Contents

Structured Finance

Critical mass

RPL securitisations gaining traction?

Increasing supply, combined with the high yields on offer is pushing US re-performing loans (RPLs) closer to becoming a mainstream securitisation asset. Concerns remain over the lack of information provided on such loans, however.

A recent Barclays Capital analysis found that around US$658bn in US non-performing loans (NPLs) is circulating, with a further US$500bn-$600bn in re-performing loans estimated to be outstanding (SCI 24 September). This volume is expected to increase further with Fannie Mae and Freddie Mac preparing to sell whole loans over the next couple of years.

The rise of RPLs in the US RMBS market is one fall-out from the 2008 crisis. "There were a bunch of settlements in which servicers - mainly banks - were subject to enforcements from the OCC and Fed, where they were required to modify underlying mortgage loans to get borrowers back to performing status," says Gaurav Singhania, svp RMBS at Morningstar Credit Ratings.

Changes involved a combination of interest rate reductions, payment relief, modification of loan terms, reduction of loan balances and so on. The modifications have enabled some borrowers to catch up on their mortgage payments, paving way for RPLs to become more prominent in the market. Re-performers seen today have typically been performing for at least a year.

The difference between RPLs/NPLs and traditional RMBS lies in the history - or lack thereof - of the underlying borrowers. Singhania points out that traditional RMBS deals are put together with fresh loans and new borrowers that do not have any history of indebtedness.

"They have a clean record and full documentation. In contrast, RPL and NPL borrowers are often seasoned. They have an indebted history, which changes the way collateral is analysed," he says.

He adds: "However, the most likely outcome with NPLs is liquidation. Once a seriously delinquent or foreclosure status is reached, very little to no curing is possible at that point."

In fact, there is little uncertainty as to the chances of default with NPLs. Singhania says that rating agencies and investors factor this in as the most likely scenario, whereas with traditional RMBS there would be a longer process involving the prediction of the default and the borrower's behaviour.

"All you have to do with NPLs is predict the liquidation timeline and the costs that come with that. In that sense, it is an easier loan to get your arms around," he notes.

Nevertheless, RPLs and NPLs have still not hit the securitisation mainstream. Singhania suggests that bulk trading of these loan types in the capital markets is a major reason for this.

"Think of it as a wholesale transfer of loans from one issuer to another. These go completely under the securitisation radar. Bank A might step in and say it will buy 500 NPLs from Bank B, so there's no reason to securitise those loans," he explains.

He continues: "Market participants don't generally hear about these transfers; only two bodies have knowledge of them: the seller and the buyer. Even rating agencies don't get the full picture - this is the main reason why we don't see RPLs/NPLs as a mainstream asset. There has been a fair amount of whole-loan assets circulating in the market though."

Another reason is what Singhania dubs the economics of execution. "What we've heard over the past year is yields have been generally attractive for whole loans. A typical non-agency RMBS security might create a yield of around 5%-6% and legacy RMBS seasoned loans will fetch 6%-8%. However, NPLs might provide a yield from 8% to 12%. Investors see an opportunity to double their yield and buy these loans in bulk."

He suggests, however, that shrinking supply will change yield economics for investors, which could make the securitisation avenue more attractive to them in the future.

Brian Grow, md of RMBS at Morningstar, adds that although there has been temptation to rate more RPL and NPL deals, securitisation investors and older rating agencies were extremely wary of the lack of information provided on such loans. Circumstances have changed with time though.

"Now that you have seasoning on the loans, performance history and newer, more innovative players in the market, people are now more willing to look at these loans," he says.

Singhania agrees and suggests that the RPL market, in particular, should continue to come into vogue. "The US$500-US$600bn mentioned by Barclays speaks volumes about the market. I'll add that this number only covers private-label RMBS. The fact of the matter is that there are twice as many loans on the government agency books. There are also twice as many loans, separately, on bank portfolios," he observes.

He concludes: "So there's a huge vent of supply of RPLs in the market. Combine that with the increasing level of data history and this is pushing RPLs closer to that of a mainstream asset."

JA

CMBS

Embracing change

Investor base limiting European CMBS growth

European CMBS investors have this year embraced a wider variety of property types and jurisdictions, as well as greater complexity in terms of multiple loans from unrelated sponsors. However, while the product also appears to be increasingly outcompeting bank lender financing, the size of the investor base is expected to limit issuance volumes in the near term.

European CMBS deal sizes are down and therefore the overall issuance amount is down on last year, but more transactions have been issued in 2014. "The market has moved away from the large multifamily refinancings that characterised 2013 towards a broader range of deal types, including financings of non-core assets. That we're seeing more unconventional deals in the mix is a positive development for European CMBS," observes Conor Downey, partner at Paul Hastings.

For instance, September's €250.14m DECO 2014-Tulip transaction was notable for being the first publicly-rated multi-loan, multi-sponsor European CMBS in six years. The deal funds the purchase of the Deutsche Bank-originated Windmolen (sponsored by PPF Real Estate Holding) and Orange (sponsored by a MK CRE GP/S5 CRE Vastgoed joint venture) loans. The €125.5m Windmolen loan is secured on mortgages over eight offices and one shopping centre, while the €124.5m Orange loan is secured on mortgages over 11 retail properties.

Charles Roberts, partner at Paul Hastings, indicates that the high level of CMBS issuance this year has surprised the industry. "Demand for bonds is increasing, driven partly by limited opportunities for high yielding fixed income product and also partly driven by new fund investors entering the market in search of yield. They are happy with multi-loan transactions, although there appears to be a general preference for fewer loans in a pool; fewer loans are easier to underwrite."

Meanwhile, Downey suggests that market consensus is emerging around risk retention requirements and a European CMBS 2.0 standard. "Arrangers are fully up to speed with the risk retention rules, but investors appear to be a little behind the curve - there are still misconceptions about how it works."

He cites reports of investors questioning the risk retention requirements for Westfield Stratford City Finance as an example - although initially marketing the deal in the summer period didn't give it the strongest start. Once it became clear that the transaction was a single tranche and didn't fall foul of the CRR, Credit Agricole and Deutsche Bank were able to place £750m of the bonds at the beginning of October.

The Westfield Stratford deal is among a handful of single-tranche transactions issued this year. The others include €135m Reni SPV, €237.5m Pangaea Funding I, £107m AYR Issuer and most recently £350m Intu (SGS) Finance series 3.

Downey says that deals aren't actively being structured to avoid risk retention. "Large single-property assets with low leverage have traditionally been structured as a single tranche; for example, the Intu issuances. However, in terms of the bigger picture, at some point risk retention will act as a cap on the amount of CMBS that banks can originate - although we're still quite a way away from that."

The Reni and Pangaea transactions - together with the €410m Taurus 2014-FR1 - were also notable for being unrated. Avoiding the cost of liquidity facilities is the main driver behind such deals, according to Downey.

"They are typically single-asset refinancings and are most attractive to investors where the asset is already familiar and investors are able to take a view on its creditworthiness. Rating agency treatment of liquidity facilities remains an impediment to the growth of the market, although it seems that banks may have a green light to provide such facilities again," he notes.

August's Taurus 2014-FR1 stands out as a highlight for Roberts so far this year. Financing Lone Star's acquisition of the Coeur Defense property out of Windermere XII, he explains that the transaction brought both positives and negatives.

"Now we have a good example of the timeframe for restructurings of this type and there is increased clarity around the enforcement regime in France, but the asset took seven years to resolve," Roberts observes. "I expect more deals securitising the financing of properties emerging from restructurings - they are prime candidates for CMBS."

In particular, he warns that the recovery in asset values may not be significant enough to resolve the leverage hangover. "Many loans remain significantly over-levered and are coming due or being restructured; previously extended loans are also coming due. I expect the industry to continue dealing with legacy issues, while taking advantage of the current optimism regarding property values and credit availability."

The bank lending market typically charges a premium in these situations because of the stigma, whereas it's possible to achieve economic pricing in the capital markets. Downey says: "A functioning market should work like this and drive down the cost of capital. CMBS is outcompeting banks, especially for the more troubled assets."

European securitisation analysts at Bank of America Merrill Lynch believe that the Westfield Stratford transaction, in particular, marked a turning point in the re-emergence of the European CMBS market in that the deal appears to have priced inside the banking market for the first time for prime property. Previously, banks and other balance sheet lenders had typically been more competitive than CMBS for financing prime assets in core markets, with CMBS being used to finance lower quality assets.

The BAML analysts suggest that issuance could therefore grow significantly and encompass higher quality assets as more borrowers are attracted to the potential cost savings from CMBS. At the same time, CMBS spreads could tighten materially over roughly the next three to six months on the back of the ECB's ABSPP.

If triple-A spreads tighten to 60bp, for example, CMBS could become roughly25bp cheaper than bank loans for borrowers to finance prime UK property. "For many borrowers, we think a potential 25bp saving could go a long way to justify the perceived additional complexity of CMBS," the analysts note. "Faced with a potential 25bp saving, we think more borrowers will opt for CMBS over bank lenders, which could be a game changer for CMBS issuance in terms of raising issuance volumes and including more high quality assets in core countries."

SCI's new issue database shows that six European CMBS for a total of €1.59bn have been issued so far this year, as well as five UK CMBS for a total of £1.53bn. Jurisdictions represented include France, Greece, Italy and the Netherlands.

One notable jurisdiction that is yet to be tapped in 2014 is Germany, although at least one or two German deals are slated to come this year, away from the multifamily segment. Indeed, IVG Immobilien is said to be currently preparing a €750m transaction.

With competition in the bank lending market potentially neutralised, the analysts believe that the biggest remaining obstacle to European CMBS issuance is the size of the investor base. Only 27 accounts are understood to be buying new issue CMBS at present.

While this number is expected to grow as the search for yield intensifies and more transactions contain prime quality assets in core property markets, it is unlikely to see a quantum leap in size. "To move CMBS from being a niche product in Europe to a mainstream product as it is in the US, there needs to be greater standardisation between deals in terms of the lending criteria, definitions, documentation and reporting, in our view," the analysts conclude.

CS

RMBS

Euro MBS activity winding down?

The European MBS markets have been quiet for the last week or two. Sterling prices in particular are refusing to tighten as investors appear reluctant to pursue paper.

"Most people have had a good year so I do not think they want to do much more before year-end," says one trader. "There was the big portfolio which traded last week from a German bank, but otherwise it has been quiet."

While some trades followed that burst of activity, the market has quietened down since. The trader notes that clients are frequently blaming the ECB for their lack of activity.

"They want to wait and see what will happen with the ECB. That is almost understandable for RMBS investors, but given the ECB will not be purchasing CMBS, it is a much weaker excuse there," says the trader.

He continues: "If you think that the ECB buying is going to happen then waiting until prices move will mean you are late to the party. That said, I think the larger issue here is that people have had a good year and they are seizing on this as an excuse because, now we are near year-end, they do not want to do much more."

Like RMBS, the CMBS market is quiet, says the trader. He notes that prices have generally pulled back, although multifamily is now stable.

"We have done some trading, mainly in seniors, but it is largely just bits and pieces. Clients are better sellers at the minute. Italian paper is also a bit weaker," says the trader.

SCI's PriceABS data picked up a few European CMBS names and several RMBS. Among the CMBS names was the LEMES 2006-1 C tranche, which was talked in the mid/high-97s to 98 area and which was covered at 97.875, while VELAH 4 A2 was an Italian RMBS tranche which was talked at low/mid-98 and covered at 98.65.

A trend in the primary market has been for sterling paper to price at the wide end of price guidance and this is also something the trader has noticed. Paragon Mortgages 21 provides the latest example.

"Paragon came pretty wide. While that has obvious implications in the primary market, it also causes waves in secondary where people start to re-evaluate whether prices are too tight," the trader says.

JL

Secondary markets

US CLO buyers hold sway

The US CLO market is being driven by buyers rather than sellers so far today.

