Contents

Secondary markets

Euro ABS/MBS struggles back to life

The European ABS/MBS market is slowly struggling back to life after the summer lull.

Secondary market tone remains generally weaker and liquidity is still thin across the board. Euro-denominated prime assets continue to be the main focus for the market, but some buying interest has returned for peripheral paper, particularly Italian and Portuguese bonds.

There are four BWICs on the European schedule for today so far, all are mixed bags. The largest is a 12 line €96.35m auction due at 14:30 London time.

The list comprises: CHAPE 2003-I B, CRSM 10 A2, ECLIP 2006-2 C, FGOLD 1 B, GRAN 2004-2 2B, GRAN 2004-3 2M, GRANM 2006-1X C4, ITALF 2007-1 A, MAGEL 2 A, TAURS 2007-1 A1, VELAH 2 B and WINDM X-X C. Two of the bonds have covered with a price on PriceABS in the past three months, last doing so as follows: CRSM 10 A2 at 93.26 on 2 June and MAGEL 2 A at 97.41 on 15 June.

Secondary markets

Euro CLOs seek clarity

The European CLO secondary market is seeking clarity on pricing levels following a very quiet summer.

"It's been very quiet - the bulk of activity in August was in triple- and double-A 2.0s, with very little in 1.0s, and there's been next to nothing so far this week," says one trader. "So, it's very difficult to tell where clearing levels are now."

Unsurprisingly given macro concerns, the trader says: "It feels wider across the stack, but everyone will be waiting to see where the next few BWICs trade to get a proper handle on levels. Auctions and flows over the next few days or more will hopefully provide increasing clarity as to where we are in the context of headline risk and broader market volatility."

There are no European CLO BWICs on the schedule for today so far. However, there are two auctions slated for tomorrow.

At 15:00 London time tomorrow is a five line €12.23m list comprising: BABSE 2014-2X F, DUCH S V-X D, GRENP 2006-1X D, HEC 2007-3X E and LEOP IV-X E. Then, at 16:30 are three €15m lines each of GROSV 2013-1A A1, HARVT 7X A and HPARK 1X A1. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

US CLOs becalmed

A late Labor Day combined with continuing broader market volatility has becalmed the US CLO secondary market.

"We're in a holding pattern and it's really, really quiet," says one trader. "It's not unsurprising given the position of Labor Day this year - even though we're in September this is effectively the last week of summer."

Consequently, the trader adds: "I don't expect to see much going on this week. It's likely to be even quieter than last week where prices were softer, but not terrible given the stock market volatility."

That volatility combined with summer illiquidity is discouraging participants from entering the market at the moment, the trader reports. "Because we've not seen much activity there aren't many data points, so most people are sitting back watching the Fed and macro headlines in general and just trying to figure out where pricing levels are likely to go."

Further, the trader says: "There aren't many sellers out there either. It seems as if everyone is looking to after Labor Day to get things going again, though the ABS East conference might push us until even later in the month."

Nevertheless, the trader notes trades could still go through this week. "If you really need to get something done now there is a bid, but it is weaker."

There are currently no US CLO BWICs on the schedule for this week.

Secondary markets

Euro secondary still slow

Despite hopes for a post-August spike, volumes in the European securitisation secondary market are still only growing slowly.

"It's still pretty quiet and could take a while to really get going," says one trader. "This week has been slower than we hoped as broader market volatility continues and people are also waiting on the ECB today and the growing primary schedule to fully take shape."

Yesterday's secondary ABS/MBS activity was again focused around prime assets, the trader reports. "In particular we saw some small size rebalancing from real money. Overall prime spreads remained pretty stable, but UK sterling tranches did come in a little having widened over the last month."

Elsewhere, peripherals and CMBS were relatively quiet, the trader says, but CLOs are showing stronger signs of a return to form. "Both the BWIC and primary CLO calendars are picking up and we're all waiting for clues on market levels from them. 1.0s for now are unmoved and initial price talk on new deals is more or less in line with what we saw from the last CLO issues a month ago."

There is currently one European ABS/MBS BWIC on the schedule for today - four lines of UK and Dutch RMBS at 15:30 London time. The list comprises: £3m ESAIL 2006-1X D1C, £5m GHM 2007-1 EA, £5m MANSD 2007-2X M2 and €7.25m PRES 2012-1 B. None of the bonds has covered with a price on PriceABS in the past three months.

There are also five European CLO lists now due today. In addition to the two auctions mentioned yesterday, there are three short lists scheduled for 14:00 involving five line items amounting to €23.75m.

Those bonds are: ARBR 2014-1X C1, ARESE 7X B, JUBIL 2014-11X E, JUBIL 2015-15X A and OHECP 2015-3X A1. Only JUBIL 2014-11X E has covered on PriceABS in the last three months - at 96.11 on 5 June.

In addition, there is a Dutch and Irish RMBS OWIC due at 14:00. It consists of: DMPL IX A2, DMPL X A2, DRMP 1 A1, DRMP 1 A2, FSTNT 9 A1, FSTNT 9 A2, SAEC 12 A1, SAEC 12 A2, SAEC 13 A1, SAEC 13 A2, SAEC 14 A1, SAEC 14 A2, SAEC 15 A1, SAEC 15 A2 and SAEC 9 A2.

Secondary markets

US RMBS on hold

The US non-agency RMBS secondary market is effectively on hold until after the long weekend.

"It's quiet this week with volume down significantly," says one trader. "There's only about $100m in for the bid today - very low for Thursday."

The trader goes on to explain: "There's plenty of people away and there'll be even more tomorrow as the long weekend approaches. At the same time, broader market volatility has also kept people out of the market and despite the false impression given by the current holiday in China that hasn't changed."

Instead, RMBS market participants are focusing on next week. "Once the holiday is out of the way a strong new issuance calendar is expected throughout September and there are already a few large liquidations scheduled for the next couple of weeks," the trader says. "So I expect to a return to a more normal functioning market next week, which will enable us to see where secondary levels are."

Secondary markets

Euro secondary ticks up

Broader market improvement on the back of the message from the ECB and the Chinese holiday has extended into the European securitisation secondary market with a slight uptick in activity and some improvement in pricing levels.

Flows continued to revolve around the usual suspects with sterling-denominated prime and peripherals, especially Italy, benefitting the most. At the same time, the CLOs on BWIC yesterday traded reasonably well. Those areas aside, secondary spreads remain broadly unchanged away from name-specific demand.

There is only one European BWIC on the schedule for the rest of today so far - a single €7m line of AEOLO 1 A due at 14:00 London time, which hasn't traded on PriceABS in the last three months.

