Contents

CMBS

Mixed bag out for busy CMBS session

US CMBS BWIC volume totalled around US$650m yesterday as a mixed bag of securities from various vintages were put out for the bid. SCI's PriceABS data captured a range of price talk and covers.

PriceABS picked up 29 unique US CMBS tranches from yesterday's bid-lists, including the BAYC 2006-4A A2 tranche. That tranche was talked at 83, after it had been covered at 84 on 25 June and talked in the low/mid-80s on 24 June.

A US$5m piece of the LBUBS 2006-C7 AJ tranche was talked at 90 and covered at 90.19. The tranche had been covered a week earlier at 90 and before that was covered on 5 March in the mid-80s.

There was a cover at 173 for the BACM 2007-5 AM tranche, which had also been talked at swaps plus 175, while the CSMC 2007-C1 AM tranche was talked at swaps plus 285 and covered at 305. Meanwhile, the JPMCC 2007-LDPX AJFL tranche was talked in the low-60s and the WBCMT 2007-C30 AJ tranche was talked in the high-200s and at swaps plus 305.

As for post-crisis paper, the GSMS 2010-C1 D tranche was covered at 193, having previously been covered at 234 on 12 February. Another 2010-vintage D tranche - JPMCC 2010-C2 D - was covered at 159, having previously been covered at 285 on 20 September 2013.

The JPMCC 2012-C6 A3 tranche was covered at 60.49. It had been covered at plus 73 on 22 May and first appeared in the PriceABS archive back on 2 August 2012, when it was covered at 113.

There were also covers for CGCMT 2013-375P D, HILT 2013-HLT EFX, JPMBB 2013-C17 D, MSBAM 2013-C10 C, MSBAM 2013-C12 A4, WFCM 2013-BTC E, WFCM 2013-LC12 A4 and WFRBS 2013-C17 A4. That final tranche was covered at plus 68, having been covered on 24 January at 84.

A few tranches from deals issued this year were also available. Among them was the COMM 2014-CR18 B tranche, which made its first appearance in the PriceABS archive as it was talked at swaps plus 125 and was covered at 125.

COMM 2014-LC15 D was talked at swaps plus 290 and covered at 293. It had been covered last week at 294 and before that was covered on 7 May at 328.

The JPMCC 2014-C20 D tranche was talked at swaps plus 295 and was successfully traded. It was previously covered at 307 on 20 June.

Lastly, the RRX 2014-1A A tranche was another new addition to PriceABS. It was talked at swaps plus 250 and was covered at 288.

JL

RMBS

US RMBS supply stays steady

US non-agency RMBS secondary market activity remained moderate yesterday as supply was driven mainly by subprime floaters. BWIC volume was around US$650m, with SCI's PriceABS data capturing tranches from vintages as disparate as 2003 and 2014.

Among them was a US$5.621715m piece of the CWL 2003-1 M1 tranche, which was traded during the session. It marked the tranche's third appearance in the PriceABS archive, with the first - back on 26 July 2012 - recording price talk in the low-30s.

A US$5.913164m piece of the CWL 2006-BC4 2A2 tranche was also out for the bid and was covered in the mid-90s. The tranche was previously covered in the low-80s on 3 September 2013.

CWALT 2006-30T1 1A2 was talked in the mid/high-80s, while BOAA 2006-7 A3 was talked in the low/mid-70s. The CSAB 2006-3 A4B tranche was talked in the low-50s, having been talked in the mid-50s in November 2013 and in the high-50s in August 2012.

A US$3.888m piece of the CWALT 2007-9T1 2A3 tranche, meanwhile, was talked in the low-80s. There was a cover in the low/mid-90s for the BCAP 2009-RR1 1A3 tranche, while NMRR 2010-5RA 1A7 was covered in the mid/high-80s, as both tranches appeared in PriceABS for the first time.

Among the post-crisis names was the CSMC 2014-6R 15A1 tranche. That too was new to PriceABS and was successfully traded.

The BCAP 2013-RR3 6A10 tranche was another post-crisis name on yesterday's BWICs, but came back as a DNT. The BCAP 2010-RR7 5A11, CARR 2005-OPT2 M5 and FHLT 2006-E 2A1 tranches were also DNTs.

Meanwhile, BlackRock is understood to be preparing to sell another US$4.4bn of legacy bonds backed by UBS 'bad bank' collateral. The list has not been formally announced but could be launched next week and is expected to be similar to the US$3.7bn auction of subprime and home equity bonds from Tuesday (SCI 16 July).

JL

Structured Finance

SCI Start the Week - 21 July

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

Pipeline
Many of the deals that joined the pipeline last week were quick to price. However, three ABS, an RMBS, five CMBS and six new CLOs remained at the end of the week.

The newly announced ABS comprised: US$300m HOA Funding Series 2014-1, US$387m MHEAC 2014-1 and US$277m State Board of Regents of the State of Utah Series 2014-1. The RMBS was A$500m SMHL Securitisation Fund 2014-1.

US$1.3bn COMM 2014-UBS4, US$284.1m CVS Series 2014, US$430m JPMCC 2014-DSTY, US$800m Morgan Stanley Capital I Trust 2014-CPT and US$1.24bn WFRBS 2014-C21 accounted for the CMBS entrants. Meanwhile, the CLOs consisted of €300m Babson Euro 2014-2, US$666.5m Dryden Senior Loan Fund XXIV, a refinancing of US$402.3m Shackleton I-R CLO, US$413m Silver Spring CLO, US$500m Sound Point CLO VI and St Paul's CLO V.

Pricings
A great many deals left the pipeline. As well as 12 ABS prints, an ILS, four RMBS, three CMBS and one CLO priced last week.

The ABS new issues were: US$500m Avis Budget Series 2014-2; US$500m Chase Issuance Trust 2014-6; US$378m Consumers 2014 Securitization; US$722m Dell Equipment Finance Trust 2014-1; US$675m GE Dealer Floorplan Master Note Trust Series 2014-1; £882m Gracechurch Card Programme Funding; US$227.56m JGWPT XXXII Series 2014-2; NZ$150m MTF Valiant Trust 2014; US$462.5m Navient Private Education Loan Trust 2014-CT; US$250.15m TCF Auto Receivables Owner Trust 2014-1; US$38.97m Westgate Resorts 2014-A; and US$300m World Financial Network Credit Card Master Note Trust Series 2014-B.

The ILS was US$31.825m Market Re Series 2014-2. The RMBS prints consisted of €4bn BBVA RMBS FTA 13, US$2.05bn CAS Series 2014-C03, US$306m Sequoia Mortgage Trust 2014-2 and A$500m Triton Trust 2.

The CMBS pricings included US$1.2bn CGCMT 2014-GC23, US$345m HILT 2014-ORL and €200m MODA 2014. Finally, the US$513.5m TICP CLO II rounded the issuance out.

Markets
In European RMBS, JPMorgan analysts note that "spreads closed the week slightly softer in both core and peripheral jurisdictions on the back of thinner flows, despite the steady stream of BWICs". Spanish spreads were most affected, with senior bonds closing the week 5bp wider at 150bp.

The US non-agency RMBS secondary market experienced a few sessions of moderate activity, meanwhile, with BWIC supply on Thursday totalling around US$650m (SCI 18 July). SCI's PriceABS data captured tranches from a range of vintages, including paper issued in 2003 and this year.

US CMBS BWIC volume was heavy last week, with more than US$500m circulating on Wednesday's bid-lists (SCI 17 July). The mid-week session saw a number of CMBS 1.0, 2.0 and 3.0 bonds out for the bid.

In the US ABS market, several student loan and credit card bonds drove issuance early in the week (SCI 16 July). Over half of Tuesday's BWIC supply came from a US$108m list of FFELP bonds.

It was also a busy week for the US CLO market, as BWIC volumes reached around US$435m, split fairly evenly between CLO 1.0 and 2.0 bonds. "CLO 1.0 deals continued to trade well, especially at the top of the capital stack. There was more tiering towards the bottom of the stack by managers and WALs. Despite the heavy supply in the primary market, 2.0 senior tranches held firm over the week. Spread levels were unchanged overall from last week's levels," report Bank of America Merrill Lynch analysts.

