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A round up of this week's structured credit news
LCDX edges closer
Dealers prepping the US loan CDS index – LCDX – are understood to be getting nearer to resolving the small number of outstanding technical issues that have prevented launch and pushed it past the most recently scheduled commencement date of 3 April (see SCI issue 30). Expectations are that the index will be launched before the end of this month, provided nothing unexpected arises.
Market participants are currently working on finalising precise information on two reference obligations in the index where credit agreements have not been publicly filed. Furthermore, there are some credits which will be referenced in LCDX that are not currently in the syndicated secured list. Both of these issues are likely to be resolved by the end of this week.
Provisional ratings assigned to another CDPC
Moody's has assigned a provisional triple-A counterparty rating to new CDPC Koch Financial Products (KFP), together with provisional ratings of A2 to the approximately US$100m subordinated notes and Baa2 to the approximately US$50m junior subordinated notes due 2037.
Organised as a Delaware limited liability company, KFP will initially invest in a diversified portfolio of investment grade rated obligations of corporate and sovereign credits through the credit default swap market. It is an indirect subsidiary of Koch Industries and will be managed by Principal Global Investors (a member of the Principal Financial Group).
Taiwan CLN on offer
M&G Investment Management has closed Oakham, its NT$1.6bn (US$50m) Aa3 rated synthetic CDO.
The Moody's rating addresses the expected loss posed to noteholders relative to the payment of a coupon equal to 3.75% and the redemption of principal by the legal final maturity. The scheduled maturity of the notes is in December 2016, but late credit events could delay the ultimate repayment of the notes.
The portfolio initially comprises 125 corporate entities, each representing 0.8% of exposure. The average rating on the pool is currently Baa1 with a WARF of 294 (inclusive of notched names).
While the notes are denominated in Taiwanese dollars, the amounts of interest and principal due are computed by reference to a fixed US dollar-denominated principal balance. The actual payments due will be the NT$ equivalent of these amounts computed in US$ converted at the spot rate of exchange on the day falling two Taipei business days prior to the date of payment.
Dual manager Cougar CLO II marketed
M&G Investment Management and Egret Capital are acting respectively as senior and junior portfolio managers on Cougar CLO II, a high yield transaction arranged by Societe Generale.
The deal comprises €124.3m Aaa Class A notes and €45m Baa3 Class B notes, both due in 2025. This portfolio is composed of European senior loans, second lien loans, mezzanine obligations and high yield bonds, and is expected to be 80% ramped-up at closing.
2005/6 vintage SF CDOs face sub-prime pressure
As US sub-prime market stresses continue to materialise, 2005 and 2006 vintage structured finance (SF) CDOs will be under increasing ratings pressure due to their substantially larger concentrations of such collateral, according to Fitch analysts in a new report. Ratings volatility arising from later vintage sub-prime RMBS will likely be experienced in 12 to 18 months as the actual loss experience becomes clearer.
"Though 2006 performance will be very poor, Fitch's more immediate concerns focus on near-term ratings volatility that will arise from earlier vintage sub-prime RMBS," says senior director Derek Miller. "Negative selection among borrowers due to prepayments is occurring simultaneously with the release of credit enhancement due to RMBS performance triggers passing, against the backdrop of a slowdown in the US housing market."
Mezzanine SF CDOs have the highest credit exposure to sub-prime RMBS through subordinate bonds and appear to be most vulnerable. More than 220 Fitch-rated high grade and mezzanine SF CDOs have exposure to the asset class, with US CDOs averaging 44.7% exposure (compared to 22.7% for European SF CDOs).
Approximately 3.2% of 2003 to 2006 vintage mezzanine SF CDO portfolios are comprised of below-investment grade sub-prime RMBS and 16% triple-B minus assets.
Three new credit events for synthetic CDOs
Only three new credit events were called on corporate obligors in the synthetic CDOs rated by S&P in Q406, thanks to the ongoing benign corporate credit environment.
"The quarterly global corporate default rate has remained close to all-time lows, although it continued its slight upward trajectory to 13.7bp during the fourth quarter of 2006 from 10.4bp during the third quarter," explains S&P credit analyst Andrew South.
Credit events were called on Dura Automotive Systems Inc, which was referenced in 34 CDOs, as well as Damovo Group SA and Autocam Corp – each of which was only referenced in a couple of transactions. S&P has seen the number of corporate obligors triggering CDO credit events in any single quarter continue at a modest level, consistent with the recent benign default rate in the broader corporate environment.