ABS

Liquidity, collateral quality compared

JPMorgan ABS analysts have reviewed liquidity and collateral quality, based on TRACE data from 1 June to 29 August, in the two benchmark US ABS sectors - autos and credit cards. The analysis indicates that credit card ABS saw the largest cumulative trading volume during the period, at US$12bn. The sector also posted the highest number of block trades - at 614 - versus the prime auto sector (at 133).

The top six shelves by cumulative trading activity - CHAIT, CCCIT, AMEX, COMET, AMXCA, DCENT and BACCT (including MBNAS) - dominate the secondary market, accounting for 80% of trading volume. There were 419 block trades reported for the top six names versus 124 for the rest of the names that traded.

For prime auto ABS, the top five shelves account for roughly 60% of trading activity. Liquidity in the subprime auto space appears to be more concentrated, with the top three most-traded subprime shelves - SDART, AMCAR and AFIN - making up 56% of TRACE-reported secondary activity.

SDART saw just 10% turnover, compared to 26% in the less-traded subprime names. However, 20% of SDART volume came in block trades versus 1% block sizes on less-traded names. Cumulative SDART trading volume was US$2.3bn, compared to US$3.3bn in aggregate across the less-traded names, according to the JPMorgan analysts.

Meanwhile, collateral quality trends across recent vintages of auto loan ABS remain stable. The analysts note a slight deterioration from the 2010-2012 vintages, as seen in the higher percentage in deep subprime buckets (with FICO scores of less than 550) and higher LTVs. The percentages of pools backed by used vehicles stayed roughly the same over the past three years, at between 66%-68%, as did the average LTV (between 111%-113%).

However, the number of loans with original terms of longer than 60 months continues to creep higher. In prime pools, loans longer than 72 months accounted for 5% of the 2015 book versus 1% of the 2013 pools, for instance.

UACST deals have no exposure to loans with original terms longer than 60 months, while other non-prime issuers - such as SDART, PART and CRART - have kept the percentages of pools with longer loans roughly the same since 2013. However, 41% of the BMWOT 2014-A pool has a term of 60 months or longer, versus 16% in 2013-A and 7% in 2006-A.

For terms longer than 72 months, such loans only appeared in 2013-vintage AFIN, ALLYA and CRART transactions in the range of 3%-10% of pool balance. Over the next two years, 13 other issuers included loans with original terms longer than 72 months. On the most recent deals, six subprime and ten prime auto ABS programmes included loans with terms 72 months or greater.

Finally, the key collateral characteristics of credit card ABS master trusts remain favourable. Indeed, the concentration of receivables associated with the greater than 660 FICO score bucket has reached a record high and issuers aren't expected to move down the credit spectrum to any material degree in the next few years. High collateral quality is reflected in record low charge-off rates.

CS

CLOs

CLO slice financing considered

Although the US CLO market has now surpassed its pre-crisis size, the number of managers issuing CLOs has decreased. With risk retention set to cull numbers further, vertical slice financing could provide managers with a solution.

There were 181 CLO managers issuing before the crisis, but only 126 post-crisis. A Citi survey suggests risk retention rules will mean only 80-100 managers are still able to issue US CLOs after December 2016.

Obtaining financing to retain a 5% vertical slice of a CLO could be one solution to help managers meet retention capital requirements. Citi structured credit analysts believe vertical slice financing could improve capital efficiency and achieve decent leveraged returns, while also allowing investors to earn enhanced returns and do transaction-specific financing.

"Our bottom-up analysis suggests a majority of US CLO managers could find vertical slice financing both economical and useful. We expect that about 100 US CLO managers to continue to issue with access to financing. Moreover, risk retention will have less of a negative impact on issuance than expected, if an estimated US$3.4bn need for long-term financing each year is met by investors," the analysts say.

The simplest way to do the vertical financing would be for a CLO manager to obtain long-term senior financing from a single counterparty to help retain the 5% vertical slice of the deal, with the manager taking the first loss portion of that slice. The financed amount would be determined by the advance rate, which is the maximum percentage of the collateral par that the financing provider would be willing to lend.

"However, based on market demand, a segmented approach with various lenders providing customised financing to different parts (senior, mezz and/or first loss financing) of the capital stack may suit most. Based on our conversations with market participants, we believe lenders may have an appetite for providing financing, even at junior parts of the transaction," say the analysts.

A financing provider may already be investing in CLOs and would receive a financing premium over the blended spread of the reference tranches. This financing slice should also be able to trade in the secondary market, although the analysts note liquidity may be a hurdle. They believe returns could be 50bp-75bp higher than an otherwise indirect investment in blended triple-A to triple-B tranches.

Vertical slice financing has both benefits and drawbacks, however. The main advantage for CLO managers in holding a 5% vertical slice with financing on the senior portion is that they can put down significantly less capital to satisfy risk retention. The first loss piece of this slice generates a less attractive return than CLO equity, but could be cheaper to set up.

"Meanwhile, CLO managers can leverage the dealer network to obtain financing. Also, CLO debt investors may prefer managers to own a vertical slice of the deal, as it should create a more balanced incentive profile across debt and equity tranches," the analysts add.

Additionally, investors gain an opportunity to earn enhanced returns over direct CLO debt, but have to accept lower liquidity. Investors may therefore look to also buy CLO debt or equity directly in order to build up investment scale and take more control of a deal.

But execution uncertainty is a concern. "The final risk retention rule allows full recourse borrowing and pledge by risk retention piece. But it is unclear whether managers should pledge or not, since foreclosing on the manager and seizing the retention securities can be in violation of the risk retention rule," say the analysts. To mitigate that risk, the lender could require a clause that mandates the manager to be cooperative in replacing the manager if the deal fails to meet certain metrics, they suggest.

Modelled returns of the first loss piece imply that it could yield 7.1% IRR in the analysts' base case of 2% CDR, 20% CPR, 75% recovery rate, 75bp financing cost and 80% advance rate. This is less attractive than CLO equity, but is comparable to junior mezz.

JL

CLOs

CLO 1.0 potential scouted

The US CLO 1.0 market may now be well onto the home straight, but that does not mean there is not still value to be found. Illiquidity is a risk and certain plays depend on the timing of when deals are called, but investors able to handle these factors can still generate alpha.

JPMorgan analysts estimate there is still US$80.6bn of US CLO 1.0 paper remaining, US$45bn of which is from the 2007 vintage. By JPMorgan's figures, that means the market has halved in size since the end of 2013.

CLO 1.0 BWIC activity has been on a downward trend since 2012, largely because of the shrinking size of the market. A notable spike in activity in June was largely because of Volcker-related positioning and does not appear to signal any longer-term reversal in trend (SCI 27 July).

