Previous Story Next Story
PREMIUM CONTENT
Regular in-depth analysis, in addition to SCI’s usual news stories
To continue, you need to upgrade your subscription to access this article and all Premium content reports.
Existing Subscribers contact The SCI Sales Team
Not yet registered?
A round up of this week's structured credit news
GSE auction surprises market
The first stage of the FNM/FRE auction process has completed with somewhat unexpected initial results, according to analysts at Credit Derivatives Research. In both cases, the subordinated debt recovered more than the seniors and - for the first time in auction history - the net open interest has been to buy rather than sell bonds.
It appears that, given the significant disparity between senior and sub open interest, the majority of subordinated protection buyers opted for cash settlement, while in seniors it was a little more balanced. "We guess the disparity might be due to the number of index-driven FNM/FRE senior positions, which potentially are easier to allow to cash settle (since many investors may not be heavily involved in single-name analysis), whereas the sub open interest may reflect the senior-sub trades that many more sophisticated investors had on (with no natural protection seller on the other side of the subs trade)," suggest the analysts.
Structured credit strategists at Citi add that the auction was widely expected to be 'offered' and, along with the deliverability of structured credit assets, many investors were expecting a low recovery level. Protection buyers are thought to have been advised to maximise their returns by choosing cash settlement over physical, with the result that physical settlement ended up falling below expectation, thus turning the auction 'bid'.
The auction prices were decided as follows: 91.51% for FNM seniors (net open interest to buy US$12m); 99.9% for FNM subs (net open interest to buy US$608m); 94% for FRE seniors (net open interest to buy US$79m); and 98% for FRE subs (net open interest to buy US$542m). A record 651 organisations adhered to the ISDA Protocol and 13 dealers participated in the auction.
Fannie Mae subordinated protection buyers suffered in the short squeeze, according to the Citi strategists, with their contracts expiring virtually worthless (settlement of one cent in the dollar). "Freddie Mac subordinated protection buyers will also be disappointed with their final price of 98," they note. "Subordinated CDS trade in much smaller volumes than senior CDS contracts, but such skewed final prices will not increase confidence in credit derivatives at a time when confidence is low."
Auctions on Lehman Brothers and Washington Mutual are scheduled for 10 and 23 October. It isn't yet clear whether the receivership of Iceland's Landsbanki could also trigger a CDS event.
Fed launches CPFF
The US Federal Reserve has established a Commercial Paper Funding Facility (CPFF) to complement its existing credit facilities that help provide liquidity to term funding markets. The CPFF will provide a liquidity backstop to US issuers of CP through an SPV that will purchase three-month unsecured and asset-backed CP directly from eligible issuers.
The Federal Reserve will provide financing to the SPV under the CPFF and will be secured by all of the assets of the SPV and, in the case of CP that is not asset-backed, by the retention of up-front fees paid by the issuers or by other forms of security acceptable to it in consultation with market participants. The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy, and will make a special deposit at the Federal Reserve Bank of New York in support of this facility.
By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing CP obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market, the Fed says. Added investor demand should lower CP rates from their current elevated levels and foster issuance of longer-term CP. An improved CP market will enhance the ability of financial intermediaries to accommodate the credit needs of businesses and households.
The Fed has also increased the size of its term auction facility to US$150bn.
Correlation assumptions revised
S&P has revised certain correlation assumptions it uses to rate global CDOs and CDS that have exposure to financial intermediaries, reflecting its views on the effects of the recent consolidation and greater observed interdependence of institutions within the financial services sector over the past few months. The revised assumptions were developed jointly between the agency's financial institutions and structured finance CDO groups after evaluating the characteristics and expected performance of the institutions operating in this industry.
S&P believes that, for purposes of its correlation assumptions, it is no longer appropriate to classify brokers, dealers and investment houses as a distinct and separate industry from other financial intermediaries. The recent events affecting these entities, including mergers between banks and brokers/dealers and two leading US brokers/dealers choosing to become bank holding companies, combined with the lack of asset differentiation and the high level of interdependence that exists among banks, brokers/dealers and investment houses, indicate that these market segments should be classified as a single industry. Accordingly, the agency now classifies all brokers, dealers and investment houses in the financial intermediaries category.
As a result of changes to the economic drivers and competitive landscape that have occurred over time in the financial intermediaries industry, S&P believes asset co-dependence and behaviour has increased in this sector. Therefore, it has increased its asset correlation assumption among financial intermediaries to 0.25 from 0.15, regardless of the region where they operate.
