Contents

Structured Finance

SFR securitisations surveyed

Five firms have so far completed eight transactions for US$4.4bn in the single-family rental (SFR) securitisation market's first year. Growth in the sector is slowing, however, as the stock of distressed properties lessens and foreclosure timelines in judicial states lengthen.

Deutsche Bank ABS strategists note that the eight SFR deals issued so far have structurally been quite similar, with a single loan as collateral, five-year fully-extended maturities and either two- or three-year initial terms. Capital structures comprise triple-A to double-B rated tranches, with cashflow received sequentially from top to bottom and losses applied sequentially from bottom to top.

However, average all-in borrowing costs have increased from 159bp for the first 2014 deal (CAH 2014-SFR1) to over 200bp for the most recent deal (ARP 2014-SFR1), with greater spread widening observed in lower-rated tranches. Both the rating agencies and investors appear to have become more conservative in their views as the market has progressed, according to the strategists.

For example, the percentage of the loan balance receiving triple-A ratings has declined from 50% in the initial IH 2013-SFR1 securitisation to about 40% on the most recent four deals. Debt service coverage ratios also have increased from just over 2x for the first two deals to a range of 2.5x-3x for later deals.

If the DSCR falls below 1x, cashflow will be insufficient to pay the required principal and interest and the bond 'breaks'. The Deutsche Bank strategists calculate the breakeven levels of stress on the three factors (lower rents, higher expenses and higher vacancies) needed for the DSCR to fall just below 1x, assuming that vacancy levels are identical at 12.5% and that the degree of stress on revenues and costs are equal.

They estimate that the breakeven level of stress for the CAH 2014-SFR1 bond is 8% - meaning that at a 12.5% vacancy rate, there is sufficient free cashflow to pay all required principal and interest, if revenues decrease by 8% and costs increase by 8% concomitantly. The breakeven stress point is highest at 18% for AH4R 2014-SFR1, while it ranges between these two extremes for the other transactions.

The strategists note that only small differences exist between deals in terms of the size of the houses in collateral portfolios. The average size across all securitisations is 1845 square-feet.

With respect to age, however, the houses in ARP 2014-SFR1 and AH4R 2014- SFR1 average about 12 years old, compared with 24-30 years for houses backing the other deals. Yet American Homes 4 Rent spends nearly three times as much on renovations as American Residential Properties. The strategists suggest that this discrepancy may help explain why Morningstar assigned only 3.2% capex costs in the AH4R budget versus 9.1% capex costs for the ARP budget.

Meanwhile, differences in geographic concentration can help explain differences in capital structure. Properties securitised so far are located in 27 MSAs, with five areas - Atlanta, Chicago, Dallas, Las Vegas and Phoenix - accounting for an aggregate 44% of the collateral.

Silver Bay 2014-SFR1 stands out from other portfolios, with 73% of the properties located in just three MSAs. "This factor is in large part responsible for Silver Bay having less than 35% of its collateral value rated as triple-A, compared with 40%-45% for the other deals. Its reliance on external management for a significant part of its portfolio is also a factor," the strategists explain.

Institutional investors generally have achieved gross yields in the range of 10%-12%. But in three of the most heavily-invested areas - Phoenix, Tampa and Riverside - yields have fallen by two percentage points in the last two years, while house prices have risen. Gross yields are likely to fall in other MSAs, as prices rise and rents fail to keep pace.

The strategists suggest that one way of mitigating the risk of declining yields in existing portfolio markets is to invest in markets that have higher average yields. For example, moving down a notch to metropolitan areas with fewer than 500,000 houses but at least 100,000 houses would increase opportunities for achieving average yields above 10%.

"What investors are likely to do instead is to push deeper into potentially higher-yielding submarkets of MSAs in which they already operate," they conclude.

CS

ABS

Auto ABS issuer fined

The Consumer Financial Protection Bureau (CFPB) has taken action against First Investors Financial Services Group for distorting consumer credit records. The agency claims that the auto finance company failed to fix known flaws in a computer system that was providing inaccurate information to credit reporting agencies, potentially harming tens of thousands of its customers.

A CFPB investigation found that First Investors furnished inaccurate information about its customers to credit reporting agencies for at least three years. When the company discovered the problem in April 2011, it notified the vendor of its computer system but did not replace it or take any steps to correct the inaccurate information it had supplied. The CFPB is consequently ordering First Investors to pay a US$2.75m fine, fix its errors and change its business practices.

Structured Finance

European operations spun off

Institutional Financial Markets Inc (IFMI) is to sell its European operations for approximately US$8.7m to C&Co Europe Acquisition, an entity controlled by Daniel Cohen, president and chief executive of IFMI's European operations and IFMI vice-chair. The purchase price consists of an upfront payment at closing of US$4.75m and up to US$3.95m to be paid over the four years following the closing of the sale.

Upon closing, IFMI will also enter into a non-cancellable trust deed agreement, whereby it will retain the right to substantially all revenues from the management of Munda CLO I, as well as the proceeds from any potential future sale of the Munda CLO I management agreement. The Munda CLO I assets under management totalled approximately US$800m, as of 30 June. Revenue generated by the transaction for the twelve months ended 30 June was approximately US$3.4m.