Deal news
• Pricing on the TMAN 7 class D bonds is said not to reflect the risks involved. An update call last month from special servicer Hatfield Philips has enhanced transparency around the transaction, but concerns about possible tax costs remain.
• 2007-vintage Eurosail RMBS continue to attract headlines due to their unhedged FX exposure and associated restructuring activity (SCI passim). Nevertheless, ESAIL bonds could offer interesting entry points for a range of investors, given the varied mix of currencies, ratings, WALs and risk profiles on offer.
• The US$54m Colony V portfolio located in the Chicago and Washington DC metro areas has received a modification creating two hope notes. The portfolio previously backed a US$53.7m loan in JPMCC 2007-LDPX.
• Simon Property Group formally completed its spin-off of 54 strip centres and 44 malls to Washington Prime Group (WPG) at the end of May. The new entity financed seven of these properties with US$410m of debt securitised in 2014-vintage CMBS 2.0 deals, meaning that 26 properties are now encumbered by a total of US$1.2bn of CMBS debt.
• C-III Asset Management has issued a clarification pertaining to the US$60.8m Rock Point Corporate Center loan securitised in CD 2006-CD2. The move is in response to a recent note published by Morgan Stanley's CMBS research team highlighting that an affiliate of the special servicer exercised a fair value purchase option (FVPO) on the asset for US$52.1m in May.
• BNP Paribas and Santander have announced a tender offer for two UCI bonds - the ninth for UCI paper over the past five years and the first Spanish RMBS tender offer of 2014. The offer is to repurchase the UCI 14 B and UCI 14 C bonds.
• Fitch has updated the presale for Volkswagen's Driver China One Trust (SCI 3 June). While the update reflects that references to the agency were removed from the transaction documents, there should be no rating impact.
• The first in a series of private FDIC bank Trups CDO auctions was scheduled for 17 July (SCI 24 June). A separate auction has been scheduled for Birch Real Estate CDO I on 23 July.

Regulatory update
• The 2014 ISDA Credit Derivatives Definitions contain a number of changes that are likely to impact the economic value of new financial CDS contracts, potentially bringing them more in line with the economics of the underlying cash bonds. Any projections of where the new CDS contracts will trade should consequently take cash bond pricing into account.
• The Full Federal Court of Australia last month dismissed an appeal by S&P, ABN Amro and Local Government Financial Services (LGFS) against a decision in favour of a group of New South Wales councils regarding the marketing and sale of Rembrandt CPDO notes (SCI 6 November 2012). The court also extended Justice Jane Jagot's original decision to rule that each of the three defendants were 100%, rather than proportionately, liable for the losses incurred.
• Democrats in the US House of Representatives have proposed a bill to wind down the GSEs and provide an explicit government guarantee while increasing private sector participation in the market. The Partnership to Strengthen Homeownership Act has been proposed by John Delaney, Jim Himes and John Carney.
• The FHFA is set to issue guidance by 1 December aimed at ensuring that non-bank servicers meet current servicing requirements. The move follows the release of an Office of Inspector General (OIG) report identifying broad problems in the mortgage servicing industry.
• The Russian State Duma last month approved a number of amendments to several articles of the Federal Law On Mortgages, including defining lender's mortgage insurance (LMI) in the event of borrower default and clarification of creditors' rights. Such changes are said to be credit positive for future Russian RMBS issuance as they limit losses for investors, while also potentially improving mortgage affordability for Russian borrowers.
• A relaxation of LTV and DTI regulations on Korean banks' mortgage loans could increase household debt and pressure Korean banks' asset quality. In a scenario where banks compete aggressively on underwriting standards or pricing to grow business, the credit risk of residential mortgage loan portfolios could increase quickly.
• Citigroup has agreed to settle an ongoing investigation by the RMBS Working Group. The agreement resolves actual and potential civil claims by the US DOJ, several state attorneys general and the FDIC relating to RMBS and CDOs issued, structured or underwritten by Citi between 2003 and 2008.
• American International Group has reached a global resolution of its RMBS-related disputes with Bank of America. The resolution also covers AIG's obligations to the US$8.5bn settlement of Countrywide's mortgage repurchase obligations to various investors (SCI passim), as well as disputes concerning the issuance of mortgage guaranty insurance by AIG's United Guaranty subsidiaries to Bank of America and Countrywide.
• JPMorgan and FDIC have filed their motions for summary judgement in the Washington Mutual rep and warranty lawsuit. The replies to the motions are due by 5 September, after which the judge's order is due.
• ISDA has published its recommendation for FpML version 5.7. Among the latest enhancements made to the FpML standard is coverage of package transactions. Version 5.7 also electronically represents the Standardised Credit Support Annex (SCSA) document and supports the ISDA 2014 Credit Derivatives Definitions.

Deals added to the SCI New Issuance database last week:
Adams Mill CLO; Alamo Re 2014-1; Ally Master Owner Trust Series 2014-4; American Express Credit Account Master Trust 2014-2; AMMC CLO XIV; Apidos CLO XVIII; Ares European CLO VII; ARL Second; Avery Point V CLO; BAMLL 2014-IP; Bavarian Sky Compartment German Auto Loan 2; Berica ABS 3; BPL Mortgages series VII; Cabela's Credit Card Master Note Trust 2014-II; Carismi Finance ABS; Carlyle Global Market Strategies CLO 2012-2 (refinancing); CG-CCRE 2014-FL1; CLI Funding V Series 2014-1; Covenant Credit Partners CLO I; Cutwater 2014-I; CVP Cascade CLO-2; DECO 2014-Gondola; Dryden 32 Euro CLO 2014; Dryden XXIII Senior Loan Fund (refinancing); Eaton Vance CLO 2014-1; E-Carat Compartment 7; Edsouth Indenture No. 7 2014-3 Series; FirstMac Mortgage Funding Trust No. 4 Series 1A-2014; Flexi ABS Trust 2014-1; Ford Credit Auto Owner Trust 2014-B; FTA RMBS Santander 1; FTA RMBS Santander 2; Golub Capital Partners CLO 10 (refinancing); Gramercy Park CLO (refinancing); Guerriero SPV; Hyundai Auto Lease Securitization Trust 2014-B; JFIN CLO 2014-II; Madison Park Funding VIII (refinancing); Madison Park Funding XIV; Magnetite IX; Mercedes-Benz Auto Receivables Trust 2014-1; MidOcean Credit CLO III; Monviso 2014; Neuberger Berman CLO XVII; Octagon Investment Partners XX; OZLM VII; Paragon Mortgages 20; Peaks CLO 1; Phoenix Park CLO; Precise Mortgage Funding 2014-1; Progreso Receivables Funding II series 2014-A; PUMA Series 2014-2; Rural Hipotecario XXVII; SC Poland Auto 2014-1; Shackleton 2014-VI CLO; Sierra Timeshare 2014-2 Receivables Funding; Silver Creek CLO; SoFi Professional Loan Program 2014-A; Sunrise Series 2014-1; Taurus CMBS UK 2014-1; Tralee CLO III; Trinitas CLO II; Voya CLO 2014-3; West CLO 2014-1; WhiteHorse IX.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2004-5; BACM 2004-6; BACM 2006-2; BACM 2006-3; BACM 2006-4; BACM 2006-5; BACM 2006-6; BACM 2007-1; BACM 2007-3; BACM 2008-1; BRUNT 2007-1; BSCMS 2006-PW13; BSCMS 2007-PW16; Canary Wharf Finance II; CCIC 2006-WEM; CD 2006-CD2; CD 2006-CD3; CGCMT 2006-C5; CGCMT 2007-C6; CMAT 1999-C1; COMM 2012-CR1; COMM 2012-CR3; CSCMT 2007-C3; CSFB 2005-C3; CSMC 2006-C3; CSMC 2006-C4; CSMC 2007-C5; CTCDO 2005-1 & BACM 2005-3; DECO 2005-C1; DECO 2005-E1; DECO 2006-E4; DECO 2007-C4; DECO 2007-E5; DECO 7-E2; ECLIP 2006-1; ECLIP 2006-3; ECLIP 2006-4; ECLIP 2007-1; ECLIP 2007-2; EMC VI; EPC 3; EURO 28; FOX 1; GCCFC 2005-GG3; GCCFC 2005-GG5; GCCFC 2006-GG7; GCCFC 2007-GG11; GCCFC 2007-GG9; GECMC 2006-C1 & GMACC 2006-C1; GSMS 2005-GG4; GSMS 2005-GG4 & GCCFC 2005-GG5; GSMS 2006-GG8; GSMS 2007-GG10; GSMS 2013-KYO; IMSER 2; JPMCC 1998-C6; JPMCC 2003-C1; JPMCC 2004-LN2; JPMCC 2005-CB12; JPMCC 2005-CIBC13; JPMCC 2006-CB16; JPMCC 2007-CB19; JPMCC 2007-CIBC20; JPMCC 2007-LDPX; JPMCC 2011-C5; JPMCC 2012-CIBX; JPMCC 2013-FL3; JPMCC 2013-INN; JPMCC 2013-LC11; JPMCC 2014-FL4; LBUBS 2006-C4; LBUBS 2007-C6; LBUBS 2008-C1; LEMES 2006-1; MALLF 1; MLCFC 2007-5; MLCFC 2007-9; MLMT 2005-MKB2; MLMT 2007-C1; MSBAM 2013-C7; MSC 2007-IQ14; OPERA GER²; PCMT 2003-PWR1; Portfolio Green; PROUD 1; TAURS 2006-2; TAURS 2007-1; THEAT 2007-1 & THEAT 2007-2; TIAAS 2007-C4; TITN 2007-1; TITN 2007-2; TITN 2007-3; TITN 2007-CT1; TMAN 6; TMAN 7; WBCMT 2006-C28; WINDM X.

CLOs

HARBM 3 hit by lack of credit support

The Harbourmaster CLO 3 class B tranche last week defaulted at the deal's legal final maturity. The transaction differed in several ways from typical legacy European CLOs, but appears to have primarily succumbed to a lack of credit enhancement.