The new financial intermediaries' classification assumes that these entities are affected not only by regional changes in the economic environment, but also by global changes. Accordingly, this modification also eliminates the diversification effects on S&P's analysis of CDOs and CDS that included financial institutions that operate in different geographical regions. When taken in aggregate for given rating categories, these changes should lead to higher credit enhancement levels in the agency's analysis of certain transactions exposed to financial institutions.
LevX documentation revised ...
ISDA has released a revised template for CDS referencing the iTraxx LevX index, incorporating provisions for auction settlement following a credit event and bringing the European documentation in line with the North American LCDS documentation in this regard.
"Market participants have seen the benefit of auction settlement in the North American Loan CDS market and in senior unsecured CDS and were keen to incorporate it into this product. ISDA is pleased to be able to respond to this and to have facilitated the continued evolution of this market," says David Geen, ISDA general counsel.
The 'ISDA iTraxx LevX Standard Terms Supplement for Use with Credit Derivative Transactions on Leveraged Loans' is designed to document CDS transactions where the reference obligation and the deliverable obligation are a European syndicated secured loan listed in the index. The form is primarily intended for use in the European market.
ISDA has also published a revised version of the single name 'Standard Terms Supplement for Use with Credit Derivative Transactions on Leveraged Loans'. This template has been updated to include auction settlement on the same terms as the index version, providing consistency for those entering into single name LCDS trades on reference obligations that are listed in the index.
...while LCDX index roll postponed
The Markit LCDX index roll into Series 11 has been postponed pending the launch of a market standard non-cancellable single name LCDS contract. LCDS dealers are designing such a contract to enhance liquidity by eliminating uncertainty linked to the cancellability of the current market standard contract (see SCI issue 93). If and when market participants agree on a market standard non-cancellable single name LCDS contract, Markit will integrate the language and characteristics of this contract into the LCDX.
IMF raises loss estimates
The IMF's latest Financial Stability Report substantially raises its estimate of potential financial sector write-downs and mark-to-market losses from US$945bn to US$1.4trn. The increase in estimated losses was predominantly in US unsecured loans (prime up US$40bn to US$85bn, commercial real estate up US$60bn to US$90bn and corporate loans up US$60bn to US$110bn), ABS CDOs (up US$50bn to US$290bn) and corporate debt (high grade to US$130bn from zero and high yield from US$30bn to US$80bn). However, CMBS losses were revised lower from US$210bn to US$160bn.
The report estimates that banks will bear US$725bn to US$820bn of the total estimated losses, with pension funds bearing US$125bn to US$250bn, insurance funds US$160bn to US$250bn, GSEs and government US$100bn to US$135bn, and others, including hedge funds, US$115bn to US$225bn.
SIV senior debt placed on review by Moody's ...
Moody's has placed on review for downgrade the ratings of eight MTN programmes, with a total nominal amount of approximately US$19bn, from four bank-sponsored SIVs - Carrera Capital Finance, Harrier Finance Funding, Kestrel Funding and Links Finance. The rating action was prompted by the fact that both the market value and credit quality of the portfolios, as well as the ratings of sponsoring financial institutions have been weakened by prevailing market conditions.
The agency notes that the current status of SIVs can be characterised under four categories: vehicles in enforcement (Axon, Cheyne, Orion, Rhinebridge, Victoria, and Whistlejacket/White Pine); senior debt repaid or cash collateralised (Asscher, Cortland, Cullinan, Hudson Thames, PACE, Tango and Vetra); restructured by sponsoring bank through provision of liquidity and/or repo facilities (Carrera, Harrier, K2, Kestrel, Links, Nightingale and Parkland); and restructured by sponsoring bank through mezzanine capital injection (Beta, Centauri, Dorada, Five, Sedna and Zela). This rating action affects certain SIVs whose sponsors provided liquidity facilities, rather than cash injection, as a means of support.
Portfolio market values have continued declining for almost all types of debt instruments. At the same time, financial institutions ratings have been adjusted in certain circumstances, as a result of these unprecedented market conditions. Moody's review will focus on the sponsors' ability and willingness to provide additional liquidity support to the affected SIVs, as well as the market value of assets in their portfolios.
... Fitch ...
Fitch has placed the senior notes of Five Finance, Beta Finance and Sedna Finance on rating watch negative. The actions reflect the continued decline in the market value of the SIVs' portfolios, the continuing closure of the funding markets and the recent negative action taken on Citi.