"We're seeing a few small sellers, but it's very light volume today," says one trader. "Instead it's mainly about buyers and they are looking for 1.0 deals with a high coupon and coming with a strong bid. Holders appear to be happy to sell into those levels."

Buyers are also being selective on structure. "We continue to see manager tiering between the better managers on Volcker deals versus the better managers on the non-Volcker deals, particularly at the higher part of capital stack - lower down it's still there but to a less noticeable extent," the trader reports.

Secondary markets

Triple-As today

Amid a reasonably busy day for CLO BWICs either side of the Atlantic today, two triple-A European CLO auctions due this afternoon are currently dominating traders' attention.

A ten line €20.9m list is due at 13:00 London time. It consists of: CRNCL 2006-1X A2, DUCHS VII-X A1, EGRET I-X A, EUROC VI-X AT, GSCP I-RX A1, HYDEP 1A A1, HYDEP 1X A1, JUBIL VII-X AT, JUBIL VI-X A1A and OCI 2007-1X A2. Only GSCP I-RX A1 has covered with a price on PriceABS in the last three months - 99.76 on 17 September.

Then at 14:00 there are eight line items with a total original face of €143.755m. The bonds are: ARESE 2007-1X A1, DRYD 2006-14EX A1, DRYD 2006-15X A1, GSHAM 2006-3X A2, GSHAM 2007-4X A2, OCI 2007-1X A2, QNST 2006-1X A2 and QNST 2007-1X A1. Only DRYD 2006-14EX A1 has covered with a price on PriceABS in the last three months - 99.3 on 29 October.

Secondary markets

European ABS/MBS stay firm

The European ABS/MBS markets are staying firm ahead of the ECB press conference this afternoon at 14:30 CET.

Spreads have tightened a little across euro-denominated ABS/MBS deal types over the last few days and into this morning. At the same time, a buying bias in UK CMBS and RMBS emerged yesterday and today.

The moves are primarily driven by the widely touted view that today's ECB press conference will provide further details on the ABSPP. Most traders are taking a positive view on what will be revealed, but there remain some investors with the belief that the ABSPP announcement, whenever it comes, has significant potential to disappoint.

Secondary markets

Big lists keep coming in non-agency RMBS

Today saw the latest in a succession of large BWICs in the US non-agency RMBS market and more are expected to follow.

A $1.2bn list from a GSE traded at 10:00 New York time this morning with all lines executed at slightly higher than talk. "We've seen a few of these big lists lately and they've gone well as they offer efficiencies for sellers and and one-stop shopping for buyers. So, we expect more and more of these lists to come over time," says one trader.

The downside has been in the past that big lists tend to mute trading volume elsewhere in the RMBS secondary market as traders focus purely on the big ticket auctions. However, the trader notes that the market has become more used to the big lists and now absorbs them better.

Indeed, there are BWICs from a range of sellers, including some liquidators, scheduled to trade throughout the remainder of today. "There are a few lists behind the big list today and that used not to happen in the past. That said, if you take the big list out of the equation BWIC volume today is currently around $500m, which is quiet for a Thursday, but that's the way the market is operating at the moment - slowly but surely as people position for year-end with prices grinding higher."

Secondary markets

No news is good news for euro ABS/MBS

The European ABS/MBS has taken the lack of any further ABSPP details from the ECB yesterday in its stride.

"Draghi mentioned ABS enough times to alleviate any concerns that the ABSPP would not happen at all," says one trader. "Even the optimists who expected a buying timeframe to be announced yesterday have taken their disappointment well."

Consequently spreads have remained unchanged from Wednesday's close into this morning. Equally, there has been no major upsurge in activity since the ECB press conference - the few BWICs there have been have traded in line with expectations and it has been quiet off-BWIC other than some two-way trading in Spanish bonds.

Rumours are now circulating that ABSPP purchasing will start the week after next. But as the trader says: "They are just rumours and no one is sure of their veracity or who is behind them."

Secondary markets

Subprime strong

A strong pipeline of US subprime RMBS BWICs for next week is already building with more expected to follow.

"Next week will be an interesting week in US subprime, says one trader. "The sector has traded well this week and now there's a decent amount of accounts putting lists out for next. We expect more to follow during the week including at least one really big list."

However, the trader warns: "All that supply is subject to a decent nonfarm payrolls number today." The NFP figures are released at 08:30 New York time.

Assuming there are no surprises in NFP, the trader expects the sector to remain busy throughout November. "There should be a lot more activity over the rest of the month as subprime RMBS investors rebalance their positions prior to the December lull," he says.

Secondary markets

CMBS BWIC matches investor interest

A European CMBS BWIC due for trade later today is expected to go well as it matches recent investor interest.

The two line auction is due at 14:00 London time and consists of €5m of DECO 2007-E5X D and £6.35m of NEMUS 2006-2 E. Neither bond has traded with a price on PriceABS this year.

"We've been seeing increasing investor interest in deep mezz European CMBS," says one trader. "It's being driven by people wanting to put on convexity plays."

Secondary markets

US RMBS stays quiet

The US non-agency RMBS market is relatively quiet today ahead of tomorrow's public holiday.

"We're seeing very light volume today as many people are using Veterans Day to make it a four day weekend," says one trader. "There have been a couple of BWICs from a big money manager who has had redemptions and a sizeable wrapped list from a hedge fund seller, so nothing really out of the ordinary."

Friday's nonfarm payrolls number was neither big enough nor small enough to shake up the RMBS secondary market. However, the calm won't continue for too long.

"I expect volatility will pick up again in the next few weeks," says the trader. "It's just that right now I can't see a catalyst for it to do so."

Secondary markets

Euro ABS/MBS unmoved

The European ABS/MBS markets are so far unmoved by confirmation that next week will see the start of the ABSPP.

In a speech late yesterday ECB board member Yves Mersch confirmed that the ECB will be ready to starting buying ABS next week. Market speculation is now that 19 November will see the first purchases.

Spreads were unchanged on the day at yesterday's close and have not moved yet this morning on very low volume. Expectations continue to be that activity will remain light until ABSPP finally begins.

Secondary markets

Flurry of Trups CDO auctions due

The next two days look to be busy ones by recent standards for the Trups CDO market, with a flurry of BWICs already scheduled.

Tomorrow starts with a single $500,000 line of TRPE 2005-1X SUB due at 10:00 New York as part of a larger CLO list. The equity piece hasn't traded on PriceABS before.

Then, at 11:30 there is a five line triple-A list totalling $8.64m of original face consisting of PRETSL 16 A1, PRETSL 17 A1, PRETSL 21 A1, USCAP 1A A1 and USCAP 2A A1. Only two of the tranches have traded on PriceABS in the last three months - PRETSL 16 A1 and PRETSL 21 A1, last doing so at LM70s on 15 October and L70s on 7 October, respectively.

At 14:00 there is another triple-A list of three lines totalling $78.643m. It consists of: TRAP 2003-3A A1B, TRAP 2003-5A A1B and USCAP 2 A2. TRAP 2003-5A A1B is the only bond to have traded on PriceABS in the last three months, covering at M70s on 16 September.

Finally, at 11:00 on Thursday is the 15th FDIC auction, this time consisting of 17 bonds with a total original face of $86.8m. The bonds involved are: PRETSL 24 D, TBRNA 2005-2A B, TBRNA 2005-2A C1, TBRNA 2005-3A B1, TBRNA 2005-4A C2, TBRNA 2005-4A D1, TBRNA 2006-6A E1, TBRNA 2006-5A A3, TBRNA 2006-5A B1, TBRNA 2007-8A E, TPREF 2 INC, TRAP 2006-11A E1, TRAP 2006-11A E2, TRAP 6 PREF, TRAP 2007-13A F, TRAP 2007-12A E1 and USCAP 2 SUB. None of which have traded on PriceABS in the last three months.

Secondary markets

CLOs get under way

The week gets fully under way in the CLO space today with eight BWICs already scheduled either side of the Atlantic.

Today's auctions see 42 line items totalling 243.9m in original face. Tranches from all areas of the capital structure are represented, so it is perhaps fitting that the day begins with a triple-A list and ends with some equity pieces on offer.

14:00 London time sees a two line triple-A list made up of €20m of ALME 2X A and €28.051m of ARBR 2014-1X A. neither bond has traded on PriceABS in the last three months.

The current schedule sees the day ending at 14:30 New York time with a six line list totalling $20.47m. It consists of five equity tranches and a double-B slice: INGIM 2006-3A PREF, INGIM 2006-3A SUB, KING 2006-3A SUB, OCT11 2007-1A INC, VENTR 2012-12A E and WITEH 2006-4X SUB.

Only double-B rated VENTR 2012-12A E has traded on PriceABS in the last three months. It covered at 92.3 on 9 October.

Secondary markets

Europe shaking off its slumber?

European secondary markets are attempting to shake off their pre-ABSPP slumber this morning with activity and interest being seen across asset classes.

After a quiet couple of days, traders report increased investor buying interest in both core and peripheral CMBS and RMBS. "Everything feels a bit more pro-active today and we've moved a bit tighter as a result," says one.

On-BWIC interest this morning has focused around two lists of rarely seen bonds due at 12:00 London time. One is a £70m block of AIREM 2006-1X 2A3, which has never appeared on PriceABS.

The other is two lines of ABS CDO CAVSQ 2 - the €19.2m combo note and a €1.9m slice of equity. Again, neither has ever appeared on PriceABS.

Once those auctions are completed attention will shift to the predominantly more regularly traded names in the healthy schedule of ABS, CLO and MBS BWICs for the remainder of the European day.

ABS

Punch A bonds still offer value

In light of Punch's latest results, Punch A bonds continue to offer better value than Punch B across the capital structure, say Barclays Capital analysts. While both Punch A and Punch B may be refinanced in a couple of years, Punch B seniors are pricing in some probability of refinance already.

Punch's results suggest the core estate can continue to grow at 1% per annum and disposals continue at a good pace, with the company selling 102 pubs for £43m, which £14m above book value. With both securitisations in dividend block, refinancing is expected in two years when the non-call period ends.

The analysts identify the Punch A class AFs as having upside to 119, where they would trade on a spread of 250bp, with further upside to 124 over the next two years. The market is expected to begin to price in a further refinancing of the capital structure in that time.

Punch A class AV bonds also have upside and should trade in line with the AFs. While there is an argument to say there should be a liquidity premium for the AVs, the analysts say this is mitigated by the requirement on Punch A to prepay and buy back bonds.

The Punch A class M3s are also attractive on their running income yield of Libor plus 550bp, the analysts note. With a price of 98.5 they earn a yield to call in two years of around 7%.

JL

Structured Finance

SCI Start the Week - 10 November

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

Pipeline
Another fifteen deals joined the pipeline last week. They consisted of four ABS, one ILS, six RMBS, two CMBS and two CLOs.

The ABS were US$1bn AmeriCredit Automobile Receivables Trust 2014-4, US$556.3m Apollo Aviation Securitization Equity Trust 2014-1, US$200m Diamond Resorts Owner Trust 2014-1 and C$450m MBARC 2014-A. The ILS was US$350m Ursa Re 2014-1.

A$500m Avoca Series 2014-1, €98.11m ELIDE FCT Compartiment 2014-01, FCT Opera 2014, €7.5bn FTA RMBS Santander 3, US$402.8m JPMMT 2014-IVR6 and Precise Mortgage Funding 2014-2 accounted for the RMBS, while the CMBS were US$307.6m Colony 2014-FL2 and US$463.9m MSCI 2014-MP. Meanwhile the CLOs were US$410.79m ACAS CLO 2014-2 and €415m Castle Park.

Pricings
A long list of deals priced last week, led by 11 ABS. There were also four RMBS, three CMBS and five CLO prints.

