Citi and Fortis bring Botticelli

A round up of this week's structured credit news

Citi and Fortis bring Botticelli
Citi and Fortis Investments have launched a managed equity programme called Botticelli. The programme includes a variety of equity tranche-linked notes, each of which offers different risk/return characteristics, with a projected internal rate of return of up to 21%.

The initial portfolio is composed of 80 equally-weighted credits. The aim behind the product is to defend the carry typically provided by the equity tranche by managing the portfolio against defaults and credit events. Fortis Investments' bottom-up credit-picking investment style and the deep resources behind it – dedicated structured credit portfolio managers, credit analysts and quantitative and risk specialists – aims to allow it to meet that goal.

The seven and 10-year fund-linked transaction is available in either funded or unfunded format. The three core products are principal protected notes (PPN) (Citi-guaranteed), combo notes (with a different mezzanine portfolio) and straight equity-linked notes.

The PPN and combo notes can achieve principal and interest rating (AAA/AA) with a small guaranteed coupon paid. The structure offers modelled internal rate of return of Libor + 16% on a straight equity transaction and Libor + 200-250bp on the PPN/combo structures.

Citi and Fortis Investments will market the transaction in Europe, Asia, the Middle East, the US and elsewhere. The first pricing will be in mid April.

Strong Taiwanese structured credit issuance expected
Fitch Ratings expects Taiwanese CBO issuance backed by structured bonds or principal-only notes to remain strong, with more than NT$110bn in term liabilities or ABCP in the pipeline for 2007. The agency says the majority of this issuance represents bespoke transactions for insurance firms that are flush with liquidity.

"The major local insurance companies have exhausted their capacity for US$ (or the other foreign currency) denominated investments. They are buying the equity tranches of the bespoke structured credit transactions that are backed by NT$ bonds with a remaining maturity of two to five years and 'selected' US$ assets with a maturity greater than five years. This enables them to get 'indirect' exposure to foreign assets whilst holding a NT$ liability."

Additionally, domestic originators view arranging such transactions as a lucrative source of income, particularly given that issuance of corporate bonds and commercial paper is expected to decrease when compared with 2006. Meanwhile, the agency adds that CLO issuance is expected to continue on a steady path in the region, with Fitch anticipating a number of balance sheet CLOs and primary CLOs to come in 2007.

Regarding cross-border CDO issuance, Rachel Hardee, head of Asia Pacific structured credit, Derivative Fitch, says: "In the short term, I do not think that CDOs backed by NT$-denominated assets can be sold to the global market given their relatively tight credit spread and the very tight currency basis swap level. Securitising US$ assets owned by Taiwan institutions may in principle be feasible, but the majority may find it difficult to achieve a suitably diversified US$ portfolio. By way of contrast, fully-hedged US$ assets will look attractive from a yield perspective for Taiwanese investors."

Carador remains resilient
Listed structured credit fund Carador announced its results for February this week. Its NAV has dropped slightly, but the fund has again (see SCI issue 26) successfully avoided the worst of the sub-prime market turmoil.

Carador's monthly report from manager Washington Square Investment Management says: "Carador's significant underweight position in the ABS market in general and the sub-prime market in particular has meant that our NAV performance has been resilient. Carador's NAV decreased by 0.36 cents, or 0.37%, month on month, during February."

The report explains that this reduction in NAV is due to a conservative mark-to-market in the manager's CDOs of ABS positions and expenses for the period. The low impact is due to its minimal exposure to the sub-prime sector.

Washington Square adds: "The current portfolio continues to be overweight senior secured loans, and underweight transactions backed by structured finance securities. This has been a view we have highlighted since our initial monthly report back in May 2006. At the time of launch, we took a view opposed to the consensus on the corporate market, in the belief that senior secured loans offered significant value, particularly given the very low funding rates we could achieve in CDOs backed by these assets. Similarly, we decided to underweight CDOs backed by ABS securities."

FSA lobbied over EEPE
ISDA and LIBA have written a letter to the UK's FSA hoping that the regulator can lend its backing to their views on the correct approach to Effective Expected Positive Exposure (EEPE) within the Capital Requirements Directive (CRD). The associations say that the CRD indicates EEPE must be computed at the level of the netting set.

However, the letter argues that this definition is not consistent with the level at which firms manage credit exposures, which is that of the counterparty itself. "Calculating EEPE at netting set level will therefore require upgrading systems and internal validation practices, at a significant cost, and for no clear purpose other than to abide by a regulation divorced from firms' practice. The change will cause a rift between exposures used for risk management purposes and those calculated for regulatory capital purposes, causing system differences and a dichotomy in user/senior management understanding," it says.

Furthermore, the associations report that their member firms do not believe that computing EEPE at the level of the counterparty would substantially change the size of their total counterparty credit risk capital.