"Legacy CLO performance is largely contingent upon the rate of prepayments and reinvestment language of a particular deal. Over the past several years, CLO 1.0s have outperformed as prepayment rates were historically high and credit conditions were benign," note the analysts.

Loan prepayments were 47% in 2013 and 28% in 2014, according to S&P LCD. However, the estimated annualised prepayment rate in the first half of this year was only 20%. The analysts expect this to pick up in the second half of the year, but also consider the fact that a higher portion of the remaining 1.0s will have tighter reinvestment language.

Among the analysts' top picks is CLO 1.0 triple-A paper. CLO benchmark triple-As have widened 45bp year-to-date and are currently at Libor plus 140bp. While illiquidity is a risk, non-bank buy-and-hold investors could prosper.

CLO 1.0 single-A paper also appears attractive. Current spread levels of Libor plus 225bp are wider than refi double-A tranches, with shorter duration. There is also some call upside.

The analysts also suggest selectively buying 1.0 triple-B and double-B paper. They say: "This trade is more nuanced, as upside is contingent on the deal getting called. Equity investor strategy and post-reinvestment language should be considered. Roughly US$2-US$5 of call upside is possible at current market levels."

JL

CLOs

CLO drilling exposure weighed

Moody's has placed 11 offshore drilling companies under review for downgrade, five of which have loans held in outstanding US CLOs. Wells Fargo structured products analysts suggest that the potential downgrades present key, yet difficult to model, risks to CLO investors.

The five companies with exposures in CLOs are: Transocean; Seadrill Partners; Ocean Rig; Paragon Offshore; and Pacific Drillings. A total of 445 CLO funds have exposure to at least one of the five companies under review. By volume, Ocean Rig represents the largest CLO holding at US$961.4m across 281 transactions.

The Wells Fargo analysts note that CLO coverage test values can decrease due to downgrades. As downgrades occur, managers may see growing triple-C baskets, for example. Excess triple-C assets are typically carried at market value for coverage test calculations in a CLO.

Coverage test cushions remain high, but the risk that tests will fail will increase in line with any downgrades, while cashflows to equity or mezzanine notes may be diverted. The analysts do not believe that these downgrades will cause immediate pain for CLO investors, but suggest they could be a harbinger of future coverage test degradation.

Many CLOs now will likely have to count Pacific Drillings (US$415.4m in CLO assets across 173 funds) in the triple-C bucket. However, an analysis of LPC data shows that only 12 CLOs have more than 1% exposure to the loan, with the maximum exposure at 1.73%. Just 68 CLOs have exposure between 0.5% and 1%.

Further, although many funds are exposed to the drilling companies, the average exposure among CLOs to any one of the potentially downgraded companies is limited to just 0.55%. The maximum exposure of any transaction to all five is 4.37%.

Moody's has also downgraded two energy sector companies - Breitburn Energy Partners and Parker Drilling Company - although CLOs appear to have limited exposure to them.

JA

Structured Finance

A bright future for securitisation

James McEvoy, head of structured finance at Alter Domus, applauds regulatory recognition of the benefits of securitisation to the real economy

An increasing appreciation of how securitisation can help fund the real economy seems to be finally gaining traction, after a number of years of limited activity throughout Europe.

The European Commission's green paper on building a Capital Markets Union published earlier this year set securitisation as a key pillar in creating a fully integrated single market for capital and funding the EU economy. The Commission is aiming to encourage a new class of high quality, transparent ABS and is now moving forward in proposing new regulations to lower capital charges imposed on banks originating ABS by a quarter.

Securitisation has become increasingly streamlined, transparent and balanced. This has occurred via a combination of regulatory developments - such as the Capital Requirements Regulations and Directive (CRR/CRD) - industry initiatives (such as Prime Collateralised Securities (PCS)), rating agency requirements and not least investor demand. Solvency 2 is now also playing a key role in setting capital requirements (a regulatory capital regime) in respect of investments in securitised assets.

Certification
While broadly positive, some elements of the draft law have been received with scepticism, with investors raising concerns over the requirement (or ability, depending on one's perspective) of issuers to self-certify that portfolios meet the regulation-dubbed 'STS' (simple, transparent and standardised) criteria. While questions can arise of whether creating a 'high quality' securitisation implies all others are by consequence not, certification of securitisation transactions is not a completely new concept.

The Prime Collateralised Securities Association provides a PCS Label to the most senior tranches of securitisation transactions meeting certain criteria under the headings of quality, simplicity, transparency and liquidity. Although the PCS Label is not compulsory, it has gained strong traction with investors and issuers since its establishment and the association has been an active voice in the STS debate, also pointing to the need for independent certification. No doubt debate on this point will continue.

Non-bank securitisation
In the meantime, non-bank lending has become a major driver of the financing market, bringing major investment managers to the centre of the lending sector and securitisation as a tool along with them in the form of CLOs. This asset class - in its new guise of 'CLO 2.0', since issuance began taking place post-crisis - remains robust, no doubt helped by the solid performance of pre-crisis vintage deals.

CLOs form a key part of credit managers' strategies in the US and Europe and while not fitting as neatly into the Commission's plans, these activities are certainly benefitting the real economy, with a number of CLOs issued this year solely backed by loans to SMEs. While the regulatory landscape for securitisation is not yet bedded down and will no doubt need continuous tweaking - particularly as a full Capital Markets Union starts to take shape - after over five years of uncertainty, it is very encouraging to see industry and regulators coming to the same conclusions - almost.

Structured Finance

Solar firm taps SF expert

8minutenergy Renewables has named Fred Vaske as vp of project finance. He previously worked as director of structured finance for SunPower, where he structured and negotiated both power purchase agreements with commercial customers and the sale of commercial project portfolios to financial investors. Vaske has also held senior roles in project finance for Hanwha Q CELLS USA and Recurrent Energy, and was vp in structured finance at Scatec Solar North America.

Structured Finance

Blackstone buys into mortgage insurer

Blackstone has bought a significant equity stake in PMI Group through its Blackstone Tactical Opportunities unit and has agreed to provide a working capital facility to the company in exchange for warrants and other rights. Blackstone is also expected to nominate a director to the board. PMI will use the funds to pursue its investment strategy, which may include raising additional capital.

Structured Finance

Corporate services rival acquired

Elian has agreed terms to buy SFM Europe, which it says will significantly expand its European footprint, on top of enhancing its corporate services and structured finance offering. On completion of the deal, SFM Europe will operate as a separate division of Elian.

Elian's parent company Electra Partners says funding for the transaction will be provided exclusively by Elian. This will be done through a mixture of cash on its balance sheet and debt raised from the refinancing of the business' existing debt facility.

