Contents

Structured Finance

Staying afloat

Rising pressures test servicer resilience

Recent regulatory and investor pressure on Ocwen has highlighted the operational weaknesses of some US RMBS servicers. Improved risk management - especially regarding communication, information and process flows - is key to strengthening their approach.

The past few months have seen Ocwen agreeing to a US$150m settlement with the NYDFS and responding to investor allegations of contractual breaches in connection with a number of RMBS and servicer advance ABS (SCI passim). Scrutiny has extended to other servicers as well, with Walter Investment recently receiving an investigative subpoena from the California Attorney General regarding its subsidiary Green Tree Servicing (SCI 12 November 2014).

In the latest development, the California Department of Business Oversight (DBO) agreed a US$2.5m settlement with Ocwen over the servicer's failure for more than a year to provide loan information needed by the DBO to assess its compliance with state mortgage lending laws (SCI 27 January). The settlement prohibits Ocwen from taking on any new California customers until the DBO determines the firm can fully respond in a timely manner to future requests for information. In return, the DBO will drop its effort to suspend Ocwen's license to operate in the state.

"It's a big wake up call for the ABS market," says Ron D'Vari, ceo at NewOak Capital. "It is certainly not a surprise that concerns have been growing. This has increased the standards that investors will now look for with servicers."

D'Vari suggests that although a settlement has been agreed between Ocwen and the DBO, the investigation may not have been thoroughly completed yet. Although it seems remote, the possibility of a suspension of Ocwen's license should not be completely ruled out, depending on the outcome of the review of the requested information from Ocwen. In a hypothetical scenario, the servicer may be required to sell its entire non-agency MSR portfolio as most pools contain California loans.

"These loans could also be transferred to a third party," says D'Vari. "However, I believe it is highly unlikely that the license will be removed, as it would cause more servicing disruption than provide favourable solutions for the borrowers."

He believes this would be an iterative process that regulators would rather avoid, particularly as they are looking to drag the current issue towards a direction that provides a positive outcome for most parties involved. Hence, the DBO's fine presents a stark contrast to the fee the NYDFS imposed on Ocwen last year (SCI 23 December 2014).

Ocwen released a filing with the US SEC on 5 February disclosing that it has received strong interest from eligible buyers for its agency MSRs (SCI 12 January). The servicer anticipates selling US$5bn-US$20bn of unpaid principal balance per month starting in 2Q15 and continuing through the end of the year. Ocwen anticipates the proceeds to be substantial and could be used to fund new and existing assets, as well as repaying portions of its senior secured term loan.

Nevertheless, other states may levy additional fines on Ocwen, which would exert further liquidity pressure on the servicer. In its SEC filing Ocwen states its awareness of 21 pending examinations in 15 states. However, the servicer suggests that based on its current engagement with state regulators, it does not anticipate any further fines, penalties or settlements - with the exception of two open legacy matters that will be resolved at a sum of less than US$1m.

D'Vari stresses that regulators generally appear to be seeking more positive solutions to such issues. "One thing that is certain is that every state is looking to ensure that servicers are putting standard procedures in place," he says. "However, they have often been guilty of presenting a lack of flexibility in their regulations, creating a rigid process as a result. The onus is now on them to come together to make a complex servicing process more manageable and less confusing to the borrowers, especially if the loans are in default."

D'Vari suggests that improved communication is a prime factor in this being achieved. "One of the main grievances with the DBO was that it was unhappy with the information flow it was receiving from Ocwen. That is where the role of the independent auditor comes in. The DBO will expect to start receiving the information it believes it had originally requested."

He adds that the experience has likely enlightened both sides and fits quite tidily into the "evolving servicing environment" that surrounds the relationship between servicers, regulators and investors. This evolution seems to be speeding up in light of recent issues and applies to what D'Vari believes servicers must do going forward if they are to avoid falling into similar situations.

"Servicers need to continue upgrading their technology to address tight servicing process needs. Ocwen, in particular, needs a data-rich process flow management to monitor and continuously improve its current approach," he explains.

Fitch on 5 February downgraded Ocwen's RMBS primary, special and master servicer ratings, citing the servicer's inability to provide competent corporate governance and operational control framework as key factors in the downgrade. In addition, the agency referred to the servicer's weaknesses in its control environment, senior management's lack of oversight in connection with identifying and resolving operational deficiencies, as well as the inability to respond satisfactorily to regulatory requests for information and the lack of sufficient escalation procedures that would raise serious issues to senior management.

Fitch adds that Ocwen's aggressive portfolio, staff growth and integration process over the past several years have not resulted in a unified and cohesive risk management framework for its entire servicing business. The agency says that while the servicer has realised greater economies of scale as a result of its acquisitions and use of technology, investment in risk management has lagged and has resulted in a number of deficiencies identified over the past several years.

JA

RMBS

Unusual sectors for US RMBS

Secondary US non-agency RMBS activity is quieter this week overall, but two sectors of the market are unusually busy.

"We've seen a slowdown in advance of the conference in Vegas next week," says one trader. "However, there has been a lot of activity in two areas where we don't often see high volumes trading - wrapped bonds and re-REMIC structures."

BWIC volume today is currently around $800m, which some way below the Thursday average, but it does include a $150m list of wrapped bonds - the third of significant size seen this week. "It seems like some large players are exiting their positions in these deals possibly as an opportunistic trade on the back of the success of smaller wrapped lists last week," the trader suggests.

There has also been an unusually hefty supply of re-REMIC bonds in for the bid this week, especially mezzanine tranches. Here, the trader says: "It's mainly hedge funds looking to take profits on what was one of the most successful sectors last year."

Overall, the trader says: "The RMBS market is trading well, with a higher than usual proportion of deals trading ahead, which indicates a pretty healthy state. Real money investors are supporting pricing levels as with longer investment horizons they continue to be willing buyers."

Secondary markets

Euro ABS/MBS holds firm

Away from Greece secondary European ABS/MBS spreads are holding firm.

Core bonds continue to grind tighter and peripheral spreads are holding up well on the back of broad-based demand. Areas of focus remain Dutch prime, UK non-conforming and Italian RMBS.

The BWIC calendar so far today is again relatively light with a fair number of line items only offered in small clips. The now usual supply mix of core and peripheral RMBS assets are in evidence and there is also a five line triple-B pubs BWIC due at 11:30 London time.

The £13.95m list consists of: GNKLN 03/15/36, GNKLN 5.702 12/15/34, MABLN 0 06/15/36, MABLN 0 34 and MARSLN 5.641 35. Three of the bonds have covered on PriceABS in the last three months all last doing so on 28 January as follows: GNKLN 03/15/36 at 86.75; MABLN 0 06/15/36 at 88.8 and MABLN 0 34 at 89.38.

In addition, there is a two-line CMBS auction due at 14:00 consisting of €40.5+m EPICP DRUM A and €42.3+m TAURS 2007-1 A1. Only EPICP DRUM A has covered on PriceABS in the last three months doing so at 92h on 28 January.

Secondary markets

Euro secondary mixed

Last week's positive tone across European secondary has followed on into this for most deal; types and jurisdictions, but there are some exceptions.

Dutch and UK prime, UK non-conforming and Italian RMBS continue to be better bid. At the same time buy-side demand for CLOs is on the rise across the capital stack.

Conversely, Greek paper continues to be impacted by negative economic headlines. Equally, non-eligible peripherals are seeing some retracement.

In any event, the first half of this week is likely to see lighter flows across the board with many US participants out at the Vegas conference. Today's BWIC schedule evidences that with only two lists currently scheduled.

At 15:30 London time is a single €3m line of RPARK 1X D. The CLO last covered on PriceABS at 92.2 on 8 December.

Then at 16:30 is a three line €17.035m CMBS BWIC consisting of: TAURS 3 B, TAURS 3 C and TMAN 4 B. TAURS 3 B and TAURS 3 C have both covered with a price on PriceABS in the last three months, doing so at 30.5 on 14 January and 0.25 on 5 February, respectively.

Secondary markets

Large US RMBS lists circulating

In an otherwise currently very quiet US non-agency RMBS secondary market as a result of the Vegas conference, two large AON BWICs are already circulating for trade at the end of this week.

Thursday at 10:00 New York time sees a 574 line item BWIC accounting for $289.4+m of current face. The list is offered on an AON total dollar proceeds basis and consists of a wide range of structure types.

On Friday at 10:00 there is a far larger list in terms of size - $2.6+bn of current face spread over 132 lines. The auction is split in to three AON pools covering inverse interest only, interest only and principal & interest deals.

Secondary markets

Light flows in European ABS/MBS

The light flows seen in European ABS/MBS secondary markets yesterday look set to continue in to today.