Under the terms of the agreement, IFMI will divest its European operations - including asset management and capital markets activities through offices located in London, Paris and Madrid - and approximately 30 employees will transition to C&Co Europe Acquisition. Upon closing of the transaction, Cohen will resign from IFMI and will receive no termination compensation related to his resignation. He will remain IFMI vice-chair and IFMI's largest shareholder.

Included in the sale are management agreements for the Dekania Europe I, II and III CDOs, as well as management agreements for several European managed accounts. These assets under management totalled approximately US$1bn (or 21% of IFMI's total AUM), as of 30 June.

Although the manager of Munda CLO I will also be part of the transferred business, the Munda CLO I management agreement will be held in trust for the benefit of IFMI. The combined European business to be sold - excluding Munda CLO I - accounted for approximately US$3.2m of revenue and US$2.1m of operating loss during the six months ended 30 June and included approximately US$3.7m of net assets.

Under the terms of the agreement, IFMI may solicit alternative acquisition proposals from third parties for up to 90 days from the signing of the agreement. The transaction is subject to regulatory approval and is expected to close in 1Q15.

IFMI says the move will simplify its business model and provide additional capital to bolster the firm's principal investing portfolio.

Structured Finance

Credit vet recruited

Hermes Fund Managers has appointed Zoë Shaw as head of fixed income, reporting to ceo Saker Nusseibeh. In this new role, she will build on the firm's fixed income and credit capabilities to create a range of specialist credit capabilities that leverage Hermes' unique ownership structure.

Shaw joins from Promethion, where she was md since 2009. Prior to that, she was founder and managing partner of New Bond Street Asset Management and has also held senior roles at BGB UK, WestLB and Bank of America.

Structured Finance

CIFC names new director

CIFC Corp has appointed Jeffrey Serota to its Board of Directors. He was previously a senior partner at Ares Management, until his retirement earlier in the year.

Concurrent with the appointment, Frank Puleo resigned from the CIFC Board to focus on his other business activities.

CLOs

Originator fund uses over-allotment

Blackstone/GSO Loan Financing (BGLF) has raised an additional €40.7m through the issue of 40.7 million shares pursuant to an over-allotment option. The company has now raised a total of €301.2m under its IPO (SCI 21 July).

Since launch, BGLF has closed a €475m three-year revolving credit facility with a syndicate of four international banks and Phoenix Park CLO - which issued the first CLO income note control stake (€23.25m) acquired by the company - was declared effective. Taking advantage of the strong primary market, the company has also invested in approximately €512m par amount of senior secured loans across 53 corporate exposures from 19 industries and 14 countries. The portfolio weighted average price was 99.78%, with a weighted average spread of 4.37%.

Charlotte Valeur, BGLF chair, comments: "The timing of the IPO and [the] issue of new shares has proved to be excellent. July 2014 was the busiest month in the European loan market for seven years, enabling the originator to deploy the IPO proceeds in a very timely manner."

RMBS

BofA consumer relief outlined

Further information has emerged on the US$7bn consumer relief portion of Bank of America's recent RMBS settlement (SCI 22 August). Its scope includes principal forgiveness and forbearance, loan modification and targeted lending, as well as an additional US$490.16m for the payment of a borrower's federal income tax liability associated with any income recognised from the discharge of indebtedness.

The US$7bn in consumer relief is based on a system of credits that varies by the form and magnitude of the relief. For most loan modification options, if Bank of America owns the loan, the US$1 forgiveness/forbearance equals US$1 credit. If the bank services but does not own the loan, US$1 forgiveness/forbearance equals US$0.50 credit.

An early incentive credit of 115% applies to all consumer relief activity offered or completed by 31 August 2015. An enhanced early incentive credit applies to all first-lien principal forgiveness completed by 31 May 2015.

The minimum credit from first-lien principal forgiveness modifications is US$2.15bn, which composes approximately 31% of the required relief. The second- and other junior lien modifications and principal forgiveness associated with a property where foreclosure is not pursued and liens are released have a maximum combined credit cap of US$3bn (comprising approximately 43% of the required relief).

The settlement also provides for participating state minimum amounts, including US$500m for California and New York, US$100m for Illinois and US$150m for Delaware, Maryland and Kentucky combined.

RMBS

FHFA agrees sixteenth settlement

The FHFA has reached a settlement with Goldman Sachs, related companies and certain named individuals. The settlement addresses claims alleging violations of federal and state securities laws in connection with private-label MBS purchased by Fannie Mae and Freddie Mac between 2005 and 2007.

Under the terms of the settlement, Goldman Sachs will pay US$3.15bn in connection with releases and the purchase of securities that were the subject of statutory claims in a US District Court of the Southern District of New York lawsuit. Goldman Sachs will pay approximately US$2.15bn to Freddie Mac and approximately US$1bn to Fannie Mae. This settlement effectively makes the GSEs whole on their investments in the securities at issue.