South adds: "In the fourth quarter of 2006, Damovo became the first European obligor to trigger a credit event since the fourth quarter of 2003. This brings the total number of credit events called on European entities through 2006 to only 16, affecting 218 synthetic CDO transactions rated by us."
TABX increases overlap in ABS CDOs
The inclusion of tranched ABX indices (TABX) in ABS CDO portfolios can sharply increase the overlap in collateral pools, Moody's says in a new report.
"Coupled with the current environment in which the new ABX-based tranches are trading at extremely wide spreads relative to similarly enhanced ABS CDO tranches, there is a risk that many ABS CDOs will see sharp increases in average pool-wide correlation through the purchase of the standardised ABX tranches in either synthetic or [CLN] form," explains Moody's md Eric Kolchinsky.
The first TABX indices began trading in February of this year. "The key to capturing the intra-CDO correlation is that any TABX exposure be properly identified. In general, collateral managers have wide discretion in classifying instruments that are incorporated into ABS CDO collateral pools, and TABX tranches might, for example, simply be classified by the name of the vehicle which issued the CLN," says Kolchinsky.
Moody's asks that managers of CDOs and other rated vehicles that wish to offer protection on the TABX, either through a CLN or swap, first discuss its appropriate treatment within the CDO with the rating agency.
Addressing inter-CDO correlation, however, is more difficult. When an ABS CDO contains both ABS-related positions as well as tranches of other actively managed CDOs, it is difficult to perform a look-through analysis on an ongoing basis because of the dynamic nature of each underlying CDO's portfolio.
Moody's is currently undergoing a research project to study the overlaps in ABS CDOs and will adjust its ABS CDO correlations accordingly. Until the research project is completed, Moody's may consider look-through correlations for ABS CDOs in the initial rating process.
LGD roll-out in EMEA
Moody's has implemented its loss-given-default (LGD) rating methodology in EMEA, following its roll-out in the US and Canada last year. The agency's EMEA ratings universe includes roughly 600 corporate families, with the LGD methodology being applied to 200 high yield issuers. 22% of these companies were affected in terms of ratings changes.
All ratings actions to first lien loans (around 40% of those publicly rated) were 1-2 notch upgrades; the average assigned LGD rating was 37% (63% recovery rate). Second lien rating actions were skewed towards downgrades (70%) versus upgrades (30%); the average LGD estimate was 71% (29% recovery rate).
The implications for CLOs are broadly similar to those for US CLOs, including potentially tighter loan spreads and decreased subordination levels for senior CLO debt, says analysts at JP Morgan. However, loan spreads have typically been more "sticky" in Europe and less reactive to the smaller (but growing) European CLO bid (US loan spreads actually widened during the period in which LGD ratings were introduced).
Rating changes were also more limited in EMEA (67% of US first lien loans saw upgrades), although the majority of high yield loans in Europe are shadow-rated, making it difficult to gauge the ultimate impact.
Revised JDA methodology released
Moody's has published its revised joint-default analysis (JDA) methodology for banks, limiting the degree of support to a notch or two and resulting in those banks already 'done' now having to face a further review.
According to analysts at RBS, it appears that the US changes are unlikely to be reversed but that many of the European bank ratings will need to be reviewed. Changes here are expected to be downgrades of a notch or two with three notches in some cases (most likely the Icelandic and Hungarian banks).
The ratings methodology looks broadly similar but the black box has been tweaked so that it produces lower final ratings uplifts with far less double counting of support. Additionally, rating analysts will have more discretion regarding the final rating as opposed to being dictated to by the model.
Moody's has also 'simplified' its notching approach with one notch now for subordinated and 'equivalent hybrid capital instruments', two notches for preferred stock and equivalents, and one or two notches for hybrids with meaningful mandatory deferral triggers.
New methodology for CRE mezzanine debt
Moody's has released a report outlining its approach to rating mezzanine debt in response to strong growth in the use of such loans to finance commercial real estate (CRE) assets. Over the last two years, mezzanine loan issuance within CRE CDOs has climbed rapidly, reaching over US$3.2bn last year from approximately US$25m in 2004.
CRE mezzanine loans are backed only by a security interest in the shares or partnership interests of a real property owner, not by security in the real estate itself, as is provided by a traditional mortgage. Daniel Rubock, a Moody's analyst and author of the report, notes: "Effectively, mezzanine debt merely enables the lender to step into the shoes of the mezzanine borrower. Because of that fact it's a weaker form of collateral."