The ABS were: US$1bn Ally Master Owner Trust Series 2014-5; US$710.63m Bank of the West Auto Trust 2014-1; €537m Bumper 6 (NL) Finance; US$1.2bn CarMax Auto Owner Trust 2014-4; US$1.3bn Chase Issuance Trust 2014-7; US$250m Cronos Containers Program I Series 2014-2; US$220m First Investors Auto Owner Trust 2014-3; US$150m Hawaii Green Energy Market Series 2014-A; US$433.33m NextGear Floorplan Master Owner Trust series 2014-1; US$303.2m SoFi Professional Loan Program 2014-B; and US$325m World Financial Network Credit Card Master Note Trust Series 2014-C.

US$350m Agate Bay Mortgage Trust 2014-3, US$562.1m Invitation Homes 2014-SFR3, £256m Paragon Mortgages No.21 and A$300m WB Trust 2014-1 accounted for the RMBS, while the CMBS were US$350m CSMC 2014-TIKI, £350m Intu (SGS) Finance 3 and US$1.01bn JPMBB 2014-C25. Lastly, the CLOs were: US$507m AMMC CLO XV; US$512m Carlyle Global Market Strategies 2014-5; US$525m Covenant Credit Partners CLO II; US$356m Golub Capital Partners CLO 21(M); and US$513m Ziggurat CLO.

Markets
Activity in the European RMBS and CMBS markets appears to be winding down, as SCI reported on Friday (SCI 7 November). One trader notes that clients are frequently blaming the ECB for the lack of activity, but suggests this may simply be a handy excuse.

"If you think that the ECB buying is going to happen then waiting until prices move will mean you are late to the party. That said, I think the larger issue here is that people have had a good year and they are seizing on this as an excuse because, now we are near year-end, they do not want to do much more," he says.

In the US non-agency RMBS market, a large US$941m BWIC on Tuesday significantly boosted supply in the secondary market (SCI 5 November). SCI's PriceABS data recorded a number of trades from the session as execution appears to have been strong, with covers recorded for several tranches, such as ABSHE 2003-HE3 M3, which was covered in the mid/high-80s.

US CMBS started the week strongly while other markets were quiet (SCI 4 November). BWIC volume on Monday was around US$150m, while a US$120m of legacy floater bonds came out on Tuesday.

US CLO secondary market activity was elevated last week, with BWIC volume of around US$830m. "Over US$500m of this week's volumes came from legacy deals and just over US$300mn of these had original ratings of triple-A in particular," note Bank of America Merrill Lynch analysts. "Overall, US secondary spreads remained unchanged over the week."

Deal news
• Jerrold Holdings has closed a restructuring of the £557.7m Charles Street Conduit Asset Backed Securitisation 1, believed to be the first publicly-rated warehouse securitisation since the financial crisis. Issuance of such transactions is expected to increase in the UK, particularly those sponsored by non-rated or low-rated lenders in relation to consumer and light commercial loans.
• A binding sale and purchase agreement has been executed in respect of the sale of all of the subsidiaries of the Titan Europe 2007-1 (NHP) borrower, through the sale of all of the shares of NHP Holdco 1 to a bid vehicle backed by Formation Capital. The move follows the special servicer's determination that implementing a sale of these subsidiaries is in accordance with the servicing standard.
• Dock Street Capital Management has replaced Dynamic Credit Partners as collateral manager to Monterey CDO. Under the terms of the agreement, Dock Street will assume all the responsibilities, duties and obligations of the collateral manager under the collateral management agreement.
• STMicroelectronics's five-year CDS have widened by 39% over the past month to trade at the widest levels observed in nearly two years, according to Fitch Solutions. The widening outpaced the broader European technology CDS index, which moved out by just 6% over the past month.

Regulatory update
• The Basel Committee has issued the final standard for the net stable funding ratio (NSFR), which requires banks to maintain a stable funding profile in relation to their on- and off-balance sheet activities, including unfunded credit and liquidity commitments in securitisations. The NSFR will become a minimum standard by 1 January 2018, with disclosure standards expected to be published for consultation around year-end.
• The Amsterdam Court of Appeal has ratified the framework agreement that sets out the compensation amount formula on due care claims of clients of the now bankrupt DSB Bank. Moody's says the move is credit positive for the securitisations originated by DSB as it removes some level of uncertainty around the amount of potential losses linked to due care compensation, as well as the length of the involvement of the bankruptcy trustees in servicing loans and handling due care claims.
• A federal judge has given final approval to a US$275m cash settlement in the MBS class action litigation against RBS and others led by New Jersey Carpenters Health Fund, Boilermaker Blacksmith Pension Trust, Iowa Public Employees' Retirement System and Midwest Operating Engineers Pension Trust Fund. Plaintiffs were represented by Cohen Milstein Sellers & Toll.

Deals added to the SCI New Issuance database last week:
ALME Loan Funding III; Anchorage Capital CLO 5; COMM 2014-CCRE20; JPMCC 2014-PHH; Koromo Compartment 2; Marathon CLO VII ; Navistar Financial Dealer Note Master Owner Trust II Series 2014-1; Private Driver 2014-4; Sapphire XIII series 2014-1; Sierra Timeshare 2014-3 Receivables Funding; STACR 2014-DN4; STACR 2014-HQ3; Telos CLO 2014-6 ; Tennenbaum Senior Loan Funding III; WB Trust 2014-1; WFRBS 2014-C24

Deals added to the SCI CMBS Loan Events database last week:
BACM 2004-4; BACM 2006-3; BACM 2007-5; BSCMS 2006-T22; CD 2006-CD2; CGCMT 2005-C3; CGCMT 2006-C5; COMM 2004-LB3A; COMM 2006-C8; CSFB 2005-C4; CWCI 2006-C1; DECO 2006-C3; DECO 2007-E5; DECO 2007-E7; DECO 8-C2; ECLIP 2007-1; GECMC 2002-1A; GECMC 2006-C1; GMACC 2001-C2; GSMS 2005-GG4; GSMS 2006-GG8; GSMS 2007-GG10; GSMS 2010-C1; GSMS 2012-GCJ7; JPMCC 2004-LN2; JPMCC 2006-CB14; JPMCC 2007-C1; JPMCC 2010-C1; MSBAM 2012-C6; MSC 2007-HQ12; TAURS 2006-2; TITN 2007-1; TITN 2007-CT1; TMAN 5; WBCMT 2005-C22; WBCMT 2006-C23; WBCMT 2007-C30

Structured Finance

A closer look at US credit risk retention rules

Morrison & Foerster of counsel Melissa Beck, senior of counsel Kenneth Kohler and senior of counsel Jerry Marlatt examine the finalised risk retention methods and their impact on the securitisation market

In a flurry of regulatory actions on 21 and 22 October, the FDIC, the OCC, the Federal Reserve Board, the SEC, the FHFA and the Department of Housing and Urban Development each adopted a final rule implementing the credit risk retention requirements of section 941 of the Dodd-Frank Act for ABS. The section 941 requirements were intended to ensure that securitisers generally have 'skin in the game' with respect to securitised loans and other assets.

The risk retention rules were initially proposed by the joint regulators in March 2011 and re-proposed in August 2013. The final rule will become effective one year from the date of publication in the Federal Register for RMBS and two years from the date of publication in the Federal Register for all other ABS. The final rule generally tracks the requirements of the re-proposal, with minor changes made to address comments submitted or to clarify meaning.

Basic risk retention requirement
As required by the Dodd-Frank Act, the final rule generally requires 'sponsors' of both public and private securitisation transactions to retain not less than 5%of the credit risk of the assets collateralising any ABS issuance. Sponsor is defined in the final rule as "a person who organises and initiates a securitisation transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity."

The final rule provides that the credit risk required to be retained and held by a sponsor or any other person under the rule may be acquired and held by any of such person's majority-owned affiliates, other than the issuing entity. If there is more than one sponsor of a securitisation transaction, it is the responsibility of each sponsor to ensure that at least one of the sponsors (or at least one of their majority-owned affiliates, as applicable) retains the required credit risk.

Standard risk retention methods
The final rule generally permits risk retention to be accomplished through one or a combination of methods: an eligible vertical interest, an eligible horizontal residual interest (EHRI) or some combination of the two (an 'L-shaped' interest'). The percentage of the vertical, horizontal or L-shaped interest to be retained by the sponsor must be determined as of the closing date of the securitisation transaction. Horizontal risk retention may be accomplished by holding ABS issued in the transaction or by establishing a cash reserve account for the transaction.

Notably, the final rule does not include as a standard risk retention method the 'representative sample' method included in the original proposal but removed in the re-proposal. This method would have permitted a sponsor to satisfy its risk retention obligation by holding, outside of the issuing entity, assets substantially similar to those transferred to an issuing entity in the amount of 5% of the assets transferred to the issuing entity.

It should be noted that the decision not to permit the retention of a representative sample as a risk retention method also impacts another, existing securitisation regulation. Specifically, in 2010, the FDIC substantially amended its rule for securitisations (12 C.F.R. § 360.6) that sets forth the conditions under which the FDIC will provide a 'safe harbour' to investors by agreeing not to repudiate certain contracts or reclaim assets in connection with certain securitisations by insured financial institutions.

This FDIC securitisation rule in some circumstances requires insured depository institutions to retain credit risk in connection with their securitisations and specifically permits the retention of a representative sample of assets of the same type as those securitised. The FDIC securitisation rule also contains, however, an 'auto-conform' provision to the effect that the risk retention provisions of the securitisation rule will be automatically conformed to those ultimately adopted by the joint regulators pursuant to Section 941 of the Dodd-Frank Act. Accordingly, insured institutions will no longer be permitted to rely on the representative sample retention method in order to avail themselves of the FDIC's securitisation safe harbour.

Eligible vertical interest
An eligible vertical interest must constitute either a single vertical security entitling the sponsor to the same percentage of amounts paid on each class of ABS interests or an interest in each class of ABS interests constituting the same proportion of each class of ABS interests. The final rule eliminated the requirement included in the re-proposal that an eligible vertical interest be valued using the fair value concept applicable to horizontal interest. Accordingly, a sponsor using the eligible vertical interest approach may in effect value the retained interest at par for purposes of the final rule.

Eligible horizontal residual interest
An EHRI is an ABS interest in a single class or multiple classes in the issuing entity that represent the most subordinated claim to payments of principal and interest by the issuing entity (with the exception of any non-economic REMIC residual interest, which is not considered an ABS interest). An EHRI's terms must provide that, if the issuing entity has insufficient funds to satisfy its obligation to pay all contractual interest or principal due, any resulting shortfall will reduce amounts payable to the EHRI prior to any reduction in amounts payable to any other ABS interest. Notably, the final rule eliminates a provision of the re-proposal that would have restricted the payment of cashflow to the EHRI in order to limit how quickly the sponsor could recover in cash the fair value of the interest.

A sponsor utilising an EHRI to satisfy risk retention requirements must retain an EHRI having a fair value (as determined in accordance with GAAP methodologies) of at least 5% of the fair value of all ABS interests issued in the transaction. The final rule contains extensive requirements for disclosure by the sponsor of its methodology for determining the fair value of the EHRI and of all ABS interests issued.

A reasonable period of time prior to the sale of the ABS, the sponsor must disclose:
• the fair value of all ABS interests to be issued,
• if the fair values of the specific prices, sizes or rates of interest of each class are not available, a range and the method to determine the range of fair values of all ABS interests issued,
• the material terms of the EHRI, and
• a description of the methodology used to calculate fair values, including a description of key inputs and assumptions.

A reasonable time after the closing of the transaction, the sponsor must disclose, based on the actual sale prices and finalised class sizes of the ABS interests:
• the actual fair value of the retained EHRI at closing,
• the amount the sponsor was required to retain at closing under the final rule, and
• any material differences between the actual valuation methodology or inputs and assumptions used from those used for the pre-sale disclosures.