The HARBM 3 class A notes repaid in full, the B1 and B2 notes were redeemed to 51.5% and 52% of their original principal balances and the C notes did not receive any principal distributions. The class B tranche, which was originally rated single-A, defaulted primarily due to low credit enhancement. Fitch notes that at issuance in 2002, the class B notes had 5.6% credit enhancement, compared with CLO 2.0 single-A rated tranches that typically have between 22% and 23%.

The class B and C notes were downgraded to double-B and single-B (from triple-B) respectively in 2008, at which time ABS assets only represented 4% of the portfolio. Unlike typical European CLOs, the transaction allowed the manager (originally Harbourmaster Capital, which was acquired by Blackstone/GSO) to purchase up to 20% of investment grade ABS.

Although the reinvestment period ended in October 2007, the manager was allowed to invest unscheduled principal until October 2011. As a result of amend-and-extend activity, however, the transaction only started to significantly delever in 2011. Consequently, the proportion of assets with loan maturities after the transaction legal final increased to 17%, as of July 2010, and to 70% by 2013.

European securitisation analysts at Bank of America Merrill Lynch suggest that these long-dated assets exposed the transaction to market value risk. "The need to sell the assets prior to maturity may have forced the manager to sell at a time that may not have been optimal," they add.

Haircuts were not applied for triple-C and below rated assets, helping to keep OC test cushions relatively stable, despite such assets increasing to a peak of 49% in October 2009. At this point, around 62% of European CLOs were failing their junior tranche OC test, according to the BAML analysts.

Fitch notes that, until 2013, an equity distribution was made on all but one quarterly payment dates. However, the application of ratings-based haircuts for the OC test would likely have seen more cash being diverted away from equity to repay the senior tranches.

Following the end of the second reinvestment period in October 2011, the manager was permitted to continue selling defaulted and credit-impaired assets, but the proceeds were required to be applied to the notes rather than for reinvestment. This, in turn, may have prevented the deal from benefitting from the subsequent recovery in loan performance.

The analysts believe that few other European CLOs are likely to see similar outcomes to HARBM 3. However, they note that some of the factors that impacted the deal may be relevant in other cases.

The majority of legacy European CLO issuance occurred in 2005-2007, with legal final maturities mainly between 2021 and 2024. CLO 2.0 maturities are mainly between 2025 and 2027.

CS

CLOs

Loan TRS 'welcome' addition

Total return swaps (TRS) on investment grade and high yield credit indices in Europe and the US have seen moderate success over the past two years. However, the recent extension of Markit's suite of TRS to include leveraged loans is expected to garner more attention - both in terms of addressing loan market hedging demand and helping CLO managers and other investors improve cash management.

TRS on loan indices is expected to gain more traction than it has done on bond indices for three main reasons. "First, while the leveraged loan market has grown significantly in the past few years, lower liquidity in the underlying loans has precluded several investors from owning them in their portfolios," note Morgan Stanley credit derivatives analysts.

On top of that, liquidity has dried up in synthetic indices on loans and there is no true credit product to express a view on corporate fundamentals. Additionally, while leveraged loan market growth has provided more companies with access to capital, deterioration in the quality of new issuance has led to a debate about loan valuations going forward.

TRS are quoted on the iBoxx USD Liquid Leveraged Loan Index that covers around 25% of the overall loan market, which the analysts note could be a concern because the liquid index is less likely to be widely used as a benchmark for dedicated loan investors.

The total returns of the liquid loan index correlates strongly with the broader loan market - represented by Markit's benchmark loan index - for both the credit crisis and lower volatility period of 2012-2014. The analysts attribute a reasonable difference in the relative beta of the two series to the difference in WAL of the indices.

Investors have regularly used loan ETFs to express a view on the asset class, but TRS has the advantage of eliminating tracking error versus the underlying. The analysts note that loan ETFs have historically traded at a basis to the underlying value, creating additional volatility - the premium to NAV was roughly 1% of the underlying in price terms in the summer of 2011, for instance.

"This tracking error can be further amplified by the difference in settlement mechanics between ETF shares and underlying loans. While ETFs settle on a T+3 basis, the underlying loans could take much longer, possibly creating a basis risk between the ETF shares and the actual holdings of the fund," say the Morgan Stanley analysts.

Significant outflows could lead to further volatility in the tracking error. By contrast, TRS exactly replicate the returns of an underlying index.

Another advantage over ETFs is the management fee and transaction costs. Whereas ETF investors incur a cost when buying and selling shares, TRS - if held to maturity - are typically settled at the observed value of the index and so only involve a cost at initiation.

There are drawbacks to TRS, however. For example, their liquidity remains unproven and the fact that the indices are fixed may not match investor benchmarks.

As loans are floating rate instruments, they are less sensitive to rising rates than bonds. While loan valuations remain attractive relative to bonds, investors concerned by the weak technical backdrop could be motivated to use products such as TRS for hedging.

As for fundamentals, the credit quality of new loans is changing. The average leverage for new deals in 2014 is already at pre-crisis levels and the analysts note that the percentage of cov-lite issuance is high.

They conclude: "For investors concerned about fundamentals, the lack of existing scalable liquid hedging opportunities has meant they typically use the liquid CDX indices as proxies, which again have the same tracking issues. For such investors, TRS could be an attractive hedging vehicle."

JL

CMBS

TMAN 7 D bonds overvalued?

Pricing on the TMAN 7 class D bonds does not reflect the risks involved, say Deutsche Bank CMBS analysts. An update call last month from special servicer Hatfield Philips has enhanced transparency around the transaction, but there are concerns about possible tax costs.

Projected end dates were disclosed for the majority of the loans in the special servicer's update and there was also greater clarity on how the €66.7m in the Mozart vehicle will be used. Next week will see €10m of it released on the July IPD, with the remainder retained for various capex initiatives, sundry expenses and a tax reserve.

There is €20.3m being reserved for a worst-case tax scenario. However, the pricing on the class D notes suggests such a scenario is not being widely anticipated.

The Deutsche Bank analysts expect losses on assets sold below the carrying values established in the 2011 restructure should offset gains on assets sold above carrying value, although it is a very complicated area. While the tax reserve could eventually be released to noteholders the analysts suggest it would be a very strong conviction trade to currently assume this would be the case.

The analysts calculate a 27% recovery for class D if the tax cash is not distributed to noteholders, yet current indicative pricing is in the mid-40s. An assumption that the entire tax reserve is distributed gives a recovery of 57%.

"In our view the risks/rewards at current pricing for the class D are not aligned with this unclear situation and we reiterate the advice from our February 2013 analysis to sell. Higher up the structure we calculate indicative DMs of 327bp for the A, 396bp for the B and 583bp for the C, which in our view still offer good risk/reward trade-offs for short duration bonds," the analysts say.

JL

RMBS

Falling factors push pricing premium

Bonds with lower factors are increasingly common on US non-agency RMBS bid-lists. As it becomes more difficult for investors to find large enough bonds to meet reinvestment demand, a pricing premium on larger blocks is developing.

Bank of America Merrill Lynch RMBS analysts note that jumbo, Alt-A and option ARM bonds with factors at or below 0.25 comprised around 20%-25% of BWIC volumes in early 2012, with the figure this year closer to 33%. Including bonds with factors at up to 0.5, the proportion has jumped from 45%-50% to 60%-65%.

In 2012, large bonds typically had high factors and small bonds were generally smaller because of low factors. The BAML analysts estimate that just under 50% of the bonds out for the bid in 2012 were under US$5m in current face. In 2013 and 2014, almost 60% of bonds on bid-lists have been under US$5m.

Whereas in 2012 the majority of bonds larger than US$5m current face had relatively high factors, in 2013 and 2014 the majority of those larger bonds have had factors at under 0.5. The proportion of bonds with a current face greater than US$5m with a factor at less than 0.5 is around 60%-70%.

As bonds have factored down, it has become harder to find paper in size. The picture is slightly different for subprime, however, where many bonds still have high factors.

While other non-agency deals were structured with senior or super-senior pass-throughs, subprime structures have typically included maturity-tranched senior classes. This has meant that - to the extent senior credit enhancement has not been depleted - outstanding tranches aside from the current-pay tranche will have a factor of one.

The use of implied write-downs can also lead to higher factors, as losses may not reduce a bond's factor until its legal final. Meanwhile, the inclusion of very thin mezzanine tranches also tends to support a high factor.

In 2010, at least 63% of jumbo, Alt-A and option ARM bonds had factors at 0.5 or above. This year, none of those sectors has more than 30% of bonds with factors at 0.5 or above.

These reduced factors are making it harder to reinvest or enter the sector, the analysts suggest. Achieving sufficient size requires finding, analysing and negotiating a larger number of bonds than it used to.

Decreasing factors have nonetheless provided technical support to the market, potentially even boosting Re-REMIC supply. "Finding bonds in size has been and will become more difficult as the sector continues to factor down. Bid-lists from large portfolios, Yankee banks and the GSEs would seemingly continue to be sources of supply - although even these outlets sometimes prove limited," the analysts note.