"The mezzanine lender's position after foreclosure is subject to whatever a borrower in its wisdom or foolishness – or, perhaps, disregard of promises to the mezzanine lender – may have done to the real estate asset. Subordinate debt, contract claims of service providers, claims of tenants, judgment creditors, mechanics' liens, federal and state tax liens, all will trump the interests of the mezzanine lender. The borrower could even sell the underlying real asset from under the mezzanine lender and misapply the proceeds, or make changes to organisational documents," he adds.
Mezzanine loans, however, are a weaker form of collateral than other subordinate debt, such as B-notes, and so have less of a negative credit ratings effect on more senior debt. This reduced penalty actually provides lenders with an added incentive to cast additional leverage as mezzanine debt, Rubock says, explaining the recent growth.
Overall, the substance of a mezzanine loan agreement should be comparable to that of a CRE mortgage loan agreement, with most of the same terms, conditions, covenants, representations and warranties – altered, of course, to reflect the nature of collateral – as those obtained by mortgage lenders.
Among the factors that strengthen mezzanine debt is a loan maturity that is coterminous with the maturity date of the senior loan. "Senior loan term default risk is reduced when the sponsor need not forage for mezzanine financing during the term. This convention benefits the mezzanine lender as well. The balloon date of the senior loan is a natural 'break point' when sponsors will be embarking on an all-out effort to restack the debt of its asset," the report says.
Quantifi adds support for TABX
Quantifi Solutions has extended the functionality of its credit derivatives valuation software to include the ability to price correlation products on asset-backed securities (ABS), such as tranches on the ABX index (TABX).
Commonly, asset-backed security analysis is scenario-based, which does not capture correlation risk. Quantifi's new tools for valuing TABX – tranches on baskets of ABCDS – build upon existing modelling tools for synthetic CDOs on corporate credits by adding the ability to model prepayments.
"We have experienced increasing demand for credit derivative models applied to alternate asset classes such as ABS. We have responded by working closely with clients who are active in this area to develop pricing models which bridge the gap between traditional credit correlation models and deterministic cashflow analysis," says Rohan Douglas, ceo and founder of Quantifi.
Lewtan revamps ABS product
Lewtan Technologies has released a new version of its ABSNet European Cash Flows product. The new version features a completely revamped interface that allows users to directly navigate between cashflows, pricing analytics, waterfall views and cashflow graphs. The system also enables users to model delinquencies, forecast excess spread rates and solve for first loss.
"Beyond the fundamental need for timely and accurate cashflows, recent instability in the US sub-prime market, as well as concerns over reserve fund draws in some UK non-conforming RMBS transactions have required investors to be more rigorous in their analytics," says Usman Ismail, evp, business development for Lewtan and its European ABSNet operations.
The ABSNet European Cash Flows library contains securities backed by RMBS and ABS, as well as CLO transactions from across all regions of Western and Central Europe. In addition, ABSNet European Cash Flows actively models pre-issuance transactions as they come to market.
Credit risk in iTraxx Europe stable
Fitch Ratings says credit risk in the iTraxx Europe Series 7 CDS index is stable following the recent roll-over from Series 6, according to its analysis using Vector version 3.1. The agency has provided credit assessments for each of the three-, five-, seven- and 10-year index maturities.
The credit risk of the iTraxx Europe Series 7 index is broadly similar to that of the Series 6 index, as the weighted average rating has only slightly improved to 2.87 (A-/BBB+) from 2.89 (A-/BBB+). Furthermore, there has been a moderate decrease of the triple-B concentration in favour of an increase of the triple-B plus concentration.
The top three industry concentrations in the iTraxx Europe Series 7 index are: banking & finance (20%), utilities (15.2%) and telecommunications (8.8%). This is similar to the Series 6 top three industry concentrations of: banking & finance (20%), utilities (15.2%) and telecommunications (9.6%).
Additionally, the number of reference entities on rating watch negative has increased to eight from seven. However, all 125 reference entities in the portfolio are rated investment-grade, as was the case in Series 6.
There have been six reference entities deleted and another six added to reflect recent dealer liquidity polls. Those excluded are: BAE Systems Plc, Banca Intesa Spa, ITV Plc, Nokia Oyj, Rentokil Initial Plc and Sanpaolo Imi Spa. Those included are: BNP Paribas, Hanson Plc, Intesa Sanpaolo Spa, Publicis Groupe SA, STMicroelectronics NV and Vinci.