Global Securitized Products Weekly

Transcription

1 23 July 2014 Fixed Income Research FOR INSTITUTIONAL CLIENT USE ONLY Global Securitized Products Weekly Securitized Products Strategy Agency MBS We maintain a tactical MBS basis long despite last week s choppy performance. Fed MBS purchases this week provided only partial support for our hypothesis that the Fed could be pushing out settlements to support rolls for longer. June existing home sales and July pooling data are consistent with our net and gross issuance forecasts. We take a tactically positive stance on 15s/30s after being neutral in recent weeks. Non-Agency MBS The largest difference between the Agency CRT deals, in our view, is the coupon difference between the deals. We believe that coupon multiple valuations offer a convenient way to compare the various last cash flows. We benchmark valuations on credit risk transfer (CRT) last cash flow bonds to IOS multiples of similar vintage and coupon collateral. Under this framework, we believe that the STACR 2013-DN1 M2 is cheap relative to the rest of the CRT last cash flow stack. Overall, most CRT last cash flows appear rich compared to IOS benchmarks, in our view. CMBS The macro-volatility we were discussing last week took another step higher, as concerns over unrest in Ukraine and the Middle East continued to escalate. Cash CMBS held up well and spreads across the new issue and legacy stack are unchanged to, arguably, slightly tighter, over the past week. Flows have increased over the past few days, as have bid lists. S&P s parent company announced that it received a Wells Notice from the SEC, related to the rating of six CMBS transaction issued in We found exactly six private label deals that S&P rated in 2011 so it would appear that these were the subject of the notice. In addition we look at the July remittance reports where delinquencies increased slightly from last month s local low. Research Analysts GLOBAL HEAD Roger Lehman roger.lehman@credit-suisse.com AGENCY MBS Mahesh Swaminathan mahesh.swaminathan@credit-suisse.com Qumber Hassan qumber.hassan@credit-suisse.com Glenn Russo glenn.russo@credit-suisse.com NON-AGENCY MBS/CONSUMER ABS Marc Firestein marc.firestein@credit-suisse.com CMBS Roger Lehman roger.lehman@credit-suisse.com Sylvain Jousseaume, CFA sylvain.jousseaume@credit-suisse.com Serif Ustun, CFA serif.ustun@credit-suisse.com EUROPEAN UPDATE Carlos Diaz carlos.diaz@credit-suisse.com MODELING AND ANALYTICS David Zhang david.zhang@credit-suisse.com European Update The past week saw a German SME leasing ABS price in the primary marketwith the pipeline currently consisting of two further deals including a UK non-conforming RMBS and European CLO with transaction details available in the European Update. Table of Contents Core Views 2 Agency MBS 3 Non-Agency MBS 9 CMBS 12 European Update 32 DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

2 23 July 2014 Global Securitized Products Weekly 2 Core Views Sector Trends Trade Ideas Agency MBS Housing Prepayment Non-Agency MBS CMBS Source: Credit Suisse Tactically long MBS basis Favor FN 3s over 3.5s; like FN 4s vs. rates Slight long 15s/30s Low coupon G2/FN swaps look rich, we like selling G2/FN 3 swap Neutral IOS coupon stack The rebound in housing should continue, albeit at a more moderate pace; we project gains of roughly 5% in We expect most of the major drivers behind the recent recovery in home prices to remain in place in We believe the slowdown in momentum is largely driven by two factors: a decline in affordability and a decline in distressed supply. We project speed increases of roughly 4% and 2.5% for the 30- and 15-year conventional sectors in July, respectively. This should be followed by roughly a 5% slowdown in both August and September. Low coupon speeds should remain flat in July followed by high-single-digit percentage declines in both August and September. Belly coupons (4 and 4.5s) should speed up roughly 8% in July on higher day count and marginally lower mortgage rates before slowing down 12%-13% over the next two months. Speeds on higher coupons should be flat to modestly higher in July followed by a 6%-8% decline through September This week s large list cleared well, with relatively large volumes on the follow. Prices held steady across all sectors. The macro-volatility we were discussing last week took another step higher, as concerns over unrest in Ukraine and the Middle East continued to escalate. Cash CMBS held up well and spreads across the new issue and legacy stack are unchanged to, arguably, slightly tighter, over the past week. Flows have increased over the past few days, as have bid lists. S&P s parent company announced that it received a Wells Notice from the SEC, related to the rating of six CMBS transaction issued in We found exactly six private label deals that S&P rated in 2011 so it would appear that these were the subject of the notice. In addition, we look at the July remittance reports where delinquencies increased slightly from last month s local low. Long FN 4s versus rates Sell FN 3.5s versus 3s plus IOS 3.5s Buy DW 3/FN 4 swap Sell G2/FN 3 swap We remain slightly cautious on RMBS in the near term. We prefer post-reset Alt-A hybrids and POA Dupers with a fairly flat credit curve. We also prefer post-reset Prime hybrids in lower-beta bonds. Wider trading AMs remain our favorite trade and appear attractive to corporates, and other legacy CMBS. Some AJs should be considered but others may be priced too aggressively. Differentiation is needed on premium super-seniors but some shorter duration bonds, like the A1As, are attractive. New issue, last cash flow super-seniors and AS bonds are also cheap to corporates and have some room to moderately tighten. They also appear cheap to slightly seasoned bonds trading in the secondary market. We are concerned about newly issued BBB- bonds given changes in underwriting. Single-A bonds and super-seniors appear relatively more attractive. Series 6/7 CMBX appears cheap to newly issued cash bonds.

