Contents

Structured Finance

Conflict of interest

Litigation activity turning towards trustees

The focus of US financial crisis-related litigation activity is turning towards the trustee community. The fundamental issue at stake in this new breed of dispute is who's going to pay.

Pre-crisis securitisations were often structured with little consideration for the conflict of interest between parties seeking resolution to an issue and those with the ability to authorise the pursuit of litigation. Especially with respect to legacy CDOs, many trustees were subject to administrative expense caps, which were sized as a function of the economic and competitive landscape. This meant that trustees were able to shave basis points off their fees, but were left with a skinny amount of cash with which to fulfil their fiduciary responsibilities.

"A fundamental issue of the crisis - which is yet to be resolved - is that many contractual principles depended on the isolated evaluation of the equities involved. Parties had sufficient bargaining power, but no-one approached transactions on a one-off basis," observes Rick Michalek, a partner with RJM Consulting.

He continues: "Rather, they focused on the potential for a series of issuances and were fighting for the line of business. It was common for trustees to take a haircut on the first one or two deals in the expectation that deals three to five would justify the engagement, but near the end, deals three to five never materialised."

As part of their fiduciary responsibilities, trustees can either pursue or defend litigation. But expense caps meant that it was unclear who was authorised to proceed when deals fell over, creating stalemates between junior and senior noteholders. Much of the litigation activity emerging today concerns senior noteholders suing to obtain authority to compel trustees to take action.

However, there is concern that courts appear reluctant to establish precedents, which could bring unintended consequences. "There are any number of cases that have met the filing requirements ahead of the statute of limitations, but which are proceeding really slowly. This is evidence of how uncertain the market remains," Michalek suggests.

He adds that while there has been a tightening of expectations to a degree, the conflict-of-interest issue still hasn't been addressed properly. For example, trustees are often divisions of sell-side banks and it remains a relationship-based business.

"Ideally new entities should be created that aren't in thrall to those relationships," Michalek says. "Perhaps the Volcker Rule could be extended to create separately capitalised entities delivering trustee services, although the required capital could be challenging. Such a shift would replace any implicit backstop from the related bank's balance sheet with a more transparent and measurable dependence on market-sourced capital."

He concedes that resolving the issue may be impossible without government intervention, but notes that completion of all of the Dodd-Frank Act rulemaking requirements would help. "The longer the market goes without regulations to affect the purpose of Dodd-Frank, the harder it is to evaluate the success of the Act. The lack of progress reveals how strong the political stalemate is currently. Sometimes stalemate in government is good because it ensures that laws are well thought through, but in this case, even having a bad regulation that could be corrected is superior to having no regulation and momentum continuing to build that will require greater correction down the road."

Davis Polk last month published a progress report marking the four-year anniversary of the Dodd-Frank Act. As of 18 July 2014, a total of 280 Dodd-Frank rulemaking requirement deadlines have passed, according to the document.

Of these 280 passed deadlines, 127 (45.4%) have been missed and 153 (54.6%) have been met with finalised rules. In addition, 208 (52.3%) of the 398 total required rulemakings have been finalised, while 96 (24.1%) rulemaking requirements have not yet been proposed.

Regarding recent industry pressure to establish clear fiduciary standards for trustees (SCI 7 May), Michalek is doubtful that trustees are taking the opportunity to beef up their economics in transactions, pointing to the lack of such provisions in deal documentation. He is also sceptical as to the degree of liability that operating advisors might accept in future RMBS deals.

"While trustees could in theory be given additional responsibilities as part of the regeneration of the private label RMBS market, there would need to be a high economic threshold to justify the attendant liabilities," he concludes.

CS

Structured Finance

Euro markets unexpectedly busy

Weakness in the broader financial markets brought volatility to the European ABS sector last week. An unseasonably high number of ABS bid-lists were observed, while activity is building in RMBS and the focus on CMBS has been on the unexpected postponement of a new issue.

"The last week and a half has seen activity picking up strongly. It was quiet before that, as the European ABS market settled into a bit of a summer lull, but suddenly we are seeing a lot of buying interest from clients and several BWICs circulating," says one trader.

The trader is surprised at how busy the sector has been, despite the fall-out from broader market volatility. One of the hottest areas at present is peripheral RMBS.

"Non-conforming and peripheral RMBS have been particularly active. Spreads for Spanish and Italian paper had widened out quite a long way and buyers now want to pick up that paper at wider levels," the trader confirms.

SCI's PriceABS data also shows UK RMBS names trading yesterday. For example, a cover for the AUBN 4 A2 tranche was recorded at 97.77, while Granite's GRAN 2004-1 3A tranche was covered at 99.43.

The trader says: "We are also seeing CMBS new issue deals trading now and then. Those bonds had rallied to a little over par; the seniors have now come back down to around about par, but mezzanine bonds still trade above it."

Legacy CMBS activity has been lower, notes the trader. Investors remain eager to find higher yielding paper, but it is becoming harder to achieve.

The biggest surprise in the CMBS sector has been the postponement of the Westfield Stratford CMBS, which appears to be due to risk retention concerns. The transaction had been anticipated for a while (SCI 10 June).

"Bringing a deal out at this time of the year without having a buyer or buyers lined up is a bit weird. The timing was unfortunate because the reception for this deal was very weak," the trader notes.

He adds: "I think they were hoping that demand was going to be there, without actually checking and firming things up. It will be interesting now to see whether they try again in a few weeks or split the deal up into different tranches."

JL

CMBS

CMBS supply stays high

US CMBS bid-list supply remained strong yesterday at around US$478m, with generic spreads wider across most vintages and product types. SCI's PriceABS data recorded 45 unique US CMBS tranches out for the bid during the session, including paper issued as recently as last month.

The tranche in question is HILT 2014-ORL A, which was talked at 100.14. As for other paper which was issued this year, there was also the JPMBB 2014-C19 A4 tranche available, which was covered at 82.

There was also senior paper issued last year, such as the GSMS 2013-KING A tranche. That tranche was talked at 66, which is the same level as price talk on Tuesday. The tranche first appeared in PriceABS on 25 February when it was covered at 100.

Moving down the capital stack, the GSMS 2013-KING B tranche was covered in the mid/high-80s. The tranche was talked on Wednesday at plus 81.

The BHP 2013-BOCA C tranche was talked at 100.63. It made its PriceABS debut in March, when it was covered at 100.19.

There were a few tranches from 2012-vintage deals - including CGCMT 2012-GC8 A2, which was covered in the low-40s - but a lot of the paper came from a large list of legacy mezzanine bonds. The BSCMS 2006-T22 AM and BSCMS 2007-PW18 A4 tranches were each talked at around 75.

JPMCC 2007-CB18 AM was talked between the 90 area and around 105 and was covered at 95. The MLCFC 2007-6 AM tranche, meanwhile, was talked in the mid-200s and covered at 266.

The CMBS 1.0 names also included several tranches from further down the capital structure. These included the GSMS 2005-GG4 F tranche, which was talked in the 20 area, mid-20s and 30 area, and the GSMS 2006-GG8 F tranche, which was talked in the high-single digits and at around 10.

JPMCC 2004-CB8 G was talked in the high-90s, at around 100 and at around 450. It was also talked at plus 450 on Wednesday and at around 450 on Monday.

MLMT 2004-BPC1 G was talked in the high-single digits and at around 10, while the WBCMT 2006-C23 G tranche was talked in the low/mid-90s and mid-90s. There was also a cover for the MLMT 2005-CKI1 G tranche.

PriceABS also recorded price talk on the GSMS 2006-GG8 J tranche in the low-single digits, which is also where it had been talked twice before during this week. Lastly, there was also a cover for the GSMS 2006-GG6 J tranche, which had been talked in the low-single digits and at around 10.

JL

RMBS

RMBS activity centres on seniors

It was a fairly quiet session across the board yesterday, although US non-agency RMBS bid-list supply did reach around US$131m. After some weakness for lower-rated legacy names last week, Interactive Data notes that dealer offering levels yesterday were mostly unchanged.

SCI's PriceABS data picked up around 20 non-agency names out for the bid in yesterday's session. Aside from a trio of VOLT tranches they were all pre-crisis and all the tranches were from the higher reaches of the capital structure.

Those VOLT tranches consisted of VOLT 2013-NPL7 A1, VOLT 2014-NPL1 A1 and VOLT 2014-NPL2 A1. The former was talked at mid-100 handle, while the two 2014-vintage tranches were each talked at mid/high-100.

The earliest vintage to be represented was 2005, where a US$3.268499m piece of the BAFC 2005-C A3 tranche was covered at 90 handle. That tranche first appeared in PriceABS on 14 November 2012, when it was talked in the mid-70s.

A US$10.738m piece of the BOAA 2005-4 CB4 tranche was talked at 12 handle and covered in the low-12s, while a US$6m piece of BSABS 2005-AC9 A3 was talked in the low/mid-70s. The CWALT 2005-81 X2 tranche, originally sized at US$200m, was traded.

