Contents

Secondary markets

Euro secondary still slow

It continues to be a slow start to the month for the European securitisation secondary market.

"It was very quiet again yesterday," says one trader. "There was one Italian CMBS BWIC that traded well, but that aside very little happened in our market."

The trader continues: "Today has started similarly quietly. It looks likely to be more of the recent usual with prime continuing to be well supported the main trend."

There is currently one BWIC on today's European schedule - a 41.4m original face six line mix of euro and sterling ABS and MBS. Due at 15:00 London time it comprises: ECLIP 2006-3 A, ECLIP 2006-3 B, E-MAC DE07-1 B, PUNTAV 0 10/15/27, THEAT 2007-1 D and THEAT 2007-2 D. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

US CLOs see slight return

The US CLO secondary market is seeing a slight return to life.

"The market is picking up a bit and there are few things going on," says one trader. "But it's still more about people feeling around for levels and direction."

The trader continues: "There are a few equity axes flying around for both the newer vintage more liquid stuff and also some distressed pieces, all with an emphasis around controlling stakes. At the same time, there's interest in cheaper mezz - in particular very wide double-Bs - and there's now a big 2.0 mezz list due at 10:00 on Thursday, which is sure to draw a lot of interest."

Overall, the trader says: "Right now, secondary is all about cash management and there's a real sense of there being plenty ready to be to put to work, especially as a lot of new issues have been delayed. However, spreads are still going wider - today versus yesterday because of stock market weakness, but longer term that's likely to continue because of where we now appear to be in the credit cycle and the sense that there are many more redemptions to come."

There are five BWICs on the US CLO calendar for today. Of those remaining the chunkiest is a a two line triple-B list due at 14:00 New York time.

It comprises $4m JFIN 2014-1A D and $5m MHAWK 2014-3A D. Neither bond has covered on PriceABS in the past three months.

Secondary markets

Euro ABS/MBS stifled

The European ABS/MBS secondary market continues to be stifled by wider market weakness.

Activity was once again limited both on- and off-BWIC yesterday as macro volatility kept many investors on the sidelines. The low beta ABS/MBS sectors continue to do well, however.

Autos and Dutch RMBS in particular are garnering some buying interest and spreads there continue to outperform; while CMBS prices are also holding up well. Elsewhere, liquidity is extremely thin and tone is increasingly softer.

There are two ABS/MBS BWICs on the European schedule for today so far. At 11:00 London time there are three lines of CMBS amounting to £17.269m original face - DECO 2007-C4X A2, DECO 2007-C4X B and TAURS 4 A. Only TAURS 4 A has covered on PriceABS in the past three months - 87.25 on 3 December.

At 12:30 there is a nine line 24.92m mixed CDO, CMBS and RMBS list, comprising: DECO 7-E2X F, EPICP DRUM E, ESTAT UK-3 E, HIPO HIPO-8 D, MONAS 2006-I B, PLLS II-X D1A, SESTA 4 B, TITN 2006-1X D and TMAN 7 G. None of the bonds has covered with a price on PriceABS in the past three months.

Secondary markets

Euro CLOs patchy

The European CLO secondary market is currently experiencing patchy trading.

"Overall, there's not much happening with only pockets of activity," says one trader. "There's really very little demand for 2.0s, but we are seeing interest in short 1.0s - where there is a possibility of a call or some other potential trigger to early pay-back."

Recent focus, instead, has been on selling, albeit still in relatively low volume. "Many accounts are have been BWICing 2.0s for a while and they're now starting to do the same with 1.0s," the trader says. "It's not clear what's driving this - it could perhaps be some kind of rotation or redemptions."

In any event, February's slow start cannot last, the trader suggests. "I believe people will have to do something eventually and will have to decide on a line in the sand for the point at which they are willing to buy again. So, everyone is hoping for a return to a stabilised market to enable them to come up with new realistic levels and take it from there."

There are currently two BWICs on the European CLO calendar for today. First up is a five line €12.5m original face 1.0 mezz list due at 14:30 London time. It consists of: ARESE 2007-2X D, AVOCA VIII-X E, CELF 2007-1X E, EGLXY 2007-2X E and LIGHP 2007-1X D. None of the bonds has covered with a price on PriceABS in the past three months.

Then, at 16:00 there is a three line €14m 2.0 mezz auction, comprising: ADAGI IV-X E, CGMSE 2015-1X D and GROSV 2013-1X D. Only ADAGI IV-X E has covered with a price on PriceABS in the past three months - at 95H on 7 December.

Secondary markets

Euro secondary difficult

Wider market weakness continues to make life difficult in the European securitisation secondary market.

"Yesterday conditions were once again difficult thanks to the global meltdown," says one trader. "As a result, flows and liquidity in our space were very thin."

However, the trader adds: "We are still seeing some pockets of activity - particularly in short-term bonds across a range of sectors. At the same time, prime assets continue to see trades, though volumes there are down considerably."

New issuance is also having an impact, the trader notes. "A new Driver deal priced yesterday, which is a good signal for autos in general and it boosted trading activity in the sector. There are also a couple of new UK prime deals being marketed at the moment and that is generating interest in secondary."

Meanwhile, CMBS is seeing supply from a different source. "We're seeing an increasing amount of CMBS on BWIC, but the sector is very slow otherwise," the trader says.

CLOs, too, are slow, the trader reports. "There's still no demand for 2.0 paper, but now sellers have started to disappear too and BWIC volume is dropping. It's a very difficult market and until there is some direction from primary could stay that way."

There are five BWICs on the European schedule for today so far. They involve CLOs, CMBS, which make up the majority of line items, and RMBS.

The chunkiest list consists of four lines of CMBS amounting to €45m original face - GRF 2013-1 D, GRF 2013-2 D, TAURS 2013-GMF1 C and TAURS 2013-GMF1 D. Only GRF 2013-1 D has covered on PriceABS in the past three months - 101.86 on 9 December.

Secondary markets

US CLOs down but not out

Despite the current downward trend in prices there are signs that US CLO secondary market is attempting to pick itself up.

"It's not a pleasant picture for sellers right now," says one trader. "There were a couple of lists from people that had to sell yesterday and they found some really weak bids."

The big news overnight was that the eagerly awaited $111.7m 2.0 mezz list due at 10:00 New York time today (SCIWire 2 February 2016) was cancelled. "The market is so illiquid especially for large size that the seller realised bids would be so far back from even the levels they were prepared to take last week they decided to pull it," explains the trader.

However, it is not all bad, the trader argues. "The market is not really trying to chase itself and there is a bit more activity than there was last week - more people are willing to sell at these current levels and so the BWIC volume is a bit healthier today. At the same time, bonds are changing hands out of comp. Overall it looks like people are beginning to try to find a way to move forward."

There are five BWICs on the US CLO calendar for today so far. One involves triple-As in relatively small size, the rest focus on 1.0 and 2.0 mezz.

The largest 2.0 mezz list amounts to $25.5m across eight line items and is due at 13:00 New York time. It comprises: ATRM 8A E, ATRM 9A E, DRSLF 2012-24RA ER, DRSLF 2015-37A F, GRAM 2012-1A DR, MVW 2015-9A D, RACEP 2011-5A ER and VOYA 2012-3A ER. None of the bonds has covered on PriceABS in the past three months.

