter trend to be increasingly prevalent in Irish RMBS as the economy improves and long-term arrears are either restructured or foreclosed upon.

RMBS

New contender for worst-performing postcode

Fitch reports that Budgewoi on the Central Coast of New South Wales has become the worst performing postcode in Australia for missing housing loan payments, with a 30+ days delinquency rate of 3.7%. The suburb has been among the 20 worst performing postcodes each March and September over the five years since March 2009, with the exception of September 2012. Surfers Paradise in Queensland was previously the worst performing postcode, but has slowly improved from a rebound in the Gold Coast housing market.

On average, the delinquency rate across Australia increased to 1.35% at end-March 2014, up from 1.24% at end-September 2013. Interest rates have had a slow impact during the twelve months to March 2014, as arrears are 10bp lower than 12 months before. During the past 12 months, local unemployment and economic trends have become the major drivers in regional mortgage performance, particularly in the current low-interest rate environment.

Although Queensland returned as the worst performing state in Australia for mortgage payments, with a delinquency rate of 1.42%, there was little divergence among the delinquency rates across all six states. As of March 2014, the gap between the best- and worst-performing states stood at a record low 11bp (versus the average of 76bp over the past eight years), indicating that borrowers across all states are in a similar situation in terms of serviceability.

Fitch has observed an unexpected deterioration in mortgage performance in Victoria, which recorded a delinquency rate of 1.37% at end-March 2014, up by 17bp from September 2013. Victoria was the only state to experience an increase in delinquency rates (8bp) in the 12 months to March 2014, despite the favourable monetary policy. The state also performed worse than New South Wales (1.32%).

Seven of the worst performing suburbs (four of the top five) were located in Victoria. Hume City continued to be the worst-performing region in Australia, with a 30+ days delinquency rate of 2.93% at end-March 2014 - the highest level since early 2008. Hume, Melton-Wyndham and Northern Outer Melbourne continue to show a significant deterioration in mortgage performance and in the six months to March 2014 the delinquency rate in these regions increased on average by 59bp, compared with an average rise of 11bp nationally.

These regions have historically shown strong sensitivity to mortgage rates due to socio-economic factors, such as high unemployment and low-income households, as is the case for regions located in the west and south-west of Sydney. Fitch believes that the divergence in mortgage performance reflects the trends in the local economy and the high unemployment rate in North West Melbourne.

Meanwhile, delinquencies in the Gold Coast continue to improve. Gold Coast East was the region that improved the most in the six months to March 2014, as arrears declined by 36bp to 1.64%.

The recent stabilisation in the housing market and economy has resulted in the higher auction clearance rates of foreclosed properties. This, in turn, reduced 90+ days arrears - which fell to 0.62% at end-March 2014 from 1.22% at end-March 2013.

RMBS

Recoveries surprise to the upside

MSAC 2006-HE3 and SVHE 2006-WF1 bondholders last month received significant pay-outs related to subsequent recoveries. The trustee for both RMBS is Deutsche Bank and the pay-outs are believed to be due to individual rep and warranty-related settlements with one of the originators or related pay-outs at the loan level.

MSAC 2006-HE3 group 2 bonds saw a subsequent recovery of about US$15m (or 5.3% of group 2 balance), while SVHE 2006-WF1 received about US$55m (25% of the outstanding deal balance), according to Barclays Capital figures. The loans in the former deal were originated by three different originators (Decision One, WMC and New Century) and Wells Fargo is the sole originator for the latter.

As a percentage of historical and projected losses, SVHE 2006-WF1 pay-outs are about 24%, compared to the 7%-11% pay-out ratios of the Bank of America, JPMorgan and Citibank settlements. For the MSAC deal, the pay-out implies approximately 9.1%, 6.8% or 8.3% of group 2 losses, depending on whether it was Decision One, WMC or New Century making the pay-outs.

SVHE 2006-WF1 M1, M2 and part of the M3 bond were written up as a result of the subsequent recovery. The MSAC 2006-HE3 M1 bond was written up from a 46% factor to a 61% factor and, consequently, the pay-out should delay crossover on the deal by 12 months versus previous expectations.

RMBS

Home price growth provides 'cushion'

Strong US home price growth since 2012 is providing recent vintage US prime RMBS with a cushion against any unexpected economic stress, according to Fitch's latest monthly prime jumbo trends report. When weighted by the geographic concentration in prime RMBS pools, home prices increased at an annualised rate close to 5% in 1Q14, down from double-digit increases last year.

"Home price increases are slowing and some regions may still be vulnerable to a correction, but most recent vintage RMBS borrowers will still be left with more equity than they had at origination, even if home prices fall 10%," comments Fitch md Grant Bailey.

Weighted average combined loan-to-values have improved to 50% from 64% for deals originated in 2011, to 55% from 68% for deals originated in 2012 and to 59% from 68% for deals originated in 2013. The improvement in equity positions to date, combined with the strong initial credit profile of the prime borrowers is reflected in low delinquency rates. As of the most recent month's data, only 13bp of outstanding prime RMBS borrowers were delinquent.