Much of the paper out in yesterday's session came from 2006-vintage deals, including the BCAP 2006-AA2 A1 tranche, which was covered at 75 handle. The tranche's first recorded cover was in August 2012, when it was covered at 60 handle.

There were also covers for DBALT 2006-AR4 A2 and INDX 2006-AR15 A1, while MSM 2006-2 2A2 was covered in the low/mid-10s. That MSM tranche previously appeared in PriceABS last August, when it was talked in the low/mid-teens.

As for 2007-vintage paper, the BAFC 2007-B A1 tranche was covered at 73 handle. Price talk in August 2012 had been in the high-60s and the tranche was talked in the very high-70s in May 2013.

A US$4m piece of CWALT 2007-18CB 1A2 was talked in the very high-60s, while a US$4.3m piece of DBALT 2007-AR3 2A5 was talked in the low/mid-70s. Meanwhile a US$23.7m piece of the WAMU 2007-OA3 2A tranche and a US$11.1m piece of the WMALT 2007-OA5 A1A tranche were each talked in the mid-80s.

JL

Structured Finance

SCI Start the Week - 11 August

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

Pipeline
The pace of deals joining the pipeline slowed down last week. There were four ABS, two RMBS and four CMBS added.

The ABS were US$1.4bn Applebee's Funding/IHOP Funding Series 2014-1, US$275m Miramax Series 2014-1, US$501m South Carolina Student Loan Corporation (1996 Indenture) 2014 Series and US$1bn Volkswagen Credit Auto Owner Master Trust Series 2014-1.

The RMBS were US$342.67m ARP 2014-SFR1 and US$256.5m Morgan Stanley Residential Mortgage Loan Trust 2014-1. As for the CMBS, those consisted of US$1bn BHMS 2014-ATLS, US$750m COMM 2014-277P, US$1.2bn COMM 2014-CCRE19 and US$350m WFLD 2014-MONT.

Pricings
It was a much busier week for deals pricing from the pipeline. There were 14 ABS, four RMBS, three CMBS and 13 CLO prints.

The ABS were: US$1bn CarMax Auto Owner Trust 2014-3; US$207m Cronos Containers Program I Series 2014-1; US$950.2m Enterprise Fleet Financing Series 2014-2; US$225m First Investors Auto Owner Trust 2014-2; US$263m Navient Student Loan Trust 2014-2; US$263m Navient Student Loan Trust 2014-3; US$263.4m Navient Student Loan Trust 2014-4; US$158.3m Navient Student Loan Trust 2014-5; US$158.3m Navient Student Loan Trust 2014-6; US$158m Navient Student Loan Trust 2014-7; Y12bn KAL Japan ABS 13 Cayman; US$95m NYCTL 2014-A; US$148.76m Orange Lake Timeshare Trust 2014-A; and US$382m SMB Private Education Loan Trust 2014-A.

US$259.637m Agate Bay Mortgage Trust 2014-1, US$720m Invitation Homes 2014-SFR², US$672m STACR 2014-DN3 and US$460m STACR 2014-HQ1 accounted for the RMBS. The CMBS were US$267.8m ACRE Commercial Mortgage 2014-FL2, US$542.8m GSMS 2014-GSFL and US$799m JPMBB 2014-C22.

Lastly, the CLOs were: US$366m Atrium CDO Corp 2014-7; €415m Avoca CLO XII; US$626.5m CIFC Funding 2014-IV; US$518m KKR CLO 9; US$618m Northwoods Capital XII; US$708m Oaktree EIF II Series A1; US$415m OFSI Fund VII; US$622m OZLM VIII; €343.15m Popolare Bari 2014; US$413m Silver Spring CLO; €361.4m St Paul's CLO V; US$643m THL Credit Wind River 2014-2; and US$618.2m Venture XVIII.

Markets
There were a couple of busy sessions for the US CMBS market last week, including on Thursday, as SCI reported (SCI 8 August). BWIC volume for that session was around US$478m and the day's bid-lists included paper which was issued as recently as last month.

The legacy US non-agency RMBS market saw weakness in pricing for the first time since mid-2013, report Wells Fargo analysts, as lower-rated paper was half a point or a point lower over the week. "STACR and CAS paper continued to have pricing volatility, with the triple-B rated and non-rated classes widening on average about 45bp over the week," they add.

There European RMBS market was also active, with SCI's PriceABS data capturing more than 60 unique European RMBS bonds out for the bid on Tuesday (SCI 6 August). Covers were recorded for tranches across the length of the capital structure, including FEMO 1 A1 and HERME 11 D.

BWIC volume in the European CLO market was more limited at around €65m, according to Bank of America Merrill Lynch analysts, with most of those bonds coming from higher up the capital structure. "Given the limited supply, particularly of lower mezzanine bonds in recent days, and the typically delayed response of the CLO market to broader fixed income trends, we expect to see some spread softening going forward as more mezzanine supply comes to market," they say.

Deal news
• Hatfield Philips International has successfully implemented a workout strategy and restructuring of the €225m Apple loan, securitised in the Talisman 6 Finance CMBS. As part of the restructuring, the parent companies of the borrowers consensually agreed to transfer their shares in the borrowers to two newly-founded independent Irish holding companies.
• Fitch says that it does not expect any immediate performance or rating impact on the IM Citi Tarjetas 1 credit card ABS, following Citibank Espana's exit of the Spanish credit card market. Citibank Espana is asset servicer for the securitisation.
• Fitch has downgraded Roof Russia DPR Finance Company to triple-B plus from single-A minus, outlook negative. The rating action comes after the downgrade of originator ZAO Raiffeisenbank (RBRU), following the revision of Russia's country ceiling to triple-B from triple-B plus.
• S&P has lowered to D (default) from double-C its rating on the US$150m Queen Street III Capital catastrophe bond, sponsored by Munich Re. The transaction covered losses due to major European windstorms between July 2011 and July 2014.
• An auction has been scheduled for RFC CDO II on 29 August. The securities shall only be sold if the proceeds are greater than or equal to the auction call redemption amount.

Regulatory update
• Mario Draghi, president of the ECB, disclosed in a press briefing following last week's Governing Council meeting that the bank is set to hire a consultant to help it design its ABS QE programme. He said that the ECB has intensified its preparations in connection with the securitisation market, with various committees of the bank involved in these efforts.
• The US Department of Justice has issued a subpoena to General Motors Financial Company, directing the firm to produce certain documents relating to its origination and securitisation of subprime auto loans since 2007. The move is in connection with a DOJ investigation in contemplation of a civil proceeding for potential violations of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA).
• Moody's reports that while Basel 3 implementation is proceeding globally, notable differences are evident between jurisdictions in a number of areas, including pace, the degrees of strictness relative to Basel Committee guidance and the resulting challenges that banks face. The agency suggests that some of the weaknesses associated with Basel 2 have not been sufficiently addressed and that it is too soon to say whether the industry has so far achieved fundamentally stronger creditworthiness as a result of Basel 3.
• The New York Fed has launched a Mortgage Operations Counterparty (MOC) Pilot Program for counterparties in agency MBS operations. The objective of the programme is to explore ways to broaden access to open market operations and gain further experience in dealing with a wider range of firms.
• SFIG has published the first edition of its RMBS 3.0 Green Paper series, a series of papers aimed at restoring confidence in the private label RMBS market. The papers are a product of SFIG's RMBS 3.0 initiative - a broad industry-supported endeavour designed to develop proposed standards and reduce substantive differences within current market practices.
• A US federal judge has ordered Bank of America to pay US$1.27bn for Countrywide's role in the sale of risky mortgages to the GSEs during the financial crisis. The loans were sold through a programme known as 'the hustle' from August 2007 to May 2008, for which the bank was found liable for fraud last year (SCI 28 October 2013).
• IOSCO has established an information repository for OTC derivatives central clearing requirements. The aim is to provide regulators and market participants with consolidated information on the clearing requirements of different jurisdictions.

Deals added to the SCI New Issuance database last week:
Agate Bay Mortgage Trust 2014-1; ALM XI; Alterna Funding I 2014-1; Ares XXXI CLO; Birchwood Park CLO ; Carlyle Global Market Strategies CLO 2014-3; CIFC Funding 2012-1; CSMC Trust 2014-IVR3; Discover Card Execution Note Trust 2014-4; Driver China One Trust; Dryden 34 Senior Loan Fund; Fanes series 2014-1; Global SC Finance II series 2014-1; Highbridge Loan Management 4-2014; HOA Funding 2014-1; ICG US CLO 2014-2; JFIN Revolver CLO 2014; JPMCC 2014-DSTY; KAL Japan ABS 13 Cayman; Louisiana LCDA System Restoration Bonds Series 2014-EGSL; Louisiana LCDA System Restoration Bonds Series 2014-ELL; MSBAM 2014-C17; MSCI 2014-CPT; Nelder Grove CLO; Nelnet Student Loan Trust 2014-6; Saranac CLO III; Shackleton I-R CLO; Sound Point CLO VI; STACR Series 2014-DN3; STACR Series 2014-HQ1; State Board of Regents of the State of Utah series 2014-1; Steele Creek CLO 2014-1; Thrones 2014-1; United Auto Credit Securitization Trust 2014-1; VFC Series 2014-2.