Secondary markets

Euro secondary varies

Volumes continue to be light in the European securitisation secondary market with performance still varying sector by sector.

CMBS continues to be one of the strongest sectors. Prices remain well-supported and yesterday's €45m BWIC traded well.

Prime assets are still seeing two-way flows albeit at much lower volumes than previous weeks. Buying interest in short-dated paper remains the dominant theme, though there was also some real money selling of prime RMBS yesterday.

Meanwhile, Portuguese paper remains weighed down by political concerns. There, the strong selling bias continues to push spreads wider.

There are currently three BWICs on the European schedule for today. They represent bonds across the CLO capital stack.

At 13:30 London time there are five lines of double-Bs totalling €11.5m - CADOG 6X E1, CGMSE 2015-1X D, CGMSE 2015-2X D, CRNCL 2015-5X E and HARVT 12X E. Two of the bonds have covered with a price on PriceABS in the past three months, both on 15 December - CADOG 6X E1 at 87.33 and CRNCL 2015-5X E at 88.15.

At 14:30 there is a four line item €5.96m seniors auction, comprising: DARPK 1X A1A, HARVT 8X A, HOLPK 1X A2 and SPAUL 5X B. None of the bonds has covered on PriceABS in the past three months.

At 15:00 there is a single €7.5m line of EGLXY 2015-4X SUB. The equity piece has not appeared on PriceABS before.

Structured Finance

SCI Start the Week - 1 February

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

Pipeline
The pipeline was slightly quieter last week as fewer deals joined and fewer deals left. At the last count there were four new ABS, one new RMBS, three CMBS and a single CLO.

The ABS were: US$112m Earnest Student Loan Program 2016-A; US$150m Nations Equipment Finance Funding III 2016-1; US$1bn Nissan Auto Receivables 2016-A Owner Trust; and US$500m OneMain Financial Issuance Trust 2016-1. The RMBS was US$400m WinWater Mortgage Loan Trust 2016-1.

US$166m BAMLL Commercial Mortgage Securities Trust 2016-SS1, US$1.2bn CGCMT 2016-GC36 and US$960m WFCM 2016-C32 accounted for the CMBS. The CLO was €410m BlackRock European CLO I.

Pricings
There were four ABS prints, four RMBS and three CMBS. The ABS were: US$1.14bn CarMax Auto Owner Trust 2016-1; US$340m CPS Auto Receivables Trust 2016-A; US$604.42m Hyundai Auto Lease Securitization Trust 2016-A; and US$488m Navient Private Education Loan Trust 2016-A.

The RMBS were: US$302m Agate Bay Mortgage Trust 2016-1; £518m Friary No.3; US$483m Home Partners of America 2016-1; and €1.8bn STORM 2016-I. The CMBS were US$1.03bn COMM 2016-CCRE28, US$936.4m CSAIL 2016-C5 and US$1.14bn FREMF 2016-K52.

Markets
In the US agency RMBS market, Citi analysts continue to believe FN 3s and 3.5s appear rich in comparison to FN 4s, trading around 3bp tighter. "Over the past week, outperformance in FN 3s-4s against Treasury curve hedges was quite comparable at 6-7 ticks as it was led by a decline in global asset volatility. We continue to see significant downside risk to relative performance in 3.5s if rates rally given the coupon's high negative convexity and tight valuations."

The re-opening of the US CMBS new issue market provided investors with context for new issue spreads last week, say Deutsche Bank analysts. They add: "Spread tiering remains pronounced, with triple-As in the 155bp-162bp context."

No new US CLOs priced last week. JPMorgan analysts comment: "January US CLO volume is the lightest since 2012, though other sectors are also slow."

While European supply was particularly high in January, Bank of America Merrill Lynch analysts believe that serves more as a reflection of deep distress in other markets than as a signal of a recovery for European structured finance. They say: "We expect the strong supply in SF bonds to continue, judging by the visible pipeline, and we expect some slow down in covered bond supply in the run up to the ECB meeting in mid-March. In both cases, the markets will keep reading behind the pronouncements of ECB board members and behind the ECB actions on its purchase programmes to divine the most likely path of action the bank is likely to take in March."

Editor's picks
Retention return?: Retained issuance volume in Europe was 63% lower in 2015 than it had been in 2014, but this decline was turned on its head in the final months of last year. Such a reversal came as something of a surprise and could signal a long-term change of direction for the market, or be forgotten by February...
Synthetic disorder: Panellists at SCI's inaugural capital relief trades conference in December discussed regulatory developments in the sector and the push towards accommodating synthetic securitisations under the new umbrella of standardisation. However, doubts persist over the viability of harmonisation in such a diverse market...
Energy stress surging: The beginning of 2016 has seen a number of stressed loan issuers - particularly in the oil and gas sector - moving closer to potential default. Wells Fargo CLO strategists highlight five recently troubled names, which account for US$1.4bn in US CLO collateral, or 0.33% of the outstanding US CLO universe...
Court rules against Canary Wharf: Canary Wharf Group sold 10 Upper Bank Street for £790m in June 2014 and used the proceeds to prepay £578m of the class A1 fixed-rate notes of its CMBS at par (SCI 2 July 2014). The spens amount of £169m was placed in an escrow account to be paid to either the class A1 bondholders or Canary Wharf Group, depending on a court decision (see SCI's CMBS loan events database), which was eventually reached this week...
Euro secondary keeps positive: The European securitisation secondary market is holding onto the positive tone of the past few sessions. "Sentiment was a bit better again [on Wednesday], flows in general are improving and prices are going higher on- and off-BWIC," says one trader. "With little primary activity, technicals are supportive of secondary, so while global credit remains relatively stable that positive trend could continue."

Deal news
• Four ABS sponsors - Ally, AmeriCredit, Discover and Ford - have completed Reg AB 2-compliant transactions so far this year. The new regulation went into effect in November and Ford was the first to issue a compliant deal, FORDO 2015-C (SCI 21 September 2015).
• Eurotunnel has reported strong revenue growth, increasing the likelihood that it will refinance its Channel Link Enterprises Finance (CLEF) A3 and A4 bonds before year-end. The deal's euro liquidity notes appear particularly attractive.
• Online lender Earnest Operations is in the market with its inaugural rated term securitisation. The US$212m transaction, dubbed Earnest Student Loan Program 2016-A, is backed by refinanced student loans.
• Armenia has seen the launch of its first securitisation, listed on the country's stock exchange NASDAQ OMX Armenia. The deal was issued through the SPV, Loan Portfolio Securitisation Fund I, which was established in August 2015 to securitise US$2m worth of microfinance loans originated by five universal credit organisations (UCOs).
• S&P has lowered its ratings on the class A and B notes issued by Vitality Re V Series 2014 and Vitality Re VI Series 2015 by two notches to triple-B minus and double-B minus respectively. The action reflects updated information received from Milliman and Aetna Life Insurance Co related to the recently-priced Vitality Re VII catastrophe bond.
• Moody's has affirmed its ratings of all Pepper Residential Securities Trust No. 15 notes, following a review triggered by a re-classification of some underlying loans. The re-classification involved 6.49% of the total pool balance having either one or two adverse credit events prior to origination, instead of having no adverse credit events.
• ISDA's EMEA Determinations Committee has extended the external review schedule in connection with the governmental intervention credit event question on Novo Banco, such that the oral argument will be held on 12 February and the decision deadline will be 16 February. The association says that the amendment is due to the availability of the external review panel. The submission deadline for ISDA members to submit written materials in connection with the external review process remains unchanged (5 February).