The recent US$3.7bn all-or-nothing bid-list (SCI 16 July) that traded above market levels consisted of 179 bonds, with just 28 of those accounting for half of the current face. Only 79 of those bonds had a current face at or below US$10m.

As new issuance fails to keep pace with maturing deals and the market shrinks, one potential source of supply could be the GSE portfolio holdings. The GSEs are believed to be holding larger pass-throughs, which typically consist of a whole tranche. While those GSE-held bonds may have factors of 0.2-0.3, their average size could still be US$60m-US$70m.

An extra consideration of declining factors is that deals with low pool factors become eligible for clean-up calls. The analysts estimate that 25% of the non-agency universe is currently callable, including 34% of the jumbo sector, which should provide particularly favourable call economics.

JL

ABS

Securitisation vet enlisted

Starwood Capital Group has hired Jeffrey DiModica. He will serve as md and assist in finding new business opportunities as well as supporting the growth and expansion of Starwood Property Trust and its affiliated entities.

DiModica was previously head of ABS, RMBS and CMBS sales and strategy for the Americas at RBS. Before joining RBS he sold derivative and MBS products at Merrill Lynch and began his career at Chemical Bank.

DiModica has been involved with Starwood Property Trust since its creation in 2009, although not as part of Starwood Capital. Therefore when he joins Starwood Capital he will no longer be considered independent for purposes of the board of directors and will thus step down from that role.

Structured Finance

Structured pro named PM

Black Diamond Capital Management has appointed Jerome Shapiro as md and structured product portfolio manager. He is based in Greenwich, Connecticut and takes responsibility for structured product investments across the Black Diamond platform.

Shapiro was previously svp at One William Street, managing an asset-backed portfolio across multiple commercial and consumer sectors. He has also worked at Merrill Lynch and Bear Stearns.

Structured Finance

Fitch appoints product head

Fitch Solutions has appointed Brian Filanowski as global product head. He will be based in New York and report to Gloria Aviotti.

Filanowski will take responsibility for the delivery and global expansion of existing and new analytical products and services from both Fitch Solutions and Fitch Ratings. He joins from Bloomberg, where he was a business manager focussed on real-time data-feeds and has also worked for Thomson Reuters, Interactive Data, Multex.com and Telekurs Financial.

Structured Finance

Gleacher dissolution draws near

Gleacher & Company has provided an update on its plan to dissolve and liquidate, which was announced earlier this year (SCI 13 March). The company intends to file a certificate of dissolution in Delaware, which is expected to become effective at the close of business on 28 July.

Gleacher anticipates making an initial liquidating distribution of US$4.05 per share of the company's common stock for an aggregate distribution of US$25m, which is US$5m more than was predicted in previous estimates. The company also expects to make one or two additional liquidating distributions but is not yet sure when those will be or how much will be distributed.

Structured Finance

Financial advisory expands capabilities

CR Investment Management has expanded its CR Financial Solutions (CRFS) business through the appointment of Andreas Costa as associate director. He will be based in London and take responsibility for expanding the company's debt and equity origination functions as well as the underwriting and distribution of performing and non-performing loans.

Costa joins from Lloyds Banking Group, where he was responsible for providing case management and strategic advice to distressed exposures arising from the bank's legacy and inherited debt and equity positions. He has also worked at Anglo Irish Bank, where he was responsible for a significant portfolio of asset-backed and project finance exposures.

Structured Finance

Asset manager adds introductions vet

Marinus Capital Advisors has hired Anthony DiNota for the newly-created position of head of business development. He will report to cio and managing partner Najib Canaan.

DiNota joins from Citigroup, where he was the senior member of the capital introductions team at the bank's prime brokerage unit in New York. Before that he was part of the capital introductions team at Merrill Lynch.

DiNota has also worked at Global Strategies Investment Management, HedgeOp Compliance, Hunton & Williams and the European Bank for Reconstruction and Development.

Structured Finance

Dealers dominate market share

Greenwich Associates reports that four global banks - Goldman Sachs, Deutsche Bank, Citi and JPMorgan - lead the US fixed income sector for overall market share, which is driven by volumes in government bonds, interest rate derivatives and MBS pass-throughs (together accounting for over 80% of total volume covered). Dealers retaining scale, as well as smaller, potentially more nimble competitors appear to have managed the best in terms of market share or gaining new customers.

The four banks captured shares of between 11.4% and 12.1% in overall volume over the past 12 months, while Barclays rounds out the top five with a market share of 10.3%. These firms are the 2014 Greenwich Share Leaders in Overall US Fixed Income Trading.

JPMorgan and Bank of America Merrill Lynch are the 2014 Greenwich Share Leaders in US Fixed Income Credit, with market shares of 14.3% and 13.7% respectively, followed by Citi at 12.5%. Credit Suisse (13.1%) and Bank of America Merrill Lynch (12.2%) are the 2014 Greenwich Share Leaders in US Fixed Income Securitized, while Citi is the 2014 Greenwich Share Leader in US Municipal Bonds and Derivatives.

Five of the six biggest US fixed income dealers saw an increase in market share over the last year, with the collective market share held by the top five sell-side firms increasing to 57% from 53% a year ago. "We're seeing a greater concentration of share among the top banks as buy-side customers try to stay as relevant as possible with the big banks," says Greenwich Associates consultant James Borger. "But we are also seeing investors seek out liquidity by adding more dealers to their list of counterparties, especially as a few banks have reduced their commitment to the space."

CDS

ISDA names new ceo

ISDA's board of directors has appointed Scott O'Malia as ceo. He will also serve as a director of the association and takes on the role from 18 August.

O'Malia was previously a commissioner at the CFTC and has also held senior staff positions in the US Senate. He succeeds Robert Pickel, who announced in April that he was stepping down (SCI 22 April).

CLOs

BGLF placement exceeds expectations

Blackstone/GSO Loan Financing (BGLF) has raised gross proceeds of €260.5m via its share placement (SCI 14 July). Correspondingly, the total number shares in issue and of voting rights in the company following admission will be 260.5 million.

Charlotte Valeur, BGLF chairman, comments: "Investors have positively responded to Blackstone/GSO's presence and track record in the European loan market. The company will enable investors to gain access, through a London traded entity, to the investment management skills of a leading European manager of loans and CLOs."

Risk Management

Bank teams with clearing houses

Deutsche Bank has formed partnerships with Clearstream and Euroclear to help clients manage collateral as part of the TARGET2-Securities (TS2) initiative. The partnerships provide clients with a single entry point to reach the collateral pools and distribution channels used by all key institutional and market infrastructure firms.

The partnerships will help clients to consolidate, optimise and more efficiently assign their collateral inventory as part of TS2. Such a holistic approach to collateral management should bring significant cost and operational efficiencies.

Partnering with Clearstream and Euroclear will help clients to make better use of assets held domestically to secure exposures and financing transactions in tri-party, while consolidating the view of inventory with their preferred provider. Clients will also benefit from a reduction of funding costs by mobilising eligible assets cross-jurisdictionally in a safe and custody-integrated framework.

Risk Management

Pre-trade risk pro added

GreySpark Partners has appointed Stephane Lannoy as managing consultant. He will lead the firm's pre-trade risk control practice in Hong Kong.

Lannoy has spent more than 20 years working in senior technology roles at exchanges, brokerages and trading and software providers in Europe, the US and Asia. He is a former cio at Fimat/Newedge and has also worked at RTS Realtime Systems and more recently at the Hong Kong Mercantile Exchange.

Lannoy's new focus will be on expanding GreySpark's pre-trade risk control practice. This will involve working with banks and securities firms in the Asia-Pacific region to assess existing controls applied to electronic trading execution systems against best practice and to advise on control improvements.

RMBS

Global RMBS claims settled

American International Group has reached a global resolution of its RMBS-related disputes with Bank of America. The resolution also covers AIG's obligations to the US$8.5bn settlement of Countrywide's mortgage repurchase obligations to various investors (SCI passim) as well as disputes concerning the issuance of mortgage guaranty insurance by AIG's United Guaranty subsidiaries to Bank of America and Countrywide.

AIG will receive US$650m in cash plus its pro rata share of whatever amount is ultimately paid out to investors in connection with the Countrywide repurchase settlement. The disputes concern the creation, offering and sale of securities from which AIG and its subsidiaries suffered losses.

RMBS

Broker targets RMBS expansion

Cross Point Capital has named Lenny Norkin as director. He was previously a junior MBS broker at Tradition Asiel Securities.

Norkin will lead the firm's efforts to grow its RMBS inter-dealer brokerage business. The focus for agency RMBS will be specified pools and CMOs, while the non-agency focus will be on prime, Alt-A and subprime bonds.

ABS

Driver China One presale updated

Fitch has updated the presale for Volkswagen's Driver China One Trust (SCI 3 June). While the update reflects that references to Fitch were removed from the transaction documents, there should be no rating impact.