Deals added to the SCI CMBS Loan Events database last week:
BACM 2000-2; BACM 2002-PB2; BACM 2004-6; BACM 2006-5; CD 2005-CD1; COMM 2006-C8; COMM 2006-C8, CD 2007-CD4 & GE 2007-C1; COMM 2013-CCRE10; COMM 2013-LC6 & COMM 2013-CR6; DECO 2006-E4; ECLIP 2006-2; EURO 28; GSMS 2004-GG2; JPMCC 2007-CB19; LBUBS 2007-C1; MLCFC 2007-9; MSC 2007-IQ16; RIVOL 2006-1; TITN 2006-5; TITN 2007-1; TMAN 7; WBCMT 2007-C33; WFRBS 2013-C15; WINDM XIV.

CLOs

Positive CLO rating trend continues

Around 85% of rating changes for European CLOs so far this year have been upgrades. The positive rating trend has been in force since 2011 and means that many tranches are now at or close to their original ratings once more, particularly at the top of the capital structure.

From a list of 180 outstanding legacy European CLOs, Bank of America Merrill Lynch European securitisation analysts count 582 upgrades and 114 downgrades by Moody's, S&P and Fitch. While credit performance has been varied, ongoing deleveraging is boosting overcollateralisation levels and large repayments have helped senior tranches repay faster than forecast.

The rating agencies frequently cite the end of the reinvestment period as a cause to upgrade. Moody's generally uses covenanted levels for inputs such as WAR and WAS when modelling reinvesting deals, but often switches to actual inputs after the reinvestment period. This switch in assumptions has been put forward as the main reason for an upgrade in many of the agency's rating reports for European CLOs this year.

Most downgrades have been for tranches that were originally rated triple-B or double-B. Deleveraging has typically helped senior tranches, while junior tranches appear to have been more sensitive to the varied portfolio performance across the sector. The BAML analysts point to a number of cases where rating reviews have resulted in upgrades for the senior tranches and downgrades for the junior tranches of the same deal.

Ratings are now broadly around one rating category below their original rating. Most tranches that were originally rated triple-A by Moody's and Fitch and now triple-A again, but S&P has generally kept them at double-A or single-A, which the analysts attribute to factors such as the tightening of counterparty criteria and largest obligor default tests.

No tranche originally rated triple-A is now rated lower than single-A. Very few tranches are currently rated double-C or single-C and while a number are rated triple-C, those are almost always tranches that were originally rated triple-B or lower.

The analysts expect the positive rating trend to continue. "However, some original triple-B and below rated bonds may continue to face downgrade risk where portfolio credit quality weakness outweighs the benefits of deleveraging," they conclude.

JL

RMBS

Rates impact weighed

With FN 4.5s prices nearing their all-time highs, the US agency RMBS sector appears to be at a tipping point from a rates perspective. So far, mortgage production and refinancing concerns have remained well contained, but Morgan Stanley MBS strategists believe that market dynamics could change if rates rally by another 25bp.

"Although any overall pick-up in refinancing activity is likely to be modest, small changes can have a significant impact because the risk premium related to prepayments is still very low," they explain. "Also, any further rally in rates is likely to force servicers to revisit their hedges if the three-month range is breached and could amplify this rate move. A lumpy readjustment of hedges is a clear risk at the current rate level."

The Morgan Stanley strategists concede that flight-to-quality rallies tend not to last for very long, so rates are unlikely to drop much lower - and, even if they do, they are unlikely to stay there for an extended period. "This, along with the fact that credit standards have not eased much this year, is likely to limit the degree to which mortgages widen into any further rally. Also, initially, production coupons are likely to benefit from servicer buying into a further rally."

If rates rally by 10bp-20bp from their current levels, agency RMBS is expected to underperform relative to US Treasuries. So far, 4.5s have not underperformed lower coupons much, but a further rally in rates would likely trigger underperformance.

Against this backdrop, the strategists recommend two tactical trades: moving down-in-coupon (short FN 30 4.5/4) in a sell-off; and underweighting 15s relative to 30s (short FN 15 3/FN30 3.5) into a further rally. They anticipate that GN/FN swaps will trade rate-directionally, but note that GN2/FN 4s are reaching levels where money manager support may kick in.

Meanwhile, in a further rally, production may pick up in the GN2/FN 3 coupon and the quality of the deliverable could shift. GN2 3 will have a lower SATO coupon and therefore a higher percentage of VA loans, which should exhibit lower turnover speeds.

The strategists believe that mortgages are unlikely to widen purely due to the flow effect of tapering. "Any spread widening due to changes in expectations regarding monetary policy is unlikely to impact negatively only agency MBS spreads. All assets have benefited from the accommodative monetary policy expectations and are likely to be negative for all spread products as those expectations become more hawkish," they observe.

CS

ABS

Green bond committee formed

After support for a set of green bond principles (GBP) was announced earlier in the year (SCI 14 January), an initial executive committee has now been appointed to oversee the GBP governance framework. The committee consists of representatives from 18 organisations, including investors, issuers and underwriters.

The committee's key priority will be to oversee the 2015 update of the principles which will be presented at a GBP AGM scheduled to take place in November. The GBP Secretariat is run by the International Capital Market Association (ICMA), which has also launched a related consultation with GBP members and observers.

The initial executive committee consists of: Bank of America Merrill Lynch; BlackRock; CalSTRS; Citigroup; Credit Agricole; EDF; the EIB; GDF Suez; HSBC; IFC; JPMorgan; Natixis Asset Management; Skandinaviska Enskilda Banken; Standish Mellon Asset Management; TIAA-CREF; Unilever; the World Bank; and Zurich Insurance Group.

ABS

Element beefs up SF team

Element Financial Corporation has appointed a team of structured finance veterans in Stamford, Connecticut, who previously worked at Credit Suisse. The members of the team specialise in structuring, investing and syndicating rail and aviation equipment finance deals.

The team is led by Scott Corman. He is joined by Imran Hussein - who has been named md - as well as David Center and Steve Marchi, who have been appointed directors.

Structured Finance

Firm builds alternative investment team

Richey May & Co has made three senior hires for its alternative investment division. The group will now be led by Daniel O'Connor, Stephen Vlasak and Jonathan Sharon.

O'Connor was previously at Rothstein Kass. He joins as an audit partner and becomes the firm's alternative investment service line leader. He specialises in ABS and RMBS and has experience across securities, swaps, commodities and futures, debt and structured credit.

Vlasak was also at Rothstein Kass and joins as an audit senior manager and director of business development. Sharon was a tax manager at Rothstein Kass and joins as a tax director, specialising in the taxation of alternative investment vehicles.

Structured Finance

Distressed credit pro added

PIMCO has appointed Ethan Schwartz in New York as evp and portfolio manager. He will focus on distressed credit and report to Sai Devabhaktuni, evp and head of corporate distressed portfolio management.

Schwartz joins from Contrarian Capital Management, where he managed a broad range of investments in liquid and illiquid fund structures. He has also worked at CRT Capital and Goldman Sachs.

CLOs

CLO firm adds RBS pair

CIFC Corp has boosted its capital markets and distribution group with the appointments of Matt Andrews as md and Mark Sanofsky as executive director. They both join from RBS Securities.

Andrews was head of CLO origination and structuring for RBS' CLO business and had previously worked in RBS' asset-backed finance group. Sanofsky was a senior member of RBS' US CLO origination and structuring group and had previously worked in structured finance as an attorney at Dechert.

CLOs

Origination activity mooted

Recent developments in the market may potentially allow Fair Oaks Income Fund (or vehicles seeded by it) to act as originator of European CLOs managed by unaffiliated managers, in line with the active investment approach described in its prospectus, the company says. As originator, the master fund or its affiliates could hold the risk retention investment required by current regulations governing European CLOs, thereby enhancing the value for independent CLO underwriters and managers.

The disclosure comes at the same time as Fair Oaks Income Fund announced its first acquisition in the primary market - US$10m of single-B rated notes of OZLM VIII CLO. This CLO's current target portfolio has a principal value of US$600m across approximately 160 unique bank loan issuers, with average exposure per issuer of approximately 0.6%. The potential total return for this investment is estimated at between 10% and 12% per annum.

Since the Fair Oaks Income Fund IPO, 51% of the net proceeds have been committed through the initial portfolio and this first acquisition. In aggregate, the portfolio now provides broadly diversified exposure to approximately 300 unique bank loan issuers. Geographic exposure is approximately 88% in the US and 12% in Europe.

Blackstone/GSO successfully listed a CLO origination vehicle last month (SCI 14 July).

ABS

LatAm receivables ABS gaining track record

S&P reports that it has rated 107 Latin American trade receivables ABS transactions, with 224 classes of debt, since it began rating these types of securitisations in the region 10 years ago. Of this approximately US$6.2bn of rated volume, 81% was backed by Brazilian assets.