Yesterday saw only patchy activity across deal types with Dutch and UK prime leading the way alongside autos. UK non-conforming saw less action than of late and Greek paper took some hits, but overall spreads stayed steady despite broader market volatility.

The ABS/MBS BWIC calendar is quiet again today with four lists currently due. There are two mixed RMBS auctions scheduled that primarily involve small sizes - one went through at 9:00 London time and the other is due at 14:00.

There is also a single line of Italian RMBS scheduled for 10:00 - €1.5m original face of GIOVC 2011-1 A. The bond hasn't ever traded on PriceABS.

At 14:30 there is a two line CMBS list - €4m of TITN 2007-2X B and €5.5m of TITN 2007-2X C. Neither bond has traded on PriceABS in the last three months.

Secondary markets

Euro ABS/MBS picks up

Despite the lack of BWIC supply activity picked up in European ABS/MBS yesterday and into this morning.

Dutch and UK RMBS, both prime and non-conforming, Italian RMBS and UK autos are all seeing strong appetite again from both buy- and sell-side players. Consequently spreads in those sectors are edging in or holding tight.

Elsewhere the story is more mixed with some major Spanish and Portuguese names seeing good demand but other peripheral bonds are widening. Greek paper retains its own narrative with prices driven up or down throughout the day by ever-changing headlines.

The BWIC schedule is quiet again today with just one due so far - a single list consisting of small clips of UK non-conforming RMBS at 14:00 London time.

Secondary markets

Lull for US CMBS

The secondary US non-agency CMBS market is currently going through something of a lull.

"Yesterday was slow and today is reasonably quiet, though a few more BWICs are coming out now," says one trader. "There doesn't appear to be any significant reason why."

At the same time, CMBS spreads are holding steady with no dramatic drivers to disturb them. "Right now, there is nothing stand-out in terms of activity or the deals on offer in BWIC," the trader says.

Total BWIC volume for the day is currently hovering around the $200m mark, with a high proportion of line items being offered in small size. The largest piece in for the bid today so far is $95m of WBCMT 2007-C32 AMFX, due on its own list at 11:30 New York.

The bond has not traded on PriceABS before, but is being talked somewhere in the region of a 140s spread.

Secondary markets

Greek RMBS hit again

Volatility in broader markets has fed through into Greek RMBS this morning, but elsewhere in European ABS/MBS spreads are steady.

Sellers are outnumbering buyers in Greek RMBS this morning on the back of the ECB implementing further funding restrictions to the country's banks. GRIF 1 A is currently quoted at 65 bid - down over two points today and a ten point drop since the Greek general election.

However, spreads across all other European ABS/MBS asset classes and jurisdictions continue to stay steady on the back of good execution levels on- and off-BWIC. Today's BWIC calendar is currently considerably lighter than yesterday's, but the positive tone is expected to be maintained across the UK non-conforming, peripheral mezzanine and CMBS deals on offer.

Structured Finance

SCI Start the Week - 9 February

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

Pipeline
A variety of deals joined the pipeline last week, with proposed issuance from the US, UK, Europe, Australia and China. A total of two ABS, four RMBS, two CMBS and three CLOs was recorded.

CNY2.99bn Fuyuan 2015-1 and US$134.6m Kentucky Higher Education Student Loan Corp 2015-1 accounted for the ABS. The RMBS were US$405.27m CSMC Trust 2015-1, A$500m Series 2015-1 Harvey Trust, £100m Silverstone 2015-1 and US$450m USROF 2015-1.

US$285m BAMLL 2015-ASHF and US$1.8bn GAHR Commercial Mortgage Trust 2015-NRF constituted the CMBS. Meanwhile, the CLOs were US$600m Ares XXXIII CLO, €243m Dartry Park CLO and US$608m Magnetite XII.

Pricings
A significant number of deals priced last week. There were seven ABS prints, as well as two ILS, five RMBS, six CMBS and four CLOs.

The ABS were: US$175m Ally Master Owner Trust Series 2015-1; US$450m Ally Master Owner Trust Series 2015-2; US$1.1bn BA Credit Card Trust 2015-1; US$850m Chesapeake Funding Series 2015-1; US$326m Consumer Credit Origination Loan Trust 2015-1; US$836.6m Ford Credit Floorplan Master Owner Trust A Series 2015-1; and US$522.8m Ford Credit Floorplan Master Owner Trust A Series 2015-2.

US$150m Atlas IX Capital Series 2015-1 and US$300m Galileo Re Series 2015-1 were the ILS. The RMBS were: US$279.49m Agate Bay Mortgage Trust 2015-1; US$940m JP Morgan Mortgage Trust 2015-1; A$2bn PUMA 2015-1; US$338.8m Sequoia Mortgage Trust 2015-1; and US$283.88m WinWater Mortgage Loan Trust 2015-1.

The CMBS were: US$421.3m BWAY 2015-1740 Mortgage Trust; US$1.2bn CGCMT 2015-GC27; US$1.125bn COMM 2015-3BP; US$635.3m JPMBB 2015-C27; US$346m Resource Capital Corp 2015-CRE3; and US$1.25bn SFAVE 2015-5AVE.

Lastly, the CLOs were €500m Carlyle Global Market Strategies Euro CLO 2015-1, US$307m Clear Creek CLO 2015-1, US$411.1m MidOcean Credit CLO IV and US$414.4m Vibrant CLO III.

Markets
US ABS spreads were mostly tighter last week, with senior auto and credit card ABS spreads compressing 1bp week over week, according to Barclays Capital analysts. "ABS trading volumes rebounded this week, after a winter storm depressed trading volumes last week. An average of US$1.7bn of ABS traded during the first four days of the week, compared with US$1.1bn during the corresponding period [in the previous week]", they note.

Demand for fixed rate bonds drove pricing tighter in the US non-agency RMBS market, where Bank of America Merrill Lynch analysts note there was a stronger tone last week. "Credit risk transfer was tighter, while SFR was mostly unchanged. Through Thursday, US$696m of investment grade bonds and US$6.7bn of non-investment grade bonds traded," they add.

The pipeline for International ABS and RMBS deals is growing, with RMBS from the UK and Australia and ABS from the UK and China. "The growing primary market pipeline and the newsflow out of Greece distracted investors," say JPMorgan analysts. As a consequence, spreads closed the week unchanged.

Deal news
• The recent landmark Titan Europe 2006-3 ruling affirmed that an issuer can have a legal basis for a negligence claim against a property valuer. The decision may prompt further cases to come forward and encourage a fresh set of standards for CMBS 2.0 deals.
• Auction.com and RealCapitalMarkets.com data indicates that 45 properties backing US$417m distressed US CMBS loans are up for auction in February and March. Barclays Capital CMBS analysts note that some of the loans, primarily securitised in GCCFC 2007-GG9, were previously out for bid in the US$250m year-end auctions and appear to be relisted.
• Rabobank International has resigned from its role as collateral manager for Vermeer Funding II and designated the replacement collateral manager as Dock Street Capital Management (DSCM). Fitch notes that the terms of the amended and restated collateral management agreement remain almost identical to the original collateral management agreement, with minor differences that are not material to the ratings of the transaction.

Regulatory update
• The US Department of Justice and 19 states and the District of Columbia have entered into a US$1.375bn settlement agreement with S&P along with its parent McGraw Hill Financial. The agreement resolves allegations that S&P had engaged in a scheme to defraud investors in RMBS and CDOs.
• The European Commission has published a report that recommends granting pension funds a two-year exemption from central clearing requirements for their OTC derivative transactions. The report explains that central counterparties need this time to find solutions for pension funds and encourages CCPs to continue working on finding technical solutions on the matter.
• ESMA has released a call for evidence as part of the development of technical advice for the European Commission on the functioning of the credit rating industry and the evolution of the markets for structured finance instruments, as required by the regulation on credit rating agencies (CRAs). The authority is seeking evidence about how the regulation is achieving the objectives of stimulating competition between CRAs, improving the choice of CRAs available and minimising conflicts of interests in the industry.
• The European Commission last week began a project to create a capital markets union (CMU) for all 28 EU Member States with a first orientation debate at the College of Commissioners. The CMU is one of the Commission's flagship projects and ties in with efforts to boost jobs and growth in the EU.