3 23 July 2014 Mahesh Swaminathan Qumber Hassan Glenn Russo Agency MBS Strategy We maintain a tactical MBS basis long despite last week s choppy performance. Net hedged carry remains attractive despite its drop last month. MBS yield spread to corporates is near its widest level since early 2008, supporting the near-term case for MBS. Fed MBS purchases this week provided only partial support for our hypothesis that the Fed could be pushing out settlements to support rolls for longer. Although some purchases were pushed out to October, others were for September settle. If the latter continue much longer, September rolls could pick up somewhat, in our view. June existing home sales and July pooling data are consistent with our net and gross issuance forecasts. June s unchanged YoY existing home sales bring the cumulative H1 total to down 5% YoY, in line with our forecast for the year. MTD pooling data shows $67B in pools so far in July and on course to hit $81B for the while month. We take a tactically positive stance on 15s/30s after being neutral in recent weeks. We recognize that the 15-year sector is fundamentally rich, but expect the current drivers of richness to hold for the near to intermediate term. Trade recommendations Initiate scaling into buy DW 3/FN 4 swap ($25MM DW 3 vs. $18MM FN 4s) following its recent cheapening and somewhat favorable risk/reward (23 July 2014, MBS Trade Note). Hold scaling into a tactical long MBS basis by buying FN 4s ($25MM) and selling 2-, 5-, and 10-year swaps (9 July 2014, MBS Trade Note).This trade is up 2 ticks. Hold scaling into a sell FN 3.5/3 swap ($25MM) hedged with IOS (9 July 2014, MBS Trade Note). This trade is down roughly 8 ticks. Hold sell G2/FN 3 swap ($100MM), based on rich valuations (11 June 2014, MBS Trade Note). This trade is down roughly 3 ticks. Exhibit 1: Current trade recommendations Actual P&L of open trades should be slightly lower as this may not reflect bid/offer spread Trade Idea Start Date P&L P&L (ticks) Long $25MM FN 4s vs. 2-, 5-, and 10-yr swaps 9-13,550 2 Sell $25MM FN3.5/3 swap (1-for-1), long $9MM IOS (61,302) (8) Sell $100MM G2/FN 3 swap 11-Jun-14 (86,016) (3) Total P&L of open trades (133,768) Total P&L of trades closed YTD (261,619) Note: Pricing date: 22 July Source: Credit Suisse Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Information, opinions and estimates contained in this report reflect a judgment at the original date of publication by CS and are subject to change without notice. The price, value of and income from any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of securities and financial instruments may be subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. The P&L results shown do not include relevant costs, such as commissions, interest charges, or other applicable expenses Global Securitized Products Weekly 3

4 Cum hedged perf 23 July 2014 MBS choppiness continues Maintain tactical long MBS performance remains choppy, with FN 3.5s and 4s outperforming the rates curve by roughly 5+ ticks over the four sessions ending Tuesday before reversing much of it on Wednesday (Exhibit 2). Higher coupons held up somewhat better and 3s performed slightly worse. This choppiness has occurred against a backdrop of a roughly sideways move in volatility on 10-year tails, which remain near their lowest levels since late 2007/early We maintain our tactical long basis recommendation based on a continued low vol outlook and signs of stabilization in dollar rolls and net hedged carry (Exhibit 3). We note that FN 4s still offer roughly 3 ticks of hedged carry, but acknowledge the risk from possible roll cheapening. Last week, we suggested that the Fed may be trying to engineer a soft landing in dollar rolls by settling a fixed amount of bonds (roughly $25B) through November, which would allow a similar settlement run rate through Q1:15. We suggested that a switch to October settlement starting this Monday would provide corroboration of such a strategy. This week s activity has not provided evidence of a clear cut shift to October, although some purchases on Tuesday were pushed out. This suggests that the Fed may not have a specific numerical target for monthly settlement in mind, but we still hold out the prospect that the Fed may plan to smooth out settlements somewhat. In the event that the Fed goes back to settling almost all of the purchases in the front month, September and October rolls can appreciate due to the increased takeout, followed by a sharper drop subsequently. Compared to 7-10 year corporates, MBS current coupon yield is near its widest level since early 2008 supporting a local relative value case for MBS (Exhibit 4). That said, we realize that MBS yield to corporates could widen further over time in a strong economy. Exhibit 2: MBS performance remains locally choppy, near one-month lows Hedged performance vs. 2-, 5-, and 10-year swaps Jun Jul Jul Jul 14 FN 3.5s FN 4s FN 4.5s Source: Credit Suisse Global Securitized Products Weekly 4

5 MBS/Corp yield spread (bp) MBS basis to 10-yr swaps (bp) Hedged carry 23 July 2014 Exhibit 3: Hedged carry appears to be stabilizing after last month s plunge Monthly hedged carry vs. 2-, 5-, and 10-year swaps May May FN 3.5s FN 4s FN 4.5s Source: Credit Suisse Exhibit 4: MBS yield spread to corporates is near its widest since early 2008 Yield spread between MBS CC and 7-10 year LUCIPLUS AA index /31/99 07/01/02 12/30/04 07/01/07 12/30/09 06/30/12 MBS LUCIPLUS yield diff Pre-crisis avg MBS basis Source: Credit Suisse Existing home sales and pooling update June existing home sales came in above consensus at 506K, on a non-seasonally adjusted basis. Though this number is unchanged versus June 2013, previous undershoots bring the total cumulative existing home sales to 2.3MM, down 5% from the same time last year and in line with our annual forecast (Exhibit 5). NAR-reported first time buyer share was 28%, in line with our model assumptions. Better than expected June sales could increase July net issuance by roughly $1B according to our model. We maintain our gross and net issuance forecast for July at $81B and $4B, respectively, while recognizing the potential for a slight upside. Correspondingly, we maintain our annual net issuance forecast at $54B for now, with the potential for a small upward revision if June s strength continues well into H2. Month to date pooling data shows issuance of roughly $67B. This is based on embs data for fixed-rate pooling of $63B MTD through 22 July ($18B, $21B, and $24B in FH, FN, and GN/G2, respectively). We estimate that roughly $4B in ARMs have been issued MTD. These figures compared to June full-month issuance of $29B, $19B, and $24B FN/FH/GN fixed-rate and $4B ARMs pools. We see this trajectory as in line to hit our gross issuance forecast of $81B for July. Global Securitized Products Weekly 5