Regulatory update
• The Italian government is set to introduce rules establishing a guarantee mechanism, dubbed Garanzia Cartolarizzazione Sofferenze (GACS), to facilitate the transfer of non-performing loans from the books of commercial banks to securitisation vehicles. The move has been welcomed as a positive step towards clearing the country's overhang of NPLs, but uncertainty remains over the transfer prices to be used.
• Canadian securities regulators across the country's various provinces have agreed to implement rules on derivatives product determination and reporting on trade depositories and derivatives data. This follows a consultation on the proposals of the rules last year (SCI 27 January 2015) and paves way for the harmonisation of a derivatives reporting regime in line with Manitoba, Ontario, Quebec and internationally.
• Eleven banks have agreed on a US$63m settlement with the Commonwealth of Virginia and the Virginia Retirement System (VRS) over allegations surrounding the sale of allegedly misrepresented RMBS. The agreement has been hailed as the largest non-healthcare-related recovery ever obtained in a suit alleging violations of the Virginia Fraud Against Taxpayers Act.
• The US CFTC has granted registration to 18 SEFs, which had previously operated under temporary registration status. A further five SEFs currently remain temporarily registered.

Deals added to the SCI New Issuance database last week:
Ally Auto Receivables Trust 2016-1; American Credit Acceptance Receivables Trust 2016-1; AmeriCredit Automobile Receivables Trust 2016-1; Arbour CLO III; Discover Card Execution Note Trust 2016-1; Drive Auto Receivables Trust 2016-A; DT Auto Owner Trust 2016-1; Ford Credit Auto Owner Trust 2016-A; Friary No. 3; Golden Credit Card Trust Series 2016-1; Gosforth Funding 2016-1; IM BCC Cajamar 1; Siena Lease 2016-2; SolarCity FTE Series I series 2015-A; United Auto Credit Securitization Trust 2016-1; Volvo Financial Equipment Series 2016-1; Westlake Automobile Receivables Trust 2016-1

Deals added to the SCI CMBS Loan Events database last week:
BACM 2006-5; CANWA II; CD 2006-CD3; CFCRE 2016-C3; CMLT 2008-LS1; CSMC 2006-C5; DECO 2006-E4; DECO 2007-E5; DECO 2007-E6; DECO 8-C2; ECLIP 2006-1; ECLIP 2006-1 & ECLIP 2006-4; ECLIP 2006-3; ECLIP 2007-2; EPIC DRUM; EURO 28; INFIN SOPR; JPMCC 2001-CIB2; JPMCC 2005-LDP5; JPMCC 2006-LDP9; JPMCC 2007-C1; JPMCC 2007-LDPX; LBCMT 2007-C3; MLCFC 2007-9; MSC 2006-IQ11; MSC 2011-C2; TITN 2006-1 & TITN 2006-2; TITN 2006-3; TMAN 5; WBCMT 2005-C20 & WBCMT 2005-C21; WBCMT 2007-C30; WFRBS 2011-C5; WFRBS 2014-C22; WINDM VII

CMBS

CMBS 2.0 delinquencies spike

January saw the largest one-month rise in US CMBS 2.0 loan delinquencies ever, but the corresponding servicer commentary appears to be relatively benign, according to Morgan Stanley CMBS strategists. Among the new delinquencies, they highlight a 2014-vintage loan requesting a modification and a number of new watchlisted loans that could potentially become credit concerns.

US$152.9m across 12 loans became newly delinquent last month, pushing total delinquencies to 39 loans with a balance of US$459.7m and resulting in a delinquency rate of 21bp. There were also six newly specially serviced loans for a balance of US$38.7m, bringing the total to 56 loans with a balance of US$704.6m, resulting in a specially serviced rate of 32bp.

The largest loan transferred to special servicing was the US$14.6m Main Street Tower, securitised in JPMCC 2012-C8, which has seen a sharp decrease in occupancy from 92.54% in December 2014 to 65.73% in November 2015. Meanwhile, the borrower for the US$6.7m Shuman Office Building loan - securitised in JPMBB 2014-C21 - is requesting a loan modification due to a major tenant vacating.

In terms of watchlisted loans, 133 totalling US$2.3bn were added in January. In total, 923 loans with a current balance of US$14.8bn are now on the watchlist, resulting in a watchlist rate of 6.65%. The largest watchlisted loan is the US$47.4m Netpark Tampa Bay, securitised in COMM 2014-UBS4, for which a springing lockbox letter was sent to the borrower after the tenant Humana failed to renew its lease by the end of November.

Another watchlisted loan that could potentially be of concern is the US$41.1m Town Park Ravine I, II, III, securitised in COMM 2014-UBS5. The borrower has confirmed that three tenants will not be renewing their leases, which are set to expire within the next 12 months.

The Morgan Stanley strategists also highlight the US$28.7m Newport Commons loan (securitised in COMM 2014-UBS3), which was watchlisted due to 20 of the multifamily units needing reconstruction after a fire impacted the property. The borrower has received an insurance cheque for US$1.57m and expects the construction to begin soon.

Regarding prepayment activity, 37 loans with a total balance of US$896m paid off in January, with all but four doing so at maturity or during their open period. In total, 263 loans with a balance of US$6.1bn have now paid off - the majority being in the 2011 vintage.

The largest pay-off last month was the US$156.2m Hollywood & Highland loan, securitised in WFRBS 2011-C2.

US$241.2m across 19 loans was defeased last month, bring the total to 216 loans with a balance of US$4.3bn. Only US$2.9bn of these loans remain outstanding, with the remainder paying off post-defeasance. Defeasance activity is concentrated in the 2013 vintage, with a total of 13 loans, according to Morgan Stanley figures.

CS

RMBS

Repo RMBS debuts

Jefferies Funding is in the market with an RMBS backed by a one-year revolving warehouse facility guaranteed by Jefferies Group. The US$225m Station Place Securitization Trust 2016-1 transaction is structured with two legs of back-to-back repurchase agreements.

The facility's collateral will be newly-originated first-lien, fixed-rate residential mortgage loans eligible for purchase by Fannie Mae, Freddie Mac or Ginnie Mae. At the end of the one-year term, Jefferies is required to pay the aggregate repurchase price, which in turn will be used to pay off the notes in full and terminate the facility. If Jefferies fails to do so, the facility will 'term out', becoming a static pool of mortgage loans whose collections will pay down the notes.