Deals added to the SCI New Issuance database last week:
AOA 2015-1177; CGCMT 2015-101A; CGCMT 2015-GC27; Dorchester Park CLO; Dryden 37 Senior Loan Fund; FCT Ginkgo Personal Loans 2015-1; Fifth Street Senior Loan Fund I; Galaxy XIX CLO; Galileo Re series 2015-1; GE Dealer Floorplan Master Note Trust Series 2015-1; GE Dealer Floorplan Master Note Trust Series 2015-2; Invitation Homes 2015-SFR1 Trust; Jamestown CLO VI; JP Morgan Mortgage Trust 2015-1; LMREC 2015-CRE1; Nissan Master Owner Trust Receivables Series 2015-A; OneMain Financial Issuance Trust 2015-1; Progreso Receivables Funding series 2015-A; Progress Residential 2015-SFR1 Trust; Sequoia Mortgage Trust 2015-1; STACR 2015-DN1; Taurus 2015-1 IT; Valins I

Deals added to the SCI CMBS Loan Events database last week:
BSCMS 2006-PW12; CSCMT 2006-C3; DECO 2007-E5; DECO 6-UK2; EPICP BROD; EURO 28; GCCFC 2005-GG3; GCCFC 2006-GG7; GCCFC 2007-GG9; GECMC 2005-C4; INFIN SOPR; JPMCC 2006-LDP7; JPMCC 2007-LDP11; LBUBS 2001-C3; LBUBS 2006-C1; LBUBS 2006-C7; MLCFC 2007-7; MSC 2007-IQ14, MSC 2007-HQ12, BACM 2007-2, BSCMS 2007-PW16, WBCMT 2007-C31 & WBCMT 2007-C32; Portfolio Green; TITN 2006-3; TITN 2007-1; TMAN 5; WBCMT 2005-C22; WINDM X

Structured Finance

To BWIC, or not to BWIC

A large, diverse block of European bonds came out for the bid last week, but in an untraditional way. The bonds were offered on a BWIC without a deadline, leading some investors to describe it more as a controlled liquidation than a true bid-list.

"It is a very unusual way to present bonds to the market. Obviously investors are used to BWICs where there is the opportunity to bid before the deadline, but not to BWICs where there just isn't one," says one trader.

He notes that it will be interesting to see what execution is like. One of the perceived downsides to BWICs when they gained popularity after the crisis was that they do not give investors very much time to assess bonds before making bids, so the lack of a deadline does away with that concern.

"This is almost like a reissuance," says the trader. One explanation for the unusual method of sale could be that the seller is looking to attract the ECB as a buyer, considering the central bank's lengthy approval process for purchases under its ABSPP that will be easier to accommodate without a bid deadline.

"Another explanation could just be that the seller is looking to get rid of these bonds over the next couple of weeks but is not in a hurry and does not need to rush prospective buyers. This means buyers and the seller can take their time to think about appropriate bid levels," says the trader.

He continues: "Of course, it could also just be that the seller wants to avoid bringing out a list that garners a load of DNTs, only to have to then put those same names on another list a week or so later. It is a different way to offer names but different does not have to mean better or worse, it can just be different."

JL

CLOs

Quality considerations

Concentration risk has resurfaced in the legacy European CLO space, following a recent spate of optional redemption notices, coupled with high repayment rates for non-called deals. Based on an analysis of the sector, European securitisation analysts at Bank of America Merrill Lynch note that a minority of transactions now only have a small number of assets left in their portfolios.

High loan prices and declining equity returns have encouraged some equity investors to exercise their call options in recent weeks. At the same time, Alliance Boots began the year with a large loan repayment, while Telediffusion de France is expected to repay its loans soon following the sale of its French unit. The BAML analysts note that these two credits were among the most widely held names in European CLOs.

On average early vintage deals appear to be more concentrated than later vintage deals, according to the BAML analysis. The exception is 2008 vintage deals, which have amortised much quicker than earlier vintage deals.

For CLO 2.0 deals, the largest borrower accounts for 2.5%-3% of the portfolios, in line with typical limits specified in portfolio tests. By comparison, this is as high as 35.7% for 2008 vintage deals. In 2006 and 2007 vintage deals, the largest borrower accounts for 9.3% and 5.3% of the portfolios respectively.

The largest exposure remains Telediffusion de France at 2.8% of collateral, according to the analysts. They note that UPC and Ziggo together account for 2.9% (UPC parent Liberty Global recently acquired Ziggo and intends to merge the two companies). Of the total European CLO collateral, 14 companies account for over 1%.

Typically single-name exposure is limited at issuance to around 2.5%-4%, with limits continuing to apply during the reinvestment period.

Several of the most widely held companies are in the communications sector, which the analysts estimate accounts for 22.5% of total European CLO collateral. The next highest exposure is to companies categorised in the consumer discretionary sector.

Within this group, retail names performed relatively poorly through 2014, with Vivarte defaulting early in the year and other companies suffering from weak growth and consumer demand. However, the outlook for the sector may be more positive in 2015, partly driven by higher expected consumer spending encouraged by lower oil prices.

Finally, the analysis suggests that European CLOs have very little exposure to the energy sector.

While the analysts indicate that concentration risk is not significant in the majority of deals, some CLOs issued before 2004 or in 2008 have a small number of assets left in the portfolio. "We therefore believe caution is required for these more concentrated deals, particularly where there is limited buffer in terms of overcollateralisation or on a NAV basis. Almost all legacy deals are now amortising and managers therefore have very little flexibility to trade. As a result, we believe investors need to consider particularly carefully the quality of the remaining assets in these portfolios, given the narrower margin for error," they conclude.

CS

CLOs

BDC equity purchasing eyed

BDCs owned almost US$3bn of CLO equity at end-3Q14, approximately US$2.5bn of which is owned by just five vehicles, according to Wells Fargo data. Structured product strategists at the bank warn that the ability of certain BDCs to purchase more CLO equity may be limited, which is one driver behind the decrease in CLO equity demand so far in 2015.

For context, the total amount of US CLO equity issued from 2011 to 3Q14 stands at US$27.2bn. Thus, these BDCs own CLO equity equal to almost 10% of all US CLO equity issued in since 2010.

The Wells Fargo strategists explain that BDC portfolio growth is limited by a leverage cap and a requirement to pay out 90% of earnings as a dividend; therefore, issuing stock is often the only way for BDCs to grow their portfolios. However, the stock prices of many BDCs are currently trading below NAV, which can limit stock issuance.

Consequently, the strategists recommend that CLO investors and managers pay close attention to the earnings calls of the BDCs that own CLO equity. "Without the ability to issue stock, BDCs may have limited capacity to purchase CLO equity. This can limit CLO equity demand, which can limit CLO issuance," they observe.

The BDC with the largest CLO equity holdings is PSEC. Although PSEC plans to spin off its CLO holdings to a separate fund, the strategists believe that BDCs are generally unlikely to sell their CLO equity positions now.

"If and when CLO-investing BDCs do raise equity capital, CLO investors should recall that BDCs have a 30% limit on 'non-qualified' assets, which includes CLO equity. For BDCs close to the limit, each equity raise only increases CLO equity capacity by approximately 30% of the amount raised," they add.

CS

CLOs

CLO pricing to reflect sector views?

Energy-related credits continue to diverge from loan index returns, in conjunction with the drop in oil prices. With increased attention being paid to sectors, JPMorgan CDO strategists examined a sample of US post-crisis CLO exposures across 21 sectors as categorised by the JPMorgan leveraged loan index.

The sample comprised 461 deals totalling US$217bn in assets. The analysis shows that healthcare, telecommunications and services account for the highest exposure, averaging a combined 31.9% of post-crisis CLO portfolios. Energy makes up more as a percentage of the total portfolio in recent vintages: average exposure in the 2011, 2012, 2013 and 2014 vintages stands at 2.8%, 4.2%, 4.6% and 5.5% respectively.

"Since our prior measurement in early December, energy exposures marginally increased by zero to 5bp on average, suggesting that CLO managers have not been selling," the JPMorgan strategists observe.

Another sector of concern is metals and mining, given recent double-digit commodity price drops. However, CLO 2.0 transactions seem more insulated, with an average 2.1% exposure to the sector, the second-lowest behind housing.

Comparing 216 CLOs from the 2011, 2012 and 2013 vintages, exposures largely remained within 1% of levels from a year ago. "As we are measuring the same portfolio across two separate periods, the sectors with the largest gains signal to us broader overweight/underweight sentiments across CLO managers. Interestingly, the sectors which added the most exposure were energy (by 1.28%), media (1.05%) and healthcare (0.82%)," the strategists note.

Up to a 10bp differential in triple-A and double-A CLO bonds has emerged in recent BWIC activity, based on energy exposure. However, the strategists believe that senior CLO debt holders have little to worry about in terms of energy exposure from a par loss perspective. Being further down the capital structure would be more concerning, depending on holdings, concentrations and subsector views.

"Thus far, our observations suggest few BB/B CLO tranches and very little equity with high energy exposure have traded this year, which makes price observations challenging. But with oil prices expected to remain below US$60/bbl for the next two years, the oil and gas theme and broader sector exposures will increasingly factor into CLO pricing," the strategists conclude.