6 Units (M) YoY difference 23 July 2014 Exhibit 5: H1:14 cumulative existing home sales down 5% versus % 2014 % change from % % % -4% Jan Feb Mar Apr May Jun Source: Credit Suisse, NAR -5% -6% -7% -8% Scale into buy DW 3/FN 4 swap (Originally published on 23 July 2014) We recommend scaling into buy DW 3/FN 4 swap following its recent cheapening and somewhat favorable risk/reward. We construct this trade by buying $25MM DW 3 vs. $18MM FN 4s at -$2-09 (72% hedge ratio). This represents a quarter of our target size in this trade and offers a roughly -0.2 tick carry. Valuations and supply/demand outlook DW 3s have underperformed 30-year production coupons by nearly 30 ticks since early March (Exhibit 6). In terms of cumulative performance, this has pushed down the DW 3/FN 4 swap to a roughly flat level since the beginning of In comparison, despite a similar recent underperformance streak vs. FN 3.5s, the DW 3/FN 3.5 swap is still up roughly 18 ticks since the start of We note that the curve (2s/10s) and vol are roughly 40bp steeper and in line with the corresponding levels at the beginning of Despite recent underperformance of the DW 3s vs. 30-year counterparts, any turn to a positive view on this coupon is challenged by its tight OAS. We note that while the relative OAS of DW 3s vs. FN 4s is near its one-year wides, the absolute OAS in the negative lowto mid-teens range on the former exposes it to the risk of further cheapening (Exhibit 7). Historically tight OAS on 15-year MBS reflects defensive positioning by REITs and banks since the May 2013 selloff. It is natural to expect a reversal of this at some future point. However, we do not expect to see an extensive repositioning of REIT and bank portfolios until the risk of further selloffs in rates and vol materially subsides. Barring a significant deterioration in the economic outlook, this is unlikely to happen until such increases materialize and move into the rear view mirror. A likely timeline for this would be early next year, a few months before the Fed initiates tightening, in our view. Historical flows suggest that REITs and banks have become marginal buyers of 30-year MBS in Q1:14 following three quarters of net sales (Exhibit 8). We note that Q1:14 REIT data are clouded by a significant repositioning by Armour, which purchased roughly $7B 15-yr MBS and sold a similar amount of 30-yr MBS in this quarter. Adjusting for this, the trend implies a continued gradual reduction in 15-year holdings since Q3:13 and moderate net buying of 30-year MBS in Q1:14. Anecdotal evidence suggests that this trend continued in Q2:14. Global Securitized Products Weekly 6

7 DW 3 OAS - FN 4 OAS (bp) Cum Performance (ticks) 23 July 2014 In comparison, banks appear to have been more resolute buyers of 15-year MBS passthroughs in recent quarters with roughly $5B 15-year MBS purchases in Q4:13 and Q1:14 each. However, banks also appear to have become marginal net buyers of longer maturity MBS passthroughs in Q1:14. Our bank estimates are based on quarterly changes in FDIC maturity/repricing data for MBS passthroughs. We assume that 80% of the quarterly change in the 5+- through 15-year maturity bucket represents 15-year flows. At the margin, we believe that REITs are more likely to continue a gradual unwind of their defensive posture than banks in the near term. Low current leverage and low volatility in the market are the key enablers of this, in our view. However, this risk for the 15-year sector is favorably offset by a significant increase in Ex- Fed supply in the 30-year sector in Q3:14 (Exhibit 9). We estimate that ex-fed 30-year FN MBS supply deteriorates by roughly $25B in Q3:14 compared to a roughly $3B increase in the FN 15-year supply. These estimates assume that the Fed s further purchases will be for October settlement or later after its shift to October on Tuesday. The actuals could be higher should the Fed continue to purchase FN MBS for September settle for longer. We recognize that at the margin, the 15-year sector is potentially more sensitive to declining Fed sponsorship than the 30-year counterpart. However, the magnitude of the gap offers the former support on a relative basis, in our view. Carry on the DW 3/FN 4 swap is near the low end of its one-year range (Exhibit 10). Furthermore, the DW 3 roll is trading at carry which lowers the downside risk on the swap from a carry perspective. Exhibit 6: DW 3s have underperformed 30-year production coupons by roughly 30 ticks since the beginning of March Since January Mar Jun Sep Dec Mar DW 3/FN 4 DW 3/FN 3.5 Credit Suisse Locus Source: Credit Suisse Exhibit 7: OAS of DW 3s relative to FN 4s is near its one-year wides 12-month history DW 3/FN 4 OAS pickup Source: Credit Suisse Credit Suisse Locus 30-Sep Dec Mar Global Securitized Products Weekly 7