The final rule provides sponsors with the option, in lieu of retaining all or any part of an EHRI, to establish and fund, in cash, an "eligible horizontal cash reserve account" (EHCRA), in the amount equal to the required fair value of an EHRI. Amounts in the EHCRA are to be used to satisfy payments on ABS interests in the issuing entity on any payment date on which the issuing entity has insufficient funds to satisfy an amount due on any ABS interest, or to pay critical expenses of the trust unrelated to credit risk on any payment date on which the issuing entity has insufficient funds to pay such expenses. The EHCRA must be held by the trustee until all ABS interests are paid in full.

L-shaped interest
If a sponsor opts to retain both an eligible vertical interest and an EHRI as its required risk retention, the percentage of the fair value of the EHRI and the percentage of the eligible vertical interest must equal at least 5%. These percentages must be determined as of the closing date of the securitisation transaction.

Special risk retention methods
In addition to the standard risk retention methods, the final rule includes special risk retention provisions for various specific asset types of transactions.

Revolving pool securitisations
The final rule contains special rules for risk retention by sponsors of "revolving pool securitisations", a structure often referred to in industry parlance as the master trust structure. The final rule permits sponsors of revolving pool securitisations to satisfy their risk retention requirement by maintaining a "seller's interest" of not less than 5% of the aggregate unpaid principal balance of all outstanding investor ABS interests in the issuing entity.

A seller's interest is defined as an ABS interest:
• that is collateralised by the securitised assets and servicing assets owned or held by the issuing entity, with certain exceptions,
• that is pari passu with each series of investor ABS interests issued, or partially or fully subordinated to one or more series in identical or varying amounts, with respect to the allocation of all distributions and losses, and
• that adjusts for fluctuations in the outstanding principal balance of the securitised assets in the pool.

The final rule also permits sponsors of revolving pool securitisations to satisfy risk retention requirements by retaining a horizontal subordinated interest in the pool, with some modifications to the standard requirements for an EHRI to accommodate common features of revolving securitisations. A sponsor may also combine a seller's interest with such an eligible horizontal residual interest to satisfy the 5% risk retention requirement.

Eligible ABCP conduits
For issuers of ABCP, the final rule provides eligible ABCP conduits with an option to satisfy risk retention requirements in lieu of using a standard risk retention option. The requirements to qualify as an eligible ABCP conduit are complex and beyond the scope of this overview. Generally, however, the assets of an eligible ABCP conduit must be ABS interests and must be issued by one or more intermediate SPVs.

Perhaps most importantly, the eligible ABCP conduit risk retention option requires that an originator-seller of assets to the intermediate SPV retain the requisite 5% credit risk exposure and that a regulated liquidity provider has entered into a legally binding commitment to provide 100% liquidity coverage to all ABCP issued by the ABCP issuer by lending to, purchasing ABCP issued by or purchasing assets from the ABCP conduit in the event that funds are required to repay maturing ABCP issued by the ABCP conduit. The eligible ABCP conduit must also comply with extensive disclosure requirements in order to avail itself of this risk retention option.

CMBS
As in the re-proposal, CMBS issuers will have the option of satisfying risk retention requirements by transferring up to two pari passu EHRIs, or B-pieces, to third-party purchasers. A B-piece buyer must perform its own due diligence of the underlying commercial mortgage loans and may be affiliated with the special servicer. The B-piece option may be used to satisfy the entire risk retention requirement or may be used in combination with the retention of a vertical interest by the sponsor.

The final rule requires that an operating advisor be appointed for any securitisation in which the sponsor uses the B-piece option. The operating advisor is required to act in the best interest of and for the benefit of all investors. The operating advisor's purpose is to consult with special servicers on major decisions after the unpaid principal balance of B-pieces held by third parties is reduced to 25% or less of the original principal balance of such B-pieces, taking into account appraisal reductions and realised losses.

The final rule allows transfers of the B-piece after five years from the closing date of the securitisation, whether the B-piece was retained by the sponsor or by a B-piece buyer, provided that the transferee satisfies the requirements applicable to B-piece buyers generally. The final rule also added a clarification that the risk retention obligation for CMBS terminates once all of the mortgage loans in a CMBS transaction have been fully defeased.

Fannie Mae and Freddie Mac ABS
The final rule exempts Fannie Mae and Freddie Mac from the risk retention requirement if such entity fully guarantees the timely payment of principal and interest on all ABS interests issued by the issuing entity in the securitisation transaction, for so long as Fannie Mae or Freddie Mac is operating under the conservatorship or receivership of the FHFA with capital support from the US government. This exemption will also apply to any limited-life regulated entity succeeding to the charter of either Fannie Mae or Freddie Mac, provided that the entity is operating with capital support from the US government.

Open market CLOs
The final rule treats managers of CLOs as sponsors and generally requires them to satisfy the 5% risk retention requirement. It also includes a transaction-specific risk retention option for 'open-market CLOs' that, subject to certain conditions, permits lead arrangers of senior secured syndicated loans held by the CLO to retain the requisite 5% risk, rather than the CLO manager.

Transfer of risk retention
Allocation to an originator
Under the final rule, the sponsor may allocate its risk retention requirement to the originator of the securitised assets under the standard risk retention options, subject to the agreement of the originator and to certain other conditions. Originator is defined to include only the original creditor that created the asset through an extension of credit or otherwise and does not include a subsequent purchaser or transferee of the asset. Any risk retention allocated to an originator reduces the sponsor's risk retention requirement commensurately.

The originator must acquire the eligible interest from the sponsor at the closing of the securitisation transaction and retain such interest in the same manner and proportion (as between horizontal and vertical interests) as the sponsor. Additionally, the ratio of the percentage of the risk position acquired and retained by the originator to the total percentage of the risk position otherwise required to be retained by the sponsor may not exceed the ratio of the unpaid principal balance of all securitised assets originated by the originator to the unpaid balance of all the securitised assets in the transaction.

Moreover, the originator must acquire and retain at least 20% of the aggregate risk retention amount otherwise required to be held by the sponsor and must comply with the hedging, transfer and other restrictions with respect to such interest as if the originator were the sponsor.

Hedging, transfer and financing prohibitions
The final rule generally prohibits a sponsor from selling or otherwise transferring any retained interest other than to majority-owned or wholly owned affiliates of the sponsor. Moreover, a sponsor and its affiliates may not hedge their required risk retention positions or pledge those positions as collateral for any obligation, unless the obligation is with full recourse to the pledging entity.

Certain hedging activities are not prohibited. Sponsors and their affiliates are permitted to:
• hedge interest rate or foreign exchange risk, or
• hedge based on an index of instruments that includes ABS, subject to certain limitations.

The restrictions on sponsors and their affiliates hedging or transferring retained interests for specified periods after the securitisation remain unchanged from the re-proposal. For RMBS transactions, the restrictions will expire on or after the date that is the later of five years after the closing date or the date on which the total unpaid principal balance of the securitised assets is reduced to 25% of the original unpaid principal balance as of the closing date, but in any event no later than seven years after the closing date. For all other ABS transactions, the restrictions will expire on or after the date that is the latest of the date on which the total unpaid principal balance of the securitised assets that collateralise the securitisation are reduced to 33% of the original unpaid principal balance as of the closing date, the date on which the total unpaid principal obligations under the ABS interests issued in the securitisation are reduced to 33% of the original unpaid principal obligations as of the closing date or two years after the closing date.

Exceptions and exemptions
The final rule exempts certain types of securitisations from risk retention requirements, including 'qualified residential mortgage' loans (QRMs) and securitisations backed by auto loans, commercial loans and commercial real estate loans that meet specified strict underwriting standards.

Qualified residential mortgages
Under the final rule, a sponsor will be exempt from the risk retention requirement for securitisations consisting solely of QRMs. The rule defines QRM to mean a 'qualified mortgage' (QM), as defined in Section 129(C) of the Truth In Lending Act that is not currently 30 or more days past due. The detailed definition of QM is currently set forth in regulations adopted by the Consumer Financial Protection Bureau (CFPB) under Section 129(C) for purposes of its 'ability-to-repay' rules.

The joint regulators determined not to adapt the 'QM-plus' concept floated in the re-proposal under which QRM would have been defined as a QM that satisfied additional conditions, including a minimum down payment requirement. Thus, under the final rule, there is no minimum down payment requirement for a QRM.

The rule also added two limited exemptions from the risk retention requirement for certain residential mortgage loans in order to conform with the ability-to-repay rules of the CFPB. The first is an exemption for securitisation transactions backed solely by certain community-focused residential mortgage loans and servicing assets.

The second is an exemption for qualifying three-to-four unit residential mortgage loans and servicing assets. There are also provisions permitting sponsors to blend community-focused loans with non-exempt residential mortgages, in which case the minimum risk retention requirement will be 2.5% or qualifying three-to-four unit loans with QRMs, in which case the risk retention requirement will be zero.

Qualifying commercial loans, CRE loans and auto loans
The final rule provides an exemption from risk retention requirements for securitisations consisting of 'qualifying' commercial loans, CRE loans and auto loans. Specifically, securitisations of such qualifying assets are subject to zero risk retention requirements provided that:
• the assets meet the specific stringent underwriting standards set forth in the final rule for each such asset type,
• the securitisation transaction is collateralised solely by loans of the same asset class and by servicing assets,
• the securitisation transaction does not permit reinvestment periods, and
• the sponsor provides to potential investors a description of the manner in which the sponsor determined the aggregate risk retention requirement for the securitisation transaction.

The underwriting standards for qualifying commercial loans include the following:
• prior to the origination of the commercial loan, the originator must have verified and documented the financial condition of the borrower at the end of the borrower's two most recently completed fiscal years and during the period, if any, since the end of its most recently completed fiscal year,
• the originator must have determined that, based on the previous two years' actual performance, the borrower had
o a total liabilities ratio of 50% or less,
o a leverage ratio of 3.0 or less, and
o a DSC ratio of 1.5 or greater, and
• the originator must also have conducted an analysis of the borrower's ability to service its overall debt obligations during the next two years, based on reasonable projections, and determined that following the closing date of the loan, the borrower will have:
o a total liabilities ratio of 50% or less,
o a leverage ratio of 3.0 or less, and
o a DSC ratio of 1.5 or greater.

The final rule defines a qualifying commercial real estate (QCRE) loan as a first lien loan on commercial real estate and improvements, including a ground-leased land loan on improved property, that meets the following underwriting standards:
• a DSC ratio of 1.25 for qualifying multi-family property loans, 1.5 for qualifying leased CRE loans and 1.7 for all other CRE loans,
• a 30-year maximum amortisation period for multi-family loans and a 25-year amortisation period for other CRE loans,
• a maximum LTV of 65% and a maximum combined LTV of 70%,
• the CRE loan must be fixed rate or swapped to a fixed rate through an interest rate swap or capped with an interest rate cap, and
• the CRE loan may not be interest only or have an interest-only period.

The final rule defines a 'qualifying auto loan' as an auto loan (but not an auto lease) that satisfies the following underwriting criteria:
• the originator must have verified specified aspects of the borrower's credit history,
• the loan must have a debt-to-income (DTI) ratio of less than or equal to 0.36, as verified through payroll stubs and the borrower's credit report, and
• the borrower must make a down payment of at least 10% of the vehicle purchase price plus all title, tax and registration fees, dealer fees and other add-ons.

Blending pools of qualifying, exempt and non-exempt assets
Sponsors of RMBS will generally not be allowed to reduce their risk retention requirements by commingling QRM and non-QRM loans in a single securitisation, with a limited exception for commingling QRMs and exempt three to-four unit residential mortgage loans. However, sponsors of commercial, CRE or auto loan securitisations will be able to reduce their risk retention requirement in proportion to the percentage of qualifying assets included by up to 50% using such blended pools. The issuer must also disclose any material differences between the qualifying and non-qualifying assets included in the pool.