S&P notes that successful examples of how this funding technique has benefitted both companies and investors during challenging periods include the Parmalat FIDC in Brazil and glass producer Vitro's securitisations (VENACB 05, 09 and 11) during its financial restructuring process in Mexico. Trade receivables deals such as the Argentinean RHUO programme and the Brazilian multi-seller FIDCs have also been used as a regular and stable funding source, as well as an alternative to bank funding.

"The consistent track record of trade receivables securitisations in Brazil, Argentina and Mexico over the past 10 years shows that companies are ready to use securitisations more extensively via the sale of short-term commercial payment rights as an alternative source of funding. We believe the good results seen in these three countries can be mirrored in others, such as Colombia, Peru, Panama and Chile," the agency says.

S&P expects a moderate increase in delinquency rates across trade receivables portfolios in the near term in Brazil, in line with its expectation of weaker economic growth. Most of the sellers and obligors in these transactions are small and mid-sized enterprises with weak credit profiles, with margins that are sensitive to reduction in demand and increase in costs.

This, in turn, reduces the ability to service financial obligations. On the other hand, the diversification seen in these portfolios is a mitigating factor.

In Argentina, the market is anticipated to maintain its steady growth, as long as bank credit facilities are stringent and have high interest rates. Any loosening of the banking financing standards will not have a negative direct impact on issuance volumes or the incorporation of new participants, but it is likely to encourage the diversification of financing sources. S&P expects a moderate increase in delinquencies in these portfolios, but within the assigned rating expectations.

In Mexico, there currently are very few rated transactions outstanding, as market liquidity has been high and direct bank lending is easily available.

ABS

Servicer swap for Spanish card ABS

Fitch says that it does not expect any immediate performance or rating impact on the IM Citi Tarjetas 1 credit card ABS, following Citibank Espana's exit of the Spanish credit card market. Citibank Espana is asset servicer for the securitisation.

Bancopopular-e, an independent banking franchise of Banco Popular Espanol, is expected to acquire Citibank Espana's credit card business and thus become the new asset servicer for IM Citi Tarjetas 1. Bancopopular-e already owns the entire card issuing business of Grupo Banco Popular, and Banco Popular will irrevocably guarantee the obligations of Bancopopular-e under the servicing agreement.

Varde Partners, in turn, has agreed to acquire a 51% stake in Bancopopular-e.

Citibank Espana is set to sell its entire credit card business in September, including the transfer of management, staff, processes and risk models, as well as contracts and relations with customers. In Fitch's view the risk resulting from counterparty replacement is limited and has negligible impact on the rating on the notes issued by IM Citi Tarjetas 1.

The agency believes that the early amortisation trigger upon a servicer substitution described in the documentation of IM Citi Tarjetas 1 is not applicable in this case because the replacement of the servicer does not follow any financial or operational impairment of the servicer and all structural and operational features of the transaction remain substantially unaltered. Further, payment interruption risk is sufficiently mitigated by the cash reserve set aside for liquidity purposes, which is available to cover up to three months of interests and senior expenses.

Fitch also says that the implementation of Citibank's exit strategy will not affect the performance of IM Citi Tarjetas 1.

ABS

UK card delinquencies hit all-time low

UK credit card charge-offs and delinquencies fell to a new all-time low in 2Q14, after losing momentum in the first three months of the year, according to Fitch's latest indices for the sector. The improvements were slightly exaggerated by the exclusion of the fully repaid Sherwood trust from the indices.

Fitch expects charge-offs to keep falling slightly or remain stable in the short term, primarily due to the ongoing downtrends in delinquencies and the unemployment rate in the UK. It also believes that UK credit card performance will remain fairly stable in the next 12 months and is therefore maintaining its stable outlook for the sector.

Average 2Q14 monthly payment rates fell slightly - but remained within the band observed since 3Q13 - after rising to an all-time high in the preceding quarter. Three-monthly average gross yield decreased to its lowest level since 4Q05. This is a continuation of a downtrend in gross yields of UK trusts, but driven to a large extent by the exclusion of Sherwood trust from the index.

ABS

Subprime auto investigation widens

Santander Consumer USA disclosed in its latest 10-Q filing that it has been issued a civil subpoena by the US Department of Justice requesting documents relating to the underwriting and securitisation of non-prime auto loans since 2007. This follows the subpoena of GM in connection with a DOJ investigation in contemplation of a civil proceeding for potential violations of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (SCI 5 August).

The Consumer Financial Protection Bureau (CFPB) is also reportedly reviewing lending and collection practices of other firms active in auto lending generally and in the subprime auto market in particular.

Average default rates, as measured by the Wells Fargo Securities subprime auto ABS default index, have been rising since early 2012. ABS strategists at the bank suggest that this has been due in part to the expansion of credit and the easing of lending standards.

An uneven economic recovery has also hurt lower income households disproportionately. "These conditions have made it more difficult for many borrowers to keep up with their auto loan payments. This economic component has been underappreciated by many observers, in our opinion," the Wells Fargo strategists observe.

Based on what has been announced so far, they do not believe that increased regulatory scrutiny represents a major risk to the credit fundamentals of outstanding subprime auto ABS deals. "Robust structural protections are in place that should mitigate the credit risk to ABS investors. Nevertheless, the subprime auto ABS sector may become vulnerable to spread widening to the extent that rising regulatory scrutiny causes an increase in headline or servicer risk. In the absence of additional guidance as to the goals, scale and scope of the government's interest in the subprime auto lending market, we would not be surprised to see investors take a more cautious stance."

ABS

SMB completes debut SLABS

Sallie Mae has completed its first student loan ABS as a standalone consumer banking business, as well as the definitive agreement for its first loan sale. Dubbed SMB Private Education Loan Trust 2014-A, the securitisation was secured by approximately US$380m of Smart Option student loans. All securities - including the entire residual interest in the loans - were privately placed with a single third-party investment manager.

Meanwhile, the loan sale involves approximately US$820m of Smart Option student loans being transferred to Navient Corporation. The sale is expected to close this month.

Sallie Mae completed the strategic spin-off of its portfolio management, loan servicing and asset recovery businesses on 30 April (SCI passim). The company now focuses exclusively on products and services that help families save, plan and pay responsibly for college.

ABS

MSA payments drop

Fitch has completed its annual ratings review of tobacco ABS, accounting for the amount of Master Settlement Agreement (MSA) payment received by each trust in 2014. The agency reports that this year the aggregate MSA payment is 18.46% lower than the amount in 2013.

This drop is due to the one-time settlement payment received by 20 settling states and territories from the tobacco companies in 2013 regarding the non-participating manufacturer dispute (SCI passim). This decline was partially offset by a settlement of 2003 disputed payments made to the remaining states.

In both cases, this one-time settlement payment was stripped out of the MSA payment amount allocated to each trust for Fitch's modelling purposes. Instead, the agency assumed that the settling states experienced the same rate of decline as the non-settling states.

Since this settlement payment is cash positive, no downgrades will be taken on any bonds issued by settling states or counties, which is consistent with the approach taken in 2013. The full benefit of the settlement payment should be seen next year, at which point the ratings will be re-evaluated.

Fitch took 38 downgrades on bonds from non-settling states. Although the MSA payment was stable year-over-year, many of these downgrades result from having model-indicated grades that were below the current rating for two consecutive years.

One upgrade was made on California County Tobacco Securitization Agency (Los Angeles County) Series 2006, which received a settlement in 2013. The remaining 179 outstanding ratings were affirmed.

Meanwhile, Buckeye Tobacco Settlement Financing Authority, 2007 (Ohio), Nassau County Tobacco Settlement Corporation, Tobacco Settlement Asset-Backed Bonds, Series 2006 continue to have debt service reserve balances below their required levels. Suffolk Tobacco Asset Securitization Corporation, Tobacco Settlement Asset-Backed Bonds, Series 2008 is drawing on its reserve account for the first time. As a result, Fitch does not give them the benefit of a rating one notch above the model-indicated grade, regardless of whether the state received a settlement.

Golden State Tobacco Securitization Corporation, United States, Series 2007-1 had been drawing on its reserve account in the past, but now is at its required level.

ABS

LMA enhancements highlighted

Credit Agricole recently amended its ABCP programme LMA by adding the capacity to issue structured notes with interest paid at fixed or floating rates, becoming the first bank-sponsored conduit outside of the US to do so. Enhanced liquidity coverage tests ensure that LMA investors will still receive full and timely repayment on their CP up to the final maturity date, without being exposed to increased interest rate risk.

Moody's says the issuance of structured notes gives the conduit greater scope for managing its liabilities while satisfying investor demand for investments with, potentially, a shorter maturity. The associated liquidity provider can therefore manage its liquidity obligations and liquidity coverage ratio through the availability of either a time 'buffer' or reserves in the form of liquid assets.