8 Carry (ticks) Ex-Fed Gross Supply ($B) 23 July 2014 Exhibit 8: Banks/REITs have turned into marginal net buyers of 30-year MBS passthroughs in Q1:14 following three quarters of net sales $B Period Net REIT MBS purchases Net Bank MBS purchases Combined Purchases 15-yr 30-yr 15-yr 30-yr 15-yr 30-yr Q1: Q2: Q3: Q4: Q1: Notes: REIT purchases are based on changes in reported holdings of AGNC, NLY, CYS, and Invesco Q1:14 REIT purchases include data for Armour. Armour purchased roughly $7B 15-yr MBS and sold a similar amount of 30-yr MBS. Bank purchases are estimates based on qtrly changes in FDIC maturity/repricing data for MBS Source: Credit Suisse, Annaly, AGNC, CYS, Invesco, Armour, FDIC Exhibit 9: Ex-Fed supply significantly deteriorates for the 30-year sector Gross issuance net of Fed settled purchases Source: Credit Suisse FN 15-yr FN 30-yr Q1:13 Q2:13 Q3:13 Q4:13 Q1:14 Q2:14 Q3:14 est Exhibit 10: Carry on the DW 3/FN 4 swap is near the low end of its one-year range 12-month history DW 3/FN 4 carry Source: Credit Suisse Credit Suisse Locus 30-Sep Dec Mar Global Securitized Products Weekly 8

9 23 July 2014 Marc Firestein Mahesh Swaminathan Non-Agency MBS An IOS framework for STACR/CAS With the issuance of CAS 2014-C03, the GSEs have issued eight credit risk transfer deals to date. Other than a small variance in the structure (notably, the 2014 STACR deals three-tranche structure) and the different severity schedule, the deals are nearly identical. The largest difference between the deals, in our view, is the coupon difference between the deals. Comparing the last cash flow bonds to each other, given the highly similar collateral characteristics (save the high LTV groups in the most recent CAS deals), becomes an exercise in pricing the coupon differences. We see many parallels between these differences and those in the IOS market. We believe that coupon multiple valuations offer a convenient way to compare the various last cash flows. We benchmark valuations on credit risk transfer (CRT) last cash flow bonds to IOS multiples of similar vintage and coupon collateral. Under this framework, we believe that the STACR 2013-DN1 M2 is cheap relative to the rest of the CRT last cash flow stack. Overall, most CRT last cash flows appear rich compared to IOS benchmarks, in our view. The framework a coupon swap of sorts Exhibit 11: With credit exposures relatively similar across the different deals CS Model projections To compare the different last cash flows, we simply take the difference in coupons to create an IO-like security. We then take the difference in price and calculate the implied multiple difference between the securities. Given the low expected defaults on these transactions (Exhibit 11), we believe that most, if not all, of the dollar price difference between the LCFs is the value assigned to the incremental coupon. Exhibit 12: The material difference between the deals is the coupon CAS M2 is the swap coupon Cumulative Defaults (%) Swaps LCF Swap Deal name Base Optimistic Stress STACR131/CAS STACR 2013-DN STACR131/STACR CAS141/ STACR 2013-DN STACR141/ STACR 2014-DN CAS131/CAS STACR 2014-DN CAS131/CAS CAS 2013-C STACR131/CAS CAS 2014-C STACR131/CAS CAS 2014-C02 (G1) STACR132/CAS CAS 2014-C02 (G2) CAS131/STACR Source: Credit Suisse, LoanPerformance, Fannie Mae, Freddie Mac Source: Credit Suisse, LoanPerformance, Fannie Mae, Freddie Mac Next, we bring in the IOS component as a point of comparison. Using the WAC and origination date, we identify the indices that best correlate with each tranche. These will provide the benchmarks for our coupon swaps either using the lower coupon or the higher coupon. Global Securitized Products Weekly 9

10 23 July 2014 Exhibit 13: IOS-implied multiples based on WAC and origination year Blends are 50/50 simple average of the two multiples (as applicable), July 22 close prices Deal WAC Origination Year IOS Coupon/Blend IOS Multiple STACR 2013-DN STACR 2013-DN STACR 2014-DN STACR 2014-DN CAS 2013-C CAS 2014-C CAS 2014-C02 (G1) Source: Credit Suisse Current valuations and relative value At current valuations, we believe that the STACR 2013-DN1 M2s are the cheapest bonds in the stack. While the 130 dollar price might cause investors concern, the coupon multiple approach reveals its relative cheapness given both the underlying collateral and its relative value versus other bonds in the stack. We believe the STACR 2013-DN1 M2, in this approach, should be about 1-2 points higher. Exhibit 14: Implied multiples on CRT last cash flow swaps versus IOS comps Indicative levels, July 22 close LCF Swap Top Bond Price Bottom Bond Price Multiple % of top bond IOS Mult % of bottom bond IOS Mult STACR131/CAS % 91% STACR131/STACR % 101% CAS141/CAS % 112% STACR141/STACR % 115% CAS131/CAS % 103% CAS131/CAS % 108% STACR131/CAS % 93% STACR131/CAS % 98% STACR132/CAS % 100% CAS131/STACR % 125% Source: Credit Suisse On the other hand, we believe that most other swaps are modestly overvalued. We believe there is an argument to be made that these coupon swaps should trade lower than IOS multiples given their slightly lower liquidity and lower leverage. In addition, the collateral blend that underlies IOS is modestly different, as it includes both HARP collateral and sub- 60 LTV loans as well. Furthermore, when the IOS multiples are lower than CRT multiples, investors can create synthetic premiums at a cheaper dollar price using IOS tranches. While current valuations on most other multiples in the LCF stack are higher than most IOS tranches, we believe that the compression should be small between the tranches. Global Securitized Products Weekly 10

11 23 July 2014 These valuation differences could potentially stem from a difference in the investor bases between CRT bonds and IOS. While using IOS to synthetically replicate higher coupon CRT last cash flows looks attractive here, it may not be in every investors mandate to purchase both. However, we still see IOS multiples as a reasonable benchmark to compare the CRT market to IOS because many investors can participate in both sectors. Conclusions As the GSEs issue more CRT transactions, the coupon multiple approach, in our view, could gain increased traction in valuing last cash flow tranches relative to one another. While the multiples may matter most to the first deals in today s landscape, we believe this approach allows investors to compare tranches on a more normalized basis. Global Securitized Products Weekly 11