CS

CMBS

Rating requirements pose questions

The US SEC's decision to bar S&P from rating new issue conduit CMBS until next year (SCI 22 January) presents a conundrum, as many money managers require either an S&P or a Moody's rating. Moody's comparatively high subordination requirements in order for an AS tranche to be rated Aaa could therefore affect how future deals are structured.

Moody's last week stated that the average credit enhancement level assigned by other market participants to class D tranches was nearly four percentage points lower than the level that Moody's would have assigned (SCI 30 January). Of the 46 conduit deals the agency rated last year, the AS tranches of 16 deals were not able to achieve a Aaa rating.

Should loan-level LTVs increase and debt yields decrease this year, Moody's could start to require more subordination in order to rate an AS tranche at Aaa. Bank of America Merrill Lynch CMBS analysts note that there is also a chance the last cashflow triple-A tranche could only be deemed worthy of a Aa1 rating unless its subordination level rises as well.

Should Moody's decide that the natural Aaa level is 30% subordination, the BAML analysts believe either last cashflow triple-A subordination will have to rise in line with Moody's assessment, or the senior-subordinate triple-A structure could be eliminated, with the AS and last cashflow triple-A bonds being collapsed.

Under the first scenario, the analysts model a hypothetical conduit structure with subordination and pricing spreads similar to where recent conduit deals have priced. They also modify this base case with a six point thick AS tranche with 29% enhancement, while holding pricing constant for all tranches except for the last cashflow triple-A.

In order to keep proceeds to the issuer constant between the base case and modified scenario, the last cashflow triple-A would need to price around 12bp tighter in the modified case than in the base case. That would be a spread of plus 83bp.

The alternative reaction to Moody's more stringent credit enhancement requirements is to revert to pre-2004 structures, collapsing the AS and last cashflow triple-A bonds. Holding the pricing spreads for all tranches other than the new A4 constant, the analysts find that creating a structure which time-tranches the triple-A bonds requires the new last cashflow bond to price around 8bp tighter than it currently does in order to keep dealer proceeds unchanged.

Ultimately, dealer proceeds may not actually need to remain unchanged, although the need for last cashflow triple-A bonds to be rated Aaa by Moody's is probably less flexible. Should future conduit loan underwriting allow for higher LTVs and lower debt yields, the scenarios the BAML analysts present are likely to become more pressing for investors.

Of all the investors the BAML analysts spoke with at the CREFC conference last month, only one indicated they would be willing to pay up for a super-senior triple-A that had more than 30% subordination. "If the majority of investors deem it superfluous to have more than 30% subordination beneath the last cashflow triple-A bond, we can easily envision a market in which AS bonds become unnecessary," they say.

JL

CMBS

Retail hits

The US CMBS market was last week hit by a double-whammy of negative news, as RadioShack filed for bankruptcy and Staples announced plans to acquire Office Depot. However, the ensuing store closures are anticipated to have only a minor impact on CMBS transactions, despite the sector's large exposure to the retailers.

Staples expects its acquisition of Office Depot to deliver at least US$1bn annualised cost synergies as the two firms reduce global expenses and optimise their retail footprint. The combined entity would have approximately 2000 stores across the US, with some of them potentially at risk of closure in the medium term.

This is the second merger in which Office Depot has been involved in recently, having acquired OfficeMax in 2013, which led to over 400 stores being closed (SCI passim). Barclays Capital CMBS analysts calculate that 390 loans and 430 properties have either Office Depot or OfficeMax as one of the top-five tenants, with a total allocated loan balance of US$6.6bn. There are 309 loans and 330 properties with exposure to Staples, with a total allocated loan balance of US$4.4bn.

"While there is significant exposure to both Staples and Office Depot, no property seems to have both as a tenant under the same roof," they note.

The Barcap analysts estimate that approximately 75% of the affected properties have less than 20% exposure to Staples/Office Depot. Staples/Office Depot stores at the remaining properties currently occupy more than 20% of the total property leasable area.

The loan likely to be most affected by the merger is the US$49m OfficeMax Headquarters, securitised in MLMT 2007-C1. The US$21m 600 Jefferson Avenue loan securitised in GSMS 2006-GG8 is the largest of Staples' properties and has a 100% exposure to the retailer.

Meanwhile, the RadioShack bankruptcy includes the transfer of 1500-2400 stores (out of 4000) to Sprint and its largest shareholder Standard General. The remaining stores will be shut down.

The Barcap analysts suggest that any stores not purchased by Sprint are likely to default on their leases, resulting in an immediate cashflow hit for properties with these tenants. However, the stores purchased by Sprint are expected to see no immediate effect on their cashflows, as the firm would assume the leases.

In total, 189 CMBS loans with a balance of approximately US$3.2bn across 202 properties have exposure to RadioShack as one of the top-five tenants, according to the analysts. But the total allocated loan balance of the properties is only US$985m, as several of the properties are part of large portfolios.

For approximately 82% of the affected properties, RadioShack comprises less than 10% of their leasable space. Only 21 properties have over 20% of their space leased to the retailer, totalling US$33m in allocated balance.

"While unlikely by itself to push a mall into default, the closing of half of RadioShack stores will likely dent incomes of struggling secondary malls if their store leases are not assumed by Sprint. Additionally, if Sprint locations overlap with RadioShack locations, we could see an increased likelihood of Sprint stores not renewing their leases. But this risk is quite small, with only US$76m having significant exposure," the analysts observe.

CS

Structured Finance

Italian expansion for investment firm

Tikehau Capital is developing its direct investment activities and its asset management liquid funds solutions in Italy. Ignazio Rocco di Torrepadula, senior advisor at The Boston Consulting Group, has been appointed senior advisor at Tikehau Capital Italy.

Furthermore, Luca Bucelli will relocate to the firm's new offices in Milan. Bucelli and Torrepadula will both work closely with Jean-Pierre Mustier, who recently joined as a partner (SCI 27 January).

Through its expansion, Tikehau says it is aiming to address the increased demand for new asset classes from individuals to institutional investors seeking to diversify their asset allocation.

Structured Finance

Distressed debt exec moves

Ray Costa has joined Benefit Street Partners as md. He will lead the firm's event-driven/distressed investing platform, reporting to Thomas Gahan, founder and ceo of BSP.

Costa arrives from Deutsche Bank, where he was also an md. His responsibilities at the bank ranged from the global head of distressed debt trading to co-head of credit fixed income trading in North America.

Prior to joining Deutsche Bank, Costa traded a variety of credit fixed income products at Donaldson, Lufkin and Jenrette, as well as Swiss Bank Securities.

Structured Finance

MBS team strengthened

Cantor Fitzgerald has expanded its MBS sales and trading team by appointing Brendan Donnelly and Mohil Gupta as mds. They will focus on strengthening relationships with institutional clients across securitised products, reporting to John Baldo, global head of fixed income sales at the firm.

Donnelly previously served as vp of global structured products sales at Bank of America Merrill Lynch. Prior to this, he held a number of senior positions at Annaly Capital, JPMorgan and Bear Stearns.

Gupta also most recently served as vp of global structured products sales at BAML. Before this, he traded and structured agency CMOs at BAML.

Structured Finance

Data pro swaps firms

Ned Myers has joined Black Knight Financial Services' data and analytics division. He will lead the division's strategy for its capital markets and government solutions.

Previously, Myers was svp in market development for Lewtan, where he held responsibility for corporate and product strategy. He also has executive management experience in sales and marketing, product management, mergers and acquisitions, customer support and professional services.

Structured Finance

Lender explores strategic alternatives

MCG Capital has determined that it will explore strategic alternatives for maximising value for stockholders, including a possible sale of the company. The board of directors has engaged Morgan Stanley as financial advisor and Wachtell, Lipton, Rosen & Katz as legal counsel to assist in the process.

The firm does not expect to comment further or update the market with any additional information on the process until its board has approved a specific transaction or otherwise deems disclosure appropriate or necessary. MCG notes that there is no assurance this strategic alternatives review will result in it changing its current business plan, pursuing a particular transaction or completing any such transaction.

Structured Finance

Law firm expands LatAm presence

Clifford Chance has recruited Gianluca Bacchiocchi as a partner to its banking and finance practice in the Americas. His arrival will bolster the firm's support of its clients in the Latin American region.

Bacchiocchi comes to Clifford Chance from DLA Piper. His practice focuses on representing sponsors, issuers and underwriters in cross-border capital markets transactions in Latin America, including project bond financings, public and private issuances of ABS, private issuances of future flow-backed securities and high yield debt issuances.