The most significant change is the removal of rating thresholds designed to maintain the rating of the account bank at a minimum level commensurate with a double-A rating for the most senior notes. Volkswagen Finance China has confirmed that it intends to take actions consistent with Fitch's criteria - which it is legally obliged to do - and while the trustee could choose not to maintain the bank account with an appropriately rated counterparty if the bank's rating falls, this is seen as unlikely.

ABS

Canadian card performance improves

The charge-off rate in S&P's Canadian credit card quality index decreased to 3.5% in May, down 4% year-over-year. The 30-plus day delinquency rate also decreased to reach 2.2%, while the payment rate, yield and excess spread rose to 40.9%, 23% and 15.7%, respectively.

The rating agency partly attributes the performance improvement to the removal of Gloucester Credit Card Trust from the index. The Canadian unemployment rate increased from 6.9% to 7%.

ABS

US card indices to break records

Prime US credit card ABS collateral performance metrics are set to break records in the next reporting period, says Fitch. Improving employment rates and strong credits underlying trusts are creating powerful support for the asset class.

The agency expects its charge-off index to decline to a new low, while the prime 60-plus day delinquency index is also expected to reach an all-time low. The rating agency's prime gross yield index is expected to rise modestly, while the prime monthly payment rate index is expected to decline, but not at a rate which suggests risk to ABS pools.

Fitch's retail indices are also expected to improve, but not to reach new records. Fitch's retail charge-off index should decrease a few basis points. The rating agency expects a small rise in retail 60-plus day delinquencies will indicate normalisation from the records set in the May reporting period.

ABS

Depreciation could impact auto losses

Depreciation rates on used vehicles are approaching levels not seen since the recession. However, a report by Black Book and Fitch says depreciation could soon lead to marginally higher losses for US auto ABS.

Black Book notes that new and used vehicle markets are seeing positive growth, with depreciation increasing as a result. New vehicle sales next year are expected to climb to 16.5m, likely pushing annual depreciation levels to 15%.

Increased depreciation rates would translate into increased auto ABS losses, although those should not stray beyond initial loss expectations. Interest rate rises, which are predicted next year, could also drive depreciation higher if they dent consumer demand for new and used vehicles.

ABS

Italian repurchases mask performance

The number of loans repurchased by originators in Italian lease and SME ABS transactions accounts for between 10% and 20% of securitised pools in a third of the transactions Moody's rates. The agency believes actual default levels may therefore be higher than reported.

Repurchases might be credit positive in the short term as cash injections benefit noteholders, but they mean the pools' actual credit quality is masked and present a heightened risk of performance deterioration if originators stop supporting transactions. Repurchases are generally undertaken on loans with a higher default risk.

Buying back assets artificially improves pools' performance, says Moody's, by taking out the weaker borrowers. The agency calls for greater transparency, particularly around the state of loans at the time that they are repurchased rather than just an indication of the magnitude of cumulative repurchases.

ABS

IDEA student loan programme mooted

US Senators Mark Warner and Marco Rubio last week introduced a student loan bill, called 'The Dynamic Repayment Act of 2014', which is designed to overhaul the current government student lending system. Under the bill, DLP loans would be replaced with new income dependent education assistance (IDEA) loans, whose repayments would be based on a borrower's annual income during each year of repayment.

Barclays Capital ABS analysts note that under the proposed legislation, the Department of Education (ED) would be prohibited from making any Federal Direct Stafford, Federal Direct Unsubsidized Stafford or Direct PLUS student loans after 1 July 2015, with certain exceptions. Students who have an outstanding DLP loan in place as of July 2015 could continue to take out additional Direct Unsubsidized Stafford and PLUS loans through 30 June 2019. In addition, the bill would continue to allow for Parent PLUS loans and Federal Direct Consolidation loans.

IDEA loans would be originated by participating universities, financial institutions and other originators designated by the Secretary of Education to make these loans. Only students would be eligible to apply for them, with funding for the programme replacing the funding currently in place to pay for the DLP programme. All IDEA loans would be placed under the same repayment plan.

The Barcap analysts suggest that while the legislation enjoys some bipartisan support and may be more appealing to Republican lawmakers than Senator Warren's refinancing bill, it still faces significant hurdles for enactment. For one, Democrats may be reluctant to support a bill that eliminates subsidised loans for students with demonstrated financial need, while Republicans may balk at supporting a bill that still provides forgiveness on the loans after a 20- or 30-year period.

Nevertheless, if the bill were to pass, it could increase FFELP student loan ABS prepayments among existing loans as some borrowers consolidate their FFELP loans into IDEA consolidation loans.

ABS

Punch paves way for restructuring

Punch A and Punch B noteholders voted overwhelmingly in favour of Punch Taverns' covenant waiver requests at meetings convened on 18 July. All 16 meetings were quorate and the waivers will now expire on 19 November. It is a condition of the waivers that certain milestones are met, including that a restructuring to implement the stakeholder group proposal is launched by 11 August (SCI 27 May).

ABS

Seasonal blip for card charge-offs

US credit card ABS quarterly charge-offs rose for the first time in over three years, increasing by 7bp to 3.07% from 3%, according to Fitch's latest quarterly index for the sector. However, the agency suggests that the move is likely to an aberration.

"Credit card ABS delinquencies have been easing for the last three months, so the increase in losses is more a seasonal blip," says Fitch md Michael Dean. "The credit quality of credit card ABS borrowers remains stellar as consumers are keeping their payment obligations in check."

Even with last quarter's increase, charge-offs remain 21% lower than in 2Q13 and 72% lower since the 2009 peak. Credit card ABS outstandings have also risen consistently for the last six quarters and, at US$132bn, are now back to pre-2012 levels.

ABS

Subprime auto caution 'warranted'

Credit metrics in recently issued 2013 and year-to-date 2014 subprime retail auto loan ABS have continued to deteriorate and concern persists over whether the sector is overheating. S&P believes that subprime auto lending has not yet reached its boiling point, but says that caution is warranted.

Based on an examination of the range of auto lending activity across the prime and subprime borrower segments through 1H14, the agency notes that subprime lending activity is already close to pre-financial crisis levels. Credit-challenged consumers, who had been previously locked out of the credit market during and shortly after the crisis, are now finding that financing is plentiful and lending terms more favourable. As a result, they are replacing their aging vehicles.

This growth in subprime lending and the liberalisation of credit standards is affecting credit metrics for subprime ABS transactions. "We have been monitoring changes in these credit metrics, as shown by our rising loss estimates in auto loan pools that reflect higher loan-to-value ratios, longer loan terms (the percentage of loans with terms greater than 60 months) and other trends that may signal worsening long-term performance in this sector," says S&P credit analyst Amy Martin.

To offset the declining credit quality, however, credit enhancement levels on new issue auto loan ABS are rising for those subprime issuers reporting higher losses or with deteriorating collateral characteristics. As credit continues to weaken, the agency expects credit enhancement levels to also continue to rise.

S&P expects subprime auto loan ABS classes rated triple-B and higher to remain stable. "In addition, we're closely monitoring the performance of below-investment grade classes, which tend to be more vulnerable to higher-than-expected losses. We currently do not expect any downgrades on the older vintages and we haven't placed any of our ratings on subprime auto loan ABS on credit watch negative, but we expect rating upgrades for the subprime segment to continue as more seasoned transactions deleverage," the agency observes.

A recent report from Moody's suggests that subprime auto lenders are slowing their lending to riskier borrowers, in contrast to prime lenders, which appear more comfortable taking on increasing risk in light of continued improvement in prime loan performance. However, the agency agrees that subprime lenders are still willing to assume risks in some areas, such as offering loans with longer payment terms and larger principal balances.

First-quarter data from Experian Automotive show that for the second consecutive quarter, average credit scores on loans for used vehicles rose year-over-year, to 641 from 637 in 1Q13. In contrast, the average credit scores of borrowers taking out new vehicle loans again declined year-over-year, to 714 in 1Q14 from 722 a year earlier.

Rising interest rates on subprime auto loans also point to the increasing caution of subprime lenders, according to Moody's. Rates on subprime loans for used vehicles rose to 14.5% in 1Q2014 from 13.9% in 1Q13, while rates on subprime loans for new vehicles rose at a slower pace to 9.39% from 9.13%.

Meanwhile, the average amount that subprime borrowers financed for new vehicle loans rose to US$27,528 in 1Q14 from US$26,347 in 1Q13, while the average amount financed for used vehicle loans rose to US$16,045 from US$15,570. The average term for new vehicle loans for subprime borrowers rose to 71.1 months from 70.1 months during the same period, while the average term for used vehicle loans rose to 60.4 months from 59.0 months.

ABS

Tobacco ABS under pressure?

The merger between Reynolds American and Lorillard could impact future payments to the Master Settlement Agreement (MSA) and put pressure on tobacco ABS pools, Fitch says. While Reynolds' share of the market will increase, the divestments to smaller tobacco manufacturers could increase the market share for manufacturers that do not pay into the MSA. The acquisitions by Imperial Tobacco do not present a risk to the cashflows, however, as the firm participates in the MSA.