Specifically in the case of LMA, if the conduit were to issue 60-day puttable CP and the investor decided to exercise a put option on Day 5 of issuance, the earliest the noteholder would be paid would be on Day 35 as the put notice period is 30 days. Credit Agricole, as liquidity provider, would still have the 30 days' buffer before any potential draw on the liquidity facility. If the noteholder were not to exercise the put, then the bank would still have up to Day 60.

For a conduit such as LMA, each time CP is issued with less than 30 days' maturity, high quality liquid assets (HQLAs) have to be put aside by Credit Agricole to cover the potential amount of the outflow that could arise from the associated liquidity facility. If the maturity is maintained over 30 days with embedded put/call options, then the conduit would not be required to put the HQLA aside.

LMA is fully supported and is structured such that the same level of support is provided to ABCP holders irrespective of whether they purchase structured or conventional CP. Liquidity coverage tests are crucial to the full support mechanism, according to Moody's.

For LMA specifically, each transaction in the portfolio effectively benefits from a liquidity asset purchase agreement (LAPA) under which Credit Agricole agrees to purchase LMA's assets at par, thereby providing full support. The LAPA is sized at 102% of the conduit's purchase limit in each transaction.

When LMA utilises only a portion of the asset purchase limit for an underlying transaction, the unused portion of the LAPA can be used to cover any shortfall on the interest due on floating rate notes (excess liquidity). The conduit monitors and aggregates all the excess liquidity available for its euro asset portfolio and US dollar asset portfolio and ensures that on a daily basis, and as long as floating rate notes are in issuance, the aggregate excess liquidity amounts will cover any possible theoretical increase in floating rate applicable to the FRNs.

This maximum theoretical amount is calculated using a 20% stress rate and assumes that all FRN CP is issued with maximum maturity of 270 or 364 days, depending on the notes to be issued and the market. FRNs are also subject to a special redemption option: if the aggregate excess liquidity calculated is less than the theoretical FRN interest to maturity, LMA will be required to redeem the FRNs through the special redemption.

Structured Finance

Chinese ABS to 'build on recent successes'

S&P reports that 23 financial institutions issued 43 securitisation transactions in the Chinese interbank bond market between the market's inception in 2006 and 31 May 2014, with an aggregate issuance amount of RMB179.3bn. The agency notes that recent growth of the sector has been significant, with about 40% of this volume being issued this year.

"The market expects securitisation in China to build on its recent successes," says S&P credit analyst Vera Chaplin. "The market sees securitisation as being a regulated and transparent instrument that should help address financial market issues in China, provide alternative funding and reduce the economy's reliance on credit extension by banks."

With their growing experience, issuers, investors and important third parties in securitisation have expressed confidence over deal structuring and risk analysis in China, and believe that important issues in legal foundations and credit performance history have been addressed. However, open items still require continued development, such as the clarification of enforceability on particular contracts, details on recovery analysis, loss projections for a potentially less-promising future economic environment, cashflow test assumptions and the ability to have qualified servicer replacement.

Chinese securitisation investors are said to have become more proactive in making enquiries about deal structures. They are also demanding greater disclosure of transaction information, opportunities to learn about methods used in securitisation analyses and more market research material.

"In our view, a lot of consideration has gone into the development of the securitisation market by regulators and market participants in China. [We] believe the accumulation of experience and sharing of knowledge, backed by growing demand from originators and investors, should help to advance the securitisation market in China," S&P observes.

Structured Finance

RFC issued on trustee role

SEBI has released for comment a concept paper regarding the introduction of a standardised term sheet for securitisation transactions. The aim is to rationalise, clarify and enhance various aspects of the Indian market, such as eligibility criteria, roles and responsibilities associated with securitisation trustees.

Schedule III of the country's Securitised Debt Instruments Regulations states that it is the duty of the trustee to disseminate to all investors adequate, accurate, explicit and timely information fairly presented in a simple language. Schedule V of the Regulations requires comprehensive disclosures in case of public issue, including details regarding asset pools, transactions and arrangements with originator, credit enhancer, underwriter and liquidity provider, and credit ratings.

SEBI is proposing to further clarify the roles and responsibilities of securitisation trustees.

Structured Finance

Volatility weighs on hedge fund performance

Aggregate hedge fund performance was negative at -0.35% in July, the industry's fourth down month of 2014, according to eVestment. The losses pushed year-to-date returns down to 2.62%, as Europe re-emerging as a source of instability, escalating tensions in eastern Ukraine and conflict in the Middle East all weighed on investor preference for risk assets.

In particular, a sell-off in high yield markets appeared to negatively impact directional credit strategies last month. A decline of 0.64% for the aggregate of credit strategies was their first negative month since August 2013. However, relative value credit managed to perform well, rising by 0.22% in July.

Distressed fund performance was also negative during the month, although the sector remains the best performing major hedge fund strategy in 2014.

Structured Finance

Japanese credit quality correlations examined

Japanese structured finance credit performance and fundamentals have generally remained stable for the past couple of years. However, transaction-specific risks and certain macroeconomic elements remain key factors with the greatest potential to undermine this stability, according to S&P.

The agency says the top-five macroeconomic factors that have been leading indicators of the credit quality of Japanese structured finance deals in the past are unemployment rate, land prices, real GDP, equity returns and corporate credit risk premium. "We use the top-five macroeconomic factors to help us better understand and assess the current and future state of the credit quality and rating performance of Japanese structured securities," it explains. "Data from 2000 to 2014 show a high correlation between Japan's unemployment rate and the credit quality of structured securities, and a reasonably high correlation between land price movements and credit quality. Japan's real GDP, equity returns, and corporate credit risk premiums also show correlations with credit quality."

S&P reviewed over 10 years of data to determine correlations between economic factors and the credit quality of structured finance securities, as well as changes in credit quality on a trailing 12-month basis from January 2000 to March 2014. The volatility in credit quality that Japanese structured securities (ex-CDO) have experienced in the past was shown to be moderate relative to that of global structured securities.

Japanese structured securities (ex-CDO) experienced net rating upgrades from October 2002, before falling to net downgrades from April 2009 to January 2012. Accounting for both the magnitude and frequency of rating changes, the average credit rating for all Japanese structured securities (ex-CDO) dropped by 0.57 notches in 2009 and 0.65 notches in 2010. These declines were less volatile than the averages for all global structured securities, which dropped by 3.5 notches in 2009, up from a 3.2-notch decline in 2008.

Triple-A rated securities saw a 0.1-notch average decline in rating performance in both 2009 and 2011. The drop was more severe for the double-A rating category or below, particularly those with speculative-grade ratings.

The average credit quality of Japan's CMBS sector has declined since the beginning of 2009, with a 2.5-notch decline in 2010. The average credit quality of the ABS sector - which also declined in 2009 - began to improve in 2010, but then experienced a 0.1-notch decline in 2013 after a 0.7-notch decline in 2011.

For the latest 12 months ended March 2014, Japan's ABS and CMBS sectors remained in the downgrade region, with respective 0.2-notch and 1.2-notch declines. Meanwhile, the RMBS sector maintained a net upgrade of 0.1 notch.

Empirical evidence based on the downturn in ratings from 2009 to 2011 further reveals that a one percentage point rise in Japan's unemployment rate corresponds with an average 0.4-notch decline in S&P ratings on Japanese structured securities.

The agency suggests that because Japan's economy has never experienced an unemployment rate of more than 5.5% over the past several decades, fundamental changes in future labour market conditions may potentially lead to deterioration in the credit quality of Japanese structured securities. Also, because Japan's corporate credit risk premium has been relatively stable over the past 10 years, the ability to estimate the impact of significant dislocation in Japan's financial market is limited.

However, even if Japan's labour and financial markets were to shift in such fundamental ways, S&P doesn't expect the shift to occur rapidly. In addition, for the next 12 months, it does not forecast the same level of deterioration in macroeconomic factors as seen during 2008 and 2009.

Structured Finance

ECB to hire ABS consultant

Mario Draghi, president of the ECB, disclosed in a press briefing following yesterday's Governing Council meeting that the bank is set to hire a consultant to help it design its ABS QE programme. He said that the ECB has intensified its preparations in connection with the securitisation market, with various committees of the bank involved in these efforts.

"Our monetary policy stance remains, and will remain, accommodative," Draghi stated. "I can only reaffirm that the Governing Council is unanimous in its commitment to also use unconventional measures, like ABS purchases, like QE, if our medium-term outlook for inflation were to change."

He added that the ECB's final action with regard to ABS will depend "on the action of many other actors", but confirmed that the bank is proceedings with its work regardless of the timing of possible regulatory changes in this area.

Structured Finance

Debut ETI linked to commodity futures

The first exchange-traded instrument (ETI) issued under the Malta Securitisation Act went live recently on the European Wholesale Securities Market (EWSM). Dubbed the Dynamic Trading Strategies ETI, it is backed by a performance-linked bond issued by a special purpose acquisition vehicle, the sole purpose of which is holding managed accounts at Interactive Brokers and Sensus Capital Markets.

