Job Swaps
King moves to the buy-side
The latest company and people moves
King moves to the buy-side
Citadel Investment Group has appointed Bill King as a senior md and head of securitised products. He previously served as global co-head of securitised products at JPMorgan, where he was responsible for trading mortgages, ABS, CDOs and CMBS.
King joined JPMorgan in 2000, where he served as head of pass-through trading, head of mortgage trading and co-head of US securitised products before being promoted to his role as global co-head of securitised products. Prior to that, he traded mortgages at Donaldson Lufkin & Jenrette and Merrill Lynch.
King will be based in New York and will begin with Citadel in August.
Cash to head insurance fund
Michael Cash has been appointed ceo and chief underwriting officer of the newly-created Juniperus Insurance Opportunity Fund. The fund will manage third-party funds that will focus on insurance-linked securities and collateralised reinsurance. Philip Lotz has been appointed executive chairman.
Cash has been active in the reinsurance market for over 15 years, having worked at Renaissance Re between 2000 and 2005. Lotz was formerly ceo of Swiss Re Capital Management and Advisory.
Reinsurance company Benfield, which holds a significant shareholding in Juniperus Capital, has pledged US$50m to the new fund and will also provide up to US$2m in working capital.
Credit quant head leaves
Jon Gregory, global head of credit quantitative analytics at Barclays Capital in London, has left the firm for personal reasons. Gregory joined the bank from BNP Paribas in 2005, where he was global head of credit derivatives research. It is believed that an internal replacement for him will be found.
Schroders hires for strategic investments
Schroders has hired Ronald Albahary to lead the growth of its strategic investment solutions initiatives in North America. He will report directly to Jamie Dorrien-Smith, ceo of Schroders Americas, and will be based in New York. This key new hire is part of the firm's continuing North American expansion plans.
Albahary will be responsible for developing and executing Schroders' strategy to leverage its global multi-asset and quantitative investment capabilities into North America in order to build and deliver objectives-based solutions through intermediaries and to institutional clients.
Albahary joins Schroder from SEI, where he was md, global private client portfolio management since 2005. Previously he worked as the chief investment officer with Merrill Lynch Retirement Group and as a portfolio manager for Northern Trust Global Investments.
ICE to acquire Creditex
IntercontinentalExchange (ICE) has entered into a definitive merger agreement to acquire Creditex Group. The transaction consideration will total US$625m, comprising approximately US$565m in ICE common stock and US$60m in cash, as well as a working capital adjustment to be finalised at closing.
Approximately US$50m of the cash component is intended to provide some liquidity to employees that hold Creditex stock, with the remainder provided to unaccredited Creditex shareholders in lieu of shares of ICE common stock. Upon the closing of the transaction, expected during late Q308, Creditex Group will be a wholly-owned subsidiary of ICE operating under the Creditex name.
The acquisition is expected to be accretive in 12 to 18 months from closing. Based on recent results and expected synergies, the transaction would yield US$9m to US$14m in total pretax synergies in 2009, comprising incremental revenues and expenses.
BONYM makes further hire
The Bank of New York Mellon has appointed Scott Posner ceo of its global corporate trust business. He will succeed and report to Karen Peetz, who has been promoted to ceo of issuer, treasury & broker-dealer services, effective from 1 July.
Since joining The Bank of New York in 1997, Posner has held leadership positions within global corporate trust and other securities servicing businesses. He currently oversees all sales and marketing efforts globally for the corporate trust division, and was previously responsible for developing and implementing its business strategy. He was also ceo of Asset Solutions, a wholly-owned subsidiary of The Bank of New York Mellon that provides commercial loan servicing, and cfo for the company's shareowner services business.
The Bank of New York Mellon's corporate trust business services US$12trn in outstanding debt from 55 locations around the world. It services all major debt categories, including corporate and municipal debt, mortgage-backed and asset-backed securities, collateralised debt obligations, derivative securities and international debt offerings.
Cut in compensation expected
The economic downturn triggered by the sub-prime lending crisis could reduce finance compensation packages for new hires by as much as 20%, according to a survey of leading recruiters released by market research firm the smart cube.
Although there is general agreement that job functions related to the sub-prime lending sectors have been impacted the most, recruiters couldn't identify job functions they believe are relatively secure. Recruiters generally agree that the migration of financial sector jobs to low cost centres overseas will not be accelerated because of the sub-prime crisis and that so-called offshoring decisions will continue to be made on a strictly strategic basis.