Certain foreign-related transactions
The final rule includes a limited exemption excluding from the risk retention requirement certain predominantly foreign securitisations. The foreign securitisation safe harbour is available only if all of the following conditions are met:
• registration of the ABS interests is not required under the Securities Act of 1933,
• not more than 10% of the value of all classes of ABS interests are sold to US persons,
• neither the sponsor nor the issuing entity is organised under US law or is a branch located in the US of a non-US entity, and
• not more than 25% of the securitised assets were acquired from an affiliate or branch of the sponsor organised or located in the US.

General exemptions
The final rule includes a number of general exemptions from the risk retention requirements, including:
• certain US government-backed securitisations of residential, multifamily or healthcare facility mortgage loans that are insured or guaranteed (in whole or in part) by the US or an agency of the US government, or involves the issuance of ABS that are collateralised solely by residential, multifamily or healthcare facility mortgage loans, which ABS are insured or guaranteed by the US or an agency of the US government,
• certain State and municipal securitisations where the ABS are issued or guaranteed by a State, a political subdivision of State or by certain public instrumentalities of a State,
• certain qualified scholarship funding bonds,
• certain pass-through resecuritisations that are collateralised solely by servicing assets and by ABS for which the requisite credit risk was previously retained or that were exempt from the credit risk retention requirements, provided that the resecuritisation is structured so that it involves the issuance of only a single class of ABS interests,
• certain first-pay-class securitisations structured to reallocate prepayment risk and not credit risk,
• securitisations collateralised solely by 'seasoned loans' and by servicing assets,
• certain public utility securitisations, and
• securitisations sponsored by the FDIC acting as conservator or receiver for a financial institution.

There is also a reduced risk retention requirement for certain student loan securitisations where the student loans were made under the FFELP. The risk retention requirement for such securitisations is zero, 2% or 3%, depending on the degree to which such FFELP loan is guaranteed as to default in principal and accrued interest.

Periodic review of QRM definition and related exemptions
The joint regulators must review the QRM definition and the related exemptions for community-focused and 3-4 unit residential mortgage loans four years from the effective date of the final rule and every five years thereafter, or at any time upon request by one of the regulators, to determine if the CFPB's QM definition at such time is still the appropriate definition to use to define QRM and whether such related exemptions are still appropriate.

Market impacts
The final rule is expected to have a significant impact on securitisation markets generally, although the impact is likely to vary considerably among specific asset classes and transaction structures. The impact extends to the far reaches of the securitisation markets, both because it covers privately placed ABS transactions, such as Rule 144A and Regulation D offerings, in addition to publicly offered ABS transactions, and because it applies to foreign issuers who are not willing or able to limit their offerings in the US to less than 10% of the total transaction, even in cases where the offering is predominantly foreign in nature.

Sponsors, and in turn originators, will have substantial incentives to produce qualifying assets that are exempt from risk retention requirements when securitised. This will be more easily achieved for some asset classes than others.

Due to the significant loosening of the requirements for QRMs since the original proposal in response to widespread concerns that the definition would inhibit mortgage lending to low- and moderate-income borrowers, it is expected that a relatively large percentage of residential mortgage loans originated in the US will qualify as QRMs and can therefore be securitised without a risk retention requirement. In contrast, the requirements for commercial loans, CRE loans and auto loans remain nearly as strict as were initially proposed, and relatively small percentages of loans of these asset types are expected to be qualifying assets, such that securitisers of these assets are much more likely than RMBS sponsors to be required to retain risk in accordance with the final rule.

This outcome is perhaps most ironic in the case of auto securitisations and CLOs. While RMBS securitisations were a contributing factor to the 2008 financial crisis, auto loan securitisations and CLOs performed relatively well through the crisis. Now, under the new risk retention rules, auto loan securitisers and CLO managers are much more likely than residential mortgage loan securitisers to be required to retain skin in the game through risk retention.

The final rule is one of the last securitisation reforms to be put in place as the result of the Dodd-Frank Act and other remedial legislation and regulation, as well as accounting rule changes, adopted following the financial crisis. Considering the restrictive requirements that have already been put in place by federal legislation and numerous regulatory agencies, it will be instructive to see whether the addition of risk retention requirements will significantly improve the performance of and confidence in the markets or whether, instead, it will unnecessarily constrain markets that have largely corrected themselves and performed well since the financial crisis.

Structured Finance

Corporate trust pro added

Elian Global has added Gary Webb as an associate director for business development and international finance. Webb was most recently with BNP Paribas, where he held roles as global network manager for debt market services and global head of sales and relationship management for the bank's corporate trust services.

Structured Finance

Credit strategist makes move

AXA Investment Managers has appointed Gregory Venizelos as senior credit strategist in its research and investment strategy team. Based in London, Venizelos covers credit, investment grade and high yield, as well as sub-sovereign assets. The team is led by Eric Chaney, head of research at AXA IM and chief economist at AXA Group.

Prior to AXA, Venizelos held the role of senior credit strategist in BNP Paribas' fixed income division and was a structured credit strategist at RBS. His arrival follows the recent appointment of David Page as senior economist in July.

Structured Finance

Valuations pro adds training experience

Karl D'Cunha, senior md at Madison Street Capital, has joined the New York Institute of Finance as a faculty member. The move will see him leverage his broad financial services experience as an investment banking and valuation professional to train participants in scenario-based education. Subjects will include M&A, hedge funds, valuation, capital markets, FINRA, emerging markets and corporate finance.

CLOs

Business development exec hired

Highland Capital Management has hired Felicia Smith as md. Smith joins Highland's business development team and will be responsible for identifying and developing new relationships with institutional clients. In particular, she will focus on raising assets for the company's CLO and credit platforms.

Smith arrives from Santander Consumer USA (SCUSA), where she served as vp of capital markets. In this role, she was responsible for overseeing all corporate funding and liquidity activities, and was head of debt investor relations.

Smith also served as vp of corporate and business development while holding various other positions at SCUSA in pricing and analytics, capital markets and financial risk. She has also worked in sales and trading - and as an analyst - at JPMorgan.

Smith will be based in Dallas, Texas, and will report to Josh Terry, head of structured products and trading for Highland.

CMBS

Bellwether adds CMBS vet

Laurie Morfin has joined Bellwether Enterprise as svp, where she will be based in the company's Irvine, California office. Morfin has 18 years of CRE finance experience and joins Bellwether from Prudential Mortgage Capital Company.

While at Prudential, Morfin was responsible for the direct origination of multifamily debt on behalf of Freddie Mac, Fannie Mae, the FHA, Prudential's general account and CMBS executions. She has also held roles in Wells Fargo's CMBS group and the Nationwide Insurance loan origination team.

CMBS

Portfolio manager appointed

Malay Bansal has joined BNY Mellon Investment Management as senior portfolio manager in New York, where he is involved with a partnership with IH Capital to build a CMBS business. Bansal arrives after over two years spent as a senior director at Freddie Mac's multifamily group. He held various roles in the past at Bloomberg, Capital Fusion Partners, NewOak Capital and Merrill Lynch.

CMBS

Colony merger mooted

Colony Financial (CLNY) and Colony Capital have reached a non-binding agreement in principle for the potential contribution to CLNY of all of Colony Capital's real estate and investment management businesses and operations. The combined company will be led by executive chairman Thomas Barrack and ceo Richard Saltzman, while employing the full management and investment team of Colony Capital.

The agreement will include the contribution of Colony Capital's management contracts for its existing real estate and non-real estate funds and investment vehicles, as well as other Colony debt and equity co-investment and parallel investment vehicles, to an operating subsidiary of CLNY. CLNY will also have the right to conduct all future Colony-branded investment activities going forward, including the formation of real estate and non-real estate private investment funds, and will own the Colony name and related intellectual property. Colony American Homes, which has become a self-managed REIT, will not be included in the transaction.

The aggregate consideration for the deal will be US$675.5m. Of this, US$547.5m would be paid upfront and up to US$110m will be contingent upon certain performance as well as fundraising targets. The transaction is expected to close by end-1H15.

CMBS

Board shuffle for CREFC Europe

The head of loan markets real estate and public finance at pbb Deutsche Pfandbriefbank, Andreas Wuermeling, is the new chairman of CREFC Europe and will serve in this capacity for one year. Immediate past chairman, Peter Denton, will remain on the board of directors for another year.

A number of other appointments were also made to the boad: Peter Hansell, md at Cairn Capital, will serve an initial one year term; Emma Huepfl, co-founder and head of capital management at Laxfield Capital, will also serve an initial one year term but as independent director; and Dale Lattanzio, managing partner at DRC Capital, has been given a three-year term. Finally, Peter Cosmetatos - who has been serving as ceo for CREFC Europe since late 2013 - will also join the board.

CMBS

CRE solutions team strengthened

CR Investment Management has expanded its CR Financial Solutions (CRFS) business with the appointment of Tim Jones as associate director and the promotion of Andreas Costa to director. Jones will be based in CR's London office and will be specifically responsible for broadening the scope of its CRE lending business, with a focus on sourcing UK loans with a value of up to £30m. He arrives following previous roles for Omega Group, The Clydesdale Bank and Royal Bank of Scotland. .

Following Costa's recent appointment to expand CRFS' debt and equity origination functions, he will now lead its UK CRE lending operations. The focus will be on providing debt solutions to under-served parts of the UK market, typically - but not exclusively - smaller balance lending on more difficult assets in secondary locations.

Risk Management

BGC stance reaffirmed

BGC Partners has responded to the recommendation by GFI Group's board of directors to reject its tender offer of US$5.25 per share in favour of the US$4.55 proposed by CME. BGC, which currently owns approximately 13.5% of GFI's outstanding shares, reaffirmed its commitment to completing its transaction on the terms proposed.

BGC's offer represents a premium of more than 15% to the transaction announced by CME and GFI in July and a premium of more than 68% to the price of GFI shares as of 29 July, the last day prior to the CME announcement (SCI passim). Among the advantages set forth by BGC are that its offer contains conditions which provide it with substantially similar protections to those provided to CME by GFI. For example, it says that both the BGC tender offer and the proposed CME transaction provide the buyer with board control, thus making its request for a two-thirds majority of GFI's board consistent and logical.

BGC says that the GFI Special Committee may, with or without the consent of management, take the actions necessary to ensure BGC's nominees constitute at least a two-thirds majority of the GFI board, via some resignations and the filling of additional board seats. The company also intends to file an amended tender offer to revise the impairment condition in its offer to clarify that it only covers actions by GFI taken after the announcement of the CME transaction that are outside of the ordinary course of business. Such actions might include new change-of-control agreements with executives or other non-arm's length arrangements that would have a material adverse significance with respect to the value of GFI. BGC also will amend its tender offer to provide for an objective standard to determine whether this condition has been satisfied.

Finally, it notes that Jersey Partners has committed itself to selling its shares to the CME for US$4.55. While that means that it cannot currently participate in BGC's tender offer, Jersey Partners has no means of blocking outside shareholders from receiving the US$5.25 per share from BGC.

The offer is currently scheduled to expire on November 19, unless extended.

RMBS

RMBS lawsuit targets trustee

The NCUA has filed suit in federal court against Deutsche Bank National Trust Company, alleging that the bank violated state and federal laws by failing to fulfill its obligations as trustee for 121 RMBS trusts. The agency's suit seeks damages to be determined at trial.

Five corporate credit unions - US Central, WesCorp, Members United, Southwest and Constitution - purchased US$140bn in RMBS issued from the trusts between 2004 and 2007. Those securities lost value, contributing to the failure of all five corporates.

"Trustees have the basic duty to protect, and Deutsche Bank NTC failed to comply with the duties imposed by federal and state law," NCUA board chairman Debbie Matz says. "This failure harmed trust beneficiaries, including the corporate credit unions. NCUA will do all it can to pursue appropriate remedies and recoup the losses suffered by the credit union system."