Argentarius ETI Management arranged the instrument, which is issued by ETI Securities, one of the SPVs incorporated under the Malta Securitisation Act. The underlying assets are commodity futures contracts, enabling UCITS fund managers to diversify into additional asset classes. Commodity futures do not qualify as eligible assets under the UCITS directive, but ETIs do - regardless of the eligibility of the underlying assets - providing certain criteria are met.

Argentarius says it is currently in discussions with many leading advisers to the fund industry in Germany, Malta, Switzerland and the UK and is looking at several new issuances of this type.

CDO

ABS CDO auction due

An auction has been scheduled for RFC CDO II on 29 August. The securities shall only be sold if the proceeds are greater than or equal to the auction call redemption amount.

CDS

Genworth CDS widen on subpar results

Subpar results posted last quarter have sent credit default swap spreads on Genworth Financial to their widest levels since February, according to the latest CDS case study from Fitch Solutions. Five-year CDS on the name have widened by 56% over the past month.

After pricing consistently in the triple-B minus space since April, the market is now pricing Genworth's credit risk in line with double-B plus levels, in speculative grade territory. "In addition to its second quarter results, souring market sentiment for Genworth also seems to stem from its recent announcement that it will be reviewing the adequacy of its long-term care insurance claims reserves," comments Fitch Solutions director Diana Allmendinger.

CDS

Succession event for BES

ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a succession event occurred with respect to Banco Espirito Santo, following the bank's bail-out by the Portuguese central bank (SCI 4 August). Banco de Portugal confirmed that over 75% of all bonds and loans - which the DC decided would constitute relevant obligations - had been transferred to Novo Banco.

The EMEA DC had previously ruled that a bankruptcy credit event had not occurred with respect to BES. However, it notes that eligible market participants are permitted to submit a new DC request, should further events occur or additional publicly available information be submitted.

CDS

US CDS ETFs rolled out

ProShares has launched two funds that aim to provide exposure to the credit component of the US high yield bond market uncoupled from the interest rate component. ProShares CDS North American HY Credit ETF (TYTE) and ProShares CDS Short North American HY Credit ETF (WYDE) are listed on the BATS exchange.

TYTE and WYDE invest in index-based credit default swaps. The funds' exposure is not leveraged.

ProShares notes that with more than US$8bn in average daily trading volume, the market for high yield CDS has been more liquid than the high yield bond market itself. At the same time, the volatility of the high yield CDS market has been lower than equities and comparable to the high yield bond market.

CDS

RadioShack CDS hit widest-ever levels

RadioShack Corporation's increasingly precarious financial standing is being reflected in its credit default swap (CDS) spreads, which are now trading at their widest-ever levels, according to the latest CDS case study from Fitch Solutions. Five-year CDS on RadioShack have widened by 70% over the past month, with much of the widening happening over the past week.

"Markets appear increasingly concerned over RadioShack's weak sales, which is likely why CDS has come out so significantly in such a short period of time," comments Fitch Solutions director Diana Allmendinger.

Further evidence of RadioShack's struggles is in its dwindling CDS liquidity. After trading within the top tenth global percentile through March of this year, CDS on RadioShack are now trading in the 65th percentile.

"The drop in RadioShack's CDS liquidity is likely indicative of trader apprehension to enter into positions at such wide spread levels," adds Allmendinger.

CLOs

SNC enforcements could have mixed impact

The US Fed, the OCC and the FDIC have warned that banks found to have unsound practices - based on leveraged lending guidance released in 2013 - could be subject to enforcement actions. Such actions would have a mixed impact on CLO investors, Moody's suggests.

Enforcement actions could follow the regulators' annual Shared National Credit (SNC) review of syndicated loans, the results of which are due to be released soon. "US regulators are increasingly focused on getting banks to exercise restraint when originating or participating in these loans," says Allen Tischler, a Moody's svp. "But US corporate leveraged loan volume has risen to record levels in recent years and underwriting standards are still loosening. There is no sign yet of a reversal in the general trend towards weaker covenants, larger credit lines, narrower pricing and other indications of slacker underwriting."

The agency expects regulators to criticise more loans than they did in the 2013 review. Regulatory tools include criticising reviewed loans, issuing enforcement orders or assigning low supervisory ratings to banks. These actions can prevent banks from obtaining regulatory approvals and impede banks' business plans.

Adherence to the regulatory guidance could be both credit positive and negative for CLOs, as changes in credit standards for loans would affect both the performance of existing deals and the issuance of new ones, according to Moody's.

CLOs

Refi activity set to continue

The average US CLO triple-A spread for transactions rated in July 2014 was 1.51%, similar to the average triple-A spread for 2012 vintage transactions that are currently exiting their non-call periods, according to S&P. The agency notes that although current triple-A spreads would appear to limit opportunities for refinancing, it has received a steady stream of such requests, even just over the past several weeks.

"We attribute this to the shorter weighted average life of the refinanced tranche and some level of seasoning in the loan portfolio," S&P says. "Also, significant opportunities currently exist for CLOs to refinance the mezzanine and subordinate notes in the capital structure, where current spread levels are still tight compared to those for 2012 vintage CLOs. For instance, the average new issue CLO spread levels in July 2014 for mezzanine and subordinate notes are well below the respective spread levels for the deals currently exiting their non-call period."

By end-July this year, 14 US CLOs had refinanced one or more tranches in their capital structure: ALM V, Avalon IV Capital, Dryden XXII and XXIII, ING IM CLO 2012-1, LCM X, Octagon Investment Partners XII, Race Point V CLO, Golub Capital Partners CLO 10 and 12, Madison Park Funding VIII, Gramercy Park CLO, Carlyle Global Market Strategies CLO 2012-2 and Neuberger Berman CLO XII. S&P says it is currently reviewing further refinancings.

Half of the 14 refinanced transactions were also looking to be brought into compliance with provisions of the Volcker ruling, so that they would not hold non-loan paper. Of these seven deals, four transactions also increased their covenant-lite bucket limitations by 10%-20%, likely to offset the effects of not being able to hold bonds.

For the 14 refinanced transactions, S&P calculates the related average drop in spreads to be 61bp (excluding two fixed tranches that refinanced into floating-rate tranches). For refinance activity to pick up further, tighter spreads would need to be seen akin to those in 2012 and 1H13. US triple-A CLO spreads have widened since 2H13, followed by a very marginal tightening in 2Q14.

"Reduced market depth and triple-A demand can make triple-A level spreads inelastic, though a wider triple-A CLO investor base can help tighten spreads. The presence of shorter duration triple-A investors has helped to increase the frequency of CLO refinancing and also lower the refinanced triple-A notes' spreads to below current new issue spread levels," the agency observes.

Over 100 US CLOs will be exiting their non-call period within the next year. Even if the current new issue liability spread levels were to hold, S&P suggests that there may still be many opportunities for CLOs to refinance in the near future.

CLOs

Recovery values to benefit equity

S&P's incorporation of loan recoveries into its analysis of CLOs (SCI 4 August) is expected to have a broadly positive impact on the sector. In particular, Wells Fargo CLO analysts suggest that the changes should benefit equity investors, if managers are able to add higher spread assets to their portfolios.

"It appears that after this update, each CLO asset's assigned recovery value should be higher than or equal to the value before the methodology change," they observe.

S&P stated that managers who amend their transaction documents to incorporate the new recovery information into their calculation of weighted average recovery rate may potentially see a modest increase in their CDO Monitor Test cushion. The Wells Fargo analysts note that managers may have a choice: they can keep the same portfolio and add cushion from a ratings perspective; or they can attempt to maintain a similar recovery value for the portfolio, which may allow for a portfolio of lower-rated (and theoretically higher-yielding) assets.

Specifically equity investors in 2012-2013 S&P-rated CLOs are expected to benefit the most from the changes. However, the analysts point out that equity investors could suffer in the long run if CLO ratings are less stable or if asset quality decreases.

At the same time, spreads on loans included in the higher end of the recovery rating tier should tighten, while loan investors may see less demand for low-yielding assets with higher recovery ratings. "In the long run, this could lead to spread tightening across the loan market, as the leverage in CLOs could slightly increase. If managers are able to increase leverage, they should be able to achieve similar returns, even at tighter asset spreads," the analysts note.

CMBS

Innovative workout for Apple loan

Hatfield Philips International has successfully implemented a workout strategy and restructuring of the €225m Apple loan, securitised in the Talisman 6 Finance CMBS (see SCI's CMBS loan events database). As part of the restructuring, the parent companies of the borrowers consensually agreed to transfer their shares in the borrowers to two newly-founded independent Irish holding companies.

Originated in 2005 by ABN AMRO, the loan was granted to a group of German companies for the acquisition of commercial real estate properties throughout Germany. In conjunction with the transfer of shares, the borrowers' debt was restructured for insolvency purposes by way of certain debt assumptions of the new Irish holding companies.

Furthermore, HPI secured a final settlement of certain intercompany loans between the borrowers and their parent companies, which were not part of the original security package. The proceeds from the settlement significantly exceed the cost of restructuring.