As part of the settlement, the FHFA, Fannie Mae and Freddie Mac will release certain claims against Goldman Sachs related to the securities involved. The settlement also resolves claims that involved a Goldman Sachs security in FHFA v. Ally Financial Inc., et al.

This is the sixteenth settlement reached in the 18 PLS lawsuits that the FHFA filed in 2011 (SCI passim). Three cases remain outstanding and the FHFA says that it is committed to satisfactory resolution of these actions.

RMBS

Record settlement agreed

Bank of America has reached a comprehensive settlement with the US Department of Justice, certain federal agencies and six states. The settlement includes releases on the securitisation, origination, sale and other specified conduct relating to RMBS and CDOs, as well as an origination release on residential mortgage loans sold to the GSEs and private-label RMBS trusts or guaranteed by the FHA.

The claims relate primarily to conduct that occurred at Countrywide and Merrill Lynch prior to Bank of America's acquisition of the entities. Bank of America will pay a total of US$9.65bn in cash and provide approximately US$7bn worth of consumer relief. The cash portion consists of a US$5.02bn civil monetary penalty and US$4.63bn in compensatory remediation payments.

The settlement resolves certain actual and potential civil claims by the DoJ, the SEC and State Attorneys General from California, Delaware, Illinois, Kentucky, Maryland and New York (all of which are members of the Residential Mortgage Backed Securities Working Group), the FHA and Ginnie Mae, as well as all pending claims brought by the FDIC. Under charges filed by the SEC, Bank of America also admits that it failed to disclose known uncertainties regarding potential increased costs related to mortgage loan repurchase claims, stemming from more than US$2trn in residential mortgage sales from 2004 through 1H08.

Borrower relief will be in the form of mortgage modifications, including first-lien principal and forbearance forgiveness and second-lien extinguishments, low- to moderate-income mortgage originations and community reinvestment and neighbourhood stabilisation efforts, with initiatives focused on communities experiencing - or at risk of - urban blight. This includes lien releases, uninhabitable and abandoned property demolition, and remediation and property donations. Also, Bank of America will support the expansion of available affordable rental housing.

The firm has committed to complete delivery of the relief by no later than 31 August 2018. The consumer relief will be subject to oversight by an independent monitor.

The settlement is expected to reduce 3Q14 pretax earnings by US$5.3bn, or approximately US$0.43 per share after tax. The EPS impact reflects the varying tax treatment of the components of the settlement.

The claims released include current and potential claims for securitisation-related conduct occurring prior to 1 January 2009 under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). The origination release with respect to loans sold to PLS trusts covers all loans originated by Bank of America and its legacy entities and securitised prior to 1 January 1 2009; the origination release with respect to loans sold to the GSEs covers all loans sold to the GSEs by Bank of America or Countrywide prior to 31 December 2013. The FHA release covers loans originated by Bank of America or Countrywide on or after 1 May 2009, on which claims were submitted on or before 31 December 2013 to the FHA.

The settlement does not cover potential criminal claims; potential claims against individuals; and certain purported whistleblower actions. In addition, it does not cover the O'Donnell case, for which Bank of America intends to file an appeal with the US Court of Appeals for the Second Circuit.

ABS

Impact of Argentinean default weighed

Argentina's sovereign default increases the likelihood of rising inflation and falling employment and real wages, threatening the performance of certain ABS, Moody's says. Securitisations backed by unsecured consumer loans whose payments are not automatically deducted from borrowers' accounts will be hardest hit by the sovereign's default.

"Borrowers who use automatic payment deduction typically have more stable jobs in the public sector or are pensioners, and are better able to withstand the effects of rising inflation," says Moody's vp and senior credit officer Martin Fernandez-Romero.

Conversely, unsecured consumer loan obligors of consumer finance companies tend to be low- or middle-income borrowers with private sector jobs, whose purchasing power would weaken significantly with inflation - raising the likelihood of default. "Deteriorating economic conditions will cause delinquencies and defaults in some collateral pools to rise because unsecured consumer loans constitute the largest share of the ABS market in Argentina," adds Fernandez-Romero.

However, performance will continue to be strong for transactions backed by secured consumer loans, such as auto loan and lease ABS. Rising inflation helps ABS backed by secured loans, because the price of the collateral will rise, while the interest remains the same.

ABS

RFC issued on venture debt ABS

Moody's is seeking feedback on its proposed approach to rating venture debt-backed ABS. The agency expects that adoption of the credit rating methodology would result in downgrades of up to one or two notches on its ratings of currently outstanding US venture debt transactions.

The proposed approach includes assumptions about asset correlation, obligor default probabilities and recovery rates on defaulted loans. Moody's has changed the proposed asset correlation assumption to reflect the correlation framework used in Moody's CDOROM software.

Feedback on the proposal is invited by 30 September. Moody's will finalise the changes to its rating approach for venture debt-backed ABS after taking responses into account, following which it will publish its revised methodology.