Adding further pressure, among Imperial Tobacco's acquisitions will be Lorillard's e-cigarette product Blu. The popularity of e-cigarettes has grown rapidly in recent years and could lead to a future decline in the consumption of traditional tobacco products, Fitch suggests. Growth in the e-cigarette market would negatively affect tobacco ABS as the consumption of smokeless tobacco is not included in the MSA payment calculation.

Tobacco ABS ratings are capped at triple-B plus, one notch above Fitch's tobacco industry assessment. The agency says that changes in the composition of the market could impact the industry assessment and, if the outlook of the industry were to change, tobacco ABS ratings would also be affected.

Structured Finance

Interest rate hedges evolving

A deeper examination of interest rate risk in structured finance deals is key when analysing structures that try to hedge this risk with interest rate caps, note rate caps or issuance of fixed rate notes, Fitch says. These increasingly popular structural features protect deals where the SPV pays a fixed or a capped rate on the notes in return for a floating market interest rate on the portfolio from extremely high interest rates. However, the agency warns that they would not do so if rates rose more moderately from their current low levels but did not exceed the cap/notes fixed rate.

Given the increased cost of traditional interest rate swaps, many transaction sponsors are looking at new ways to address interest rate risk where portfolios include fixed rate loans in addition to floating rate receivables. So far, RMBS transactions with interest rate or note rate caps have emerged in Italy and the Netherlands, and Fitch says it is receiving enquiries in other jurisdictions and for other asset classes as well.

An overall portfolio can generate substantial excess spread by paying more interest than is required to pay interest on the notes. This is possible when the interest rate on the notes is capped and underlying loans pay an uncapped floating rate of interest or have a fixed rate that resets periodically, should interest rates rise beyond the point where the cap/fixed rate on the notes is set and stay there for a long time. Similarly, the issuer would benefit from substantial cashflows in transactions with an interest rate cap provided by a third party, should the interest rate consistently exceed the strike rate.

For transactions with these structural features, Fitch says its standard rising interest rate stresses can be beneficial or less stressful than scenarios where rates rise from their current very low levels close to the cap strike. The agency adds that it will - in such cases - test different deal-specific interest rate patterns, to analyse whether the notes would still be able to pay interest and principal according to their terms, without the benefit of the additional cashflows created by the cap. Tests could also include different amortisation speeds and default distributions between the floating and the fixed rate sub-pools.

Alternative hedging structures may also provide for issuance of fixed as well as floating-rate notes, typically in a proportion that mirrors the portfolio interest rate composition. The effect of rising interest rates on these transactions would be the same as for deals with interest rate caps. However, scenarios where rates stay at current market levels or decrease are usually the most detrimental ones.

"Such imperfect interest rate hedging results in a lower rating for a given credit enhancement level compared with fully hedged transactions, all else being equal. This impact increases with a transaction's weighted average life, as any mismatch needs to be sustained for a longer period. On the other hand, avoiding the use of derivatives transactions reduces the sensitivity of the notes' rating to a hedging counterparty downgrade," Fitch observes.

Structured Finance

Agency to update impairment definition

Moody's intends to align the definition of impairment used for structured finance securities in Japan with the definition used in all other geographies, whereby securities are considered impaired if poor collateral performance or failure by any transaction party to perform under its obligations causes previously scheduled interest or dividend payments to be suspended. This is the case even if payment delays are contractually allowed in the securitisation's supporting documentation.

For Japanese securitisations, missed payments did not constitute impairment if such interest payments were made in full over the life of the transaction with no compensation for such delays. The proposed change in definition of impairment would be expected to have rating implications for some Japanese transactions.

Adopting the international definition could see securities downgraded by many notches where there are interest payment deferrals. Moody's currently expects the number of affected ratings to be small.

Already, two tranches from two RMBS and six tranches from one CMBS have been placed on review for downgrade. These are: the Mezzanine Beneficial Interests class of Hokuriku Roudou Kinko Residential Mortgage Trust No.1 RMBS; the Class 2 Senior Beneficial Interests class of SBIM 2007-1 RMBS; and the class B, class B1, class B2, class C, class C1 and class C2 tranches of the Chelsea Asset TMK and Chelsea Asset Trust CMBS.

CDO

Trups CDO sale due

Bank of New York Mellon, as trustee for the Preferred Term Securities XII CDO, has retained Stifel, Nicolaus & Co as liquidation agent for the Trups collateral pool. An auction is scheduled for the transaction on 1 August, with settlement to occur on 6 August.

PRETSL XII B1, B2 and B3 tranches were out for the bid last week, with SCI's PriceABS data showing talk for the bonds of low-60s, very high-50s and high-50s respectively.

CDS

LCDS auction scheduled

The auction to settle the credit derivative trades for Solocal Group (formerly known as Pages Jaunes Group) LCDS is to be held on 19 August. A failure to pay credit event was determined on the entity last month (SCI 13 June).

CDS

Banking sector wider on BES concerns

Five-year CDS on the European banking sector have seen notable widening over the past month, according to the latest CDS case study from Fitch Solutions. Fitch's CDS Index for European banks is 16% wider compared to a month ago. In contrast, CDS for European issuers overall have widened by just 6% over the same period.

"CDS referencing banks domiciled in Portugal, Italy and Spain widened the most in the last month - on average 60%, 25% and 20% respectively," comments Diana Allmendinger, director, Fitch Solutions. "Market concerns over Banco Espirito Santo in recent weeks have likely fuelled the CDS widening."

CLOs

Volckerised Euro CLO structured

3i Debt Management last month priced Harvest CLO IX, the first European CLO to comply with the Volcker Rule by excluding non-loan investments. Doing so opens the transaction up to banking entity investors who the Volcker Rule will prohibit from holding the CLO notes once it goes into effect next year, Moody's notes in its latest CLO Interest publication.

"By excluding non-loan investments, Harvest IX qualified for the loan securitisation exclusion and avoided falling under the covered fund definition. Limiting investments to loans can be a credit neutral way to avoid covered fund status," the agency says.

Other European managers have avoided covered fund status by structuring deals via the SEC Rule 3a7 exemption from the 1940 Act and by amending deals' manager removal rights and event of default language. "While a Rule 3a7 structure is credit neutral, eliminating investors' manager removal rights is credit negative because it lowers managers' incentive to perform to the noteholders' satisfaction," Moody's observes.

CLOs

Little change for CLO manager rankings

Moody's rankings of the top-10 CLO managers in the US, Europe and globally have changed little since December 2013, but their share of the US CLO market has slipped to 29% from 33% during the period. First-half issuance reached US$45bn in the US and €4.6bn in Europe, with strong issuance offsetting redemptions in the former region resulting in a net increase of US$23bn, including deals from eight first-time managers. In Europe, however, amortisation drove an €8bn decline in outstanding CLOs that the agency rates.

CIFC Asset Management remains the largest US CLO manager by number of deals at 29, followed by Carlyle Group and GSO/Blackstone Debt Funds Management. Highland Capital Management leads managers in CLO assets under management with US$11.7bn, followed by CIFC's US$11.5bn and Credit Suisse Asset Management's US$11.2bn. MJX Asset Management and CVC Credit Partners made it into the list of top-10 managers by AUM in the first half of 2014, each adding two CLOs with total par of more than US$1bn.

Alcentra and GSO/Blackstone manage the European CLOs with the highest number of deals (13), while CELF Advisors and Alcentra manage the European CLOs with the most AUM at €4.3bn apiece. Carlyle and GSO/Blackstone remain the global leaders in both number of deals and AUM: each manages 37 deals, but Carlyle's US$15.7bn in AUM exceeded GSO/Blackstone's US$15.3bn.

Among CLO 2.0 managers, CSAM, Carlyle and GSO/Blackstone led the pack, each with 11 deals - including two new CLOs that each closed in the first half of 2014. CSAM's CLO 2.0 AUM of US$6.5bn exceeded Carlyle's US$6.1bn and GSO/Blackstone's US$6bn.

Och-Ziff Loan Management, which entered the market in 2012, made the top 10 for the first time by issuing two CLOs with total par of US$1.4bn in the first half.

CLOs

Warehousing facilities weighed

The entrance of new and varied types of equity investors in the CLO market willing to contribute a first-loss piece during the warehousing phase has made it easier for CLO managers to access warehouse financing. However, different warehouse structures have their own unique credit risks, Moody's notes in its latest CLO Interest publication.

"The vast majority of broadly syndicated CLOs now have the benefit of warehouse financing, which is credit positive. Warehousing of assets prior to the closing date minimises ramp-up risk and provides managers more time to make investment decisions," the agency observes.

As investors such as business development companies and CLO equity funds increasingly take the warehouse first-loss piece, arrangers have extended their balance sheets to carry the CLO take-out risk. Additionally, in deals with smaller arrangers that lack balance sheet capacity, non-CLO arranging banks are providing funding lines.

CLOs that use the 'print and sprint' strategy are rare, given that most arranging banks offer warehouses to managers as an additional incentive to work with them. Further, the increased difficulty in sourcing collateral from the secondary market has necessitated the use of pre-closing warehouse facilities.