The first leg of repos is between each of the two underlying sellers - LoanDepot and Greentree Mortgage Company - and Jefferies Funding, as buyer. The second leg consists of a repo between Jefferies Funding (as seller) and the issuer (as buyer).

Both underlying sellers are approved sellers and servicers by the GSEs, and have originated the mortgage loans in accordance with their guidelines. The underlying sellers will also service the loans, with US Bank as stand-by servicer.

Under the repo agreements, Jefferies Funding will purchase eligible mortgage loans and participation certificates from the underlying sellers, and sell them on to the SPV. Jefferies will then repurchase the assets on the repurchase date and the underlying sellers will, in turn, repurchase them from Jefferies at their respective repurchase price.

Provisionally rated by Moody's, Station Place Securitization Trust 2016-1 comprises: US$173.25m Aaa rated class A notes, US$18m A2 class Bs, US$27m Baa3 class Cs and US$6.75m unrated trust certificates. Proceeds will be used to purchase the assets at closing, as well as additional eligible mortgage loans and participation certificates from time-to-time.

Each mortgage loan in the pool must be fully funded, in compliance with agency eligibility and underwriting requirements and have received an 'approve/eligible' output from an agency automated-underwriting system. All loans must be current and fully amortising, with a maximum CLTV of 90%, weighted average LTV of 70% and weighted average FICO of 700.

Clayton Services will conduct ongoing due diligence every 60 days on 100 randomly selected loans. The scope of the review will include auditing key credit characteristics of the loans, compliance with federal and state regulations, property valuation and data integrity. If errors from an underlying seller exceed certain thresholds, no additional loans from that seller can be contributed to the facility.

There is also an aging restriction: a purchased loan becomes ineligible if it has already been subject to transactions for over 60 days in aggregate. Moody's indicates that such a restriction reduces the likelihood that defective loans will be included in the pool if it terms out.

Further, marking the value of the purchased assets to market on a daily basis and requiring the repo seller to cure any margin deficit increase the likelihood that if Jefferies defaults on its obligation to pay off the notes, there will be sufficient collateral in the pool for the trustee to complete a successful auction sale to pay the notes in full.

However, Moody's points out that the due diligence may not be fully representative of the collateral quality of the facility at all times. The review will only be conducted every 60 days, while repo transactions can occur every day. By the time the due diligence review is complete, the loans may no longer be in the facility.

The agency also notes the weak representation and warranties enforcement associated with the deal. Although the transaction allows for the repo seller to repurchase loans that have breached the underlying sellers' representations, warranties or covenants, mechanisms for identifying breaches exist only after a repo EOD has occurred and the loan is 120-days delinquent. Following an EOD, the repo seller is unlikely to be willing and able to repurchase loans.

CS

RMBS

Dispute resolution framework inked

Fannie Mae and Freddie Mac have implemented a new independent dispute resolution (IDR) process for handling alleged loan-level breaches of selling representations or warranties that are unresolved after completing the GSE appeals process. The aim is to provide lenders with a simpler and more certain representations and warranties framework for originations.

Andrew Bon Salle, evp, single-family business at Fannie Mae, comments: "Our intention has been to ensure lenders can lend with confidence knowing that if they originated to Fannie Mae guidelines their risk of repurchase has been minimised. Many lenders have told us that our efforts are paying off and that they are more comfortable lending to the full credit box of our guidelines. This latest step provides a clear, reliable and independent process to resolve disagreements over repurchase requests in a timely fashion when needed."

For loan disputes that have gone through the appeals process and have been escalated without resolution, the IDR enables lenders to submit them to a neutral third-party arbitrator. The process is expected to offer a streamlined alternative to costly and time-consuming litigation and, according to Morgan Stanley RMBS strategists, may provide comfort to lenders that there is a fair, cost-effective and quick method for resolving disputes.

The process applies to whole loans purchased or loans delivered into MBS on or after 1 January 2016 and for now only covers selling-related disputes, although at some point it will also extend to servicing-related disputes. It applies to loan disputes that arise when significant defects are identified, after which the lender may correct the defect, repurchase the loan (if the defect cannot be corrected), be offered a repurchase alternative (at the GSEs' discretion) or appeal the demand.

If the lender appeals, both lender and GSE go through the first round of the appeal process. If unresolved, the lender has a second opportunity to appeal and provide further evidence that the defect does not exist or has been corrected. If after the second round of appeals the dispute still exists, either the lender or GSE may elect the IDR process.

At the conclusion of the process, the arbitrator makes the final determination on whether the defect existed at the time the IDR process began. The award is determined by the arbitrator and the non-prevailing party is responsible for a 'cost and fee award', defined as 10% of the UPB at the time the loan was sold to the GSE.

Completing this part of the rep and warranty framework is an important development in terms of getting lenders more comfortable with put-back risk, according to the Morgan Stanley strategists. "The use of an independent third-party arbitrator effectively balances the scales, giving lenders (especially large banks) more comfort around the final rep and warranty framework. We shall see in the months ahead whether this will open the credit box further and give particular focus to large money centre banks, which collectively have been losing market share to their smaller non-bank counterparts," they observe.

The move follows the release of the FHFA remedies framework, which aims to address corrections of origination defects that the GSEs identify (SCI 13 October 2015). Although this was seen as a step in the right direction, the strategists note that ultimately it did not improve the fundamental rep and warranty risk lenders face.

CS

Structured Finance

Distressed credit vet tapped

Black Diamond Capital Management has appointed Todd Arden as senior md and co-chief credit officer. He will have responsibility for co-managing Black Diamond's underwriting processes and credit exposures, as well as sourcing stressed and distressed investment opportunities for the firm's funds.

Arden will be based in Black Diamond's Greenwich, Connecticut office, and brings over 20 years of experience in the credit and distressed investing field. Most recently, he served as cio for Octagon Credit Opportunities and has also worked at Angelo Gordon, AIG/SunAmerica, Troubh Partners and Arthur Andersen.

Structured Finance

Capital markets group beefs up

Cadwalader, Wickersham & Taft has added to its capital markets group in New York with the addition of Chris Gavin as partner. His practice focuses on US and international structured finance transactions covering consumer and corporate debt, including residential mortgage loans.

Gavin is expected to help develop the firm's global ABS bench, as well as serving clients on the non-agency RMBS side. His securitisation experience further entails auto loans and leases, unsecured consumer loans, commercial mortgage loans and marketplace loans.

Gavin moves from Perkins Coie, where he was also a partner in structured finance. Prior to that, he served as associate and eventually partner at Mayer Brown.

Structured Finance

Business development leader added

ZAIS Group has appointed Gregory Barrett as head of client relations and business development. He reports to ceo Michael Szymanski and is based in Red Bank, New Jersey.

Barrett will work with the firm's client relations team, portfolio managers and cio to lead and create distribution strategies for ZAIS. He will also be responsible for client service for investors.

Barrett has 23 years of industry experience and was previously md and a senior member of Dyal Capital Partners. He has also worked at Barclays in the bank's capital prime services group and as head of its capital solutions group.