ABS

Stable default rates for Japanese auto ABS

Japanese auto loan ABS default rates are more stable than those for US prime auto loan ABS, according to Moody's latest Structured Thinking: Asia Pacific publication. The agency notes that this is because their loan pools comprise higher quality debtors that are less prone to unemployment during periods of economic weakness.

"For example, default rates for Japanese auto loan ABS remained stable at low levels, even during the economic downturns that followed the 2008 global financial crisis and the 2011 earthquake and tsunami. In addition, the enforcement of several revised laws since 2007 has led to a tightening of underwriting standards by Japanese loan originators, which, in turn, has contributed to the sector's stable performance," it explains.

The annualised default rate of Moody's auto loan performance index in Japan remained at low levels around 1.6% in 2007 and 2008, before dropping to about 1.3% in 2009. Meanwhile, Japan's unemployment rate increased from 3.7% in 2007 to 4.4% in 2008 and 5.2% in 2009.

The default rate for Japanese auto loan ABS started declining from early 2009, due to a number of factors. First, the gradual enforcement of the revised Money Lending Business Act since 2007 and enforcement of the revised Installment Sales Act in 2010 led to a tightening of underwriting standards by auto loan originators. In particular, the revised laws required better information-sharing between credit bureaus, which resulted in better screening of borrowers.

The changes also required finance companies to more closely monitor member auto dealers. The revised laws have had a particularly positive impact on the credit management of finance companies that are not associated with auto manufacturers, which tend to have higher default rates on the loans they originate than the captive finance companies of auto manufacturers.

Second, some newer auto ABS pools issued since 2009 were composed largely of loans for the purchase of new cars originated by captive finance companies. Loans with these characteristics are less prone to default than those for used vehicles originated by non-captive finance companies.

After the 2011 earthquake, originators bought back receivables of directly affected debtors as part of their support for disaster-hit areas. This helped limit defaults while also increasing the repurchase rate during this period.

Recent auto ABS pools have lower cumulative default rates than older vintages, Moody's reports. Specifically, vintages between 2008 and 2010 contain loans that were originated by the captive finance companies of luxury car manufacturers, which display lower cumulative default rates. Additionally, lower default rates in the 2008 to 2012 vintages reflect the tightened lending policies of non-captive finance companies.

Meanwhile, US prime auto loan ABS default rates increased during the financial crisis. Losses from underperforming vintages between 2006 and 2008 continued to accumulate in subsequent years, leading to a peak in defaults in 2010 in terms of dynamic data. When static data on individual vintages is considered, the performance of US prime auto loan ABS pools improved from the 2009 vintage onwards.

In terms of recent performance, however, Japanese auto loan ABS default rates have increased more than US prime auto loan ABS default rates. This is due to changes in the composition of the index to include deals with relatively high default rates from mid-2012.

Structured Finance

Sunshine Act meeting scheduled

The US SEC is set to hold an open meeting tomorrow (27 August) pursuant to the provisions of the Sunshine Act. The topics slated for discussion include the new Regulation AB 2 and nationally recognised statistical rating organisations (NRSROs) rules.

Specifically, the Commission will consider whether to adopt rules revising the disclosure, reporting and offering process for ABS. The revisions would require asset-backed issuers to provide enhanced disclosures - including information for certain asset classes about each asset in the underlying pool in a standardised, tagged format - and revise the shelf offering process and eligibility criteria for ABS.

The Commission will also consider whether to adopt rule amendments and new rules to implement provisions of the Dodd-Frank Act concerning NRSROs, providers of third-party due diligence services for ABS, and issuers and underwriters of ABS under the Securities Exchange Act of 1934.

Structured Finance

Reg AB 2 concerns highlighted

Lewtan has published the results of a survey of securitisation professionals that aims to understand the market's readiness in adopting the US SEC's Regulation AB 2 proposal and re-proposal. The survey confirms that many issuers and investors are concerned by the potential risks introduced by the re-proposal, particularly regarding how 'potentially sensitive' data is to be provided and handled.

Respondents are divided on how they view that risk; the most common concern is the headline risk posed by potential re-identification of a securitisation issuer's customers. This concern trumped any legal concerns, including Fair Credit Reporting Act or Graham Leach Bliley Act risks and other state privacy laws. Nevertheless, respondents are fairly evenly split on whether there is or is not any risk created by the new overlap between securities laws and consumer privacy laws.

Although public issuance has been on the decline since 2008, it has largely tracked the overall decline in all types of securitised transactions. With the new Regulation AB 2 requirements potentially impacting both public and 144a deals, most respondents believe that private deals will be more prevalent than public or 144a transactions after the adoption of Regulation AB 2.

The majority of respondents are hopeful that the SEC will adopt many of the aspects highlighted in the various comment letters. Specifically, a majority believe that the SEC will reduce the amount and type of loan-level data required. At the same time, loan-level data for RMBS and CMBS are deemed to be the most important - although a fair number of respondents cited auto loan, auto lease, student loan and equipment lease asset classes as being similarly important.