The addition of Bacchiocchi brings the number of Clifford Chance partners in the Americas to 73. He is the third major partner hire made by the firm in the region over past few months, following the arrival of structured finance partners Bob Gross and Will Cejudo in December (SCI 2 December 2014).

Structured Finance

Man adds distressed credit vet

Himanshu Gulati has joined Man GLG as head of US distressed credit. He will manage a new distressed investment strategy, which the firm plans to launch later this year.

Gulati arrives from Perry Capital, where he was a managing partner responsible for distressed credit and special situations investments. Prior to this, he was at Rockview Capital, after working within the leveraged finance division at Merrill Lynch.

Gulati will report to Man GLG co-ceo Mark Jones.

CDO

ABS CDO manager replaced

Rabobank International has resigned from its role as collateral manager for Vermeer Funding II and designated the replacement collateral manager as Dock Street Capital Management (DSCM). Fitch notes that the terms of the amended and restated collateral management agreement remain almost identical to the original collateral management agreement, with minor differences that are not material to the ratings of the transaction.

The agency says that the most senior class in the transaction is currently rated single-C, indicating that default appears inevitable for the notes. The transaction is no longer in its reinvestment period. Fitch therefore does not expect the novation to have any impact on the ratings of the notes.

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

CDS

BGC deadline extended again

BGC Partners has extended to 19 February the deadline for its tender offer to acquire all of the outstanding shares of GFI Group for US$6.10 per share. The offer was previously scheduled to expire on 3 February.

As of 3 February, approximately 37.9 million shares were tendered pursuant to the offer. The 37.9 million tendered shares, together with the 17.1 million shares of GFI common stock already owned by BGC, represent approximately 43.3% of GFI's outstanding shares - or approximately 70% of shares not owned by GFI executives or directors.

BGC has responded to the announcement by GFI that it will explore a 'strategic alternative', following the rejection of CME's bid (SCI 2 February). Howard Lutnick, chairman and ceo of BGC, says: "BGC's US$6.10 per share all-cash tender offer is both the highest price offered for GFI and the only proposal that remains actionable by GFI's shareholders. GFI and its management team have been exploring 'strategic' alternatives for their company for a year and a half and decided based on this exploration that the now defunct US$4.55 per share was the price that GFI shareholders should have accepted."

He continues: "The statements by GFI's management team in their 30 July 2014 press say it all: '...Optimising GFI's value for stockholders has been a goal of management since becoming a public company in 2005 and this (US$4.55 per share) transaction represents a singular and unique opportunity to return value (to GFI shareholders)'."

Lutnick adds that GFI shareholders must decide for themselves whether or not they should listen to GFI's management team and board, or if they should tender their shares to BGC.

CLOs

CLO transfer anticipated

Jefferies Finance is set to transfer its responsibilities as portfolio manager for JFIN CLO 2013 and JFIN CLO 2012 to Apex Credit Partners. The transfers aren't expected to cause the downgrade or withdrawal of the current Moody's rating assigned to the class A notes issued. In reaching its conclusion, Moody's considered the experience and capacity of Apex Credit Partners to perform the duties of portfolio manager to the issuer.

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

CLOs

Fair Oaks to tap demand

Fair Oaks Income Fund reports that in light of the current pipeline of investment opportunities and a new investor commitment of at least US$21m, it is making additional new ordinary shares in the company at an issue price of US$0.9932. Fair Oaks believes that issuance of new shares is in the interests of shareholders as it will further enlarge the company and diversify its portfolio.

The issue is expected to close on 13 February, with admission of the new shares scheduled for 19 February. The issue price represents a premium of approximately 2.5% to the NAV, as at 31 January.

The company shares and NAV went ex-dividend on 29 January. Adjusting for the dividend, NAV was down by 0.2% last month, generating a NAV total return since inception of 4%. The shares closed at a mid-market price of 105.75 cents on 30 January, implying a 8.4% premium to NAV and a 10% total return since inception.

Insurance-linked securities

Tokio beefs up

Tokio Solution Management has added Susan Lane as svp and head of business development and client services. John Drnek has also joined the firm as vp and legal counsel.

Lane arrives from Aon Insurance Managers, where she was svp of business development. Prior to this, she worked in the insurance industry in the Cayman Islands and Ireland.

Drnek was most recently a senior associate in the corporate and securities department for Mayer Brown. Previously, he was with Hogan Lovells in its corporate insurance and reinsurance department. Drnek began his legal career in the capital markets department of Cadwalader, Wickersham and Taft.

ABS

Reset ABS affirmed

Fitch reports that the credit enhancement levels of six Indian auto ABS have been reset with no rating impact since the Reserve Bank of India released guidelines on CE reset in July 2013. The agency expects the volume of CE resets in Indian transactions to rise as the sector matures.

CE reset refers to the removal of credit enhancement from a transaction during its life. Indian ABS portfolios are static and begin amortising from a transaction's closing date.

As a result, when transactions perform well with minimal or no losses, transactions become super enhanced as the notes pay down and continue to benefit from the full, original credit enhancement. The RBI guidelines were designed to address this issue and, provided certain conditions are met, the central bank now allows transactions to reset the enhancement level by shedding credit support.

Among the conditions are that a pool demonstrates satisfactory asset performance, there is no rating impact after the reset on the transaction and the transaction has amortised by at least 50%. A pool meets the criteria of satisfactory asset performance if the sum of all overdue loans and other losses does not exceed 50% of the available first loss and second loss credit facilities, and also does not exceed 50% of the amortisation-adjusted amount of first loss and second loss cover, which is the closing CE multiplied by the percentage amortisation at the time of reset.

A maximum of 60% of the excess CE above the minimum CE for retaining the existing rating on each pass-through certificate can be released. The release is subject to a floor of 30% of the original CE.

Of the six deals to be reset, four were originated and serviced by Sundaram Finance, one by Shriram City Union Finance and one by Cholamandalam Investment and Finance Co.

ABS

Floorplan criteria finalised

S&P has published its rating methodology and assumption criteria for global non-diversified auto dealer floorplan (ADFP) ABS. The agency has added qualitative factors relating to the relevant auto manufacturer to be considered in its analysis.

These factors include consideration of the stand-alone credit profile (SACP) of the manufacturer, which is S&P's opinion of the manufacturer's creditworthiness in the absence of extraordinary support or burden from a parent, affiliate or government. The criteria also incorporates the overall position of the manufacturer relative to its peers based on the credit rating assigned to it and S&P's assessment of its business risk profile, which includes its competitive position.

S&P noted in its RFC for ADFP ABS that it believes the corporate credit rating (CCR) on the manufacturer is an important indicator of the non-diversified ADFP ABS credit risk profile (SCI 30 July 2013). In most instances, it believes the CCR provides an appropriate proxy for the rank ordering of manufacturers when assessing the potential impact of industry consolidation and an extreme economic stress on the non-diversified ADFP pool.

However, in limited situations, S&P believes the SACP of the manufacturer and its business risk profile are relevant supplemental credit risk factors that it should also consider in assessing the potential impact of industry consolidation and an extreme economic stress on a manufacturer, its product offerings and its dealer base. If the SACP on a manufacturer is materially different than the CCR or the business risk profile is atypical for the CCR, then the expected cumulative net losses may be adjusted accordingly.

The agency has also expanded the maximum range of positive or negative adjustments to its default-to-liquidation (DTL) and loss-given-default modelling assumptions, based on additional manufacturer-related qualitative factors. The expanded range of DTL and LGD modelling assumptions results in a wider range of possible loss-to-liquidation (LTL) and corresponding cumulative net loss assumptions.

In the final criteria, the impact of the qualitative adjustments results in a potential increase or decrease to the corresponding base LTLs and the cumulative net loss assumptions of up to about 20% for a given manufacturer CCR and payment rate trigger. Under the proposals outlined in the RFC, the resulting potential increase or decrease to the corresponding base LTLs and the cumulative net loss assumptions was up to about 15%.

S&P has expanded the range of DTL and LGD modelling assumptions to reflect the potential positive or negative effects of additional qualitative considerations incorporated into its final criteria that could cause the potential adjustments to be greater than those previously described in the RFC.

ABS

Used car price impact gauged

A rising amount of turned-in and off-lease vehicles will lead to declining values for used cars over the next couple of years, according to Fitch. However, the agency doesn't expect this trend to dent performance of US auto ABS.

Higher volumes of trade-ins and off-lease used vehicle returns have led to a rising inventory, while increased new car production and sales are diverting some used car demand. Fitch expects the shift in the supply and demand balance to lead to a deterioration in prices throughout 2015 and 2016. This rising supply could lead to other stresses, such as increased incentives, that may put a further strain on used vehicle values.