Clifford Chance advised HPI on the restructuring.

CMBS

Strongest recovery seen for apartments

US major market apartment prices have risen above their pre-crisis peak by 32%, according to the latest Moody's/RCA CPPI national all-property composite index. The CPPI itself increased by 1.2% in June and is now 64.1% above its January 2010 trough and only 2.4% below its November 2007 peak. The apartment component rose by 2.7%, while the larger core commercial component rose by 0.6%.

"Of the 23 indices in the Moody's/RCA CPPI, the strongest recovery has been in major market apartment prices, because of strong underlying fundamentals and abundant liquidity," says Tad Philipp, director of CRE research at Moody's. "Over the last 12 months, apartment prices in general - in both major and non-major markets - have gained 16.1% and now exceed their pre-financial crisis peak by 14.6%."

The second-strongest price recovery in the CPPI is in major market CBD office, which is now about 17% higher than its pre-crisis peak - although its fundamentals still lag the recovery in apartments, despite ample liquidity in the sector. Seven of the 23 indices in the Moody's/RCA CPPI have now surpassed their pre-crisis peaks: apartment, major markets; apartment, national; office central business district, major markets; office CBD, national; major markets aggregate; apartment, non-major markets; and retail, major markets.

Of the core commercial sectors, industrial has performed the best over the last 12 months, with prices rising by around 18%. Additionally, CBD office was up by 23.5% and suburban office by 23%, making them the best performing non-major market segments over the past 12 months.

Finally, hotel prices have recovered around 40% of their peak-to-trough price decline, remaining around 25% below peak. The share of hotel transactions recorded by RCA as distressed has declined to about 30% in recent months from more than 60% in late-2010.

CMBS

Workout fees accrue on defeased loan

The US$50m Ridgeview Apartments loan - securitised in DBUBS 2011-LC2A - was fully defeased in June, but workout fees continue to accrue. Morgan Stanley CMBS strategists note that this is due to a prior technical modification.

The servicer on the transaction issued a default notice in March 2012, after the borrower refused to use the lockbox under the current terms of the cash management agreement. The loan was then transferred to special servicing in August 2012 and a modification closed in June 2013, waiving the use of the lockbox and allowing an affiliate of the borrower to become qualified manager.

The Morgan Stanley strategists note that NS Servicing I is special servicer on the deal and therefore entitled to the workout fees. According to the offering documents, an affiliate entity of the special servicer (NRFC CMBS Funding I) was also the initial directing holder, given its purchase of the class F and G notes.

The workout fees on the Ridgeview Apartments loan resulted in interest shortfalls to the class G notes of nearly US$167,000.

Morgan Stanley's CMBS 2.0 Credit Tracker indicates that six additional loans have received technical modifications, resulting in workout fees being paid to the special servicers.

CMBS

CMBS 2.0 take-outs continue

The lending environment remains strong for CRE and take out activity continues to be seen in CMBS 2.0 collateral, says Fitch. Some early payoffs are taking place shortly after expiration of the lock-out period, with borrowers paying the premium of yield maintenance to take advantage of the persistent low interest rate environment.

Cash-outs raise the question of sustainability, although prepay activity remains a small part of the overall CMBS 2.0 universe. Most prepays are occurring in large loan and single-borrower transactions; of the 49 loans that were prepaid, 33 loans with a balance of US$2.5bn were prepaid with yield maintenance or with a premium.

Fitch notes that 30 loans were from multi-borrower deals and three from single-borrower deals. Prepayment penalties averaged around 10% as a percentage of the balance prior to disposition, while 16 loans were prepaid at no additional cost as they were in their freely pre-payable period.

While the number of prepayments has been increasing this year, so has the size of individual loans being prepaid. Prepayments in 2011 totalled only five loans from one transaction, three loans prepaid in 2012 and 18 loans prepaid last year, while so far this year 23 loans have been prepaid.

Individual loan balances for the prepays in 2011 were all below US$6m, while balances ranged from US$17m to US$75m in 2012 and from US$1.5m to US$1bn in 2013. This year, balances have ranged from US$3.5m to US$1.1bn.

By vintage, the 2011 vintage has seen the most prepayments with 31 loans across 16 deals, while the 2010 vintage has seen nine loan prepayments across four deals. The 2012 vintage had five loans and the 2013 vintage has had four loans.

Across all the 2.0 multi-borrower deals Fitch rates, 35 loans with a current outstanding balance totalling US$409.8m were defeased. The loans currently have between seven and 86 months before they are able to openly pre-pay and have between seven and 89 months before their maturity date.

Loans secured by multifamily, retail and office properties topped the multi-borrower defeasance list with 10 loans, eight loans and five loans, respectively. Only one Fitch-rated single borrower transaction - BALL 2009-FDG - was fully defeased in November 2013.

Risk Management

End-user reliance on derivatives underscored

ISDA has published a new research study, entitled 'Dispelling myths: end-user activity in OTC derivatives', which challenges the assumption that only a small fraction of derivatives activity relates to hedging that benefits the real economy. BIS data reveals that 65% of OTC interest rate derivatives market turnover involves an end-user on one side and a reporting dealer on the other. The remaining turnover activity relates to dealer market-making and the hedging of customer transactions.

The study notes that non-dealer financial institutions and non-financial customers use derivatives primarily to hedge risks and reduce volatility on their balance sheets. "OTC derivatives play a very important role in the risk management strategies of many firms. Whether used by global corporates to eliminate exchange-rate risk in foreign currency earnings, by pension funds to hedge inflation and interest-rate risk in long-dated pension liabilities or by governments and supranationals to reduce interest-rate risk on new bond issuance, OTC derivatives allow end-users to closely offset the risks they face and to ensure certainty in financial performance. More balance-sheet security means firms can invest for the future with greater confidence, creating jobs and contributing to economic growth."

The fact that publicly available data does not provide a detailed break-down of derivatives market activity - such as which firms or industries use these instruments and why - creates confusion and misperceptions about the nature of global derivatives activity and the extent to which it is socially and economically useful, according to the study. It further states that to claim non-dealer financial end-users don't play a vital role in the real economy ignores the social and economic importance of, for example, pension schemes being able to pay future retirees what they expect, banks being willing to provide repayment certainty to borrowers through fixed rate mortgages and insurance companies being able to pay policyholders as promised.

RMBS

RFC issued on single GSE security

The FHFA has released a request for input on the proposed structure for a single security that would be issued and guaranteed by Fannie Mae or Freddie Mac. The initiative aims to improve the overall liquidity of GSE MBS by creating a single security that is eligible for trading in the to-be-announced (TBA) market.

In particular, the FHFA is seeking input on TBA eligibility, legacy Fannie Mae and Freddie Mac securities, potential industry impact of the single security initiative and the risk of market disruption. Maintaining a highly liquid secondary mortgage market is a fundamental requirement for the success of the single security, the agency notes.

In order to achieve maximum market liquidity, the single security would leverage the GSEs' existing security structures. The proposal therefore encompasses many of the pooling features of the current Fannie Mae MBS and most of the disclosure framework of the current Freddie Mac Participation Certificate (PC).

The single security will be a first-level securitisation that contains underlying mortgage loans acquired either 100% by Fannie Mae or 100% by Freddie Mac; there would be no commingling of loans. Single securities issued by either enterprise would have key common features that exist in the current market, including: a payment delay of 55 days; pooling prefixes; mortgage coupon pooling requirements; minimum pool submission amounts; general loan requirements, such as first lien position, good title and non-delinquent status; seasoning requirements; and loan repurchase, substitution and removal guidelines.

FHFA's goal is for legacy Fannie Mae MBS and legacy Freddie Mac PCs to be fungible with the single security for purposes of fulfilling TBA contracts. Because the proposed single security design would include most of the features of the current Fannie Mae MBS, an exchange option for legacy Fannie Mae MBS to single securities may not be necessary. To ensure that legacy Freddie Mac PCs are fully fungible with the single security as well, if necessary, investors would be offered an option to exchange a legacy PC for a comparable single security.

The single security would also continue to enable the formation of multiple-lender pools, currently known as Fannie Mae Majors or Freddie Mac Multi-lender pools. The proposal also encompasses second-level securitisations (resecuritisations) of single securities issued by either GSE. Resecuritisations would contain underlying first-level securities issued entirely by Fannie Mae, entirely by Freddie Mac or commingled securities issued by both enterprises.

The initial focus of the initiative would be the highly liquid market for TBA-eligible fixed rate mortgages, with an emphasis on 30-year and 15-year loans. Additionally, 10-year and 20-year mortgages would be in scope.

The development of the single security is expected to be a multi-year effort. Input on the proposal is invited by 13 October.

RMBS

RFC issued on RPL approach

Fitch is inviting feedback on its approach for rating RMBS backed by re-performing loan (RPL) collateral. Under the proposed criteria, the agency expects to analyse the key risk drivers of the RPL asset class using its mortgage loan loss model and existing representation and warranty and due diligence review criteria. However, it notes that since the existing methodologies were developed with a focus on newly originated and seasoned performing collateral, RPL pools and some seasoned performing pools purchased in the secondary market are likely to have factors that require additional consideration or an alternative approach.