The Lewtan survey also asked issuers what they planned to provide and investors what they hoped to receive. The results were mixed: while some investors wish to receive raw XML data files directly from the issuer, the majority of investors will continue to look to third-party vendors to play an intermediary role.

Finally, since 'don't know' was a valid answer to some of the survey questions, many respondents selected that option. "The only conclusion we draw from that uncertainty is that the industry has only begun to contemplate the impact of Regulation AB 2 on their business. The good news is that we likely won't need to spend much more time on speculation," Lewtan concludes.

Structured Finance

Low Euro default rates continue

The credit performance of European structured finance transactions continues to be resilient. Only 1.6% by original issuance volume of notes outstanding in mid-2007 had defaulted by end-2Q14, according to S&P.

At end-2Q14, the 12-month rolling default rate declined to 0.16%, its lowest level since 1Q10. "At 14.8% at the end of 2Q14, the 12-month rolling downgrade rate has slightly declined over the past six months and is now at a three-year low, primarily due to the fading effect of our European CMBS criteria roll-out and the positive knock-on effect of our 23 May 2014 upgrade of Spain," comments S&P credit analyst Arnaud Checconi.

Consumer transactions continue to outperform corporate transactions, with a cumulative default rate of 0.06% and a cumulative downgrade rate of 29.10%. "We estimate that nearly 70% of notes that were outstanding in mid-2007 have since fully redeemed. This high number is all the more positive, in our view, given that European structured finance is currently experiencing a period of unusually low prepayment rates on many types of underlying collateral," adds Checconi.

S&P's quarterly commentary analyses cumulative rating transitions and defaults from the beginning of the financial downturn - assumed to be mid-2007 - until mid-2014, aggregated by original issuance volume.

Structured Finance

BWIC 'interface' launched

DealVector has launched a central repository for daily BWIC information, which aims to improve liquidity in structured markets. Dubbed BWIC Board, it is a single interface that provides a simple overview of the entire market and notification linkages based on investor preferences.

The platform says that brokers who contribute BWIC list data will maintain control of their relationships while receiving free targeted marketing. They can also use the 'contact holders' feature to reach out directly to holders of BWIC assets.

Meanwhile, the investors should benefit from having all of their daily BWICs consolidated into one intuitive interface and by setting notifications to alert them when a bond they care about comes up for bid. They also can identify/contact which of the brokers with whom they are open have the BWIC list.

Finally, the BWIC Board allows managers of structured deals to be alerted whenever one of their deals comes up for bid, thereby facilitating contact with the deal's investor base.

Structured Finance

VM timing issues highlighted

ISDA has sent a letter to the Basel Committee and IOSCO regarding timing issues for margin rules for uncleared derivatives. The letter outlines industry concerns about the market's ability to meet an implementation date of December 2015.

This concern is based not only on the significant infrastructural changes required of market participants, but also due to the significant coordination effort required of global regulators. The letter notes that implementation has been delayed due to significant issues in the proposed rules, including a lack of clarity and a potential increase in risks. Implementation efforts will continue to be constrained until the rules have been finalised, which does not appear likely to occur until early to mid-2015, according to ISDA.

After the rules are clarified and finalised, the association says that a significant period of time will be needed to put the margin arrangements in place. It therefore proposes that the rules become effective two years after they are clarified and finalised in Europe, Japan and the US.

ISDA also proposes a phase-in schedule for upcoming variation margin (VM) requirements and urges regulators to avoid imposition of implementation dates during the year-end code freeze periods. The association notes that many parties do not currently post VM and implementation of VM requirements will involve fundamental changes to existing VM arrangements.

"A 'big bang' approach - under which all market participants must be fully compliant with the VM rules, as of a single compliance date - is unnecessary and potentially systemically dangerous," it observes. "It is unnecessary because many of the parties required to post VM will be trading in low volumes and will pose very little risk to the system. A big bang approach is potentially systemically dangerous because of the difficulties of implementing the VM requirements simultaneously for a very large population of swap users."

In addition, ISDA suggests that the likely result of imposing VM requirements on smaller market participants is that they would be forced out of the market because they are not able to meet VM operational and documentation requirements. A mechanism therefore needs to be established to permit non-systemic market participants to remain in the derivatives market, it says.

The association requests that VM with zero thresholds is phased in corresponding to the initial margin phase-in, except with an expedited schedule for VM. It indicates that the threshold level should start at €3trn and decrease to €2.25trn, €1.5trn and €8bn in two-month increments, beginning on the date of implementation.

"Under such an approach, all market participants of systemic importance would eventually post VM, while non-systemic market participants (those with less than €8bn in aggregate notional) would not need to post," ISDA explains.

Structured Finance

RFC issued on debt fund approach

Scope Ratings is requesting comments on its recently-published debt fund rating methodology, which entails assigning a credit rating and a risk-return rating to funds invested in debt products. The agency anticipates further strong growth in this segment in Europe (SCI 29 July).