NCUA's complaint states that the value of the securities depended on the quality of the pooled mortgage loans the trusts contained and that the bank, as trustee, had contractual and statutory duties to protect the interests of certificateholders. The complaint adds that - despite knowing about defects in the mortgage loans - Deutsche Bank NTC failed to provide required notices to certificateholders and other parties and failed to take timely action to force the repurchase, substitution or cure of defective mortgage loans or otherwise preserve trust remedies.

A significant portion of the trusts were sponsored by: American Homes Mortgage Acceptance and American Homes Mortgage Corporation, Ameriquest Mortgage Company and Argent Mortgage Company, Greenwich Capital Financial Products, Impac Funding Corporation and Impac Mortgage Holdings, IndyMac Bank, Morgan Stanley Mortgage Capital and Morgan Stanley Mortgage Capital Holdings, NC Capital Corporation, Option One Mortgage Corporation, and Washington Mutual Bank and Long Beach Mortgage Company.

RMBS

Loan servicing practices probed

Walter Investment disclosed in its Q3 10Q filing that it had received an investigative subpoena and interrogatories from the California Attorney General in September. The firm last month also received a list of questions and a request for documents from a working group representing the attorneys general and regulators of several other states and representatives of the Office of the US Trustee. Walter indicated that it met with the working group to discuss loan servicing practices of Green Tree Servicing.

ABS

Auto financing incentives to hit ABS?

Contract terms are shortening and interest rates falling to support sales of new cars in Germany, according to a DBRS analysis of European DataWarehouse loan-level data. The net result of this could affect some securitisation structures by increasing payment rates and decreasing the cashflow cushion provided by interest rate spreads.

As average contract terms of loans underlying German auto securitisations shorten, weighted average lives are likely to decrease. Lower loan rates can have an impact on the incoming cashflows by lowering excess spread for some transactions, depending on structure and how the underlying receivables are sold to the SPV.

As sales of German cars began to decline in 2012 and 2013, manufacturers made use of financing to help recover flagging sales. Securitisation helped to play a part by keeping the cost of funding low for auto loans and leases.

In 2013, 78% of all new vehicles in Germany were purchased using leasing or financing, according to the Verband der Automobilindustrie. Based on analysing German auto loan and lease transactions reported in the European DataWarehouse, DBRS found some interesting trends in financing.

As vehicle sales turned negative towards end-2012, correspondingly a change occurred in the interest rates of loans as both amortising and balloon loan rates began to fall. Average interest rates of amortising loans fell from a level of 5.9% in April 2012 to as low as 4% in January 20141. Rates have been falling since 2010, with a peak of 6.8% in January 2010 for amortising loans and 6.6% for balloon loans.

Meanwhile, effective leasing interest rates reported within the EU DataWarehouse have increased from below 5% in 2010 to hover around 6% from 2011 to 2014, peaking at 6.2% in July 2012. This may be due to the reduction in leasing contract terms. Higher depreciation rates are typically observed immediately following new vehicle registration and rates are potentially kept high to account for the steep depreciation curve.

While the rates on leases increased, contract terms fell in order to potentially incentivise higher turnover by decreasing the trade cycle between new car acquisitions. DBRS notes that lease term periods fell from 60 months to an average of 39.8 months in January 2014.

Contract terms have also been falling in amortising and balloon loans. Amortising loans have fallen from 62.1 months to 46.6 months, while balloon loans vary from between 51.1 months and 46.9 months, with the recent trend having been downwards towards end-2013.

The main driver for the moves in interest rates has been loans for new vehicles: rates on loans for used vehicles remain comparatively stable, while those for new purchases have a wide range of movement. This further demonstrates the financing support by manufacturers for new vehicle sales.

Amortising loans for new vehicles have steadily fallen from 6.0% in January 2010 to 2.8% in January 2014. By contrast, loans for used vehicles have only fallen from 6.9% to 5.6% over the same period.

However, balloon loan rates have been much more volatile, falling from 5.8% in January 2010 to 2.8% in April 2011 - only to increase to 4.5% in August 2012 and then fall back down to 3.3% in January2014. As the contract terms for balloon loans remained relatively stable, interest rates appear to be a main driver for incentivising the purchase of new cars, DBRS suggests.

Adjusting rates and contract terms help to support the sales of automobiles, but they also affect the securitisation structures that they are bundled in. The impact from these changes can decrease excess spread for some transactions and decreasing contract terms should lower weighted average life levels.

"At an industry level, decreasing rates can lower the bandwidth available, should transactions come under large adjustments in cashflows. However, with lower contract terms turnover is likely to be higher, shortening durations," DBRS concludes.

ABS

ABS comparison tool launched

Fitch has launched ABS Compare, an Excel tool that provides access to the agency's surveillance and index data on European consumer and credit card ABS transactions. The service enables users to review the performance of European ABS transactions in comparison with Fitch's benchmark indices and macroeconomic indicators. It also allows the comparison of transactions using performance measures, such as arrears, defaults, recoveries and loss severity.

Its main features include the ability to compare originators, vintages and product types. A selected portfolio of transactions can be compared and will be provided with a full data history for each transaction. ABS Compare additionally allows users to visualise comparisons with customisable charts and tables for inclusion in documents.

Fitch also publishes RMBS Compare, providing the same features for key European residential mortgage markets.

Structured Finance

Covered bond amendments increase protections

The German Parliament (Bundestag) has passed a range of amendments to the German Covered Bond Act, which will come into force by 1 January 2015. S&P believes that the collective amendments will strengthen Germany's covered bond framework, but will be broadly neutral to its ratings on German Pfandbriefe.

The legislation grants authority to the Federal Financial Supervisory Authority (BaFin) to request a risk-based add-on to the statutory overcollateralisation requirement of 2% for individual covered bond programmes. Examples of where this might be relevant include: material differences between the applied lendable values and market values of cover assets, risk concentrations in the cover pool, significant exposure to related companies, new products or new markets, or certain material interest and currency mismatches between cover pool assets and liabilities.

In addition, an add-on may follow the identification of operational or organisational weaknesses. Any requirement for such add-on would be made public.

S&P believes these new powers could result in additional protection for covered bond investors. They may potentially provide a greater backstop for covered bonds with higher risk profiles if there is a change in available overcollateralisation. The agency says that the examples listed in the official reasoning for the law are relevant factors that might characterise heightened credit, market or operational risk in a covered bond programme.

The legislation also clarifies that bank account balances may constitute cover pool-eligible substitute assets. This amendment provides an option to mitigate the risk that, if an issuer becomes insolvent, the cash collected with respect to the cover assets and standing on an external collection account would be included in the insolvent estate or temporarily restricted from servicing the covered bonds. S&P believes such commingling risk would be mitigated if the issuer actually registers any of the programme's external collection accounts in the cover register.

The agency also says that this amendment will have a limited effect on its analysis. Currently, only five rated Pfandbrief programmes by three issuers use external collection accounts. Moreover, even if issuers were to implement this new option from the legislation, balances on the collection accounts would still be exposed to the risk that they may be 'lost' or 'frozen' as a result of the insolvency of the third-party account-holding bank.

S&P lists a number of other amendments which it believes does not materially change rating-relevant legal and regulatory risks according to its criteria. This includes an update regarding the minimum credit quality of claims on credit institutions, including under derivative contracts. The amendment grants authority to BaFin to lower the credit quality threshold after consultation with the EBA to avoid single-name concentration risk in cover pools that might emerge as a result of these revised standards.

Structured Finance

Working capital optimisation in vogue

Working capital optimisation will continue to be a high priority for corporate treasurers in 2015 as the global economy picks up, according to Demica's latest research study. In their drive for competitive advantage, treasurers are increasingly looking beyond the traditional forms of finance to explore a wider range of alternative funding options that support their working capital requirements, including supply chain finance (SCF), trade receivables securitisation (TRS) and factoring.

Demica lists more effective cash management/forecasting (accounting for 63% of respondents), releasing working capital (60%) and improving working capital risk management (58%) as the three most important priorities for surveyed treasurers in the coming year. Of the respondents, 60% believed that there is still a fairly or very high potential for releasing trapped working capital in their industries in the next five years in view of the post-crisis economic landscape, where standard bank credit is more restricted and expensive.

Around 87% of surveyed treasurers acknowledged that corporates are particularly keen on exploring methods of releasing additional liquidity from their accounts receivables. Because of the ability of SCF to extend buyers' payment terms while enabling early payments to suppliers at an affordable financing cost, 83% of respondents observed growing enthusiasm for this credit facility.

In addition, 40% of respondents already offer such a finance facility to their suppliers. Enhancing working capital liquidity for the buyer company is the most important driver for the implementation of the programme, followed by the provision of liquidity to suppliers and reducing supply chain risks.

A revival of interest in TRS for its role of monetising receivable portfolios is affirmed by another 60%, with 16% of respondents currently running a TRS programme. Demica notes that a quarter of those that have not implemented one yet plan to do so in the next 12 months. Improving liquidity is the main source of incentive, while obtaining more favourable financing conditions and diversification of refinancing channels came as the second and third most important motivators.

Factoring - once regarded as the lender of last resort - now ranges from €700,000 to €800m in volume, with more than a quarter of the surveyed treasurers using it as an effective funding tool to increase liquidity.

Structured Finance

Auto ABS sets groundwork

Auto loan securitisation has established a foothold in China, with six transactions being rolled out between March and August 2014 (SCI 23 October). The new funding option has emerged amid increasing vehicle sales and financing needs, S&P says.

Most of the auto loan receivables that have been securitised to date are of the vanilla variety, backed by passenger vehicles and mostly in the retail sector. They are diversified across borrowers and geography, and amortise with payments every month.

Transactions so far have adopted simple payment hierarchies, with collections from the collateral pools used to redeem notes rather than to purchase additional collateral. The duration is short and, according to public information, the senior tranche of issued notes generally has a maturity of around one year.

Regulators recently announced plans to sequentially streamline the approval process for securitisation issuance. S&P notes that originators and investors are expanding their bases and believes that participants in China's securitisation market are demonstrating greater experience. These factors may help to improve the country's securitisation infrastructure and shape practices that are likely to support more market-driven developments, according to the agency.

Structured Finance

Consecutive declines for credit

Aggregate hedge fund performance was nearly flat in October at negative 0.06%, marking the industry's third down month in the last four, according to eVestment. Year-to-date performance through October stands at positive 2.3%, the industry's lowest return in the first ten months of a year since 2011.

Last month saw a wide distribution of returns across the industry, illustrating very large gains and losses for the second consecutive month. The volatility of returns produced in October was the third highest in nearly three years. The highest level in this span was in May 2012, driven by Europe's sovereign difficulties.

Credit strategies saw a relatively large aggregate decline in September, followed by another negative month in October, with returns falling by an average of 0.5%. The universe hasn't produced consecutive down months since mid-2011 when Europe's sovereign crisis first flared.

Structured Finance

Flexible fund on the horizon

Catella is set to launch a new fixed income fund, dubbed the Catella Credit Opportunity. The fund will seek absolute returns by investing in the entire fixed income capital structure and in bonds with both high and low credit ratings.

The fund has a target return of 6%-8% and an expected risk level, measured as its standard deviation, of 5%-7%. It will use the derivatives market to protect capital against interest rate risk and credit risk. All currency exposure is hedged back to its base currency, the Swedish krona.

"Instead of having a strict mandate with a benchmark, today's market requires an unconstrained approach in order to generate adequate risk-adjusted returns. A fund must be able to allocate to the best asset class at any given time. In addition, the fund should work with asset classes that provide capital protection in order to fend off rising market interest rates and/or a widening of credit spreads, for example, as a result of a major stock market decline," says Fredrik Tauson, one of the fund's managers.

Tauson will manage the fund with Magnus Nilsson. Launch is set to occur in late November.