"Despite expected wholesale market deterioration, auto loan ABS losses are still at or near historic lows," says Fitch senior director Brad Sohl. "Auto lease securitisations are also still exhibiting residual gains on the whole, though it is worth noting that certain platforms are seeing more substantial softening."

Fitch subjected its rated auto ABS deals to numerous scenarios to gauge when collateral and rating performance would be affected. Under the moderate scenario (an approximate 20% haircut to recoveries), the agency anticipates no rating deterioration.

Only in a severe stress scenario (an unlikely 50% reduction) would there be a discernible ratings impact. In this case, Fitch would expect one- to two-notch downgrades on the most subordinate tranches of subprime auto ABS, while downgrades would still be unlikely for virtually all prime auto ABS.

Structured Finance

Aussie outlook 'mixed'

As Australia continues to shift away from its reliance on the mining sector, S&P suggests that the country's economic outlook remains mixed. Against this backdrop, the agency has identified a number of key risks and developments that may shape the Australian securitisation market in 2015.

Among the risks is household indebtedness, which remains high in Australia and has been relatively stable at these levels for some time. S&P expects monetary policy to remain accommodative, with no increase in interest rates in the short term.

There has been a recent rise in interest-only lending and greater lender competition has resulted in interest rates edging lower. This has exacerbated the risk of certain borrowers facing mortgage stress when interest rates return to more normalised levels.

The risk is heightened for less-seasoned loans originated in a historically low interest rate environment. However, S&P says the risk is mitigated in the Australian RMBS sector by sound underwriting practices and loan-origination policies, particularly those implemented since the financial crisis.

Further, the agency expects property price growth to moderate in 2015 following a strong rise in 2014, but it does not anticipate a material correction in prices. A majority of loans underlying RMBS transactions in Australia are relatively well seasoned - at around 60 months - and have modest loan-to-value ratios of around 62%. As such, S&P believes they are well placed to withstand any deterioration in local housing markets, due to the equity built up in the underlying loans.

Key regulatory bodies recently announced plans to increase their surveillance on certain aspects of the mortgage lending market, which came in response to a strong increase in interest-only lending, largely driven by surging demand for investment property. In conjunction with the implementation of loan-level data reporting, these developments will set the future standards of the Australian securitisation market, as well as increase transparency for existing and potential investors, in S&P's opinion.

In addition, the agency says that the loan portfolios underlying non-conforming transactions issued in more recent years have a higher proportion of full documentation loans and loans to borrowers with no adverse credit history. This has diluted S&P's performance index (SPIN) for non-conforming Australian mortgages because the inclusion of more full documentation loans in certain transactions has improved the overall arrears performance of the sector. S&P expects this trend to continue as many specialist lenders further diversify into the non-conforming space.

While it does not expect the unemployment rate to rise materially during 2015, S&P adds that wage growth is likely to be more subdued because many businesses face pressure to contain costs. A substantial increase in unemployment and an associated decrease in disposable income are the agency's key concerns that could worsen arrears and defaults because such events can quickly change a borrower's ability to service debt obligations.

Finally, S&P expects RMBS and ABS new issuance activity in 2015 to be about the same as it was in 2014 due to more subdued credit growth and a diverse range of funding options available to financial institutions, including deposits. The timing of issuance could be sensitive to changes in interest rates and exchange rates, as well as the refinancing activities of covered bonds.

Structured Finance

Call for market 'restart'

A healthy securitisation market can confer important financial benefits and revitalising this source of financing has emerged as a key area of focus for policymakers, IMF economists observe in the institution's latest Survey Magazine. In its analysis, the IMF offers a comprehensive suite of measures targeting both supply- and demand-side reforms to strengthen securitisation and mitigate risk.

"Restarting and expanding securitisation would create room for banks to fund small and medium-sized enterprises," says José Viñals, IMF's financial counsellor and director of the monetary and capital markets department. This is deemed particularly relevant in Europe, where capital markets are considered to be under-utilised as a funding source for the economy and banks are both under pressure to deleverage and reluctant to lend in an environment of such economic uncertainty.

Prominent among the measures suggested by the IMF are the strengthening of each element of the financial intermediation chain, refining proposals for the labeling of high quality securitisations and the development of a dedicated non-bank institutional investor base. To enhance the supply-side functioning of securitisation markets and reduce risks, the institution suggests strengthening a number of existing practices, including beefing up the quality of underlying loan origination practices.

In addition, the IMF encourages securitisation intermediaries to develop structures that are transparent, straightforward to value and designed to finance the economy. It also argues that full disclosure of the credit ratings process would help to increase transparency and confidence and suggests that the removal of references to external ratings in regulations should be accelerated too.

A further proposal would see consistency in the application of capital charges across asset classes and borders. Indeed, avoiding large step-changes in capital charges between classes of assets that do not differ much in underlying quality would be helpful.

With regard to measures that could spur investor demand for securitised assets, the IMF explains that standardised classifications of the underlying risk characteristics of securitisations - such as the maturity of assets and the ease with which investors can take possession of collateral in the event of default - could help preserve the benefits of risk labels. It believes this will mitigate the prospect of investors shirking their due diligence responsibilities by relying on an aggregate classification of risk for the overall transaction.

At the same time, through working in conjunction with industry participants, policymakers could also strengthen securitisation markets by creating an environment in which a diversified institutional investor base can develop. The IMF believes this is particularly relevant in continental Europe, where non-banks have traditionally played a minor role in securitisation markets relative to the US. To advance this aim, the institution says the development of an institutional investor base will require the pan-European harmonisation of loan-level reporting standards, documentation standards, insolvency regimes and the taxation treatment of securitisations.

Furthermore, the IMF also believes policymakers need to address regulatory, institutional and product design issues, such as extending the maturity of ABS and easing the hedging of prepayment risk, to invite greater sponsorship from European insurers and pension funds. It explains that both are under-utilised potential sources of long-term capital.

Finally, achieving a better balance between bank and capital markets-based intermediation over time will have the added benefit of making Europe's economy more resilient, according to the IMF.

CDS

Sharp widens on profit warning

Sharp's five-year CDS have widened by 80% over the past month to price at the widest levels observed since February 2014, according to Fitch Solutions. After consistently pricing in the double-B plus to double-B space for much of the past year, credit protection on Sharp's debt is now pricing in line with single-B minus levels.

"CDS widening for the Japanese electronics company likely reflects market concerns stemming from its warning that earnings might fall short of guidance, as a weaker Yen hurts the company's profits," says Diana Allmendinger, director at Fitch.

The CDS curve for Sharp has inverted, with investors pricing in more credit risk for shorter-term contracts.

CDS

Trade repository prepped

In response to bank demand, SIX is to establish a central trade repository for derivative transactions in Switzerland. The service will use the reporting technology of London Stock Exchange Group's UnaVista platform.

The repository will be operated and hosted by SIX and will allow Swiss clients to fulfil their reporting obligations under the Swiss Financial Market Infrastructure Act (FMIA), which is currently in parliamentary consultation but are expected to come into effect in 2016. The derivative transactions will be uploaded to the SIX controlled trade repository, which will record the details of the transactions. Following validation and consistency checks, the information collected will be passed on to the supervisory authorities, as well as aggregated and made available to the public in anonymised form.

CDS

Credit events decided

The external review panel of ISDA's Americas Credit Derivatives Determinations Committee has resolved that a failure to pay credit event did not occur in connection with Caesars Entertainment Operating Company in December 2014 (SCI passim). However, an auction in respect of outstanding Caesars CDS transactions will be held in due course, following the occurrence of a bankruptcy credit event last month.

ISDA's Americas DC has also resolved that a bankruptcy credit event occurred in respect of RadioShack Corporation, following its Chapter 11 filing last week. An auction in respect of outstanding CDS transactions referencing the entity will be scheduled. ISDA will publish further information regarding both auctions in due course.

CLOs

Static Euro CLO debuts

The first static CLO 2.0 deal has been placed on the European market. The €233.4m Bosphorous CLO I is a transaction managed by Commerzbank Debt Fund Management and co-arranged by Sterne Agee & Leach and Sterne Agee UK.

The deal is the debut CLO for Commerzbank, with the loan assets being sourced from its Bosphorus Capital vehicle. The portfolio comprises senior secured loans and bonds granted to speculative-grade European corporates.

Rated by Fitch and S&P, the transaction comprises seven tranches: €135.4m of triple-A rated class A notes (that priced at 115bp over three-month Euribor); €24.6m double-A plus class Bs (195bp); €17.5m of A/A+ (Fitch/S&P) class Cs (250bp); €14.1m of BBB/BBB+ class Ds (310bp); €15m of double-B class Es (550bp); €6.9m of single-B class Fs (700bp) and €19.9m of unrated subordinate notes.