New SIV rated, another issues euro paper
SIV activity continued apace this week, with Axon Financial Funding receiving provisional ratings and Cortland Capital issuing euro-denominated CP and MTNs.

Both Moody's and Fitch have assigned preliminary Prime-1/F1+ and Aaa/AAA ratings to Axon Financial Funding's new European and US CP and MTN programmes, which can issue up to US$20bn in securities. In an usual move, the agencies have also assigned provisional A1/AA- ratings to the SIV's US mezzanine note programme, which sits above its capital notes.

The SIV is sponsored by Axon Financial Services, a wholly owned portfolio company of TPG-Axon Capital Management. According to analysts at Fitch, Axon's key strengths include its very well staffed and experienced management team, strong asset surveillance and liability management team, and large secured capital commitment.

It also has a large and diverse ramped-up portfolio and its investment purchases are restricted to 100% triple-A rated structured finance assets. Maximum deal size for any security is limited to the amount of capital in the structure (or 50% of capital if asset-weighted average life is greater than five years).

Meanwhile, Moody's has assigned definitive P-1 and Aaa ratings to the euro CP and MTN programmes of Cortland Capital, up to a US$20bn limit. The vehicle currently issues US CP and MTNs under P-1/Aaa rated programmes that closed on 17 October 2006 (as well as unrated capital notes). The ECP and EMTN programmes will share exactly the same risks and interests in Cortland's assets as the US programmes.

The management of Cortland has been delegated to Natixis Securities North America, which has in turn delegated certain administrative functions to QSR Management – a wholly owned subsidiary of The Bank of New York.

Cortland differs from several other SIVs in that it has a reversible restricted funding state instead of the irreversible defeasance state found in many other vehicles.

Fitch Launches SME CDO VECTOR model
Fitch has published a new rating methodology for European SME CDO transactions and simultaneously launched its new rating tool, Fitch Default VECTOR SME Model.

The Fitch Default Vector SME model (VECTOR SME) will be the primary quantitative tool in the agency's analysis for European SME CDO transactions and is based on the same theoretical framework as VECTOR 3.0. It is a multi-risk factor model that takes as input default probabilities or ratings, recovery rate assumptions and correlations to produce default and loss distributions using a Monte Carlo simulation.

The criteria report, European SME CDO Rating Criteria, outlines the theoretical framework behind VECTOR SME, explains the generation of necessary input assumptions into the model, and gives guidance on how to read and interpret the model's output. It also briefly introduces various transaction types securitised in European SME CDO structures, explains the qualitative analysis carried out at the originator and servicer level, and describes Fitch's cashflow modelling assumptions.

Rating agencies tackle sub-prime concerns
Reports released in the past week from both Moody's and Fitch look at the effects of sub-prime stress on two structured credit sectors. Moody's suggests that the impact of sub-prime RMBS is manageable for many structured finance CDOs, while Fitch says ABX-HE referenced sub-prime loans may see continued stress.

The effects of potential performance deterioration of sub-prime RMBS should be mild to moderate for the average SF CDO, says Moody's Investors Service in a new report. But the agency also notes that the average deal is beginning to show significant credit deterioration, especially for the lower investment grade tranches, in cases where the sub-prime market exhibits severe underperformance.

The 2003 to 2006 vintages of SF CDOs have exposures to sub-prime RMBS averaging around 45% of total collateral (by par), ranging from almost zero to nearly 90%, says Moody's. Well-diversified SF CDOs hold a range of assets from other sectors, including prime RMBS, CMBS and securities backed by auto loans and credit cards.

The structural protections in some SF CDOs – including calculating the par coverage ratio with ratings-based haircuts and treating securities on watch for upgrade or downgrade as if they have already been upgraded or downgraded – will mitigate some of the portfolio deterioration that may occur in the sub-prime RMBS sector.

Rising delinquencies and resultant price declines have been felt most acutely in the ABX-HE 06-2 and ABX-HE 07-1 CDS indices due to their heightened exposure to a slower home price appreciation (HPA) environment and riskier low documentation loans to sub-prime borrowers with piggyback second loans, according to Fitch Ratings. And, according to a new report by the rating agency, continued problems in the sector are likely.

Sub-prime loans underlying the indices could face more stress in the future since most of the underlying transactions contain hybrid adjustable rate mortgages that have not yet experienced a rate adjustment, says Fitch. It is too early in the life of the underlying RMBS transactions to determine exactly which bonds may underperform, and to what degree.

However, the agency believes that 2006 sub-prime vintage delinquencies and losses could continue their relatively high trajectory, increasing downgrade risk for the lowest-rated investment grade bonds backing the index. Fitch notes that there are important risk mitigants, such as low unemployment and relatively solid economic growth that may help contain the loss rates. Any decline in short-term interest rates could also have a positive impact.

MP