12 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun July 2014 Roger Lehman Sylvain Jousseaume, CFA Serif Ustun, CFA CMBS Market activity and relative value The macro-volatility we were discussing last week took another step higher, as concerns over unrest in Ukraine and the Middle East continued to escalate. While broader markets, such as equities and corporate credits, reacted, the move in these sectors was not that great. For example, US stocks were initially lower on Thursday but are now only down 0.3%, from last Wednesday s record high. Similarly, the IG CDX index is not even wider by 2 bp and the high yield index is down about half a point. Cash CMBS held up even better and spreads across the new issue and legacy stack are unchanged to, arguably, slightly tighter. While the performance is impressive, given the minor rise in volatility, it is not that surprising. Both interest rate and equity volatility (Exhibit 15 and Exhibit 16) ticked higher but not materially so, especially compared to spikes earlier in the year, and remain at very low levels from a historical basis. Exhibit 15: Interest rate volatility (CIRVE index) 120 Exhibit 16: Equity market volatility (VIX index) Source: Credit Suisse Source: Credit Suisse, the BLOOMBERG PROFESSIONAL service CMBS performance is not that surprising. Despite some renewed geo-political concerns most of the reasons behind this year s tightening remain in place. These include: a strong supply/demand story (with the asset class still being cheap), improving real estate fundamentals, that is leading to fewer new loan problems, and some better-than-expected loan resolutions (see section below for our July credit update). Lastly a robust financing market combined with an improving economy is helping property prices to rise. The increase in volatility and the recent spread performance helped to increase trading flows and bid list volume over the past few days. While some of the lists wound up not trading, TRACE data shows that flows definitely picked up. TRACE data indicated that there was net selling on Wednesday but generally the supply appears to be reasonably well absorbed, over the past few days. Global Securitized Products Weekly 12

13 Jun 19 Jun 20 Jun 23 Jun 24 Jun 25 Jun 26 Jun 27 Jun 30 Jul 01 Jul 02 Jul 03 Jul 07 Jul 08 Jul 09 Jul 10 Jul 11 Jul 14 Jul 15 Jul 16 Jul 17 Jul 18 Jul 21 Jul 22 Jul July 2014 Exhibit 17: Daily CMBS trading activity from TRACE $mn 2,500 2,000 Dealer to Dealer Customer sells Customer buys 1,500 1, Source: Credit Suisse, FINRA The latest conduit deal (COMM 2014-UBS4) priced on Wednesday, coming wide of both the initial talk and the prior deal s levels (CGCMT 2014-GC23). The prior deal priced at the end of last week right before volatility kicked higher, but it was also very well received. The last cash flow super seniors and the AS class priced at the tightest level since the new issue market restarted, post crisis. The mezzanine classes were at multi-year tights. One of things we found interesting on the latest conduit deal is the selective use of rating agencies. As we have been discussing (for example, last week in our analysis of second quarter credit quality) some transactions have dropped Moody s at the triple-b minus level. The latest deal took that a step further. On the COMM 2014-UBS4 deal, four rating agencies weighed in but Moody s did not rate any bonds below the super-senior level. Interestingly, Moody s LTV on the collateral came out 113%, the highest of any deal since the conduit market was revived (the prior high was on COMM 2014-UBS3). Another rating agency, Fitch, was then dropped on the BBBbonds, leaving just DBRS and KBRA at that level. The new MSBAM 2014-C17 deal, that is currently in the market, has taken a similar tack, dropping Moody s on the classes below double-a. Despite the pricing on the latest conduit deal, recently issued bonds do not feel any wider, over the past week. Super-seniors from 2013 are still trading in the S+mid-60s area and some 2013 BBB- bonds traded in line with spreads from last week. MSBAM 2014-C17 started the marketing process on Wednesday, joining the single borrower deal backed by the Destiny retail property (JPMCC 2014-DSTY). While cash spreads have held in well, CMBX has been more susceptible to the overall macro concerns and have widened over the past week (Exhibit 18 and Exhibit 19). We continue to believe that last two CMBX series remain cheap to cash. Global Securitized Products Weekly 13

14 23 July 2014 Exhibit 18: CMBX 6/7 price changes CMBX CMBX AAA AS AA A BBB- BB Source: Credit Suisse Exhibit 19: CMBX 6/7 spread changes CMBX CMBX AAA AS AA A BBB- BB Source: Credit Suisse S&P receives Wells Notice tied to six 2011 deals McGraw Hill Financial, the parent company of Standard & Poor s (S&P), announced on Wednesday that it received a Wells Notice from the SEC, related to the rating of six CMBS transaction issued in The Wells Notice notified the company that a preliminary determination was made to recommend brining an enforcement action, alleging a violation of securities laws. No formal allegation has been made but the notice allows S&P the opportunity to address the issues raised, by the staff, before any decision on an enforcement action is made. The press release goes on to state that the SEC staff can recommend a variety of remedies that include a cease-and-desist order, disgorgement, pre-judgment interest, civil money penalties, and remedial sanctions such as revocation or suspension of S&P's NRSRO registration. We found exactly six private label deals that S&P rated in 2011 so it would appear that these were the subject of the notice. In addition, the company rated three agency CMBS deals as well. We show these in Exhibit 1 We know little about the alleged violations other than it relates to public disclosure made by S&P regarding those ratings thereafter. Given the scant amount of information, it is difficult to assess the potential fallout from today s news but the ongoing news bears monitoring, in our opinion. Exhibit 20: 2011 S&P rated deals Private Label Original bal ($mn) Current bal ($mn) JPMCC 2011-C3 1, ,319.5 JPMCC 2011-C4 1, ,369.5 JPMCC 2011-CCHP JPMCC 2011-FL MSC 2011-C1 1, ,490.2 WFDB 2011-BXR 1,000.0 Paid off Agency Original bal ($mn) Current bal ($mn) FREMF 2011-K701 1, FREMF 2011-K11 1, ,140.5 FREMF 2011-K13 1, ,209.7 Source: Credit Suisse, Bloomberg As a reminder, in July 2011, S&P was unable to deliver final ratings for a planned conduit deal. The announcement came right before the deal was set to settle and resulted in the deal being shelved for several months. A press release from the sellers stated that the retraction was due to S&P reviewing its criteria. The review was prompted by the discovery of potentially conflicting methods without changing the overall calibration of the conduit CMBS criteria, according to S&P. Global Securitized Products Weekly 14