The rated notes will pay quarterly interest, while the underlying assets may reset their interest period from quarterly to semi-annually. To mitigate potential timing mismatches, the transaction incorporates an interest smoothing account and a frequency switch mechanism, which switches the payment frequency on the rated notes to semi-annual.

Since this is a static transaction, the portfolio will be fully ramped up at closing, with no reinvestment or discretionary trading permitted thereafter. However, the portfolio manager will identify and dispose of credit-impaired and defaulted assets during the transaction's life.

The rated notes benefit from par value ratio tests that track the degree to which the performing collateral is sufficient to repay principal to the debt investors. Once the par value ratios fall below certain minimum levels, the transaction will redirect available interest and principal proceeds, if required, towards the redemption of senior liabilities.

The numerator of the par value ratios is adjusted to reflect the quality of the performing assets. For example, loans rated triple-C (above a certain threshold) and loans that have defaulted are included in the numerator of the par value ratios at less than full par value.

The retention holder for the deal is NPIC, which will hold a principal amount of the subordinated notes equal to at least 5% of the portfolio target par amount until there are no rated notes outstanding.

CLOs

Euro SME CLOs outperforming

Fitch reports that European SME CLOs are showing better asset performance than originating banks' loan books, albeit this performance may be distorted by the repurchase or refinancing of delinquent and defaulted loans or by positive selection common in collateral portfolios.

The number of 90 to 360 days delinquencies as of end-3Q14 across Italian, Portuguese and Spanish SME CLOs averaged 2.9% and were significantly lower than their corresponding arrears at originating banks. Arrears on bank balance sheets vary by country and range from 5% per annum for Italy to 6.5% for Portugal.

In Spain the 90-360 delinquency index between 1Q13 and 3Q14 averaged 1.9% and was significantly lower than 3.8% based on trustee report data relating to mostly Fitch-rated transactions. The difference reflects a larger proportion of pre-crisis transactions in the Fitch-monitored universe whose performance has been worse compared with that of more recent retained transactions, a result of more lax underwriting standards and higher exposure to real estate risk.

In addition, the Italian 90-360 delinquency index during the same period was 4.6% and, excluding defaulted loans, was 3.8%. The same index based on trustee report delinquency data but limited to Italian deals rated by Fitch was 2.5%. Therefore Fitch-rated deals appear to outperform the non-Fitch rated transactions.

Finally in terms of loan level data quality, loan records with negative current balances or unexpectedly high balances were found in the European DataWarehouse database, from which Fitch sourced its data. However, data quality has improved over time and these unconventional values were no longer present in more recent pool-cuts.

CMBS

CMBS pay-offs bounce back

The percentage of US CMBS loans paying off on their balloon date rebounded in January after a sharp drop in December, according to Trepp. The latest reading is about 25 points higher than the December rate of 49.6%, which was the lowest reading since July 2012.

The January rate was 71.9%, which is above the 12-month moving average of 66.1%. 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, 70.9% of loans paid off in January. On this basis, the pay-off rate was up by over seven points from December's 63.7% level. The 12-month rolling average by loan count is now 70.5%.

CMBS

Loss severity tumbles

Trepp says that overall loss severity in disposed US CMBS loans decreased significantly in January, dropping by more than 13% to 37.09%. Contributing to the sharp decline was an up-tick in small losses on large loans like the Parkoff Portfolio, which managed to pay off early with minimal damage to the loan itself (see SCI's CMBS loan events database).

However, when marginal losses (less than 2%) are removed from the calculation, loss severity dropped by almost 10% from December, to 54.51%. Almost a third of loans liquidated in January recorded losses of less than 2% of their outstanding balances. In addition, all realised losses of 100% or more were on loans with less than US$7m outstanding.

Trepp suggests that the increase in small losses is due in part to the rush to refinance at low interest rates, even if it means eating a prepayment penalty. The US$170m Parkoff Portfolio still had two years of lock-out left when it liquidated for less than a 1% loss in January.

The Parkoff loan backed 13.50% of the MSC 2007-HQ12 deal and its disposal had the greatest impact on the LCF A5 class. The weighted average life for the bond contracted from 2.20 years to just 0.35 years.

Total January loss volume continued to trend lower than the historical average, but the month recorded the highest volume of disposed loans since September. January brought over US$1.2bn in loan liquidations, a 40% increase from December. However, when losses of less than 2% are excluded, volume sinks to US$823.26m for the month.

Insurance-linked securities

Cat bond innovation expected

A flurry of activity in 4Q14 resulted in record 144A P&C catastrophe bond issuance that exceeded US$8bn for the year, according to GC Securities' latest ILS update. This followed one of the slowest third quarters to date for issuance.

Total risk capital outstanding equalled US$22.868bn, the highest level of outstanding risk capital the market has ever supported. GC says that persistent year-on-year growth in issuance and risk capital outstanding indicates that the market is showing signs of maturity and stabilisation.

As a result, it expects repeat and new sponsors to continue to utilise the ILS market in 2015. Seven new sponsors entered the 144A P&C cat bond market in 2014, issuing 10 new tranches of notes. Five were insurers (American Strategic Insurance Group, Great American, Heritage, General and Sompo Japan Nipponkoa), one was a reinsurer (Everest Re) and the other a residual markets insurer (TWIA).

"Sponsors took advantage of strong investor demand, as more than 70% of deals coming to market in 2014 settled at greater notional value than initially expected," says Cory Anger, global head of ILS structuring at GC. In 4Q14 alone, of the six new deals that came to market, four closed at higher notional limits.

The continued influx of third-party capital from new and existing market participants also favourably impacted ILS pricing for protection buyers. The continued low interest rate environment encouraged institutional investors to seek the higher yields offered by natural cat risk notes. As a result, sponsors took advantage of the opportunity to lock in attractive rates and hedge rate volatility.

In addition, the soft rate environment, combined with the presence of accommodating investors allowed cedents to place more innovative, flexible and bespoke transactions. By end-4Q14, several key structural features emerged and became more prevalent as the terms and conditions of cat bonds and traditional reinsurance continued to converge.

Of the P&C ILS issued last year, 81% was structured with an indemnity trigger on a per-occurrence, annual aggregate or multi-year aggregate basis. The use of indemnity triggers increased steadily from a low of 30% in 2011 to 55% in 2013.

However, 89% of issuance had a bond tenor of either three or four years in 2014, a decrease from 93% in 2013. This was due to increased usage of risk periods longer than four years. GC says this was largely influenced by Sanders Re 2014-1 - a US$300m five-year transaction sponsored by Allstate - and Kilimanjaro Re 2014-2, a US$500m five-year transaction sponsored by Everest Re.

Indeed, investors appeared to be particularly receptive to longer-term transactions - a position GC expects will continue into 2015 - as both deals were oversubscribed. However, they closed either above or at the midpoint of initial price guidance, indicating that investors required additional compensation for risk periods longer than four years. Sponsors continued to express interest in bonds with risk periods beyond five years, which GC also expects will persist through 2015 and beyond.

4Q14 was also an active quarter for the private catastrophe bond market. Approximately US$561.5m of limit was transferred to the capital markets via 17 transactions. These figures represent a 210% increase in the notional amount of limit placed year-on-year and a 183% increase in the number of transactions YOY.

A notable transaction in 4Q14 was the CHF70m Regulation S placement of notes through Kaith Re to benefit Gebäudeversicherung Bern and provide protection against Swiss natural perils (SCI 8 January). This transaction was the first-ever Swiss franc-denominated catastrophe bond.

Looking ahead, pricing levels for 1Q15 deals will be influenced by the number of bonds maturing during the period. January alone will see US$2.3bn of principal returned to investors as 10 transactions have or are set to mature.

Additionally, another US$1.24bn of capital will be returned to investors in February and March, taking the total notional value of 1Q15 maturities to US$3.54bn. Maturities in 1H15 - which has the highest percentage of outstanding cat bonds as of the end of the preceding year since 2011 - are expected to provide further pressure to lower ILS pricing.

Finally, GC says that the market will likely continue to see more innovative catastrophe bonds issued in 2015, with structural features on a larger scale that may include: non-modelled natural perils, such as meteorite impact, wildfire and volcanic eruption; man-made perils, including terrorism; longer-duration bonds (greater than five years); and increased usage of ILS by corporate sponsors.

Risk Management

Risk management recommendations issued

The Basel/IOSCO Joint Forum has published a report on developments in credit risk management across sectors, covering current practice and recommendations. The report surveys supervisors and firms in the banking, securities and insurance sectors globally in order to understand the current state of credit risk management, given the significant market and regulatory changes since the financial crisis.