Citi has supported the SIVs that it manages by providing mezzanine capital to enhance the vehicles' mark-to-market overcollateralisation (defined as the market value of the capital divided by the portfolio credit exposure); currently, this is approximately 8%. The ratings of the SIVs are thus partially and increasingly credit-linked to Citi's willingness and ability to provide continued credit and liquidity support.
Fitch does not expect to resolve the RWN until the rating on Citi has been resolved. The agency expects that the resolution of the SIVs' RWN will be in the double-A category.
... and S&P
S&P has placed on credit watch with negative implications its ratings on the senior debt issued by Nightingale Finance. At the same time, it placed the vehicle's issuer credit rating on watch negative and kept the rating on its income notes on watch negative.
Earlier this year, Nightingale secured 100% support from AIG Financial Products to cover the senior obligations. Following S&P's rating action on AIG Financial Products, to A-/Watch Neg from A-/Watch Dev on 3 October 2008, the agency is reviewing the support provided to see whether there are any rating implications for the SIV.
Although the ratings on Nightingale could be affirmed if Banque AIG (as manager) puts in place a suitable plan, S&P does not rule out the possibility of lowering its ratings by more than one notch.
Cortland ratings withdrawn ...
Moody's has withdrawn its ratings on the senior debt programmes of Cortland Capital, following the vehicle's decision to wind down. All outstanding senior debt of the company has been repaid in full, using proceeds of asset sales executed between August 2007 and March 2008.
... while Theta is downgraded
Moody's has downgraded Theta Corp's triple-A counterparty rating to Aa2 (on review) and placed the vehicle's MTN and CP programmes on review for downgrade. The rating actions are the result of significant deterioration in the credit quality of Theta's CDS reference portfolio and a breach in one of its liquidity tests.
In particular, through its portfolio of reference obligations, Theta has credit exposure to Lehman Brothers Holdings Inc and Washington Mutual. Due to these credit events, the vehicle has breached one of its liquidity tests, which - if not cured - will result in an automatic enforcement. An enforcement event would lead to a move of management control to the security trustee and effectively result in a wind-down of Theta.
Moody's rating actions also take into account current stressful market conditions. Theta may need to liquidate portions of its bond portfolio to meet CDS credit event payments as they arise. But the unprecedented illiquidity in the market for asset-backed and financial securities may affect its ability to liquidate assets without crystallising additional losses to its capital.
Primus ...
Moody's has downgraded and kept on review the counterparty rating of Primus Financial Products from Aaa to Aa1, as well as the senior unsecured and issuer ratings of Primus Guaranty from Baa1 to Ba1. The rating actions are the result of significant deterioration in the credit quality of Primus Financial's CDS reference portfolio; in particular, recent credit events have resulted in the company not being adequately capitalised in respect of its previous ratings. Furthermore, it has failed its counterparty capital shortfall test and has substantial exposure to the financial sector, which is currently experiencing significant stress.
Moody's says that the downgrade reflects the substantial credit deterioration at Primus' main operating company, Primus Financial Products, and the adverse effect on its ability to generate incremental revenues. The rating agency adds that stress at Primus Financial may also weaken the holding company's financial flexibility and create substantial uncertainty about the group's strategic direction. Such adverse developments are only partially mitigated by the current strong liquidity position at the holding company.
... and Athilon downgraded
Fitch has downgraded CDPC Athilon from triple-A to double-A, and has also downgraded seven classes of deferrable interest notes. In addition, a negative rating outlook has been assigned to Athilon's Issuer Default Ratings (IDRs).
The actions are the result of exposure to two structured finance CDOs for which Athilon sold protection to counterparties. These transactions have experienced significant negative ratings migration in their underlying collateral assets.
Sigma-backed CDOs downgraded
S&P has lowered and placed on watch negative its credit ratings on nine synthetic CDOs issued by the C.L.E.A.R. vehicle. At the same time, Moody's downgraded the ratings of Series 48, 49 and 61 notes - worth Y6.5bn - issued by the same vehicle. The actions reflect the recent downgrade of the underlying collateral - the debt issued by Sigma Finance Corp - which the issuer purchased using note proceeds in each transaction.
Tembec settled
The credit event auction to facilitate the settlement of credit derivative trades referencing Tembec Industries was completed this week. The final price was fixed at 83%. On 6 October, Markit and Creditex will be conducting four credit event auctions in relation to the settlement of CDS contracts referencing Fannie Mae and Freddie Mac.
US$7.2bn US CDOs downgraded...