SFM Europe's existing management team will continue to run the business on a day-to-day basis, with SFM Europe's ceo Robert Berry joining the Elian executive team. On completion of the deal, Elian will employ over 640 people across 16 jurisdictions covering all major time zones.

CDO

Fee fraud settlement reached

The US SEC has approved a settlement concerning Taberna Capital Management (TCM) and its alleged involvement in fraudulently retaining fees belonging to CDO clients. RAIT Financial Trust, the parent company of TCM, says the agreed payment fee is US$21.5m.

According to the SEC's investigation, TCM failed to inform CDO clients that it was retaining payments known as 'exchange fees' in connection with restructuring transactions. TCM's retention of the exchange fees was neither permitted by the CDOs' governing documents nor disclosed to investors in the CDOs. The SEC says that the fees rightfully belonged to the CDOs and created conflicts of interest that TCM failed to disclose.

The investigation notes that from 2 March 2009 to 28 November 2012, TCM sought and retained millions of dollars in exchange fees paid by issuers of securities held by the CDOs when TCM recommended exchange transactions to CDO clients. TCM allegedly obscured its misconduct by improperly labelling the exchange fees as 'third party costs incurred' in various documents, but such costs comprised only a minimal portion of the overall exchange fees.

In quarterly reports that TCM provided to investors, the firm supposedly omitted any mention of exchange fees in its detailed descriptions about the exchange transactions. TCM is also accused of failing to identify the fees in Forms ADV, despite an obligation to do so.

The SEC also charged TCM's former md Michael Fralin and former coo Raphael Licht for their roles in certain aspects of the firm's misconduct. Fralin has been charged of being responsible for exchange negotiations and transaction documents that mischaracterised the exchange fees as compensation for third-party costs. Licht supposedly helped approve and supervise TCM's collection of exchange fees, and played a role in the drafting and review of inaccurate Forms ADV.

Along with the settlement fees - broken down into payments for disgorgement of US$13m, prejudgment interest of US$2m and a penalty of US$6.5m - TCM will also not act as an investment adviser for three years. Fralin has agreed to pay a US$100,000 penalty and is barred from the securities industry for at least five years, while Licth will pay a US$75,000 penalty with a ban of at least two years.

CDS

CDS trader returns to bank

Melvyn Merran has joined UBS to trade clearing house-processed credit derivatives. He will trade CDS indices, credit options and ETFs, reporting to global head of credit flow Philip Olesen. Merran most recently traded credit index options at Deutsche Bank following a first stint at UBS.

CMBS

Ground lease venture formed

Anika Equities has partnered with David Eyzenberg, principal at Avison Young, to form a subsidiary called Anika Equities GLF. The new entity will create and purchase ground leased fee positions.

The aim is to acquire the ground under select quality-stabilised commercial real estate assets valued at US$15m and over at a premium cap rate. The ground is then leased back to the seller (typically for 99 years), with fixed rent increases over the term.

The team will assist the seller/leaseholder in sourcing accretive leasehold debt to complete the capital stack and enable it to achieve greater positive leverage than is possible in the fee position alone, through a purchase or recapitalisation. The leaseholder may also enjoy favourable tax treatment, as 100% of the improvements can be depreciated and the full ground lease payment expensed.

Anika Equities GLF says that most stabilised asset types are acceptable under the initiative, providing that the anticipated cashflow and submarket conditions are not subject to extreme volatility.

Japanese CMBS RFC issued

Moody's is requesting comment on proposed enhancements to its approach to rating Japanese large loan and single-asset/single-borrower (SASB) CMBS, with the proposals likely to result in rating upgrades. The rating agency sought comment on similar CMBS in other jurisdictions last month (SCI 7 August).

The rating agency's proposals are broadly the same as its proposed approach to rating large loan and SASB CMBS in the Americas and Asia ex-Japan. It would recalibrate benchmark Moody's LTV ratios, refine adjustments to these ratios and consider longer tail periods to be credit neutral, with new rating caps applicable during the tail period.

Moody's believes the proposed changes would result in upgrades of around one notch for the majority of Japanese large loan and SASB classes. No downgrades are anticipated.

ABS

Auto delinquencies outpace losses

Most US subprime auto finance securitisers have reported higher managed portfolio delinquencies since year-end 2011, according to S&P. The agency says this is partly due to a return to pre-crisis underwriting standards and new relatively small, deep subprime auto finance companies entering the ABS market.

Delinquencies averaged a record low of 6.05% at year-end 2011, but made a 65% increase with a 10% average at the end of the 2014. Average delinquencies didn't rise as steeply for the two largest securitisers though, increasing only 23% to 12.94% in 2014 from 10.5% in 2011.

"Tight liquidity during the recession caused lenders to limit their focus to higher credit quality consumers, but with liquidity returning to prerecession levels, they are once again lending to a broader segment of the population and making loans with higher LTV ratios," says S&P credit analyst Amy Martin.

Although trending higher than prior years, a slower rise in annual net losses suggests that other factors could also be contributing to the increase in delinquencies. Average losses for all subprime securitisers increased by 36% between 2011 and 2014.

S&P says that the higher delinquency rate is because companies are now giving borrowers more time to make late payments before repossessing the vehicle - sometimes as long as 120 days past due. In addition, several lenders told the agency that they adopted 'softer and gentler' collection practices in response to increased regulatory oversight, which has shed light on alleged fair debt collection violations. As a result, it sometimes takes longer to arrange a payment plan with the borrower or locate the vehicle for possible repossession, meaning the account remains delinquent longer.

In contrast, S&P adds that the reduced impact on subprime auto finance losses may partly be due to strong recoveries. However, as loan terms lengthen, LTV ratios rise and off-lease vehicle volumes increase, recoveries are likely to decline in this sector. In addition, the agency believes that losses for most of the companies will continue to rise this year to coincide with rising delinquencies.

"Although delinquencies and losses will remain high for many subprime auto securitisers and recoveries are likely to decline, we expect investment grade ratings for subprime auto loan ABS to remain generally stable to positive," explains Martin. Negative variances from S&P's loss expectations have been relatively mild so far. In addition, robust structural features of related deals - such as the sequential pay mechanism and dollar-level floors to the reserve and overcollateralisation levels - have caused credit enhancement to grow as the pools amortise.

Martin adds: "Classes with speculative grade ratings, however, have less credit support and are more susceptible to a downgrade under mild or business stresses."

ABS

SME ABS growth predicted

A new study commissioned by Amicus reveals that 69% of European institutional investors believe there will be an increase in the issuance of SME finance-related ABS over the next two years. In addition, 73% of institutions polled expect there to be a growing appetite for investing in securitisations providing access to SMEs' underlying cashflow assets.