A number of recommendations are made in the report, based on insights into the current supervisory framework around credit risk, the state of credit risk management at firms and implications for the supervisory and regulatory treatments of credit risk. One recommendation is that supervisors should be cautious against overreliance on internal models for credit risk management and regulatory capital. Where appropriate, the report says that simple measures could be evaluated in conjunction with sophisticated modelling to provide a more complete picture.

Furthermore, with the current low interest rate environment generating a 'search for yield' through a variety of mechanisms, the report recommends that supervisors should be cognisant of the growth of such risk-taking behaviour and the resulting need for firms to have appropriate risk management processes. In addition, supervisors should be aware of the growing need for high-quality liquid collateral to meet margin requirements for OTC derivatives sectors and if any issues arise in this regard, they should respond appropriately.

The Joint Forum's parent committees should consider taking appropriate steps to monitor and evaluate the availability of such collateral in their future work, while also considering the objective of reducing systemic risk and promoting central clearing through collateralisation of counterparty credit risk exposures that stems from non-centrally cleared OTC derivatives. Finally, supervisors should consider whether firms are accurately capturing central counterparty exposures as part of their credit risk management.

RMBS

Hearing scheduled for Citi settlement

The New York Supreme court last week signed a show cause order in the Citi RMBS rep and warranty case, scheduling the first oral hearing for the case for 19 May. Investors who oppose the deal have until 17 April to file their objections and trustees have 17 days after that to file their response to the objections.

The trustees have accepted Citi's US$1.125bn settlement for the majority of the 68 trusts involved and filed for judicial instruction in December (SCI 14 January). Barclays Capital RMBS analysts suggest that if the JPMorgan settlement is any guide, at least a few objectors might intervene.

"Like JPMorgan, Citigroup has the option to exclude certain deals from the settlement; hence, the settlement approval can be expedited for trusts with no objectors. Overall, we continue to believe that settlement will be approved and that payouts might be made to most of the trusts by the end of this year, soon after payments are made in the JPMorgan settlement," they observe.

RMBS

Mixed reception for mortgage limits

Limits on mortgage lending announced by the Central Bank of Ireland last week are positive for the health of the banking system in the long term, as they should support more sustainable and prudent lending by Irish banks, Fitch suggests. But in the short term credit demand and supply may be reduced, which could slow house price growth and NPL recoveries.

Irish house price growth was among the highest in the world at end-3Q14, at 15% year-on-year and 24% in Dublin, due to the improving economy and increased credit availability. However, the new mortgage regulation is expected to dampen credit growth as fewer borrowers are able to meet the new requirements.

Slower house price growth may also extend the time banks take to resolve NPLs. Further reductions in NPLs are nevertheless anticipated in 2015, with restructurings and renegotiations remaining an important challenge for banks.

Fitch notes that rising prices are likely to bring a portion of borrowers back to positive equity, providing incentives for them to work with lenders to resolve arrears problems. The agency forecasts that market-wide arrears will continue to decline in 2015 by 2pp to 15.9%.

Owner-occupied mortgages for all new non-first-time buyers will be subject to limits of 80% LTV and 3.5x LTI under the new CBOI cap. A maximum LTV of 90% will apply to first-time buyers of properties valued at up to €220,000, with amounts above the limit subject to the 80% LTV cap.

Buy-to-let mortgages will have a maximum LTV cap of 70%. Exceptions to the rules for owner-occupied properties will be limited to less than 15% of the cumulative annual value of loans.

Fitch expects the LTI limit to be the more important cap on borrowing.

RMBS

PLS loss expectations tested

The US Treasury last week published the findings from its study on credit rating agency loss expectations. The move is part of the Department's initiative to expand access to credit by boosting the private-label RMBS market (SCI 1 July 2014).

The Treasury says it recognised that the PLS market has been dormant since the financial crisis partly because of a 'chicken-and-egg' phenomenon between rating agencies and originator-aggregators. "Rating agencies will not rate mortgage pools without loan-level data, yet originator-aggregators will not originate pools of mortgage bonds without an idea of what it would take for the bond to receive a triple-A rating," it explains.

As such, the Department invited six CRAs to participate in an exercise over the last several months intended to provide market participants with greater transparency into their credit rating methodologies for residential mortgage loans. "By increasing clarity around loss expectations and required subordination levels for more diverse pools of collateral, the credit rating agencies can stimulate a constructive market dialogue around post-crisis underwriting and securitisation practices and foster greater confidence in the credit rating process for private label MBS," it adds. "The information obtained through this exercise may also give mortgage originators and aggregators greater insight into the potential economics of financing mortgage loans in the private label channel and the consequent implications for borrowing costs."

The exercise involved the CRAs analysing six hypothetical pools of residential mortgage loans and producing a report with loss expectations for these pools at each rating category (triple-A through single-B). In defining these hypothetical pools, the Treasury used the collateral underlying the STACR 2014-DN3 transaction, which references the most recently originated collateral at the time the exercise was initiated.

For Pool 1 (consisting of all the loans in the study), triple-A enhancement levels range between 7.7% and 11.6% across CRAs. For Pools 2 and 5 (consisting of loans with a principal balance greater than US$417,000 or conforming-jumbo loans), triple-A enhancement levels are not very different from those in RMBS 2.0 execution, according to Barclays Capital RMBS analysts. Although there is some variation between rating agencies, the triple-A expected loss for Pool 2 is 8%-8.5% on average and slightly lower for Pool 5, owing to its lower DTI (below 43).

"This is only slightly higher than the triple-A enhancement in the recent new issue jumbo deals and, hence, suggests that such securities could be executed at levels roughly similar to those of RMBS 2.0. This would imply that private label triple-A execution for conforming-jumbo pools would be 30bp-40bp back of TBAs or 15bp-25bp back of current conforming-jumbo spreads," the Barcap analysts observe.

They point out, however, that these loss expectations are indicative only and enhancement levels depend highly on the characteristics of the underlying collateral. Additionally, eventual execution levels would be subject to market forces and the nascent RMBS 2.0 market would have to expand by multiples in size to absorb the entire conforming-jumbo cohort.

RMBS

Loss severities compared

Loss severities on liquidated US residential mortgages are comparable between Freddie Mac and non-agency loans when controlling for attributes, according to Fitch. Freddie Mac recently enhanced its single-family residential loan-level historical dataset by adding loan-level loss data (SCI 25 November 2014).

In doing so, the GSE increased transparency to the market in anticipation of an actual loss credit offering in 2015. To date, all risk-sharing transactions have passed losses on defaulted loans to investors using a pre-determined loan loss severity schedule.

While differences in aggregate loss severity exist between Freddie Mac and non-agency RMBS data, Fitch says these can be attributed to specific loan attributes like property values and mortgage insurance (MI), rather than differences in operational risk or procedure. "Loss severities are very similar when comparing loans with similar attributes," says Fitch director Sean Nelson. "This suggests that the underlying drivers of loss severity are the same across both agency and non-agency loans."

Fitch has also compared historical Freddie Mac loss severities to date to the fixed loss severity schedules in recent STACR risk-sharing transactions. The agency found that observed severities to date are generally comparable to the fixed levels for 60%-80% LTV loans and lower than the fixed levels for 81%-95% LTV loans. However, depending on the attributes of the loans, loss severities in an actual loss transaction may differ from the aggregate historical data.

"Credit enhancement requirements for an actual loss transaction will be driven by the particular credit, leverage and mortgage insurance profile of the pool, and may be higher or lower than the credit enhancement in existing fixed-severity transactions," Nelson explains.

Fitch adds that while MI recoveries on liquidated loans can significantly lower loss severities, the percentage of MI claims receiving payouts has declined steadily over the last several years.

RMBS

Spanish arrears declining

The Spanish economic recovery is feeding into mortgage performance, according to Fitch's latest quarterly index report for the sector. Late-stage arrears are down and national home prices have stabilised.

Indeed, loans in late-stage arrears - including defaults - have decreased for the second quarter in a row to stand at 6.2% in December 2014 from their most recent peak of 6.4% in June 2014. Although the volume of borrowers in late-stage arrears remains elevated, Fitch says the declining trend appears to be established and expects it to continue.

Another positive indicator is the decline in the pace of new defaults. As of December 2014, the constant default rate stood at 1.2%, 50bp below the value reported 12 months ago. The highest default rates continue to be reported for loan portfolios from between 2005 and 2007, but even these vintages have come down from their most recent peak in 2H13.

Further, national home prices increased for two consecutive quarters for the first time since 3Q07, with quarter-on-quarter growth of 0.2%. The stabilisation in home prices is also evident from information received on properties in possession and sold. The data suggests that properties sold in the first three quarters of 2014 had depreciated by nearly 70% from their original valuations, which is the same level of decline reported in 2013.