Structured Finance

Regulatory partner named

Azad Ali has joined Fieldfisher's financial services regulatory practice as a partner. He was previously counsel in the financial institutions advisory & financial regulatory group at Shearman & Sterling, having been at the firm since 2005.

Ali specialises in advising clients on UK and EU regulatory matters across a wide range of regulated sectors. He has significant experience in bank capital and structural reform, bank resolutions, trading/clearing/settlement and derivatives regulation.

Structured Finance

Pricing firm hires coo

Solve Advisors has brought in Michael Pascuma as coo and head of business development. He joins the credit pricing firm from his role as vp at Nomura, where he traded high grade and high yield credit derivatives, including single name CDS. Pascuma has also held senior trading roles at Barclays and Lehman Brothers, primarily focusing on high grade flow trading.

Structured Finance

Goldman credit team formed

Goldman Sachs is creating a new credit group that will combine its structured and leveraged finance businesses, as well as integrate its financial and strategic advice in these areas. Americas Credit Finance Group will be led by co-heads Christina Minnis and Vivek Bantwal, following the retirement of Craig Packer, who was co-head of the bank's leveraged finance unit in the Americas.

Minnis was the other co-head in leveraged finance, while Bantwal was the bank's sole structured finance head in the Americas - a role he picked up last year. Both are also mds and partners at the bank.

CLOs

CLO manager takeover completed

Conning has completed its acquisition of CLO and high yield bond specialist Octagon Credit Investors (SCI 6 November 2015). As of 31 December 2015, Octagon managed US$12.6bn in assets. It is headquartered in New York.

Insurance-linked securities

ILS manager promotes two

Elementum Advisors has promoted Paul Barker and Chris Cebula as portfolio managers. Barker has also been made principal by the ILS firm, having previously held roles as a catastrophe modelling analyst and portfolio management associate, where he focused on portfolio construction, hedging and analysis of collateralised reinsurance investments.

Meanwhile, Cebula also moves up from being a portfolio management associate. He was previously an analyst and the primary cat bond trader for Elementum.

Risk Management

Eurex granted DCO registration

The US CFTC has granted Eurex Clearing registration as a derivatives clearing organisation (DCO) under the Commodity Exchange Act (CEA), as part of its commitment to working across borders to promote central clearing. Eurex Clearing is now authorised to provide swaps clearing services for US clearing members, as well as their customers, under Section 5b of the CEA. The registration will become effective after Eurex Clearing meets CFTC's straight-through processing requirements.

Eurex Clearing requested that CFTC issue a conditional registration, as it preferred to comply with those requirements in the future, at the same time as it complies with the expected European requirements for straight-through processing. Those requirements have not been issued due to the delay in the implementation of MiFID 2.

In light of the delayed effectiveness of registration, the CFTC has extended previously provided relief to permit Eurex Clearing to continue to clear proprietary positions in interest rate swaps for US clearing members. This relief has been provided since July 2013. After Eurex Clearing complies with the straight-through processing requirement and its order of registration becomes effective, it may begin clearing FCM customer positions, as well as continue clearing proprietary positions for US clearing members.

The CFTC has also provided no-action relief that permits Eurex Clearing to use a modified version of the acknowledgment letter required under CFTC Regulations 1.20(g)(4) and 22.5 for customer accounts maintained at the Deutsche Bundesbank. This follows a memorandum of understanding with the central bank and BaFin, the domestic regulators of Eurex Clearing, to facilitate information sharing and cooperative oversight.

Eurex Clearing becomes the sixteenth DCO registered with the CFTC and the sixth registered DCO based outside the US.

RMBS

Morgan Stanley settlement reached

Morgan Stanley has agreed to pay the FDIC nearly US$63m regarding claims over the sale of RMBS to three banks that later failed. The settlement, which resolves lawsuits brought forward by the regulator as receiver for the banks, will be distributed among their respective receiverships.

The three banks include Colonial Bank of Montgomery, Alabama, which failed in August 2009. The other two are Security Savings Bank of Henderson, Nevada, and United Western Bank of Denver, Colorado. The former closed in February 2009, while the later failed in January 2011.

According to the FDIC's allegations, Morgan Stanley made misrepresentations in the offering documents for 14 RMBS that the three banks purchased. Losses from the transactions prompted the regulator to act as receiver in filing four lawsuits between February 2012 and January 2014, accusing Morgan Stanley of violating federal and state securities laws.

The latest US$62.95m that Morgan Stanley has paid out adds to the US$24m it settled over claims related to Franklin Bank of Houston, Texas, which failed in November 2008. This brings Morgan Stanley's RMBS claim settlement with the FDIC to US$86.95m in total.

As of 31 December 2015, the FDIC has now filed 19 RMBS lawsuits on behalf of eight failed institutions, including the four lawsuits against Morgan Stanley. This latest settlement was reached in coordination with the US Department of Justice.

RMBS

UKAR servicing transfer agreed

Computershare has been appointed preferred supplier in the tender process to undertake the mortgage servicing activities of UK Asset Resolution (UKAR). The firm will now work with UKAR on an exclusive basis to finalise details over the coming months, with a view to agreeing binding contract terms. A dedicated team will concentrate on this next phase of work.

The contract is for a seven-year term to undertake mortgage servicing activities on behalf of UKAR, with £30bn of assets under management. In addition, there are separate contracts for the servicing of the £13bn of Granite assets purchased by Cerberus from UKAR in November 2015 (SCI passim).

After the signing of a contract, around 1,700 staff based in Sunderland and West Yorkshire are expected to transfer to Computershare and continue to service customers. Mortgages will continue to be serviced on existing UKAR systems as part of the transaction.

ABS

Credit card comparison tool launched

Fitch has launched Credit Card Compare, an Excel tool providing access to its surveillance and index data on North American credit card ABS transactions. Users can review the performance of US and Canadian credit card ABS transactions in comparison with Fitch's benchmark indices and macroeconomic indicators.

The tool allows the comparison of transactions using performance measures such as delinquencies, charge-offs, monthly payment rate and gross yield. ABS Compare was rolled out in 2014 for European ABS (SCI 12 November 2014).

ABS

Gracechurch link to base rate 'positive'

From the start of this month, Barclays is linking the interest rates it charges UK credit card customers to the Bank of England's base rate. The current low interest rate environment means such a move will support excess spread levels in the Gracechurch credit card ABS trust and reduce potential asset-liability interest rate mismatches between the receivables and note liabilities.

"If rates rise in the future, a pricing mechanism that automatically reflects increased rates means that a combination of static asset rates and increasing note costs is less likely to reduce excess spread levels in a credit card ABS trust," says Moody's avp Greg O'Reilly. Moody's notes that the direct linkage of Gracechurch trust credit card charges to the Bank of England's base rate is more transparent and should make it easier for consumers to adapt to future changes.

ABS

Fitch adjusts tobacco ratings

Fitch has finally concluded its review of all non-New York tobacco settlement ABS, affirming 60 bonds and downgrading a further 56. The downgrades are a result of the agency's revised tobacco settlement ABS criteria, which it issued in an RFC last year (SCI 23 June 2015).