15 23 July 2014 A follow up note, from S&P, the following week, indicated that the company determined its approach used for DSCRs on new transactions since early 2011 has produced results that are consistent with its rating definitions. The next year S&P finalized new guidelines for evaluating CMBS collateral, publishing a request for comment in June and finalizing them in September CMBS loans in the news Solana has updated appraisal and ARA BACM and JPMCC 2007-LDPX The properties backing the Solana loan reported updated appraisals on the July remittance reports but, once again, the reporting between deals was inconsistent. This is not the first time there have been problems with the reporting of this multi-propertied, pari passu loan. Our previous write-ups on Solana can be found here. It appears to us, from the numbers and through an inquiry with the master servicer, that the most recent appraised value, of all the collateral, now stands at $184.9 million, as is reported in the files for BACM The $143 million appraisal listed on JPMCC LDPX covers only the office component of the collateral. Furthermore, we were informed that the office appraisal was as of June while the hotel appraisal was as of March, which explains some of the discrepancy in the as of date across the two pieces. The Solana loan totals $360 million and is split into two pari passu pieces. The larger note totals $220 million and is securitized in BACM (11.6% of the deal). The other portion totals $140 million and is part of JPMCC 2007-LDPX (4.6% of the deal). Solana was one of the first large loans to go to special servicing after the downturn in March 2009 and remains one of the largest specially serviced conduit loans. The loan is backed by a mixed use development in Westlake, Texas, that includes 11 office buildings, a retail center, a hotel and land. A receiver was appointed in 2011 and the loan became REO this past February. The drop in the appraisal was hinted at last May, in the special servicer s comments, where it was noted that they anticipated a dip in value based on the largest tenant s recent request for early renewal / downsizing by 250,000 square feet. The notes also indicate that the asset was marketed for sale last December but did not transact. According to the Fort Worth Star-Telegram, M&M Properties was slated to buy most of the assets, at $195 million, but stepped away from the deal, right before the closing. That also sunk the agreement to sell one of the assets to Digital Realty Trust that had been in place. Rest of Lakes on Post Oak should pay off with YM penalty GSMS 2011-GC3 The three properties, originally backing the Lakes on Post Oak office complex in Houston, have been sold, according to Real Estate Alert. The prior owner found three different buyers for the complex with a combined sale price of $405 million. The three buildings backed a loan securitized in GSMS 2011-GC3. The loan s current balance of $69.4 million represents 5.4% of the deal. The loan paid down by nearly $42 million, in June, which appears to be related to the release of one of the three properties. Given the sale, we would expect the remaining balance to pay down shortly. The loan is not set to mature until January However, the properties could be released, subject to a release price set at 115% of the allocated balance, together with a prepayment penalty. The release of the first property resulted in a $9.3 million prepayment penalty payment (about 22 points). Some of the payment went to the A1 and A2 tranches but most was paid to the IO holder. The three properties were appraised at $177 million in 2011, a fraction of the reported sale price. Global Securitized Products Weekly 15

16 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan July 2014 July brings slight increase in delinquencies The delinquency rate for legacy conduit loans ticked slightly higher in July, but still remains at the second lowest level since late The rate has generally been trending lower, over the past several quarters. Over this time there have been a handful of months, such as July, where the rate has risen. The decline, over the course of the year, has been in line with our expectations and is being driven by a combination of fewer new problem loans falling into the delinquency bucket, as well a steady pace of loan resolutions and liquidations. Interestingly, even as the delinquency rate increased, in July, the balance of problem loans (60+-days delinquent) actually fell slightly, for the sixteenth straight month and the 26 th time out of the last 27 months. The higher delinquency rate, despite a decline in the delinquent balance, speaks to the shrinking size of the conduit universe, which we discuss further below. Although liquidations were below trend in July, falling below the $1 billion threshold, they still have a strong impact on the overall delinquency rate. A high pace of liquidations, if not in dollar terms, at least as a percentage of the outstanding universe, is also part of our base case. As we have previously laid out, given the large bucket of loans with credit problems and the high concentration of REO loans, resolutions should remain elevated, at least over the near term. REO loans now make up nearly two-thirds of the total of 60+-day legacy delinquencies, after spiking last month, due to Stuyvesant Town. That percentage has grown from 46% a year ago and 32% two years ago (Exhibit 21). We believe this argues for a continued high pace of loan resolutions and further downward pressure on the overall delinquency rate, in the coming months, even if it is not as rapid as it was in the first quarter of this year (due to the CWCapital distressed bulk sales). Exhibit 21: Percent of delinquencies that are REO 70% 60% 50% 40% 30% 20% 10% 0% 65% As the balance of the universe shrinks further, we may start to see more volatility in the headline delinquency rate. To get a clearer picture of credit trends, we try to look past a single month s results to see broader changes. In addition, our analysis of credit extends past the simple headline numbers, of delinquencies and loss severities, to see what is driving these changes. Over the rest of this year we expect the pace of new credit problems rolling into the delinquency bucket to fall, compared to the prior several years, with the new additions more than offset by the progress made on the resolution of existing distressed loans in the pipelines (through cures, modifications and especially liquidations). The Conduit Loan Impairment Rate (CLIR) There are many credit metrics that can be followed and each has advantages and disadvantages. One of the more popular headline statistics is the overall delinquency rate (with some using 30+-day and others using 60+-day measures). Global Securitized Products Weekly 16