Investor types that will likely be most attracted to SME securitisations are insurance companies, private sector pension funds, private equity investors and hedge funds. When asked to identify which cashflow assets will be most in demand among institutions, 53% of investors selected traditional property finance, closely followed by trade finance (52%), leasing (44%) and property bridging finance (44%).

Given the continued high demand for property bridging finance spurred on by the UK buy-to-let market, 60% of investors anticipate growth in demand for short-term syndication of this debt through bond issuance. Amicus ceo John Jenkins adds that greater standardisation and transparency should also help drive a greater number of securitisations onto the market.

Amicus signalled its intent last month to establish its securitisation presence in the alternative lending market when it launched the first UK MBS to be backed entirely by short term property loans (SCI 24 August).

ABS

RFC on SLABS approach extended

Moody's has published a report that illustrates the application of its proposed new assumptions for rating FFELP student loan ABS. Concurrently, the agency has extended its request for comment period on proposed changes to its approach in rating the asset class.

Among the changes Moody's proposes is adjusting rating assumptions to accurately reflect the maturity risk from the substantial and sustained slow payments in FFELP loan pools. Moody's has provided guidance through illustrative examples of the impact of lower payments on deals and will now provide additional guidance on how the new assumptions will impact its view of loan cashflows.

Following the expiration of the request for comment period, Moody's will finalise its approach and resolve outstanding ratings of the US$37bn of FFELP ABS previously put on review (SCI passim). The agency warns that the ability and willingness of the securitisation sponsors and servicers to take action to repurchase loans from, or extend maturity dates on, outstanding transactions may affect the ratings of the related deals.

Market participant must submit feedback by the new deadline date of 2 November.

ABS

Debt restructuring move agreed

The Puerto Rico Electric Power Authority (PREPA) has made a move to reduce its debt by agreeing to a restructuring of the power revenue bonds held by PREPA bondholders from the ad hoc group. The group will exchange all of their outstanding bonds for new securitisation notes and receive 85% of their existing bond claims in new securitisation bonds.

As part of the agreement, bondholders will be given two options. The first would be to receive securitisation bonds that will pay cash interest at a rate of 4% to 4.75%, depending on the rating obtained. The other option would be to receive convertible capital appreciation securitisation bonds that will accrete interest at a rate of 4.5% to 5.5% for the first five years and pay current interest in cash thereafter.

The first option of bonds will pay interest only for the first five years, while the second option will accrete interest but not receive any cash interest during the first five years. All uninsured bondholders will have an opportunity to participate in the exchange. The bonds must also receive an investment grade rating.

PREPA believes the agreement will reduced its total debt principal by approximately US$670m, while saving more than US$700m in principal and interest payments over the next five years. It could also substantially reduce PREPA's interest rate expense on the exchanged bond debt.

In total, the ad hoc group - which comprises of traditional municipal bond investors and hedge funds - holds approximately 35% of PREPA's outstanding bonds. PREPA's agreement with the group marks its first with a significant financial stakeholder as it works through its process of financial transformation.

ABS

Subprime auto delinquencies rise

The US subprime auto loan ABS sector showed mixed signals in June as losses remained stable on a year-over-year basis, but 60 plus day delinquencies rose to their highest June level since 2009, says S&P. Though showing some weakening, the prime sector stayed largely within historical norms for the month.

"The prime sector experienced a gradual increase in losses," says S&P credit analyst Steve Martinez. "However, June has historically demonstrated increases over May."

The net loss rate for the prime sector weakened slightly to 0.38% in June from 0.28% in May. It was also higher than the net loss of 0.31% in June 2014. Meanwhile, the subprime net loss rate increased to 4.62% in June from 4.06% in May, which was in line with June 2014 rates.

Recovery rates deteriorated for the prime sector but improved slightly for the subprime sector. Delinquency rates increased month over month and year over year for both sectors.

Structured Finance

IOSCO provides alignment update

IOSCO has published its final report on the implementation progress made by 25 jurisdictions in adopting legislation, regulation and other policies for incentive alignment in securitisation. The report finds significant but mixed progress has been made,

The report covers recommendations for national authorities to evaluate incentives across the securitisation value chain and formulate approaches to incentive alignment and to set out the elements of that incentive alignment approach. National authorities were also asked to minimise the potentially adverse effects to cross-border securitisation transactions resulting from differences in approaches to incentive alignment and risk retention.

Progress is reported for evaluating incentives and formulating approaches to incentive alignment, but a review of implementation of the recommendation to minimise the potential adverse effects to cross-border securitisation was considered premature.

Of the 25 respondents, only five reported having completed implementation of all measures to implement incentive alignment recommendations covered by the report in respect of the whole securitisation market. European Union jurisdictions and the United States were generally further progressed in their implementation than many jurisdictions with smaller securitisation markets.

Structured Finance

Chinese issuance quotas 'positive'

Moody's says that the People's Bank of China's (PBOC) inaugural approval of issuance quotas for Chinese securitisations is a positive development for the country's securitisation market. Under the new system, issuers should have greater certainty about the size and number of deals that they can issue over a set period.

"The quota system will enable sponsors to speed up the launch of a transaction, which is a clear improvement from the previous deal-by-deal approval, where it could take months for a transaction to be improved," says Jerome Cheng, a Moody's svp. "As such, the quota registration will not only provide higher certainty for issuers, but also improve the efficiency and bring down the overall funding costs of securitisation issuance."

The PBOC approved issuance quotas for issuers of Chinese securitisation transactions for the first time on 26 May. In total, nine issuance quotas were approved as of 31 July: four for auto loan ABS, four for RMBS and one for shantytown reconstruction loan ABS.

Moody's says that the speedier launch of transactions will lead to less amortisation in transactions' underlying assets pools and longer repayment terms for issued notes. The longer repayment terms could subsequently help sponsors lower the overall funding costs of securitisation, as the initial one-off set-up fees and expenses can be amortised over a longer period.

The agency explains that greater issuance certainty and lower funding costs will thus encourage more sponsors to enter the market and be active issuers, in turn attracting more investors. In particular, it expects that international investors will consider a new market if they are certain that there will be continuous issuance, as it would also lead to reduced overall costs.

CLOs

CLO commodity exposure 'negative'

US CLO 2.0s' exposure to oil and gas and to metals and mining increased slightly in 1H15, which is a credit negative according to Moody's. With commodity market stresses moving into the credit market, CLOs with the largest exposures could suffer credit losses on their junior notes should there be widespread and correlated distress among related issuers.