S&P has lowered its ratings on 38 tranches, representing a total issuance amount of US$7.2bn, from 13 US cashflow and hybrid CDO transactions. The downgrades reflect a number of factors, the agency says, including credit deterioration and recent negative rating actions on US sub-prime RMBS.
At the same time, S&P removed 16 of the lowered ratings from watch with negative implications and placed two additional ratings from two transactions on watch with negative implications. The ratings on 16 of the downgraded tranches are on watch with negative implications, indicating a significant likelihood of further downgrades. The credit watch placements primarily affect transactions for which a significant portion of the collateral assets currently have ratings on watch with negative implications or have significant exposure to assets rated in the triple-C category.
Seven of the 13 affected transactions are mezzanine ABS CDOs, which are collateralised in large part by mezzanine tranches of RMBS and other structured finance securities. Six of the 13 transactions are high-grade ABS CDOs, which were collateralised at origination primarily by triple-A through to single-A rated tranches of RMBS and other SF securities.
To date, S&P has lowered its ratings on 3,857 tranches from 873 US cashflow, hybrid and synthetic CDO transactions as a result of stress in the US residential mortgage market and credit deterioration of US RMBS. In addition, 1,334 ratings from 464 transactions are currently on watch with negative implications for the same reasons.
... and European CSOs impacted
S&P has taken various rating actions on a total of 43 European synthetic CDO tranches. The rating actions reflect a change in the rating of a dependent entity in the transaction - either a transaction party or an underlying collateral or obligor.
The breakdown of these rating actions is as follows:
• Ratings were lowered on three tranches;
• 17 ratings were placed on watch with negative implications;
• 10 ratings were placed on watch with developing implications;
• One rating was removed from watch negative and lowered;
• The ratings on three tranches were lowered and placed on watch negative;
• Five ratings were lowered and placed on watch developing;
• One rating was lowered and remains on watch negative;
• Two ratings were placed on watch positive; and
• The rating on one tranche was withdrawn.
BoE broadens repo collateral range
The Bank of England is extending its collateral repo operation and will broaden the range of eligible repo collateral. Included in the updated list of eligible collateral is the most senior triple-A rated tranche of UK, US and EEA: prime ABS (backed by student loans, consumer loans, auto loans and certain equipment leases); CMBS (excluding construction loans); and securitised portfolios of senior secured or on-balance sheet corporate loans (leveraged loans aren't permitted); as well as covered bonds where the underlying assets include commercial mortgages and highly rated ABCP.
Synthetic deals remain ineligible, as do those transactions that have obtained a higher rating due to a wrap. Eligible assets may be denominated in sterling, euro, US dollars, Australian dollars, Canadian dollars, Swedish krona or Swiss francs.
Japanese SROC results released
S&P has placed its ratings on 23 tranches relating to 18 Japanese synthetic CDO transactions on credit watch with negative implications. The affected tranches had SROC levels that fell below 100% during September's month-end run.
LBDP/LBFP counterparty ratings downgraded
Moody's has downgraded the counterparty ratings of both Lehman Brothers Derivative Products and Lehman Brothers Financial Products to Baa3 with direction uncertain from triple-A. The rating actions are the result of the voluntary bankruptcy filings of both entities on 5 October and the expectation that they will be unable to make scheduled payments as a result of the automatic stay caused by the bankruptcy filings.
Although both LBDP and LBFP are currently sufficiently capitalised to make scheduled payments, there is uncertainty as to when they will be made as a result of the bankruptcy proceedings, Moody's says. Factors such as the lifting of the automatic stay could have a positive impact on the ratings. Conversely, negative rating action may be warranted if there is a significant delay in issuing the payments or the capitalisation of LBDP and LBFP becomes inadequate.
CRD changes draw closer
The European Commission has firmed up its proposed changes to the Capital Requirements Directive, amongst which is a measure to improve risk management for securitised products. Originators will be required to retain some risk exposure to these securities, while firms that invest in the securities will be allowed to make their decisions only after conducting comprehensive due diligence. If they fail to do so, they will be subject to heavy capital penalties.
Lehman impacts CPDO
Moody's has downgraded the rating of the €135m Series 2007-2 note of the Ulisse Capital CPDO issued by Ruby Finance from Ba3 to Ca. The transaction is exposed to Lehman Brothers due to Lehman Brothers Special Financing being total return swap counterparty and Lehman Brothers Bankhaus being the deposit provider on the transaction. LBSF payments under the TRS are guaranteed by Lehman Brothers Holdings Inc.