The key features distinguishing RPL RMBS analysis from that of new issue RMBS are the limited rep and warranty frameworks or weak rep providers and the potential for incomplete collateral files or missing documentation. Because the servicer's ability to foreclose and liquidate the property takes on heightened relevance in the agency's RPL analysis, Fitch reviewed each of the 35 reps comprising its existing criteria to determine if the risks they are intended to address could be mitigated by a third-party due diligence review of the collateral file or additional credit enhancement.

The agency found that most risks can be addressed by the presence and review of certain loan file documents or additional CE. Therefore, for transactions that do not have all 35 reps listed in existing criteria or that have a below-investment grade rep provider, the due diligence and document file reviews will be critical to Fitch for gaining comfort with lien enforceability and the servicers' ability to foreclose.

Other risk factors identified by the agency include limited servicing and borrower pay history, as well as missing modification type or payment reduction amounts.

When estimating losses on RPLs and seasoned performing mortgage loans, Fitch generally uses the same probability of default, loss severity and rating stress framework as used for analysing newly originated loans. However, it considers additional risk attributes that will drive expected losses for RPL and seasoned mortgage loan pools, which include updated valuation types, borrower pay history and modified payment amounts.

The agency believes that RPL RMBS backed by highly seasoned performing collateral with sufficiently clean performance history could achieve a high IG rating if the reps and warranties, document file and due diligence review, and transaction structure are also supportive of the rating.

Fitch is accepting comments on its proposals until 15 September.

RMBS

BBVA distressed loans understated

Fitch has downgraded 10 and affirmed three tranches from three BBVA RMBS deals, after it found that the volume of distressed loans in the underlying portfolios was understated in the regular reporting for the transactions. The notes were placed on rating watch negative in May, pending analysis of the information provided by the management company Europea de Titulizacion (EdT).

The structure of the three Spanish RMBS recognises loans in arrears by 12 months or more as defaulted with provisions made with excess spread. The structures also provision for loans where the underlying assets have been taken into possession and in a number of instances this is before the loans have reached the 12-month arrears stage and recognised as defaulted. While loans declared as defaulted range between 3.5% and 8.9% of the original balance, the extra data recently received suggests that if loans with foreclosed properties were included, the total number of failed borrowers would be 4.9% (for BBVA RMBS 1 and 2) and 11.7% (BBVA RMBS 3) of the original balance.

Despite the recent decline in the reported constant default rate in BBVA RMBS 1, the inclusion of loans with foreclosed properties in the provisioned amounts has meant that the volume of un-provisioned loans continued to increase to June 2014, when the first decline of €700,000 was reported. Meanwhile, credit enhancement for BBVA RMBS 2 and 3 continues to be eroded by an increasing amount of un-provisioned loans.

As of 2Q14, the balance of these implicit principal deficiencies ranged between €10.7m and €202.1m. Analysis of the defaulted loans suggests that the underlying borrowers have adverse credit characteristics: broker-originated loans (on average 55.6% of the defaulted balance) and/or loans to borrowers with temporary employment contracts (on average 20.6%) or self-employed (on average 18.8%).

"Although the level of arrears in the three transactions remains low compared with most other Spanish RMBS transactions, Fitch does not put much emphasis on the pipeline of late-stage arrears as an indicator of future defaults," the agency explains. "The tendency of the servicer to start foreclosure proceedings ahead of the 12-month arrears default definition would suggest that the pipeline of future enforcements is understated."

Information on sold properties suggests that the market value decline across the BBVA series has been steeper than the market average. In its analysis of the transactions, Fitch found that sales on properties sold in 2013 achieved only 27.5% of the original property values.

Given the already high loan-to-value nature of the loans in the underlying portfolios, recoveries on these assets are expected to be limited. In combination with the expected defaults, the agency concludes that the expected losses for these portfolios across all rating scenarios no longer warrant their current ratings.

In order to estimate more precisely the levels of actual defaults in BBVA RMBS and other EdT-managed Spanish RMBS, Bank of America Merrill Lynch European securitisation analysts calculated the level of provisions accrued to the deals via the artificial write-off mechanism based on available waterfall data. They then compared default rates derived in this manner with default rates based on cumulative 18-month delinquencies.

The BAML analysts find that during 2013-1H14 the average default rate re-estimated using waterfall data was 1.3% for BBVA 2007-1 and 2007-2 (versus a previously estimated average rate of circa 0.8%), while it was 2.3% for BBVA 2007-3 (versus 1.4%). "While for senior tranches this may not necessarily imply significantly different performance, for lower-rated tranches using correspondingly higher CDRs, it is likely to lead to a much less attractive return profile, as CE in these deals are lower than average - making them more sensitive to CDR assumptions," they observe.

The analysts found that the pattern of high levels of defaults being either declared early or being repossessed early does not seem to be repeated in other EdT-managed Spanish RMBS.

RMBS

RMBS 3.0 green paper released

SFIG has published the first edition of its RMBS 3.0 Green Paper series, a series of papers aimed at restoring confidence in the private label RMBS market. The papers are a product of SFIG's RMBS 3.0 initiative - a broad industry-supported endeavour designed to develop proposed standards and reduce substantive differences within current market practices.

The Green Papers are preliminary documents released with the aim of stimulating further debate and discussion. Ultimately, they are expected to evolve into a final set of White Papers, relating both to the release of Green Papers and to additional agenda items identified for future delivery.

The RMBS 3.0 initiative was launched following an October 2013 SFIG RMBS roundtable, where representatives from various industry sectors came together to debate issues inhibiting the return of the RMBS market. Subsequently, SFIG formed its RMBS 3.0 Task Force including individuals from over 50 institutional members across all industry sectors. Work streams are co-chaired by at least one issuer, one investor and other relevant market participants.

The initiative seeks to: create standardisation where possible, in a manner that reflects widely agreed-upon best practices and procedures; clarify differences in alternative standards in a centralised and easily comprehendible manner to improve transparency across RMBS deals; develop new solutions to the challenges that impede the emergence of a sustainable, scalable and fluid post-crisis RMBS market; and draft or endorse model contractual provisions, or alternative benchmark structural approaches.

The release of SFIG's second edition Green Paper is expected in early November, to coincide with the SFIG/IMN's 1st Annual Private Label RMBS Reform Symposium.

RMBS

Association urges PLS support

SIFMA has responded to a request for comment from the US Treasury on the development of a functioning private-label securities (PLS) market with a series of high-level suggestions. It has also responded to an RFC from the FHFA on GSE guarantee fees, including how they might impact PLS.

SIFMA applauds the Treasury's efforts to boost PLS (SCI 1 July) and notes the market is constrained by the lingering effects of poor origination practices during the housing boom as well as ongoing issues such as regulatory uncertainty, disagreement over roles and responsibilities of transaction participants. The association also notes that the comparative advantage provided to GSE and FHA MBS due to government guarantees is another contributing factor.

PLS execution typically comes at a higher all-in cost than GSE or bank portfolio execution and SIFMA says investors need more confidence to invest in mortgage credit risk in the PLS market. Efforts should therefore focus on increasing competitiveness of PLS so that issuance can grow.

Investors are also concerned about data and transparency of cashflows, documentation and the enforcement of contractual terms as well as eminent domain and other ex-post policy changes. SIFMA also identifies difficulties estimating future costs of doing business as another factor holding the market back.

Uncertainty around the direction of GSE reform and broader housing policy questions have also discouraged issuance, says SIFMA. The association suggests that GSE reform should move forward, regulations should be finalised, policymakers should pay more consideration to the costs to originators and securitisers, policy risk should be mitigated and industry dialogue should continue.

As for the FHFA's RFC on guarantee fees, SIFMA says a balance must be struck which protects taxpayers from credit risk and ensures the availability of credit to mortgage borrowers without unduly raising costs. The impact of changes to liquidity in the market and creating a more level playing field for PLS should also be kept in mind.

RMBS

SFIG proposal 'positive' for RMBS

SFIG's proposal to increase standardisation and transparency in the US RMBS market (SCI 7 August) is a positive step forward for the industry, says Fitch. The agency believes the establishment of best practices that focus on aligning interests and increasing transparency can only improve market confidence and drive a more sustainable and scalable market.

"Post-crisis RMBS remains a niche market, with very limited issuance," Fitch observes. "Weak RMBS economics, open regulatory issues and thin investor demand have all weighed on the market's restart. While collateral underlying new issue RMBS transactions remains strong, varying rep and warranty frameworks have also emerged with mixed investor views."

The agency suggests that SFIG efforts through Project RMBS 3.0 could help improve structural and disclosure standards that should ultimately help increase investor confidence. Key topics covered include the standardisation of fraud and compliance reps and related materiality factors, mandatory breach review triggers and make-whole provisions, and expanded underwriting guideline and due diligence disclosure.

SFIG plans to release additional proposed standards on a quarterly basis.