In the real estate segment alone, the number of new debt funds increased sharply from six in 2012 to 31 at end-2013, according to Scope. Stefan Bund, group md and head of asset-based finance at the agency, comments: "Scope expects to see further growth in debt funds and, in response to investor demand for independent analyses, has drafted a methodology that takes into account the specifics of this type of fund."

Scope Ratings' debt funds methodology sets the framework for rating the credit risk of a fund's investment portfolio, as well as the risk-return ratio on the fund's shares. The former addresses the weighted average credit risk of the assets in the fund, while the latter addresses the relation between the credit risk on the investment portfolio and its expected return. Together, they constitute the agency's forward-looking opinion on the fund's credit risk and its risk-return ratio.

The rating of debt funds follows Scope's established rating process based on three analytical blocks, the first of which assesses the weighted average credit risk of the portfolio in order to determine the fund's credit rating. The second block assesses the quality of the asset manager and its ability to manage the fund, as described in the prospectus. Finally, the third block establishes the risk-return rating of the fund by analysing the impact of structural aspects - such as leverage provided to the fund or any risks arising on the transaction partners - and adjusts the credit risk and return assumptions from the first analytical level.

Comments on the methodology are invited by 30 September.

CDS

New Definitions protocol launched

ISDA has launched the ISDA 2014 Credit Derivatives Definitions Protocol as part of the implementation process for the 2014 ISDA Credit Derivatives Definitions. The Protocol is designed to enable market participants to apply the 2014 Definitions to certain existing credit derivative transactions, thereby eliminating distinctions between those transactions and new transactions entered into on the 2014 Definitions.

By adhering to the Protocol, market participants agree to amend transactions within the scope of the Protocol with all other adhering parties to incorporate the 2014 Definitions into the documentation for those transactions in place of the 2003 Definitions. The adherence period for the Protocol is now open and will run until 12 September. The documentation changes set out in the Protocol will take effect on 22 September, when trading using the new Definitions is scheduled to begin.

CDS

Argentine auction rescheduled

The auction to settle credit derivative trades for Argentine Republic CDS is to be held on 3 September. ISDA's Americas Determinations Committee has resolved the challenge received in respect of ISINs ARARGE03E667 and ARARGE03E659 (SCI 20 August).

CMBS

Staples exposure 'fairly limited'

Staples confirmed in its 2Q14 earnings results that it expects to close approximately 140 stores in North America this year, 80 of which have already been closed during the second quarter. An official list of the affected properties has not been published, but Bank of America Merrill Lynch CMBS analysts have identified 83 Staples stores that have been or will be closed this year.

Of these 83 properties, 13 collateralise CMBS conduit loans. The largest exposures include the US$10.25m Greensburg Commons loan (securitised in JPMCC 2011-C4), the 526 Route 111 property backing the US$11.32m Phoenix Retail Portfolio loan (GECMC 2005-C1) and the US$12.01m Arrowhead Promenade loan (GSMS 2012-GCJ7). Although MSC 2004-HQ4 has the largest exposure to Staples of any CMBS deal, recent servicer commentary states that it received an executed letter of intent in July for the purchase of the collateral at a price that is greater than the amount of outstanding debt.

The BAML analysts note that although uncertainty regarding future retail store closings could weigh on investors, the direct exposure that conduit deals have to Staples is fairly limited in aggregate. Additionally, Staples' difficulties are well known - especially given that office supplies derive a significant percent of their overall sales from internet purchases, which may already be factored into many investors' loan loss expectations.

Indeed, the analysts remain significantly more concerned about Sears/Kmart, which has a significant presence in conduit deals. The company last week reported a nearly US$1bn loss in 1H14 and while comparable sales for domestic Sears stores grew by 0.1% year-over-year in Q2, they fell by 1.7% at Kmart stores. Of the roughly 130 locations identified by the company for closure, about 95 stores have already been shut down.

CMBS

Minimal impact from Napa earthquake

Barclays Capital CMBS analysts estimate that US$620m of US CMBS loan allocated balance is located around Sunday's earthquake zone, just south of Napa, California. The area has a high concentration of hotel and retail properties due to its popularity as a tourist destination.

Significant damage was reported to several buildings and homes in and around the Napa area, following the 6.0 magnitude earthquake. Over US$215m of allocated loan balance for nearby CMBS properties consists of hotels, while the property type with the second largest exposure to the earthquake is mixed use, including a US$42m hotel-retail property and several retail-office combinations in downtown Napa.

The cash-out incentive and favourable lending environment for hotels has made loans in Napa a popular choice for new issuance, according to the Barcap analysts. Indeed, most of the exposure to the earthquake was from 2013-2014 CMBS deals, including some recently-issued loans.

The analysts note that 12 loans with balances of more than US$15m are exposed to the earthquake, the largest of which is the US$91m Meritage Resort and Spa securitised in WFRBS 2013-C15. The hotel is located only a few miles from the epicentre of the earthquake, but is reported to have suffered minimal damage and remains operating.

The second largest loan is the US$41.5m Vintage Estate hotel and retail properties loan, securitised in COMM 2013-CR11. The properties backing the loan also appeared to be operating, as of yesterday.