An additional 15 transactions, comprising 83 bonds, securitise MSA payments received by the State of New York. These were not subject to the review, along with an additional 21 bonds from a sole transaction issued by the Tobacco Settlement Financing Corporation. This deal was excluded as it was newly issued in 2015.

Fitch also corrected previous errors across five separate California-based transactions, comprising an additional 32 bonds, pushing the total number reviewed to 252. The errors were sufficient to prompt various rating adjustment.

Upgrades were made to  two bonds in California County Tobacco Securitization Agency (Kern Country Funding). However, California State Financing Authority saw seven of its bonds downgraded. The Children's Trust Fund received a combination of adjustments, with its 2002 and 2005 series both separately receiving two bond upgrades, while the 2008 series saw two of its bonds downgrade.

ABS

RV risk reconsidered

When mitigating features are in place, some auto lease ABS with low residual value (RV) risk exposure only have moderately higher credit risks than traditional auto loan ABS, says Moody's. Auto lease ABS with low RV risk exposure could qualify as simple, transparent and standard (STS) securitisations, based on the STS criteria from European policymakers.

The agency says that in addition to the elements considered by various European public policymakers, it considers additional pool features in its analysis, such as manufacturer diversity and strength, and the inclusion of guarantees or dealer buy-back arrangements. A diverse pool of manufacturers reduces the potential impact of a weakening in any single manufacturer. Any pool predominantly composed of a single brand is exposed to idiosyncratic risks other than financial weakness, such as failures of a firm's engineering, changes in consumer taste or a weakening in a manufacturer's key markets.

Where dealer buy-back arrangements are in place, Moody's considers that the dealer would have to default before noteholders would be exposed to the risk of declining vehicle values. Many leases benefit from dealer buy-back arrangements, in which the dealer agrees to purchase the vehicle at a predetermined price at contract maturity if the lessee chooses to hand back the vehicle to the lessor.

In the agency's view, all auto ABS deals are exposed to some level of vehicle price risk following a borrower's default, since the large majority of recoveries will stem from the sale of the vehicle. Furthermore, auto ABS lease deals including RV may offer only slightly additional market-value risk compared to auto ABS loan deals with balloon payments.

Both balloon loan and RV lease deals can benefit from dealer buy-back arrangements. In such cases, the risk from these deal types would usually only differ if the dealers were to default on these buy-back arrangements, because the first source of repayment to the securitisation would be the dealers.

Where dealer buy-back arrangements are either not in place or if a dealer defaults such that the arrangements are not fulfilled, Moody's notes that the risks that RV leases introduce would still only be moderately greater than for balloon loans. This is because a borrower's capacity to cover the balloon payment often depends on their ability to either enter into a new contract with a dealer or sell the vehicle in the used car market. As a result, the agency considers market value risks to be implicit in balloon loan deals.

Structured Finance

STS expected losses highlighted

Preferential capital treatment for simple, transparent and standardised (STS) securitisations would be consistent with the superior performance of STS-compliant tranches, says Fitch. However, the proposed capital charges are still significantly higher than expected losses.

Fitch expects losses of 1% for STS-compliant deals and 4.3% for non-STS deals. "This suggests that lower capital charges for STS tranches than for non-STS tranches would be justified, as they will experience significantly lower losses," says the rating agency.

As with the Basel frameworks of 2012-2013, the European CMU proposals envisage conservative capital treatment under the external ratings-based approach compared to historical and expected performance. This is more exaggerated for STS tranches, where Fitch notes that the proposed capital charge is 4.5x the expected loss, while it is 3.4x the expected loss for non-STS tranches.

Structured Finance

Brazil ABS reporting falls short

Recent changes by Brazil's securities market regulator Comissao de Valores Mobiliarios to ABS performance reporting standards still lack a number of important features, Fitch warns. The breakdown of payment data could result in users continuing to underestimating delinquencies and losses.

The changes are designed to improve standards that were initially implemented in 2011 with CVM Instruction 489. The amendments have added minor details to existing asset and liability information, but still lack important features that Fitch says are prevalent in developed-market ABS investor reporting.

This includes the lack of transaction monthly statements of cashflow waterfall allocations. In addition, reported loan delinquency information only considers installments in arrears rather than the entire loan principal balance.

As a result, Fitch believes the regulators missed the opportunity to push reporting standards in an important step towards greater transparency. Although trustees have to report on delinquencies, prepayments and repurchases, the level of detail and quality varies widely among market participants. This has led the agency not to rely on public information in its surveillance of rated transactions.

The agency says the Brazilian ABS market has a long road ahead in bringing ABS reporting standards near to those in developed markets. Nonetheless, the move still represents part of a progressive effort to increase market-wide available information and promote transparency across the Brazilian ABS sector.

Prior to 2011, many Brazilian ABS issuers had little interest or the operational capabilities to publicly report comprehensive performance information. Greater transparency was urged by the market after certain rated transactions came under stress or defaulted.

Structured Finance

True lender status tested

A recent US District Court for the Eastern District of Pennsylvania decision has highlighted once again the regulatory risks that the 'true lender' doctrine can create for internet-based lenders that partner with banks to establish exemptions from state consumer protection laws (SCI passim). In the Commonwealth of Pennsylvania vs. Think Finance Inc case, the court declined to accept federal pre-emption as grounds to dismiss an enforcement action brought by the Commonwealth of Pennsylvania against an internet-based payday lender that arranged for a state-chartered bank to fund loans at interest rates exceeding the Pennsylvania usury cap.

The defendants Think Finance arranged payday loans for Pennsylvania residents under a marketing agreement with First Bank of Delaware, pursuant to which the bank would originate loans to borrowers solicited through Think Finance websites. It appears that the bank did not retain any substantial interest in the loans and that the defendants received most of the related economic benefits, according to a Chapman and Cutler memo.

The Pennsylvania Attorney General brought suit against the defendants, claiming that the company had violated not only Pennsylvania's usury laws, but - by engaging in certain deceptive and unlawful marketing and collection practices - had also violated a number of other federal and state statutes. The Attorney General argued that the defendants could not lawfully collect any interest owed on the loans in excess of the 6% usury cap and asked the court to impose various sanctions and the forfeiture of all associated profits.

In a motion to dismiss the claims, the defendants argued that federal pre-emption of state consumer protection laws permitted the bank to offer the loans at interest rates exceeding the Pennsylvania usury cap. As the bank was based in Delaware and Delaware permits its banks to charge loan interest at any rate agreed by contract, the defendants argued the bank was not bound by the Pennsylvania usury cap and lawfully made the loans to Pennsylvania residents.

The Attorney General responded that the bank was only a 'nominal' lender and that the defendants should be treated as the 'true' lenders for regulatory purposes as they marketed, funded and serviced the loans, performed other lender functions and received most of the economic benefit of the lending programme. The court held that these allegations were sufficient to support an "inference that the [defendants] are the true lenders" and it denied the motion to dismiss.

Chapman and Cutler points out that the case will now continue for further proceedings and so it could be months before a decision is rendered and the court ultimately could decide that the defendants were not the true lenders. "Thus, the immediate impact of this case is not truly significant and should not impact internet-based programmes at this time."