Structured Finance

Rating shopping persists

Regulatory reforms have failed to end to the practice of rating shopping in the US securitisation markets since the financial crisis, according to Morningstar. Arrangers and issuers continue to control the selection of credit rating agencies and their hiring decisions are based primarily on which CRAs offer the highest ratings or demand the least stringent requirements for attaining a specified rating level.

Morningstar suggests that rating shopping is most prevalent in the CMBS market, where the arranger or issuer for a typical transaction will invite up to six active CRAs to conduct a preliminary review of an initial asset pool and transaction structure. In most cases, the arranger or issuer will hire only the two or three CRAs requiring the lowest enhancement levels or least onerous terms.

However, CRAs appear to have generally held their ground by adhering to their analytical methodologies. This is evidenced by the higher credit-enhancement levels seen in recent CMBS deals as compared to pre-crisis levels. The CRAs' unwillingness to lower their standards in the midst of reviewing a transaction is attributable in part to strong regulatory oversight from the SEC, which has focused heavily on holding NRSROs accountable for following their published methodologies.

Morningstar believes the recently enacted SEC credit rating reform rules will further strengthen this oversight regime and thereby mitigate some of the potential negative consequences of rating shopping.

The agency notes, though, that SEC Rule 17g-5 has failed to curb rating shopping, level the playing field for smaller or newer NRSROs, or raise competition in a way that benefits investors. This is primarily because CRAs have chosen not to issue unsolicited ratings prior to a transaction's closing date, for several reasons.

Providing a full rating analysis without compensation can strain an NRSRO's resources, while the derived benefits are questionable or uncertain. To offer unsolicited new issue ratings under their methodologies, most NRSROs would need to incur the costs associated with property inspections, originator and servicer site visits and face-to-face meetings with the key transaction parties, which most are not inclined to do.

Morningstar points out that NRSROs will also consider the risk that the arranger or issuer may exclude them from future ratings business, particularly if unsolicited ratings undermine the marketing and pricing of a transaction.

The agency also says that the general interests of key stakeholders remain somewhat misaligned. Smaller NRSROs have benefited because they have been able to showcase the quality of their analytics and win a share of rating mandates.

Over the long-term, however, the process may still favour the larger agencies that are better positioned to absorb the costs of providing preliminary analyses without compensation. In addition, a smaller NRSRO may suffer from the lost opportunity to have its voice heard on transactions it is not hired to rate, which in turn could stifle its efforts to build its franchise and differentiate itself from other NRSROs.

Morningstar proposes a number of alternative solutions. Primarily, it calls for a regulatory requirement to make public the tranche-specific, credit-enhancement levels of all participating rating agencies prior to when a deal is priced. Additionally, investors could be granted access to the information on the 17g-5 website, while NRSROs that are asked to provide preliminary analysis but are ultimately not hired could be entitled to receive partial compensation to cover their costs.

The agency concludes that rating shopping may not disappear, but enhanced checks and balances and information transparency combined with ongoing rating agency regulatory reforms should help sustain ratings quality and integrity.

Structured Finance

BWIC Board adds PriceABS

SCI's PriceABS secondary market data has been made available via DealVector's BWIC Board. For the next 30 days, investors registered with the marketplace will have free access to current and historical talk and cover prices recorded in the PriceABS archive. Every time a bond comes out on BWIC, members will be shown available pricing history from SCI's comprehensive database covering over 35,000 bonds.

After 30 days, access will continue to be available to PriceABS subscribers.

DealVector's BWIC Board posts US$10bn to US$15bn in weekly notional volume in the BWIC market. Since its launch in September, the service has contributed to a 50% jump in traffic to the DealVector website, offering investors a faster and more efficient way to review the dozens of BWICs that they receive and generating targeted leads for participating brokers. The firm plans to add more third-party data to the platform in the coming months.

CDO

RFC issued on country risk revision

Moody's is seeking comments on its proposed rating approach for transactions backed by a corporate portfolio with exposure to country risk and a weighted average portfolio rating of Ba3 or better. The proposed framework entails a two-step approach to capturing country risk: first, the simulation of a country ceiling event for each of the obligors in the portfolio; and second, the assessment of the impact of such an event on the obligors.

Previously, Moody's had incorporated country risk directly into its asset correlation assumptions as a weighted average of the sovereign and industry factors. If adopted, the agency expects the proposed approach to have a minimal impact on the ratings on 11 transactions that it currently monitors.

Feedback on the request for comment is invited by 6 January 2015.

CDS

CDS spikes on reserve charge

Five-year CDS on Genworth Financial are pricing 143% wider compared to a week ago, according to Fitch Solutions. This comes after the company reported a reserve charge of over US$500m relating to its struggling long-term care business and the potential for further charges in 4Q14.

The market had been pricing Genworth's debt at double-B plus levels consistently since August, but spreads have moved deeper into the speculative grade space since the earnings announcement last week. Credit protection on Genworth's debt obligations is now pricing at the widest level observed in nearly two years.

CLOs

Trade date strategies examined

A number of CLO 2.0 deals are reporting a negative principal cash balance to reflect the purchases that CLO managers have entered, but have not yet settled. Morgan Stanley CLO strategists note that this is possible because many transactions are managed on a trade date basis, whereby acquisitions of loans are recorded on the date when the trade is entered, rather than when the trade is settled.

"In our view, this strategy is important to understand because it may allow some managers to enhance equity returns to the extent that a loan settles at longer than T+7 in the secondary market, resulting in accrued interest paid to the buyer," they add. "It is our understanding that a large percentage of leveraged loans take longer to settle than the T+7 market convention. Therefore, there may be an opportunity for some CLO managers to take advantage of this inefficiency to receive interest on a loan that they have not used principal to buy, resulting in negative cash balances."

Based on an analysis of 453 US CLO 2.0 transactions that are still within reinvestment period, the Morgan Stanley strategists found 116 deals currently running a negative principal cash balance. The median negative cash balance among these deals is -1.1% of the portfolio balance.

With respect to a sample of 42 European CLO 2.0 transactions, they found six deals currently running a negative principal cash balance. The median negative cash balance among these six is -2.5% of the portfolio balance.

Such a strategy is not without risk, however. "If leveraged loan prices fall, the CLO manager will have to buy the loan which they've previously committed to buy at a higher dollar [price] than the current market. At a minimum, this limits potential par building and, in some cases, may even erode par if a loan has to be sold at a lower price," the strategists warn.

CLOs

Manager variation emerging

Aggregate performance of US CLOs remained stable last quarter, though differences are starting to emerge across individual deals and how they are being managed, according to Fitch's latest quarterly index for the sector. Roughly two-thirds of CLOs included in the index in Q2 either built or maintained par over the previous quarter, with the remainder seeing a par loss over the same period.

The average net portfolio gains/losses declined slightly to 0.5% from 0.6% in 2Q14. The average senior overcollateralisation cushion also dropped slightly to 10.8% from 10.9%, while the average junior OC cushion was flat at 4.9%.

Despite the overall stability, Fitch notes variations across CLOs, with net portfolio gains/losses over the past year ranging from -0.2% to 0.8%. Some CLOs have recently gone effective with an above-average par gain due to favourable market conditions at the time of collateral acquisition. On the other end of the spectrum, certain CLOs lost par through the release of excess amounts in the ramp-up account through the interest waterfall or due to defaulted loan positions.

Fitch adds that, absent credit losses, the largest driver of par changes is trading activity. "A slowly declining trend can indicate a defensive investment style, whereby managers proactively reduce their exposure to credit impaired names," says Fitch senior director Alina Pak. "Conversely, an upward par trend can reflect a manager's focus on building par through opportunistic trading."

CMBS

Peak pre-crisis prices topped

US commercial property prices set a new peak in September 2014, increasing by 0.5% and topping the 2007 pre-financial crisis peak by 0.2%, according to the latest Moody's/RCA Commercial Property Price Indices (CPPI) national all-property composite index. Factors reflecting the strengthening US economy are accredited with the results.

The agency says that the increase in prices coincide with the overlapping effects of the greater availability and lower cost of debt and equity capital, capitalisation-rate compression, improving property fundamentals and the declining share of distressed transactions. The price recovery varied widely by property type and market segment, however.

Apartments in both major and non-major markets, as well as CBD office in major markets, had among the earliest troughs and biggest subsequent recoveries. Apartments in major markets topped their pre-crisis peak by approximately 35%, while apartments in non-major markets are roughly 7% above their pre-crisis peak. CBD office prices in major markets are now about 28% above their pre-crisis peak. These three sectors comprise approximately 43% of the national all-property index.

The availability of debt at low interest rates - particularly from mortgage lenders Fannie Mae and Freddie Mac - contributed to the strong apartment recovery, Moody's adds. However, the commercial recovery was weaker because of the nearly four-year period in which liquidity contracted.

"This period overlaps with when the CMBS market shut down and then later reopened at a much lower issuance level," says Tad Philipp, director of CRE research at Moody's.

Decreasing cap rates - which move inversely to prices - contributed to the recovery, especially during its first three years. The run-up to the new peak received a boost from improving property fundamentals, growing liquidity and fewer distressed property sales.

CMBS

Loss severity declines

Average US CMBS loss severity measured 45.56% in October, according to Trepp, down from 55.69% in September. Of the loans that were liquidated, 72% by balance fell into the greater than 2% loss severity category, down from 88% last month.

October loss severity was below the 12-month moving average of 49.27% and just above the 44.29% average since January 2010. The number of loans liquidated during the month was 70, resulting in US$423m in losses.

Altogether in October, 17 loans totalling US$180.5m were disposed of with a loss severity of 80% or higher. Five of the loans were hope notes that took 100% losses.

Only four loans above US$50m were liquidated during the month. Consequently, the disposed loan balance dropped from US$1.8bn in September to US$928.5m.

The average disposed balance was US$13.26m in October, below the 12-month average of US$15.03m. Since January 2010, servicers have been liquidating at an average rate of US$1.2bn per month.

CMBS

Workspace resolution to hit class Cs

The sale of the final four properties of the £25.86m Workspace Portfolio loan, securitised in Eclipse 2007-1, has been completed for a purchase price of £8.6m. Trepp notes that expected net recovery proceeds will likely result in a principal loss of at least £17.26m, resulting in the full write-down of the class D notes and a partial write-down of the class Cs.

Following receipt of the requisite building and M&E reports by the purchasers, the final offer for the remaining Workspace properties was revised down from £9.3m, with net proceeds to be applied on the January 2015 IPD. The most recent appraisal value for the property was £9.69m, as of 28 February, resulting in a current LTV of 271.85%.

The loan was transferred to special servicing in September 2011 due to breach of ICR covenant and expected payment default (see SCI's CMBS loan events database). The special servicer and the borrower then agreed on a consensual sale of the properties. Accordingly, three of the properties were sold for £1.8m on 17 January (with £1.7m net proceeds applied on the April IPD) and an additional property was sold in August for £450,000 (proceeds distributed on October IPD).

Eclipse 2007-1 classes E and D (partially) were written off previously as a result of the realised losses on the Agora Max Portfolio, Apex, Greater London Portfolio and Gullwing Portfolio loans totalling approximately £45.85m.

CMBS

Balloon date pay-offs jump

The percentage of US CMBS loans paying off on their balloon date jumped sharply in October to 72.5%, according to Trepp. This is almost 20 points higher than the September rate of 53.3% and is the highest reading since May.

In addition, the rate came in above the 12-month moving average of 68.8%. The highest rate in the last five years was in November 2013, when pay-offs totalled 81.3%.

By loan count as opposed to balance, 77% of loans paid off in October. This pay-off rate was a sizable jump from September's level of 62.6%.

The 12-month rolling average by loan count is now 71.6%.

CMBS

Delinquencies down on Rubloff resolution

Continued loan resolutions resulted in another month of declines for US CMBS delinquencies, according to Fitch's latest index results for the sector. This marks the sixth straight month that the rate has remained below 5%.