17 23 July 2014 While delinquencies are an important component to understanding the current credit picture, we do not believe that, by themselves, they tell the full story. Just as important is how loans are transitioning in and out of their respective buckets. Loans can cure, be modified, or liquidated (often at a loss). Not all of these are positive credit events. We think an unchanged delinquency rate, that is accompanied by a high level of loan liquidations or modifications, is a sign of a deteriorating, rather than a stable, credit environment. Credit problems will first show as delinquencies in the initial stages of a credit downturn and attract the most attention. But we are firm believers that liquidations and mods, which only start to appear later in the cycle, should not be ignored. As we have often seen in the past, changes in the rate of liquidations and modifications can have a distortive effect on the delinquency rate. In a month when delinquent loan liquidations are above the trend, there is more pressure on the overall delinquency rate. In order to capture the dual influence of delinquencies and liquidations, we have adapted a simple construct in which we combine the two measures, adding together the delinquency rate (today s current problems) and liquidations (credit problems that have left the CMBS universe). This combination provides what we call the conduit loan impairment rate (CLIR). For the delinquency rate, we have chosen to use the current balance of loans that are 60+-days delinquent (which also includes loans in the process of foreclosure, REO, and non-performing matured balloons). To this measure, we add the balance of loans that have been liquidated and calculate the conduit loan impairment rate, as a percentage of the original outstanding balance of the universe we are analyzing. We then enhanced this measure to capture the growing number of modified loans. We have dubbed this measure Mod-CLIR. While modified loans are often reported as current, many of them are not performing as originally intended and we believe are credit impaired, despite being reported as current. In summary, our Mod-CLIR measure incorporates loans that have been modified with respect to their monthly payments but would not otherwise be captured in our original CLIR measure. Loans that have received only a maturity modification are not included. Analysis covers the pre-2010 universe Before we go on and discuss this month s credit statistics, we also think it is important to understand and clearly define the universe that one is analyzing, as this can also heavily influence the calculation of credit metrics. We focused on the CMBS fixed-rate conduit deals and specifically legacy issuance (those deals issued in 2008 and earlier). It is easier, in our view, to focus on a fixed set of deals and loans to make meaningful comparisons over time than an ever-changing universe (that is one reason why we also like to analyze vintage level information). The set of conduit deals we used in our analysis has a current outstanding balance of approximately $359 billion (and an original balance of $844 billion). We have seen other measures that incorporate the larger universe of conduit deals, including those issued over the past four years. Fortunately, at the moment, these newer vintage deals (issued in 2010 and later) have few serious credit issues. Adding the most recent conduit issuance, which has been accelerating, would increase the denominator in our calculation and suppress the overall percentages as well as any of the changes in percentages from month to month. Including the recent issuance would push the overall delinquency rate significantly lower and would mute the month-over-month change. Global Securitized Products Weekly 17

18 Jul-02 Jul-04 Jul-06 Jul-08 Jul-10 Jul-12 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul July 2014 Furthermore, as new issuance volume rises and the balance of legacy deals outstanding continues to contract (Exhibit 22), the new issuance will have an even greater impact (Exhibit 23). We are, of course, keeping track of the newer vintages and the relevant credit statistics as well, but for now, we think it makes for a cleaner comparison to segregate them. Exhibit 22: Legacy conduit universe is shrinking $bn $bn 1,100 Net change (RHS) 40 1,000 Original Current (5) 0 (10) Exhibit 23: as recent issue is picking up $bn Legacy Current Bal Post-legacy Current Bal The outstanding legacy conduit balance shrunk by $5.9 billion over the past month, or about 1.6%. This drop is in keeping with the recent trend over the past couple of years, in dollar terms but a little higher than average on a percentage basis. We expect, as the size of the universe continues to fall, the monthly declines may moderate but also could become more volatile. The current balance of $359 billion, noted above, is down about 10% year-to-date after falling about 15% in 2013, 14% in 2012 and just 11% in The total outstanding volume is down more than 50% from the peak in December As we previously noted, declining supply remains a positive fundamental for the sector, but at some point, if the outstanding balance continues to shrink, it would hurt liquidity and become a negative technical. Turning to net conduit supply, and accounting for new issuance, the outstanding balance of the universe fell slightly less but was still down over the past month. Net conduit supply was down by $20.3 billion in 2013 (versus $20 billion we forecasted and a drop of $43 billion in 2012). We still believe net supply will be down slightly, in 2014, but then will likely turn positive in The relative outstanding balance between pre- and post-2009 deals is quickly changing. The legacy conduit universe is now about 2.6 times the size of the post-revival universe ($359 billion to $139 billion), but it was over five times bigger a year ago. Global Securitized Products Weekly 18