Warehouses often require an initial equity investment and typically are mark-to-market vehicles, meaning that the equity holder must provide additional capital if the warehouse's loan-to-value ratio falls below the warehouse lender's requirement. This first-loss piece is commonly issued as either preferred shares or subordinated notes of the issuer, which can be repurchased or redeemed with note proceeds on the CLO closing date, or from additional third-party financing sources on the pricing date. CLOs generally aggregate loans prior to closing over a three-month period.

Moody's notes that building a substantial portion of a CLO's portfolio prior to closing provides investors with a clearer understanding of the deal by demonstrating the manager's investment strategy and the assets to which the manager has access. Acquiring assets prior to closing also minimises the risk of the initial portfolio not being acquired by the effective date, thus reducing the risk of premature deleveraging. Access to early financing can insulate deals from price volatility by giving managers more time to take advantage of loan price declines, aligning the timing of CLO issuance with favourable cost of funding and giving managers the ability to execute block trades at favourable pricing.

Warehouse providers generally structure financing facilities in three ways: by using credit facilities, total return swaps or participation agreements. Credit facilities allow the CLO issuer, as borrower, to purchase loans directly on the open market.

One risk in this structure is the conflicting interests of the arranging bank and CLO. For instance, if the lender does not approve the purchase of an asset at a given time but approves the purchase at a later date, the issuer may have to pay a higher price to acquire the asset.

In TRS-based warehouse arrangements, the manager pays a financing fee for the TRS and receives the interest payments on the reference loans, thereby gaining exposure to the assets but without having to hold them on its balance sheet. In some TRS a wholly owned subsidiary of the warehouse provider acquires the referenced assets and, at closing, the warehouse sub then merges with the CLO issuer. One of the main risks of the warehouse sub merging with the CLO at closing is that by operation of law, ownership of the warehouse sub's assets and liabilities is transferred to the CLO.

Finally, in participation agreements, the CLO issuer commits to purchase loans from the open market and the warehouse provider typically purchases a 100% participation interest in each warehouse loan to provide short-term financing to the CLO issuer. On the closing date, the CLO issuer then pays the participant the purchase price for the participation interests, plus any accrued and unpaid interest.

One potential risk associated with all types of CLO warehouses is that the warehouse financing arrangement is not properly terminated or the warehouse provider's security interest in the purchased assets is not fully discharged. Other potential risks relate to true sale and bankruptcy issues.

Issuers will often use more than one type of warehouse arrangement for a given CLO.

CLOs

Second-lien loans gain favour

US CLO managers are divesting bonds in their portfolios in anticipation of rising interest rates and to realise gains. Moody's says that the replacement of some bond holdings with second-lien loans is credit neutral because both asset types are expected to have similar recovery rates.

"Capital structure position and collateral value are the primary determinants of recovery rates," the agency observes. "Although second-lien loans are senior to unsecured bonds when both exist in the same capital structure, most existing second-lien loans have no subordinate debt and thus have the same priority claim on the collateral as bonds. And, when adjusted to have similar subordination, defaulted second-lien debt recovered only slightly more (a difference of 6%) than senior unsecured debt."

Indeed, despite the shift from bonds to second-lien loans, the average weighted average recovery rate (WARR) for 101 US CLO 2.0 deals that Moody's examined remained relatively stable - decreasing by 0.17 points to 49.95% in 1414 from 50.12% in 2Q13. Based on its loss-given default assessments, the agency projects an average second-lien debt recovery rate of approximately 25% - about half the historical average of 52% and comparable to that of senior unsecured debt. This reflects the lack of unsecured debt subordinate to current second liens and weaker structuring standards compared to historical norms.

Between 2Q13 and 1Q14, US CLO 2.0 bond exposure declined by roughly US$260m, while second-lien loan exposure grew by around US$260m in Moody's CLO 2.0 sample. Following this shift, bonds now account for 1.1% of aggregate par in US CLO 2.0 deals, while second-lien loans constitute 2.3% of aggregate par.

A key motivation for the bond sales is a desire to reduce exposures to fixed-rate assets and thus to duration risk. Managers also cite market gains as a motivation for bond sales.

"The taking of gains is credit positive in deals that use such gains to build par, as opposed to distributing gains to equity investors," Moody's says. "Since bond prices tend to be more volatile than those of floating-rate loans, managers can more easily build par by purchasing performing bonds below par and selling them above par. Bonds purchased at prices as low as 80% of par still typically receive full par credit in CLO overcollateralisation tests."

The up-tick in second-lien loan exposures in CLOs corresponds to an increase in second-lien loan supply: second-lien loan issuance in 1Q14 totalled approximately US$8.5bn, up by 23% from approximately US$7bn a year ago.

US CLO 2.0 deals issued pre-2014 typically limit holdings of non-first-lien loan assets to 5%-10% of collateral par. As of 1Q14, GoldenTree Asset Management, Apollo Credit Management and Symphony Asset Management managed the CLOs with the greatest bond holdings. Meanwhile, TICC Capital Corp, GoldenTree Asset Management and Franklin Advisers managed the transactions with the greatest second-lien loan exposures.

CLOs

CLO refinancings to occur sooner?

US CLO deals refinanced so far this year have typically had only 12-15 months left in their reinvestment period, but Carlyle Investment Management earlier this month refinanced the entire debt of Carlyle Global Market Strategies CLO 2012-2 with two years left in the reinvestment period. Deutsche Bank CLO strategists suggest that the market is now moving into "interesting territory", where a host of transactions are exiting their non-call period with two full years left in the reinvestment period.

CGMS 2012-2 originally featured both fixed- and floating-rate tranches, but all tranches were refinanced into floating-rate tranches (see SCI's new issuance database). The Deutsche Bank strategists estimate that the gain from refinancing the deal is 38.2bp, with some 14bp of this due to the fixed-rate tranche refinancings, despite those tranches representing less than 10% of the debt stack. Similarly, the refinancing of the double-A rated tranches contribute to 15.6bp of the savings - slightly more than the triple-A refinancings generate (14.5bp), despite the triple-As representing an almost six times larger part of the debt stack.

"Over the last two years, triple-A spreads are virtually unchanged, so the refinancing gain is largely due to a roll down the term structure. For double-A rated tranches, on the other hand, new issue spreads are around 50bp-75bp tighter. Add that to a slight term structure roll-down and we have a significant change in funding cost when refinancing the double-A tranches," the strategists explain.

The savings are modest further down the capital structure, where spread tightening has been significant and the tranches are being refinanced at much lower spreads than the discount margins they were initially sold at. "However, the steep discount that junior mezzanine tranches have traditionally been sold at means that the gain from the spread tightening goes to the bond investors, rather than towards lowering the funding cost of the CLO and enhancing the returns to the equity investors. Optionality is a nice thing to have," they add.

CMBS

Cumulative defaults remain flat

Fitch's quarterly US fixed-rate CMBS cumulative default rate remains flat at 13.5%, due to relatively stable default and new issuance levels. In 2Q14, 68 loans totalling US$974.5m were newly defaulted, down from 91 loans (US$1.1bn) in 1Q14 and 97 loans (US$1.4bn) in 2Q13. Of the loans sized at over US$20m, 12 accounted for approximately 62% of the total newly defaulted loans by balance.

Retail properties were the largest contributor, with 26 loans comprising 44.8% of Q2 defaults. Office properties were the second largest contributor, with 20 loans at 32.4%, followed by seven hotel loans at 9.1%.

The largest quarterly default was a US$190.8m retail loan secured by Gulf Coast Town Center Phases I & II, which is the largest loan in CSMC 2007-C5. The property has reportedly suffered due to declining lease rates and occupancy issues.

Other large retail defaults consist of the US$43m Severance Town Center and the US$34m Linden Plaza loans, securitised in GCCFC 2004-GG1 and JPMCC 2006-LDP7 respectively. Both properties had significant occupancy declines when a major tenant vacated.

The second largest Q2 default was a US$78m office loan secured by 6116 Executive Boulevard, securitised in WBCMT 2005-C21. The largest tenant vacated the majority of its space, leaving the property approximately 4% occupied.

Additional large office defaults include the US$60.8m Clark Tower and the US$31.5m Overlook II loans securitised in JPMCC 2007-CIBC20 and BSCMSI 2007-TOP26 respectively. Both properties have experienced declines in occupancy.

Meanwhile, the largest new hotel default was the US$50.2m Residence Inn Hotel Portfolio I, securitised in MLMT 2005-CIP1. The properties have struggled since the economic downturn and have not benefited from the recovery in the hotel market.

Four loans from the 2010-2013 vintages defaulted in 2Q14, according to Fitch, ranging in size from US$4m to US$11.9m. The largest three loans are secured by multifamily properties and have common sponsorship, having been transferred to the special servicer in July 2012. The collateral was subsequently seized by the SEC in relation to an investigation of the sponsor's alleged connection to a Ponzi scheme.

The loans had previously been kept current but became 60+ days delinquent in April. The servicer has indicated that the properties will be marketed for sale in the near future.