Despite the large number of loans exposed to the earthquake, it is expected to have only a minimal impact on the CMBS universe. All of the loans in the region seem to be performing and the earthquake does not appear to have been severe enough to cause widespread structural damage. Additionally, CMBS loans in a high risk earthquake environment are required to have either earthquake insurance or seismic retro-fitting if an earthquake has the potential to cause a loss of at least 20%.

"We would expect smaller loans to be most at risk, as these might not have earthquake insurance and could be more susceptible to damage and business interruptions. Additionally, some retail properties in the downtown Napa area may be shutdown while the clean-up continues, but are unlikely to default/prepay unless condemned," the analysts observe.

Risk Management

SEF recordkeeping relief issued

The US CFTC has issued a no-action letter providing swap execution facilities (SEFs) time-limited conditional relief from certain data reporting and recordkeeping requirements in relation to confirmations required for uncleared swap transactions. The no-action relief will expire on 30 September 2015.

Commission regulation 37.6(b) requires a SEF to provide each counterparty to a transaction entered into on or pursuant to the rules of the SEF with a written record of all terms of the transaction, which supersedes any previous agreement and serves as the confirmation of the transaction. The no-action letter provides that, for uncleared swap transactions executed on or pursuant to the rules of a SEF, the Commission will not take enforcement action against a SEF in two instances.

The first instance is if a SEF incorporates the terms of underlying previously-negotiated agreements in the confirmation without copies of the underlying agreements first being submitted to the SEF. The second instance is if a SEF fails to obtain by the time of execution copies of the incorporated underlying agreements as required under the recordkeeping provisions of parts 37 and 45 of the Commission's regulations.

This relief is conditioned on copies of all incorporated underlying previously-negotiated agreements being available to Commission staff on request, within a reasonable period of time.

RMBS

Chinese RMBS 'benchmark' welcomed

Postal Savings Bank of China's recent RMBS (SCI 31 July) establishes an important benchmark for the Chinese securitisation market, according to Moody's. The agency suggests that the detailed level of disclosure provided by PSB will likely set the tone for future deals.

China's securitisation market has historically been mainly concentrated in CLOs and auto ABS."If China's RMBS market grows, it will open the door to an asset class that is already significant in developed markets and could offer a longer-term alternative for Chinese investors," says Jerome Cheng, a Moody's svp.

PSB provided a high level of transparency on the transaction structure, the transaction parties, portfolio characteristics, loan origination details, and underwriting and servicing policies and procedures. Moody's notes that such detailed disclosures allow investors to gain greater insight into the operational features and underlying assets of a transaction.

The agency says that the growth of the Chinese RMBS market will hinge on a number of other factors, including: favourable transaction economics and balance-sheet benefits for originators; improvements in the country's mortgage transfer system to make transactions more efficient; and the development of a broad investor base to increase demand and improve pricing. The establishment of an RMBS market could help attract a different and broader investor base to China's securitisation sector, however.

"RMBS offer a longer-term investment opportunity when compared to other securitised asset classes in China. They are also attractive because the additional risk of making a longer-term investment is mitigated by the strong performance of mortgage loans, which are one of the best performing assets on bank balance sheets," Moody's explains.

The weighted average life of the class A notes in the PSB transaction is 7.5 years, compared to less than one year for the class A notes in Chinese auto ABS. Similarly, the weighted average life for the class B notes in the PBS transaction is 16.77 years, compared to 1-2 years in auto ABS.

Low portfolio yield has been one of the major hurdles for the development of the RMBS market in China. For example, the weighted average portfolio yield of the PSB RMBS transaction is 5.88%, compared to the 5.80% interest rate for the class A notes and 6.79% interest for the class B notes.

For the PSB RMBS, the low portfolio yield is partly due to the interest rate discounts provided by lenders on some of the mortgage loans. The average discount rate was about 10% and, in some cases, interest rates were discounted by as much as 30% from the standard interest rate.

Further, the creation of a centralised real estate registration system is important if China's RMBS market is to grow, because it improves transaction efficiency. To conduct mortgage transfers, originators are currently required to go to different real estate registration offices, which can be at the city or even the district level.

"This is a significant burden for small banks that are required to complete re-registration at closing," Moody's observes. "It is less of an issue for highly rated banks or large banks, such as PSB, as they can adopt contingent perfection. However, they will still need to consider the potential for re-registration in the event of a rating downgrade."

RMBS

Competitive environment driving Mexican prepays

Fitch reports that declining interest rates for mortgage products, the halt of new housing construction in 2013-2014 and the importance of house acquisition lending in the banking sector have fostered a competitive environment for tenured borrowers and pushed prepayment rates up on Mexican securitised bank-originated mortgage portfolios. The agency estimates that the weighted average annual CPR of securitised mortgage loans related to rated banks' RMBS is 11%, as of June 2014, up from 8.1% in 2008.