19 23 July 2014 More post-legacy loans experience credit issues As we noted above, we are still keeping a careful eye on newly issued deals for problem loans. There are a handful of loans from the last few vintages that have been moved to special servicing or became delinquent. All told, delinquencies across conduit deals issued after 2010 have a 30+-day delinquency rate of 12 bp ($172 million out of $139 billion outstanding), up 1 bp over the month. The rate has generally been in the 10 to 15 bp range in the first half of this year. In addition, there is another $153 million (11 bp) of loans that are performing but with the special servicer, unchanged month-over-month. The 2011 cohort still has the highest 30+-day rate at 27 bp, up about 5 bp from last month but still below the 32 bp peak in May (Exhibit 24). Exhibit 24: Newer vintage problems by cohort and category Vintage Performing Spc. Serv 30-days Delinquent 60+-days Delinquent Total PSS or Dlq Pct Bal ($mn) Count Pct Bal ($mn) Count Pct Bal ($mn) Count Pct Bal ($mn) Count % % % % % % % % % % % % % % % % % % % % 0 0 Total 0.11% % % % Only one post-crisis loan, The Cove at Southern, has been liquidated. The loss to the trust was very small but the liquidation did help drive down the cohort delinquency rate in June. Six smaller, recently originated loans added to the credit stats in Exhibit 24. Two loans formerly associated with Wendell Jacobson (Retama Ranch and Brooksedge Apartments) moved back to current but the loans remain with the special servicer. Three of the six new loans on the list are 30-days delinquent but have not been sent to the special servicer. The other three are current but are being specially serviced. In Exhibit 25, we show the specially serviced and delinquent loans from the post-crisis vintages. We have also highlighted the six new additions in blue. Global Securitized Products Weekly 19

20 23 July 2014 Exhibit 25: Specially serviced and/or delinquent loans from recent conduit CMBS Loan Deal CMBX Cur Bal ($mn) Deal Pct Current Status Prior Month Worst Delinquency Specially Serviced Transfer Date The Commons at Manahawkin Village WFRBS 2011-C % 30-day <30 day 30-day Yes Sep 2013 Hilton Springfield MSC 2012-C % <30 day Current n/a Yes Apr 2014 Strata Estate Suites COMM 2013-CR % FCL 90+day FCL Yes Feb 2014 Independence Place - Fort Campbell MSC 2012-C % REO 90+day REO Yes Oct 2013 Acropolis Gardens Realty Corp. WFRBS 2013-C % 90+day 90+day 90+day Yes Mar 2014 Bear Creek Portfolio WFRBS 2012-C % 90+day 90+day 90+day Yes Feb 2014 Landmark Building COMM 2012-CR % Current <30 day n/a Yes May 2014 Oakridge Office Park MSBAM 2013-C % Current Current n/a Yes Jun 2014 The Hills GSMS 2011-GC % REO REO REO Yes Apr 2013 Campus Habitat 15 WFRBS 2011-C % Current Current FCL Yes Aug 2013 Stonebridge Apartments WFRBS 2011-C % <30 day <30 day 90+day Yes Jul East Erie COMM 2013-CR % 30-day 30-day 30-day Retama Ranch Apartments CFCRE 2011-C % <30 day 90+day 90+day Yes Feb 2012 Georgetown MHC Portfolio COMM 2013-CR % Current Current 60-day Yes Mar 2014 Campus South & Oakbrook WFRBS 2011-C % Current <30 day n/a Yes Sep 2013 Four Peaks Plaza JPMCC 2010-C % Current Current n/a Yes May 2014 Montgomery Village Professional Center DBUBS 2011-LC2A % 90+day 90+day 90+day Yes May 2014 Ellicott Apartments COMM 2013-CR % Current Current n/a Yes Jun 2014 Brooksedge Apartments CFCRE 2011-C % <30 day 60-day 60-day Yes Feb 2012 Langtree Ventures Portfolio GSMS 2013-GC % 90+day 90+day 90+day Yes Mar 2014 Shannon Square WFRBS 2013-C % Current Current n/a Yes Feb 2014 Prince and Bleecker Portfolio GSMS 2011-GC % FCL FCL FCL Yes Mar 2014 Pilgrim Village Apartments UBSBB 2012-C % 30-day <30 day 30-day Horizon Village CFCRE 2011-C % 90+day 90+day 90+day Yes May Third Avenue GSMS 2013-GC % 30-day <30 day 30-day Bloomfield and Northshore Self Storage WFRBS 2012-C % 30-day <30 day 30-day 3511 North Clark COMM 2012-CR % Current <30 day n/a Yes May West Division COMM 2012-CR % Current <30 day n/a Yes May 2014 Wells Street Portfolio COMM 2012-CR % Current <30 day n/a Yes May 2014 Lockaway Self Storage GSMS 2012-GC % REO REO REO Yes Feb 2013 The largest of these is Pilgrim Village ($4.1 million and 0.3% of UBSBB 2012-C4). Little information is available in the remittance reports but an article in The Buffalo News indicates that the owner is currently proposing to redevelop the community. The outlined plan is to replace the current 89 subsidized affordable units with new buildings containing at least 380 units, with a mix of market-rate, subsidized and student housing. Three loans, with the same sponsor, and securitized in the same deal (COMM 2012-CR4) are current but have been moved to special servicing. There are only servicing notes on one of the three loans which indicates it was on the watchlist due to tenant issues. The combined exposure is $7.6 million or 0.7% of the transaction. Another small rise for Mod-CLIR in July The Credit Suisse Modified Conduit Loan Impairment Rate (Mod-CLIR) was close to unchanged in July, up less than half a bp, and remains at 16.5% (Exhibit 26). The increase is one of the smallest over the past several years. We show the monthly change, as well as the 6- and 12-month moving averages, in Exhibit 27. There had been a clear downward trajectory of this measure since the middle of Year-over-year, our Mod-CLIR measure is up only 46 bp compared to a 128 bp increase in the prior twelvemonth period. This indicates to us that credit problems continue to grow but the rate of these additional issues is now at a significantly slower pace than over the previous 12 to 18 months. Global Securitized Products Weekly 20