Of the CLO 2.0s that Moody's rates, approximately 14.6% (72 in total) had at least 10% of their assets in the aforementioned commodity industries at the end of June. The 20 largest exposures range from 14.4% to 21.3%.

Moody's says that default risk among commodity-linked borrowers is becoming a concern. Energy sector defaults, together with those of coal and other mining companies, pushed US speculative-grade defaults to a three-year high of 15 in 2Q15, up from 10 in 1Q15.

Market signals also suggest increased defaults in the future. Of the 54 issuers with the largest negative changes in the gaps between the ratings Moody's assigns, 20 are oil and gas industry names, while 17 are from the metals and mining industry. Similarly, 22 of the 64 leveraged loans whose prices dropped at least 10 percentage points between the start of June and the end of July are from 19 issuers in the oil and gas and metals and mining industries.

CLOs with the highest exposures to the issuers most sensitive to commodity markets face a significantly higher risk of par losses from defaults. Par losses can accrue even in the absence of defaults, such as from selling an asset to manage portfolio credit quality or net asset value erosion. As a result, junior CLO notes, which typically have only 8% subordination, will more likely suffer losses in the event of correlated defaults within and across commodity-dependent sectors.

Moody's adds that many managers bought opportunistically during 1H15 amid loan price declines, slightly increasing their deals' commodity dependent issuer exposures as volatility increased in other commodity markets. For example, seven of the CLOs with the 10 largest commodity exposures increased their investments in the oil and gas and metals and mining industries in 1H15. The result is a median commodity exposure of US CLO 2.0s increasing slightly in June to 6.6% from 6.3% in January.

Nonetheless, most CLOs with commodity exposure largely avoided the riskiest issuers and current exposure is still relatively modest. Moody's believes these two factors will help insulate the broader CLO universe from potential negative credit events in these industries. As of end-June, just 12 deals had exposures of more than 5% to commodity-dependent issuers with the lowest speculative-grade instrument ratings, while the median CLO exposure was 1.1% and the maximum was 15.8%.

CLOs

CLO negative returns persist

The total amount of CLOs paid down in JPMorgan's CLO index (CLOIE) since the July rebalance through 31 August was US$5.88bn in par outstanding, split between US$4.04bn and US$1.84bn of pre-crisis and post-crisis CLOs. The post-crisis CLOIE added US$10.8bn, with 135 tranches from 26 deals at the August rebalance.

The CLOIE total index experienced negative returns in the month of August across five out of six tranches - double-A to single-B. The triple-A tranche provided the only positive return.

For the second consecutive month, the pre-crisis indices outperformed post-crisis indices across the capital structure. Triple-As outperformed in the pre-crisis index and returned 0.2% in August. The post-crisis index experienced positive returns in its triple-A tranche, but saw leading underperformers in the single-B, double-B and triple-B tranches, returning -1.45%, -1.1% and -0.85% respectively.

CMBS

CMBS barbelling rises

US CMBS deals are increasingly including meaningful exposures to lower leverage loans that skew a pool's overall credit metrics. While investment grade exposure is also growing, there has been a sevenfold increase in high leverage loans since 2013, leading to increased barbelling.

Kroll Bond Rating Agency examined the 101 conduits it rates to identify which underlying loans have credit characteristics consistent with an investment grade-rated obligation when analysed on a standalone basis. Pools were then analysed with and without these IG loans to give an indication of barbelling, as barbelling is more likely where IG loans are present.

The results show the percentage of IG loans with favourable credit metrics has increased over the past three years, but that there has also been an increase in the number of loans with high leverage, which Kroll defines as loans with Kroll LTVs (KLTV) over 110%. High leverage loans now represent more than a third of 2015 conduit issuance, while the presence of ultra high leverage loans (KLTV over 120%) has tripled this year to 6.1%.

Deals with IG loans range in exposure from 1.3% to 20.4%. These have superior Kroll DSCR (KDSC) and LTV than non-IG loans, with KDSC of 4.37x compared to 1.76x for non-IG and KLTV of 57.2% compared to the overall level of 98.9%.

The drastic rise in high leverage loan exposure is a result of increased competition between originators in a market where profit margins are increasingly thin. They now constitute more than a third of recent conduit transactions and Kroll expects high leverage exposure to continue to grow, albeit hopefully at a slower pace.

The presence of ultra high leverage loans has grown fourfold since 2013. Kroll believes these loans will ultimately experience higher defaults and losses than loans secured by properties of similar quality, regardless of location.

"It is no surprise that as the number of high leverage loans has been on the rise, so has the proportion of IG loans," says Kroll. "The increase in credit barbelling has certainly masked overall pool leverage, and it is an important credit consideration - particularly where larger concentrations of ultra high leverage loans are present."

Kroll combined exposure to both IG and ultra high leverage loans to create a credit barbell indicator, which has increased 85.4% year-to-date. It now stands at 10.2%.

"Given current market dynamics, we expect the presence of higher leverage loans to rise. We also suspect that we will continue to see increasing use of credit barbelling as well, although the rate of increase in IG loans is less clear. It will undoubtedly trail the rate of increase in high leverage loans, however, and regardless of credit barbelling, securitisations with higher proportions of high leverage loans will have higher overall loss potential and continue to receive higher scrutiny during the analytical process," says Kroll.

CMBS

CMBS properties acquired

CALCAP Advisors has acquired two Las Vegas apartment properties in an Auction.com sale. The seller for both properties was an LNR Partners entity, which purchased the assets via a CMBS foreclosure in January.

The two properties are El Pueblo de Los Arboles Apartments and El Pueblo de Las Brisas Apartments, which were acquired for US$9.77m and US$4.75m respectively. The purchase prices equate to US$42,829 per unit/US$56.39 per square-foot and US$42,422 per unit/US$59.39 per square-foot.

The Los Arboles asset was 86% leased at the close of escrow. CALCAP intends to perform interior upgrades to the current vacant units and take care of some general deferred maintenance items at the property.

For the Las Brisas property, CALCAP is budgeting over US$5,000 per unit in capital expenditures. This includes exterior siding, parking lot replacement, roof, pool repairs and interior upgrades.

"These Las Vegas acquisitions were purchased at 42%-45% below their previous sale prices, providing a steep discount, which is difficult to replicate in any US apartment market today," comments Pat Wakeman, principal of CALCAP Advisors. "We're looking forward to implementing our community stabilisation plans, which will allow us to begin raising rents in line with comparable properties, increasing the asset values and meeting our investment goals."

The firm continues to source multifamily acquisitions. In addition to Arizona and Nevada, it is seeking income-producing properties to grow its apartment portfolio throughout the Southwest.