The memo adds: "The case is nonetheless of interest to marketplace lenders, payday lenders and other internet-based loan marketers because it demonstrates that plaintiffs will continue to raise the 'true lender' theory and courts will not necessarily dismiss at an early stage true lender claims solely because a bank is the named lender on the loans, at least where there are allegations that the originating bank does not have substantive duties or an economic interest in the programme."

To mitigate the risk of claims based on the true lender doctrine, companies that engage in internet-based lending programmes through an arrangement with banks should consider how the programmes are structured, Chapman and Cutler suggests. For example, consideration should be given to operations where the bank has substantive duties and/or an economic interest in the programme or loans.

"We are aware that some internet-based lending programmes are considering structural changes of this nature," the firm states. "Banks should also take care to fulfil their obligations under the federal banking guidance to monitor and supervise the internet marketer's performance of its duties as a bank service provider."

Similar true lender claims, such as in last year's Madden vs. Midland Funding case, have been asserted by both regulators and private plaintiffs against other internet-based lenders that market loans for origination by bank partners. "No clear rule has emerged, although regulatory challenges almost certainly are more likely to be made when excessive interest rates and/or abusive sales or collection practices are involved," the memo concludes.

Structured Finance

AIMA calls for non-bank support

AIMA has called on the European Commission to support non-bank financing and deeper capital markets as part of its regulatory review. The organisation says any rules should allow greater asset manager participation in securitisations, which would subsequently support the supply of finance to SMEs.

The comments are in response to the Commission's call for evidence surrounding the EU regulatory framework for financial services. At the core of AIMA's issues are regulatory barriers that it says are preventing capital market financing from developing further within the EU and leading to a better allocation of resources.

Therefore, it has set out a number of specific areas where it believes existing regulation is failing to match its intended policy objectives. This includes market infrastructure used to support liquidity and regulatory reporting that ensures the right collection of data.

The organisation also stresses the importance of finalising the EU internal market in fund distribution and opening the market to third country funds. In addition, it points out the need to review public short-selling disclosure requirements, which it says has hurt equity market liquidity.

"We recognise that most of the regulatory measures introduced since the financial crisis were intended to address key policy concerns and market failures," says AIMA ceo Jack Inglis. "Our members welcome the opportunity to be part of the review and evaluation of this new regulatory framework in order to ensure that the policy objectives are being met and, if not, to adjust the structure where necessary."

CLOs

CLO concerns 'beyond commodities'

Focus on industry-wide commodity-related stress could overshadow defaults of isolated non-commodity issuers that are prevalent in US CLOs, says Fitch. Millennium Health, which filed for Chapter 11 bankruptcy in November (SCI 10 November 2015), provides a recent example.

Millennium Health was held in more than 50 Fitch-rated CLOs. The agency notes that its default was the main reason behind a more than two-fold increase in the number of CLOs reporting defaulted assets from 3Q15.

Many CLO managers have trimmed their positions in response to commodity-related stress, which is expected to continue through 2016. The combined weight of energy, oil and gas, and metals and mining in the aggregate portfolio notional of Fitch-rated CLOs was around 5% at the end of last year, with increased concentrations in computers and electronics, telecommunications, healthcare and retail.

Fitch's list of loans of concern held in CLOs had a notional of US$9.6bn at the end of last year, representing around 8% of the US$115bn of the aggregate portfolio notional of Fitch-rated CLOs in its US CLO index. The commodity sectors contributed approximately 27% of the notional amount of the loans of concern.

CMBS

Defeasance activity remains strong

Newly defeased loans in Fitch-rated US CMBS totalled US$3.6bn in 4Q15, compared to US$5.3bn in 4Q14. Overall, newly defeased loans totalled US$14.2bn last year, versus nearly US$20bn in 2014.

The 4Q15 defeasance volume brings the total in Fitch-rated US CMBS deals to US$20bn - representing 5.2% of the agency's total outstanding universe - as of year-end 2015. Of this, US$9.7bn (or 48%) mature or have an expected final defeasance payment in 2016, US$6.2bn (31%) in 2017 and US$4.1bn (21%) in 2018 and beyond.

Fewer larger loans defeased in 4Q15 compared to the same quarter a year earlier: only four loans sized at over US$100m defeased, compared to 14 in 4Q14. The average loan size of new defeasances during 4Q15 was only US$15m, although 15 loans of over US$50m defeased.

The largest share of the 4Q15 defeasances were from 2007-vintage loans (accounting for US$1.5bn, or 40%), followed by 2006 (US$1.1bn, or 30%), 2011 (US$470m, or 13%) and 2012 (US$415m, or 11%). By property type, office led the way with US$1.3bn (36% of 4Q15 defeasances), followed by multifamily with US$942m (26%), retail with US$623m (17%) and hotels with US$297m (8%).

By MSA, New York led 4Q15 defeasances with US$1.3bn (accounting for 35%), followed by Dallas with US$351m (10%). Loans backed by New York offices accounted for US$828m of the 4Q15 total.

Fitch expects first-quarter defeasance volume to remain strong. However, the overall 2016 defeasance volume is likely to decline from prior years, given the future trajectory of interest rates and considering new regulatory requirements and the health of the overall US economy.

CMBS

Delinquencies drop on StuyTown resolution

The Trepp US CMBS delinquency rate plummeted by 82bp to 4.35% in January, driven by the resolution of the US$3bn Stuyvesant Town/Peter Cooper Village loan with no loss and a significant uptick in other loan resolutions. The rate is now 131bp lower than the year-ago level.

The StuyTown resolution also helped the multifamily sector move from the worst performing property type to the best. The multifamily rate dropped from 8.28% in December to 2.31%.

CMBS loans that were previously delinquent but paid off with a loss or at par totalled US$5.8bn last month. Removing these previously distressed assets from the numerator of the delinquency calculation helped push the rate down by 113bp.

A little over US$300m in loans were cured last month, which helped push delinquencies lower by another 6bp. About US$1.7bn in loans became newly delinquent, which put 34bp of upward pressure on the delinquency rate.

CMBS

Severities up on heavy losses

Total US CMBS liquidations topped US$2.4bn across 125 loans in January, more than doubling December's total of US$887.7m, according to Trepp. The average size of liquidated loans grew to US$19.5m last month, up from US$14.8m the month prior.

Including one US$20m B-note, 14 loans totalling US$252.1m experienced over 100% losses, 11 of which were worth under US$20m. Large loans that paid off last month include the US$225m Riverton Apartments (49.98% loss severity), US$150m COPT Office Portfolio (Rollup) (73%) and US$117m Loews Lake Las Vegas (100%) assets (see SCI's CMBS loan events database).

Other noteworthy retail assets disposed of in January were the US$136m Citadel Mall and US$125.6m Northwest Arkansas Mall loans, which took 96.24% and 76.98% in losses respectively. Finally, the US$363m Bank of America Plaza was officially resolved - with close to 55.66% in losses - in January after Shorenstein Properties purchased the Atlanta office building.