CMBS late-pays fell by 7bp in October to 4.70% from 4.77% in September. Resolutions of US$721m continued to outpace new additions to the index of US$418m.

The largest new delinquency last month was the US$110m Westfield Shoppingtown Independence loan, which was transferred to special servicing in October for payment default (see SCI's CMBS loan events database). It became 60 days delinquent after the borrower notified the master servicer of cashflow shortages beginning in August.

The loan remains due for its August payment. Fitch says that the property's performance has been impacted by lower rents for new and renewing tenants, as well as declining expense reimbursements.

The largest resolution last month was the US$55.9m Rubloff Retail Portfolio, which was disposed of through a note sale for a 72% loss. The loan transferred to special servicing in November 2012 for imminent default, due to a decline in portfolio occupancy resulting from the loss of both anchor and in-line tenants that negatively impacted overall portfolio cashflow.

Office and industrial delinquency rates improved by 19bp (from 5.05% to 4.86%) and 12bp (from 4.84% to 4.72%) respectively last month. Office resolutions of US$381.1m significantly outpaced new office delinquencies of US$87m. Industrial resolutions of US$58.2m also surpassed new industrial delinquencies of US$26.1m.

Five of the seven largest loan resolutions in October - with a combined balance totalling US$146.8m - were REO office assets disposed of at losses ranging between 34% and 71%. The two largest office resolutions were the US$38.8m Birtcher Phoenix Pool and the US$35.9m Longford Medical Center.

Meanwhile, the largest office addition was the US$27.4m Reckson Portfolio II, which did not pay off at its October 2014 maturity date. The loan remains due for its September payment.

Conversely, retail and multifamily both reversed course from last month, with their delinquency rates worsening by 9bp (from 5.19% to 5.28%) and 7bp (from 5.32% to 5.39%) respectively in October. New retail delinquencies of US$232.7m outpaced $193.7m of retail resolutions.

The largest and fourth largest loan resolutions last month were retail assets: the Rubloff Retail Portfolio and the US$33.8m College Square Mall. However, Westfield Shoppingtown Independence contributed to over 45% of the new retail delinquency volume and significantly offset all retail resolution gains.

The largest multifamily resolution and new addition were both on smaller loans, each with a balance of less than US$22m. Hotel remains flat, at 5.91%, as there were no new hotel delinquencies in October.

CMBS

Construction financing risks examined

The recent sale of US$1.6bn 3 WTC Liberty Bonds to finance construction of 3 World Trade Center provides an illustrative example of the credit factors that market participants should consider when evaluating commercial property construction financing, Moody's suggests. The agency says that such considerations are critical as the pace of construction accelerates with the improving economy and as the commercial real estate cycle enters a new phase.

Moody's identifies four categories of risks for construction loans tied to commercial properties: construction risk, carry/lease-up risk, refinancing risk and real estate rental market risk. Construction risk is the risk that the development will not be completed on time or within its budget. Mitigants to construction risk may include borrower incentives and contractor obligations.

"Some important protections are in place in the 3 WTC project," says Moody's svp Dan Rubock. "Construction of 3 WTC is underway, reducing the risk profile of the construction schedule going forward." A contract is in place obliging the general contractor to complete construction for a maximum price (plus certain expense reimbursements), thereby shifting the risk of cost overruns (up to certain limits) to the general contractor.

At the same time, Moody's notes that the 3 WTC sponsor (Larry Silverstein) is not providing a completion guarantee, as are commonly provided in construction projects. "We note that while the borrower is making an equity contribution to the construction account, the borrower's interest in 3 WTC is subject to a net lease that requires substantial rent payments and diminishes the value of borrower equity," says Moody's senior credit officer Bill Fitzpatrick.

A well-structured construction loan must include reserves or other sources of liquidity sufficient to pay interest to certificateholders during the construction and lease-up phases of the project, in order to assure timely payment of interest on funded loan proceeds. The 3 WTC transaction will have reserves, funded at closing, to provide capitalised interest through 15 November 2018, allowing approximately six to eight months beyond the anticipated substantial completion. In addition, a limited backstop from the New York Port Authority is available following completion to pay post-completion shortfalls in regularly scheduled debt service, subject at all times to an overall cap in the backstop support and to borrower repayment after regular bond payments and allowable expenses.

"A key risk factor, therefore, is the feasibility of completing construction and lease-up within that time frame," says Fitzpatrick. "Major New York office buildings may in some cases take longer than two years to achieve stabilised rental income and occupancies, even in healthy markets, given the competitive spaces that are available and the long lead times and free rent periods typically required by major tenants."

Permanent financing must also be available to refinance maturing construction loans. The 3 WTC bonds provide long-term financing with no apparent contingencies related to completion and no stated requirement to refinance at a certain date or upon the occurrence of other specified events, thus effectively eliminating refinancing risk.

Finally, risk remains even after construction is complete because real estate markets will continue to evolve during construction and will determine the level of rents the project can achieve. Pre-leasing of some space in 3 WTC is a partial mitigant to real estate market risk, although it is a function of construction risk in turn because in many instances a prelease will be contingent upon achieving certain construction milestones.

CMBS

Spin-offs reduce bargaining power

Traditional in-line mall tenants are increasingly relocating outlets from second-tier malls into dominant, open-air shopping centres, according to Fitch. This developing trend could weaken the credit profiles of retail REIT landlords with sizeable second-tier mall holdings, such as Washington Prime Group (WPG) and CBL & Associates.

The weak performance of key retail anchor tenants, such as Sears and JC Penney, has already challenged occupancies and rental rates at many second-tier malls. WPG and CBL own a meaningful number of the lower-producing malls in CMBS conduits.

Conversely, some shopping centres could see a marginal benefit from retailers off-malling selected outlets. Brixmor and Kimco Realty - two of the largest shopping centre owners in the US - noted greater interest in their centres from traditional mall tenants during the companies' Q3 earnings conference calls.

Fitch says that tenants relocating out of second-tier malls and retailers entering new markets drove most of the new demand. The companies collectively cited clothing retailers The Gap, Banana Republic, American Eagle, Chico's, Christopher & Banks and Torrid - as well as a handful of jewellery stores - as the traditional mall tenants that are most actively considering relocating in shopping centres. According to Brixmor, most of the demand so far has stemmed from reverse inquiry from these retailers. The company has hired three leasing professionals away from the major mall REITs, primarily to build on the leasing demand it is seeing from traditional mall tenants.

Fitch believes that recent mall REIT spin-offs are the catalyst that has caused some retailers to consider non-mall locations to a greater extent. Simon Property Group spun off WPG in May, while General Growth Properties (GGP) spun off Rouse Properties in January 2012 (SCI passim). Prior to these spin-offs, the mall assets now owned by WPG and Rouse benefited from Simon and GGP's respective bargaining power over tenants due to their positions as the two dominant US mall owners, in the agency's view.

Risk Management

Small contraction in OTC outstandings

OTC derivatives markets contracted slightly in 1H14, according to the latest BIS figures. The notional amount of outstanding contracts totalled US$691trn at end-June 2014, down by 3% from US$711trn at end-2013 and back to a level similar to that reported at end-June 2013.

The gross market values of outstanding OTC derivatives continued to trend downwards in the first half of 2014. Values stood at US$17trn at end-June 2014, down by 7% from US$19trn at end-2013 and 14% from US$20trn at end-June 2013. Whereas in 2013 the decline had been concentrated in interest rate derivatives, in the first half of 2014 the gross market value of FX derivatives also fell significantly.

In CDS markets, central clearing has made further inroads. Contracts with central counterparties accounted for 27% of notional CDS outstanding at end-June 2014, up from 23% one year earlier. Bilateral netting agreements reduced the net market value of outstanding CDS contracts to 23% of their gross market value.

Risk Management

Data agreement reached

Eagle Investment Systems is collaborating with Interactive Data to provide the latter's pricing and reference data to Eagle's European insurance clients to assist them in addressing the complexities around Solvency 2 compliance.

As part of the relationship, Eagle has built a standard maintainable interface to automatically accommodate Interactive Data's pricing and reference data and map it into its enterprise data management solution, making the process repeatable for all insurance companies. In addition, Eagle's solutions can also be used to generate the quantitative reporting templates required to demonstrate compliance to the regulator.

Risk Management

Phased timeline for swap compliance

The US CFTC has further implemented the trade execution requirement for certain interest rate and credit default swaps. The Commission previously provided no-action relief for certain swaps required to be traded on a swap execution facility (SEF) or designated contract market (DCM) to the extent that those swaps were part of a package transaction. It has determined that further relief is appropriate to enable market participants the necessary time to fully comply with the trade execution requirement with respect to swap components of certain categories of package transactions.

Market participants will also have the opportunity to transition their trading of these swap components onto SEFs and DCMs. Accordingly, CFTC No-Action Letter No. 14-137 has been issued, providing a phased compliance timeline.

The CFTC has tailored the relief by category; for example, SEFs and DCMs are provided with flexibility in offering methods of execution for swap components of certain package transactions via their trading systems, facilities or platforms. Finally, with respect to certain categories of package transactions, the time-limited relief will enable the Commission to gather data not previously available to further assess whether SEFs and DCMs can appropriately offer the capability to transact swap components of such package transactions via competitive means of execution.

RMBS

Genworth downgrade hits RMBS

S&P has placed its ratings on 150 of Australian and New Zealand RMBS on credit watch with negative implications. This follows the agency lowering its ratings on Genworth Financial Mortgage Insurance and Genworth Financial.

Genworth is a provider of lenders' mortgage insurance (LMI) for the loans in the affected RMBS pools. Consequently, the ratings on the RMBS tranches are linked to the rating on Genworth.

The credit support in the tranches placed on watch negative is lower than the expected loss sized at the current rating levels after giving credit to LMI provided by the single-A plus rated insurer. Some of the ratings are linked to that of Genworth as the LMI provider because there is no additional credit support to the tranches. Others benefit from some other form of credit support - usually subordination - though that credit support may no longer be sufficient at the current rating levels, says S&P.

Genworth is a supporting counterparty as LMI provider to a total of 833 RMBS ratings in Australia and New Zealand. Most of the affected tranches are subordinated tranches, whereby the ratings are directly supported by the rating on the LMI provider. The unaffected tranches - for which Genworth is a supporting counterparty - have the benefit of credit support provided by subordination, as well as other structural supporting mechanisms.

S&P expects to resolve the credit watch status of the ratings after it completes a review of the current performance data, along with structural reviews.

RMBS

DSB ratification 'credit positive'

The Amsterdam Court of Appeal has ratified the framework agreement that sets out the compensation amount formula on due care claims of clients of the now bankrupt DSB Bank. Moody's says the move is credit positive for the securitisations originated by DSB as it removes some level of uncertainty around the amount of potential losses linked to due care compensation, as well as the length of the involvement of the bankruptcy trustees in servicing loans and handling due care claims.

Borrowers have now only 12 months until November 2015 to submit due care claims under the framework agreement. Chapel 2003-1, Chapel 2007, Monastery 2004-I and Monastery 2006-I bear the losses associated with the due care claims from borrowers in the securitised pools. But the Manastery and Chapel sceuritisation vehicles still have corresponding counterclaims on DSB's estate.

The framework agreement governing borrower compensation resulted from negotiations between DSB and consumer organisations in September 2011. Many borrowers have already submitted their claims and received compensation under the current terms of the framework.

Moody's estimates that due care losses amount to €75m in Chapel 2003-1, €85m in Chapel 2007, €10m in Monastery 2004-I and €15m in Monastery 2006-I. The due care losses ultimately realised are likely to fall short of these values, with the borrower claims processed up until 3Q14 amounting to an average 50% of the maximum estimates in the securitisation transactions.

The agency notes that a decrease in ultimate borrower compensation amounts compared to those assumed in our rating analysis could lead to a possible upgrade of the ratings on some of the notes in the Chapel and Monastery series.