CALCAP has completed 17 acquisitions totalling approximately 2,080 units in the past 55 months.

CMBS

Earliest peak vintage paying down

The earliest of the peak US CMBS vintages is coming to the end of its ten-year life. Fitch rated 34 conduit transactions totalling US$79bn in 2005 and the transactions have so far paid down approximately 15% since issuance, including 4% in realised losses.

Fitch's expected losses for this vintage total 7.6% of the original balance. Much of the remaining expected losses are based on the agency's assumed values on the US$2.9bn in existing specially serviced loans (representing 25% of the remaining vintage balance).

Approximately US$8bn (73% of the current vintage balance) is scheduled to mature by end-2015. While many of the loans may default at maturity and need additional capital to refinance or will need to be worked out by special servicers, many loans that don't refinance are likely to pay off within a few months of maturity, according to the agency.

It cites the US$88m Prentiss Pool loan, securitised in WBCMT 2005-C20, as an example (see SCI's CMBS loan events database). The loan failed to pay off by its 10 August 2015 maturity date, but servicer watchlist comments indicate that the borrower is currently reviewing refinancing options.

At year-end 2014, the asset had demonstrated stable performance compared with YE 2013, with an overall occupancy of 93% and a debt service coverage ratio of 1.38x. Fitch notes that current occupancy and rental rates compare favourably to competing assets within the submarket and, as such, the agency expects that a refinancing in the near term is likely due to the stable performance.

CMBS

CMBS delinquencies, losses rise

The Trepp US CMBS delinquency rate continued its summer trend of oscillation and inched up slightly in August. The delinquency rate for US CRE loans in CMBS moved up 3bp in August to 5.45%, undoing July's 3bp  improvement. The rate is now 65bp lower than the year-ago level and 30bp lower year-to-date.

In August, US$1.3bn in loans became newly delinquent, which put 25bp of upward pressure on the delinquency rate. About US$425m in loans were cured last month, which helped push delinquencies lower by 8bp.

CMBS loans that were previously delinquent but paid off with a loss or at par totalled almost US$1bn in August. Removing these previously distressed assets from the numerator of the delinquency calculation helped move the rate down by 19bp.

Meanwhile, August CMBS loan liquidation volume rose by 23% month-over-month for a total of US$837.9m across 73 loans. The average size of liquidated loans in August was US$11.5m, more than US$2m above July's average.

Six loans totalling a combined US$101.6m took losses of over 100%, three of which were B-notes. Two of the B-notes were the relatively large US$37m One & Two Prudential Plaza loan in Chicago and the US$27.5m 1100 Executive Tower in California (see SCI's CMBS loan events database). Two other large loans taking losses in excess of 80% were the US$67.7m Computer Sciences Building in Lanham, Maryland and the US$37.1m Mall at Steamtown in Scranton, Pennsylvania.

Finally, loss severity for August was 45.56%, up more than 11 percentage points from July. Looking only at losses greater than 2%, volume was US$598.2m with a 63.51% loss severity - the highest loss severity level in this category since March.

Risk Management

EMIR dispute concerns outlined

The World Federation of Exchanges (WFE) has written a letter to the European Commission expressing concern over delays and a lack of transparency in EMIR equivalence determinations for third country central counterparties (CCPs). The trade organisation believes these issues could present a challenge to economic growth and development in many emerging market economies.

"For emerging markets to develop their capital markets, their exchanges and CCPs must be able to maintain, develop and grow their links with financial institutions all over the world," say WFE's ceo Nandini Sukumar and chairman Juan Pablo Cordoba. "However, the current recognition process means that European participants are uncertain about the regulatory status of many third country CCPs and their consequent ability to engage in these markets, having a deleterious impact on 'business-as-usual' for these CCPs.''

WFE says that delays could lead to regulatory arbitrage by foreign businesses operating in emerging markets and a flight of foreign capital to those jurisdictions which do not face the same barriers. The result may be a rapid depletion of liquidity for certain markets.

WFE's letter says: "This effective regulatory arbitrage may result in a reduction of inward foreign exchange flows, which can be very costly to all markets, but particularly jurisdictions that do not have deep and resilient domestic capital markets that can backstop sudden shortfalls."

In addition, given that EU clearing obligations are expected in 1H16 and EU entities are now making decisions about those clearing arrangements and obligations, WFE says it is problematic that many third country CCPs from well-regulated jurisdictions are not yet eligible for use by EU counterparties.

"The likely impact is that, without timely decision-making on equivalence, existing pools of liquidity in OTC products that are traded and cleared on a cross-border basis will fragment along the lines of equivalence jurisdictions," WFE says. "Such an outcome will lead to competitive distortions caused by a lack of effective and timely decision making, and would exacerbate the liquidity and foreign exchange risk that emerging market CCPs are facing."

WFE is therefore urging the European Commission and other regulators to expedite the equivalence determinations in order to avoid the negative effects it has outlined.

Risk Management

IOSCO consults on OTC harmonisation

The Committee on Payments and Market Infrastructure (CPMI) and IOSCO have published a consultative report open for comment on the harmonisation of a first batch of key OTC derivatives data elements. The report refers to OTC derivatives other than unique transaction identifiers and unique product identifiers, which are subject to comment from a separate report published last month (SCI 20 August).

IOSCO says that the aggregation of the data reported across trade repositories will help ensure that authorities can obtain a comprehensive view of the OTC derivatives market and its activity. The latest report continues CPMI and IOSCO's response to the Financial Stability Board's mandate to develop global guidance on the harmonisation of data elements reported to trade repositories.

Comments on the proposals must be submitted by 9 October.

RMBS

Rates hold back Aussie arrears

Relatively low arrears for housing loans underlying prime RMBS in Australia are due to borrowers benefiting from low interest rates, suggests S&P. Nevertheless, overall arrears increased marginally during Q215 from the previous quarter.

Of all regions, arrears were highest in Western Australia where they climbed to 1.49% during Q2. This is in part due to the region feeling the effect of a slowdown in mining activity. S&P says that prepayment rates have continued to trend upward though, as borrowers take advantage of lower interest rates and refinancing opportunities.

RMBS

RMBS recoveries revealed

August non-agency RMBS remittances show cash payouts for three DBALT deals in relation to the Monarch Alternative Capital representations and warranty settlement. A few HVMLT deals also received chunky subsequent recoveries during the month.

The DBALT settlement was finalised in July between HSBC, which is trustee on the affected deals, and Deutsche Bank. The payouts came to US$29.26m, US$52.52m and US$91.18m for DBALT 2006-OA1, DBALT 2007-0A3 and DBALT 2007-OA4 respectively.