Banxico (Mexico's central bank) has published a 10.8% WA mortgage interest rate for the banking sector, compared to 12.2% in June 2013. Currently, four of the largest Mexican banks offer mortgage loans with single-digit interest rates, according to Fitch. These products are usually associated with LTVs in the 70%-80% range, assuming the loan is not co-financed by government entities Infonavit or Fovissste.

"On average, securitised mortgage loans are 6.8 years old, which suggests performing borrowers have consistently paid monthly instalments through at least one complete credit cycle. Jointly with a gradual housing price appreciation rate, securitised loan LTVs have declined to 50%-60%. We believe lower interest rates and reduced mortgage-transferability costs could continue teasing performing borrowers' prepayment rates," the agency observes.

High CPRs could have a negative impact on RMBS, as a declining number of performing borrowers reduces excess spread that could be used to insulate against future losses from borrower delinquencies. The timing of these events would dictate the overall impact: if losses are back-loaded and excess spread is released during the early life of the transaction, credit protection could be lower than anticipated when losses appear.

But while triple-A rated bank-sponsored RMBS are not isolated from risks associated with growing CPRs, they are well positioned against rising CPRs. This is due to their positive overcollateralisation and excess spread levels, as well as consistent stability in asset quality metrics.

Given the supply shortage of new housing construction seen in Mexico and considering that Infonavit and Fovissste are expanding their credit products which are complementary to banks' mortgage products, Fitch believes a persistent competition for tenured borrowers will continue in 2014-2015.

RMBS

Aussie non-conforming credit quality compared

Moody's reports that the underwriting standards and overall quality of borrowers in Australian non-conforming RMBS portfolios post-financial crisis are better than in comparable transactions in the Australian market pre-crisis and better than in subprime transactions in the US and the UK written pre-2008. The agency compared Australian non-conforming loans with pre-2008 US and UK equivalents due to the lack of US subprime/Alt-A RMBS issuance post-crisis.

"The quality of the more recent portfolios in Australia is higher than the Australian deals written before the global financial crisis, owing to the introduction of more stringent legislation and risk management practices since the global financial crisis," says Robert Baldi, a Moody's analyst. "As for US and UK subprime deals pre-2008 versus Australian non-conforming RMBS transactions either pre- or post-financial crisis, the Australian deals exhibit higher quality because they do not contain many risky types of loans common in the US and UK, such as second-ranking loans."

In contrast to the US subprime/Alt-A and UK non-conforming RMBS issued pre-2008, Australian non-conforming RMBS did not experience a significant rise in delinquencies and defaults after the financial crisis because the country did not suffer the severe economic stress and house price declines that affected the US and UK markets from 2007 onwards. While there are many common elements between Australian non-prime loans and pre-2008 UK and US mortgages granted to borrowers who did not meet traditional prime lending criteria, current market practices and legislation in Australia place strict constraints on lenders, such that the average quality of borrowers in Australia is better than in typical pre-2008 UK non-conforming, US subprime or US Alt-A portfolios.

Australia's non-conforming RMBS market re-emerged in 2013, after stalling as a result of the financial crisis. Over the last 18 months, 10 new transactions totalling A$3bn have been issued, including US$200m in US dollar-denominated issuance from Australian originators.

Moreover, while competition has been strong among non-conforming lenders in Australia post-2008, there has been no evidence of loosening underwriting standards to gain customers. Instead, lenders have focused on price to attract borrowers.

At 30 June 2014, approximately A$1.05bn of non-conforming loans were securitised, as against total mortgage securitisations of A$14.95bn. Some 7% of all RMBS were therefore backed by non-conforming loans, Moody's notes.

The agency reports that currently all Australian mortgage portfolios - including non-conforming RMBS - are performing strongly, supported by the country's low interest rate environment, stable economy and continued house price appreciation.

RMBS

RMBS 2.0 deals to withstand quake losses

The earthquake that struck Napa County will not have any material impact on the ratings of RMBS 2.0 transactions, according to Fitch. Loans on Californian properties comprise, on average, 45% of post-crisis new issue prime jumbo RMBS. However, just 0.36% of loans by balance are secured by collateral in Napa County.

Fitch-rated RMBS deals have comparable exposure at approximately 0.45%, ranging from a maximum of 1.67% for one 2014 transaction to eight transactions having no exposure to the area at all. Given average credit enhancement of roughly 1.1% across these deals for the most subordinate rated tranches (double-B), the agency considers that they are well positioned to withstand any losses that may result from the quake.

Insurance proceeds are not expected to help mitigate property losses, as damage attributable to earthquakes is not covered under general homeowners insurance and most borrowers do not obtain additional coverage. The California Earthquake Authority estimates that just 10% of state residents have earthquake insurance policies; in Napa, the average is 6%.

While the total cost of the damage is still being assessed, initial estimates from catastrophe experts such as EQECAT put losses in the range of US$500m-US$1bn. EQECAT expects roughly 25%-50% of the losses to be attributable to residential property damage, but most of the impact is expected to be felt in the commercial sector by the region's wine industry.

Some market participants have indicated that they plan to work with servicers to reach out to borrowers and potentially inspect properties for damage once aftershocks subside.