The remaining defaulted CMBS 2.0 loan, a US$4m multifamily loan, transferred to the special servicer when the borrower filed for bankruptcy. The sponsor has not provided financials for the property since issuance.

CMBS

Mod adds two hope notes

The US$54m Colony V portfolio located in the Chicago and Washington DC metro areas has received a modification creating two hope notes. The portfolio previously backed a US$53.7m loan in JPMCC 2007-LDPX.

The loan went into special servicing in March 2013 after failing to pay off at its maturity and subsequently went into delinquency. Barclays Capital analysts note that it has now been split into a US$34m A note, a US$6m B note and a US$13.7m C note.

The A note will pay interest only, while the B and C notes will not pay but will accrue interest. The analysts say it is not yet clear if one or both of the B and C notes will have to be paid off at maturity or whether they are traditional hope notes.

The loan has been extended to April 2017, with optional extensions to April 2019. The modification has reduced interest proceeds to the trust by US$100,000, increasing shortfalls on the AJ-S tranche, which was already shortfalling. That tranche could face more near-term shortfalls if there is a workout-delayed reimbursement amount applied to recover advances not repaid from the modification.

Insurance-linked securities

ILS ratings affirmed

S&P has affirmed its ratings on four natural-peril catastrophe bonds that had annual resets of the probability of attachment. The affected transactions are Caelus Re 2013, MetroCat Re series 2013-I (class A notes), Mona Lisa Re series 2013-2 (class A) and Tradewynd Re series 2013-I (class 1).

In each case the probability of attachment was reset to a percentage consistent with the transaction documents and the current rating. In addition, the agency reviewed the creditworthiness of each ceding company and the ratings on the collateral that - barring the occurrence of a covered event - will be used to redeem the principal on the redemption date.

RMBS

RMBS liquidations rise on REO sales

Annualised liquidations of US RMBS loans increased last quarter by 20bp to 4.92%, following seven straight quarters of declines, according to Fitch's latest quarterly index report. The declines were driven primarily by a shrinking distressed inventory and a decrease in the use of short sales, while the recent turnaround in the trend can be partly attributed to a growing portion of REO properties, which typically liquidate faster than those that are foreclosed.

The rate of completed foreclosures to REO property has trended higher for four consecutive quarters. "More distressed mortgage loans are making their way through the foreclosure pipeline into REO and those properties are generally sold quickly," comments Fitch director Sean Nelson. "The turnaround in liquidation rates has also been supported by greater homebuyer demand, fuelled by low mortgage rates and warmer weather."

While the aggregate CDR amount increased, performance varied by sector. The subprime sector drove the change, with a notable increase of 60bp to 6.1%, while prime jumbo (up by 12bp) and Alt-A (down by 15bp) moved more modestly.

CDR differences have also occurred along foreclosure process lines. For example, the declines in CDR over the last two years have been concentrated in states with non-judicial foreclosure processes.

The percentage of loans that are 90 or more days delinquent in non-judicial states has declined to roughly 15% from a peak of nearly 27% in late 2009. In contrast, the 90+ delinquency rate in judicial states has remained close to 35% over the same time period.

"Non-judicial states are disposing of distressed loans faster than judicial states, and their distressed inventory is now less than half the size of judicial states," Nelson observes.

RMBS

RMBS risk if Korean regulations relax

A relaxation of LTV and DTI regulations on Korean banks' mortgage loans could increase household debt and pressure Korean banks' asset quality, says S&P. In a scenario where banks compete aggressively on underwriting standards or pricing to grow business, the rating agency notes that the credit risk of residential mortgage loan portfolios could increase quickly.

Current LTV and DTI requirements in Korea are quite conservative and have contributed to the good asset quality performance of residential mortgages in the country. LTVs have been capped at 40%-60% at origination for mortgages at banks nationwide since 2002, while DTI regulations introduced in 2005 have capped DTI at 40%-75% at origination for mortgages in and around Seoul.

RMBS

Alternative GSE bill proposed

Democrats in the US House of Representatives have proposed a bill to wind down the GSEs and provide an explicit government guarantee while increasing private sector participation in the market. The Partnership to Strengthen Homeownership Act has been proposed by John Delaney, Jim Himes and John Carney.

SFIG notes that the bill would preserve the 30-year fixed rate mortgage and the liquidity of legacy securities. The private sector would be required to take a 5% first-loss position on guaranteed RMBS, while the remaining 95% would be shared between Ginnie Mae and a private reinsurer.

The bill would wind down Fannie Mae's and Freddie Mac's current activities and revoke their charter, so they could be sold and recapitalised as entities with different business plans but without their current powers. While the proposed Johnson-Crapo housing finance reform bill remains stuck in the Senate, the new plan will be discussed with the House Financial Services Committee and other lawmakers.

RMBS

Spanish RMBS tender announced

BNP Paribas and Santander have announced a tender offer for two UCI bonds - the ninth for UCI paper over the past five years. It will be the first Spanish RMBS tender offer of 2014.

The offer is to repurchase the UCI 14 B and UCI 14 C bonds. Barclays Capital analysts note that this is the first time that these bonds have been tendered.

Minimum prices have not been provided and nor has a maximum repurchase amount been disclosed. There is €72.5m currently outstanding on the two bonds and the offer will take place by way of an unmodified Dutch auction.

The Barcap analysts calculate that €2.6bn of UCI bonds have been repurchased through the previous eight tenders. The disclosed purchase prices from those tenders have varied in the premium provided to secondary market levels for the B and C tranches.

SCI's PriceABS data shows the UCI 14 B tranche was covered on a BWIC on Wednesday - hours after the tender offer was announced - at 80.76. The analysts say UCI 14 C is currently trading at around 74.3, while PriceABS confirms it was covered on 29 April at 69.

"Given the lack of previous participation in tenders for these bonds, we would not be surprised if these bonds are repurchased at premium to these [current] levels, with a reasonably good level of participation from investors, who have not had the opportunity to reduce this exposure previously," say the analysts. The tender offer will expire on 24 July.

RMBS

IO loan exposure decreasing in NC RMBS

The exposure of UK non-conforming RMBS to interest-only loans is decreasing as a result of early repayment and refinancing, according to Moody's.

"As most interest-only loans continue to repay ahead of maturity dates, RMBS pools grow less vulnerable to high concentrations of interest-only loans and thus to interest rate increases and refinancing risk," says Steven Becker, a Moody's structured finance analyst. "Interest-only loans are repaying at a similar rate to amortising loans - a trend that we expect to continue as the UK economy recovers."

Moody's notes that IO loans face marginally higher default rates than amortising loans because of their historically higher loan-to-value (LTV) ratios. Default rates are less than 2.4% higher on IO loans than on amortising loans, owing to the high proportion of IO loans with an LTV above 80%.

"High-LTV loans exhibit the highest default rates and lowest repayment rates, leading to higher cumulative defaults on interest-only loans," adds Becker. "Ultimately, our scenario analysis shows that the marginally lower repayment rates on high LTV interest-only loans leave some limited tail-risk exposure in UK non-conforming RMBS."

Moody's base-case scenario predicts that the cumulative default rate will be 4.3% higher on IO loans than on amortising loans. However, Moody's expects that UK NC RMBS will remain relatively resistant to gradual interest rate increases.

RMBS

Spanish REO sale 'credit positive'

InterMoney has opened a competitive portfolio sale of repossessed properties backing the IM Pastor 2, 3 and 4 Spanish RMBS. Moody's believes that the sale will be credit positive for the three transactions.

"The economic downturn in Spain has led to an increase in the length of time required to process individual foreclosures and to sell backing properties. Therefore the sale of REO properties will strengthen the transactions by alleviating the principal deficiency ledger or reserve fund draws," the agency explains.

The PDL for IM Pastor 3 and 4 stood at €47.6m and €35.6m respectively, as of the last payment date. To date only 20 REO properties owned by IM Pastor 3 and 13 owned by IM Pastor 4 have been sold, with total crystallised losses of 35% and 31% respectively.

As part of the InterMoney sale process, 29 specialised national and international investors have been contacted, four of which presented non‐binding offers. After obtaining a price indication from the referred non‐binding offers, InterMoney considers that there is sufficient interest for the sale process to continue. The sale is expected to close within 10 business days of the date of the notification.

As of May 2014, the three funds held 530 REO properties last valued at €61.5m, backing debt of €76m. The pools include 580 outstanding defaulted mortgages backing debt of €68.36m, for which no properties have yet been repossessed.

If the sale process goes ahead, recoveries would flow through the waterfall and be used to reduce the existing principal deficiencies in IM Pastor 3 and 4 and replenish the reserve fund in IM Pastor 2. However, Moody's points out that the ultimate benefit of the sale will depend on the discount factors applied.

"There is a trade-off between the positive effect of short-term liquidity and the negative effect of reduced recoveries, compared to those that could be achieve in a final open-market sale. This depends on final discount factors and on times to sale and house price evolution," the agency observes.

The average seasoning of outstanding defaults is in the range of 3.2-3.4 years for the three deals, while time to sale from default and from repossession range from 2.60 to 3.30 and 1.80 to 2.20 respectively.