Bank of America Merrill Lynch RMBS analysts note that the settlement payouts represent a 11%-12% recovery rate for these deals, based on projected lifetime losses of US$251.08m, US$460.19m and US$768.21m respectively. "That is about 3-4 percentage points more than our projected recovery rate for the JPMorgan and Citi settlements, which is 7.1% and 8.5% respectively," they observe.

Meanwhile, the HVMLT recoveries primarily comprised make-whole loss payments. HVMLT 2006-5 received US$11.8m, HVMLT 2006-9 received US$7.6m, HVMLT 2006-12 received US$2.7m and HVMLT 2006-4 received US$700,000.

The transactions had previously received meaningful subsequent recoveries, beginning last year. BAML figures show that total recoveries now stand at US$17.4m, US$11.7m, US$19.1m and US$11m respectively for the deals.

RMBS

Origination enhancements 'reduce risk'

Widespread changes to US residential mortgage origination practices since the financial crisis have reduced the risk of fraud and misrepresentation, according to Fitch. The agency believes a key driver behind the previous poor performance of peak vintage collateral was weak operational controls for the information used in the loan decision process.

Several of the improvements since, however, have been driven by legislative changes. In 2008, national standards for non-depository loan officer licenses were introduced for the first time, requiring a written test, completion of education courses and a criminal background check. In 2014, the ability to repay rule was implemented, prohibiting 'stated income' loan programmes for most mortgage loans, thus deterring previously common misrepresentation of income.

Nowadays, lenders typically do not rely solely on the income documentation provided by borrowers. Most lenders now require borrowers to sign Form 4506, enabling the lender to verify the income documentation provided by the borrower directly with the IRS.

Meanwhile, lenders have implemented a number of additional changes to reduce operational and misrepresentation risk. For example, loan officer compensation now typically includes consideration of quality control results and often includes claw-back provisions for poor performing loans. Similarly, underwriter compensation also typically includes quality control results in addition to volume measures.

Components of the loan production process have also been separated to prevent inappropriate influence, such as the underwriting departments and loan origination departments. Direct communication between loan officers and appraisers tends to be constrained and appraisers are now typically selected by an independent appraisal management company or by a lender group outside of production.

Many lenders have added specialised internal appraisal underwriting units too. These are used to either independently review appraisals or provide a resource for credit underwriters to maintain appraisal quality.

Finally, Fitch notes that technology advancements have also played a key role in reducing risk. Fraud risk tools - uncommon prior to the financial crisis - are now widely available and heavily used to assess misrepresentation of identity, occupancy, employment/income and a number of other types of fraud, such as non-arms-length transactions, straw-buyers and concurrent closing schemes.

RMBS

CRT rating upgrades begin

Moody's is the first rating agency to upgrade CRT bonds after taking action on CAS 2014-C01 M1, STACR 2013-DN2 M1 and both STACR 2014-DN1 M1 and M2. Upgrades for a wave of newer deals are also anticipated.

The bonds were upgraded this month as a result of recent performance of the underlying pools and because of updated loss assumptions and the buildup of credit enhancement. The CAS and STACR 2013 deals were each upgraded two notches, while the STACR 2014s were upgraded one notch.

Moody's does not rate CAS 2013-C01, so its M1 tranche will probably be upgraded by Fitch if that rating agency follows Moody's lead. Barclays analysts note that the first STACR deal - STACR 2013-DN1 - had not ratings on the FCF tranche, so it unlikely to be upgraded.

"These early CRT deals have seen significant improvement in their collateral characteristics primarily driven by the strong home price appreciation in the 2013/2014 period. Average MTM LTV/CLTVs for these deals started in the 66-71% range and have fallen by 7-9 points each to now sit in the 58%-62% range," say Barclays analysts.

They add: "The tails of the MTM CLTV distribution, which are likely to drive defaults/losses in these deals, have also improved tremendously as loans with CLTV above 80 have fallen from about 5%-6% at issuance to less than 1% currently. Current enhancement levels are about 15% higher than at origination levels and bond factors have fallen as well for the front cashflow bonds."

These early deals are traded less frequently than newer ones. Deleveraged deals are likely to be next in line for upgrades, where fast prepays have also led to significant increases in credit enhancement. Moody's appears, at this stage, more likely to upgrade than S&P or Fitch.

Specifically, the analysts believe STACR 2014-DN3 and STACR 2014-DN4, STACR 2015-DNA1 and STACR 2014-HQ2 could all be likely candidates for a rating upgrade. The M2 bonds from STACR 2014-DN3 and STACR 2014-DN4 could be the biggest beneficiaries as the M1s have already factored down to 25%-30%.

RMBS

RMBS tail risk protections examined

All post-crisis US jumbo RMBS have credit enhancement floor protections built in to protect the deals from tail-end losses. However, Moody's notes that the protections for the subordinate bonds differ across transactions.

Tail-end losses are defined as losses that occur late in the transaction's life when only a few loans remain in the mortgage pool. In those transactions, credit enhancement floors are set as a fixed percentage of the original pool balance - thus corresponding to an actual dollar amount - and limit how far the enhancement can decline as the transaction pays down.

There are two types of credit enhancement floors in post-crisis deals. Senior subordination floors protect senior bonds and are set as a percentage of the original pool balance. These floors ensure that the credit enhancement provided by the aggregate balance of all subordinate bonds remains above the floor amount by locking subordinates out of principal distributions when necessary.

Subordinate bond floors are also set as a percentage of the original pool balance. However these floors divert principal distributions to the more senior subordinate bonds, pro rata, if the total current balance of a bond and the bonds that are junior to it is lower than the floor amount.

However, Moody's notes that JPMorgan Mortgage Trust, WinWater Mortgage Loan Trust and Shellpoint transactions set the subordinate bond floors lower - as a percentage of the original pool - than the senior subordination floors. The agency adds that a lower subordination floor offers weaker credit protection to the senior-most subordinate bonds as it allows the more junior bonds to be paid longer, decreasing the amount of the credit enhancement that they provide.

Many pre-crisis prime jumbo deals allow for the subordinate bonds to receive principal payments pro rata with the senior bonds when the credit enhancement from subordinate bonds is double a percentage of the original pool. As a result, principal payments to subordinate bonds deplete senior bond enhancement more quickly.

Moody's notes, however, that post-crisis deals follow the standard shifting-interest structure but do not include provisions for subordinate principal payments under a 'two-times' test. Senior bonds receive all scheduled payments and prepayments for a specified period of time - known as the 'lock-out' period - and then an increasing percentage of prepayments are allocated to the subordinate bonds only if loan performance satisfies specific delinquency and loss tests.