Trepp notes that loss severity continues to hover above the 60% mark, due to heavy losses from a number of smaller-sized loans. January loss severity stood at 61.61%, compared to 60.9% in December and 44.06% in November. Looking only at losses greater than 2%, volume was US$2.29bn with a 65.34% loss severity.

NPLs

Creval offloads NPLs

Creval Group has agreed to sell a €314m securitisation of secured and unsecured NPLs to Credito Dondiario. The sale of the Cerere portfolio is the first significant shifting of NPLs off Creval's books as part of its medium-term NPL management plan.

The portfolio's loans are broken down into 44% secured and 56% unsecured assets and are equal to approximately 11% of the gross bad loans and 5.5% of the total gross non-performing exposures of Creval, as of 30 September 2015. The sale could benefit from the Italian Treasury's new €200bn guarantee scheme, which is expected to spur the offloading of NPLs by Italian banks (SCI 2 February).

Banca IMI acted as financial advisor on the sale for Creval, while Bonelli Erede was the firm's legal advisor.

NPLs

Catalonia law irks NPL buyers

A new Catalonian law on housing emergencies could deter potential purchases of Spanish mortgage NPLs, suggests Moody's. As a result, the adverse effects of Catalonian law 24/2015 may see fewer NPLs included within RMBS pools.

"Under the new law, private equity firms and hedge funds that buy NPL pools at high discounts could lose their benefit," says Alberto Barbáchano, a Moody's vp and senior credit officer. "If a bank sells the loan to a third party at a lower price than the loan's current balance, the borrower can be released from their debt by paying the third party the very same price."

The agency adds that even if the subsequent transfer of the loan to a securitisation is made at par value, there is still a risk that the borrower could pay back the debt for the same price that the third party paid. This would lead to part of the mortgage being effectively written off as it can no longer be collected from the borrower, prompting a loss for the SPV.

The Spanish civil code does already possess a similar provision, but Moody's says the Catalonian law is wider in scope and less burdensome for the exercise of this right by the borrower. However, although it includes Catalonian assets at below par, the law's provision would not affect outstanding or new RMBS where the seller in question directly originated the portfolio. The same would apply where the sale and the subsequent transfer to the SPV are made at par value.

Further, the effectiveness of the law could be jeopardised because of the practicalities required. For example, without contractual provisions that require disclosure with an underlying loan's borrower, it would be difficult for the borrower to find out that the loan has been sold or any of the terms and price.

Even where the entire portfolio's total price is available, Moody's says it would be difficult for the borrower to calculate how much of the mortgage does not need to be repaid if there is no loan-by-loan price for the pool purchased by the third party below par value.

NPLs

Italian valuation gap highlighted

A decree formalising the Italian treasury's €200bn NPL plan (SCI 28 January) is expected shortly. Moody's suggests in its latest Credit Outlook publication that the proposed state guarantee will improve the rating and liquidity of the senior tranches, facilitating both the placement of the senior tranches with investors and the deconsolidation of bad loans from the books of Italian banks. The framework also requires NPLs to be serviced by a specialised independent servicer, which has the potential to positively affect the timing and amount of collections.

However, the agency notes that establishing a state guarantee for NPL securitisations does not solve the key issue of the large gap between bank valuations of bad loans (about 40% of face value) and the market price of bad loans, which is lower - partly because of Italy's long workout times of around six years. "We believe that the transfer price is likely to be around 20% of the face value of the loans, based on the 17.5% transfer price to the bad bank established in the resolution of four Italian banks under administration. The treasury's estimate is that the guarantee on the securitisation structure should improve values by a further two percentage points."

The difference between banks' current valuations and the sale price to the SPVs will be a loss that banks will have to recognise. Losses cannot be transferred to the SPV and embedded into the junior tranches because banks must sell the junior tranche in order to benefit from the guarantee and deconsolidate the loans. This is in contrast to bad banks set up in Spain and Ireland, where part of the equity risk was taken by public funds before state aid rules became more stringent in 2013.

In terms of establishing the SPVs, banks must weigh the long-term benefits against the short-term costs that the transfer would entail. UniCredit and Intesa Sanpaolo, for example, already have internal bad banks and may not be interested in the small improvement in values provided by the scheme.

Still, Moody's says that the contemplated framework would be positive for creditors because banks would be able to alleviate their balance sheets of bad loans - thereby reducing risk-weighted assets (RWA) and leverage, while potentially allowing lower prudential capital requirements following the disposal.

RMBS

Risks weighed for modified RMBS

The scheduled increase in interest rates on certain US RMBS-linked modified loans is seen by Moody's as a slight credit negative for the performance of the asset class. This is because after the step-up these loans will likely re-default at a higher rate than previously.

The agency explains that modified subprime and alt-A loans with performance history of four to five years increase in the number of delinquencies after an interest rate hike more often than similar loans that have not stepped up. In July 2015, only 2% of modified re-performing subprime loans became delinquent prior to a rate reset, whereas 10% became delinquent after a rate reset.

However, Moody's says that higher default rates will only have a limited impact on RMBS, with approximately 10% of outstanding subprime loans and 6% of outstanding alt-A loans likely to undergo a similar interest rate reset over the next five years. Further, loans with scheduled step-ups have on average a stronger economic profile than other loans of the same vintage, owing to lower monthly payments and lower interest rates.

For example, new delinquencies post step-up on average declined to 8.5% in November 2015 from 16% in January 2014. The rate of new delinquencies for all alt-A loans on average had already declined to 7% in November 2015 and 9% in January 2014.

In addition, the current monthly payments on higher balances for modified reperforming loans (RPL) scheduled to step-up in the coming years are lower than those for average loans. The average monthly payment for subprime and alt-A loans modified between the years 2012 to 2014 is US$1,104 and US$1,642 respectively. This is in contrast with US$1,296 and US$2,058 respectively for an average subprime and alt-A loan.

Meanwhile, Moody's says that scheduled step-ups on modified loans included in 2015 RPL securitisations will have only a slightly negative impact on performance. Borrowers in 2015 RPL transactions with loans that are due for an interest rate reset in the coming years have already been making monthly payments for 24 to 36 months. Average updated LTV for the RPL transactions is 91%, indicating the loans have some equity and should continue to build equity with improvements in house prices.

Constrastingly, the agency warns that transactions such as CMLT 2015-A, TPMT 2015-4 and TPMT 2015-6 have LTVs close to 100%. However, long performance history, low interest rates and an improving housing market will offset some of the risk of future re-defaults in 2015 transactions.

RMBS

MI analysis updated

Morningstar Credit Ratings has published an updated methodology for US RMBS ratings, including an explanation of its analysis of mortgage insurance (MI) in RMBS. The move follows the release of an RFC in December (SCI 4 December 2015).

The agency notes that while MI does not necessarily affect a borrower's probability of default, it may decrease loss severities. As such, Morningstar's enhanced methodology allows credit to MI, in some cases up to the triple-A ratings level.

Other updates to its RMBS methodology are primarily for clarification purposes. Morningstar has also published revised US residential mortgage loan representations and warranties, a revised non-agency RMBS resecuritisation methodology, revised single-family rental securitisation ratings criteria and revised RMBS servicer advance receivables ratings criteria.