Recruiters are in unanimous agreement that compensation for new financial sector hires will decline, although there is some disagreement as to the extent of the downturn. A total of 75% of UK recruiters surveyed expect compensation to decline by at least 5% and as much as 20%, while 25% expect the decline to be more than 20%.
Some recruiters say that an increasing number of city firms are significantly cutting signing bonuses and some are eliminating them altogether. Recruiters also note that the hiring process is taking considerably longer and there is a discernible trend among firms to hire employees on a temporary or contract basis.
Respondents in the US paint a less severe picture. About two-thirds of the respondents anticipate the drop in compensation packages to be between 11% and 20%; however, of these, about two-thirds expect a range between 16% and 20%.
"There is almost a unanimous feeling that the UK and US financial sector is seeking a lower cost and more flexible workforce in the wake of the sub-prime crisis," says Omer Abdullah, the smart cube md who oversaw the survey. "In addition to imposing widespread layoffs, investment banks will only recruit new employees in areas where there are critical openings that absolutely need to be filled. With Wall Street unemployment steadily rising, the job market pendulum has clearly shifted in favour of employers."
The other findings of the smart cube survey include:
• Most recruiters (80%) say the City's job market was more adversely impacted by the collapse of the dot.com bubble than the current sub-prime mortgage crisis;
• Recruiters believe that the collapse of Bear Stearns does not signal future layoffs;
• City job candidates, particularly at the more senior level, have significantly scaled back their compensation demands and are considerably more cautious about making them;
• Employees with secure jobs are considerably less receptive to accept new positions elsewhere.
"The job market is clearly in a state of flux and the Financial Services market is simply a more pronounced example of this shift. We are operating in what is clearly a buyers' market that appears likely to continue for at least the short to medium term," Abdullah concludes.
CS
News Round-up
Fitch junks CIFG
A round-up of this week's structured credit news
Fitch junks CIFG
Fitch has lowered the insurer financial strength (IFS) ratings of CIFG Guaranty and its affiliates to triple-C from single-A minus, where they remain on watch evolving. The agency says that the downgrade is based, in part, on recent conversations with CIFG's management, in which the company has indicated it could be at greater risk of falling below regulatory minimum capital requirements, if the company's loss provisions increase in future periods which could trigger an insolvency proceeding by regulators.
If this were to occur, CIFG's entire US$57bn CDS portfolio, which is the primary form of execution for the company's entire CDO exposure (including investment grade corporate, high-yield corporate and structured finance CDOs) would be subject to termination at current valuations. Based on current market valuations, Fitch does not believe CIFG would have sufficient claims-paying resources to meet these obligations, triggering a likely default of its insurance subsidiaries. CIFG is actively working to remediate these risks and, if successful, the company's capital position and policyholders' prospects could be significantly improved.
Fitch's IFS rating downgrade reflects the weakness of CIFG's current financial position and indicates two possible conditions, consistent with Fitch's definition of a triple-C IFS rating. While obligations are still being met on a timely basis, there is a real possibility that ceased or interrupted payments could occur in the future, as a result of the possible termination of CIFG's CDS exposures at current valuations. Fitch believes capacity for continued timely payments is reliant upon the successful remediation through commutation of the company's structured finance CDO exposures.
The downgrade was also heavily influenced by Fitch's on-going review of CIFG's exposure to sub-prime mortgage collateral, with specific emphasis on RMBS from the 2005 vintage year. CIFG maintains a very large concentration of SF CDOs that are comprised of 2005 vintage RMBS.
Unlike other financial guarantors, CIFG's exposure to SF CDOs with underlying RMBS collateral was primarily comprised of mezzanine SF CDOs, which have material exposure to 2005 vintage sub-prime RMBS collateral, which was originally rated in the triple-B category and is now well below investment grade. Furthermore, Fitch has incorporated the increased possibility that the company could breach regulatory minimum capital standards, as a result of increasing reserves against its SF CDO exposures.
CIFG's claims paying resources, which include the US$1.5bn capital infusion in late-2007 from its shareholders Caisse Nationale des Caisses d'Epargne et Prevoyance (CNCE) and Banque Federale des Banques Populaires (BFBP), are currently modelled as being consistent with Fitch's standard for a below-investment grade level of capital.
Fitch expects the status of the ratings to be addressed over the very near-term, pending resolution of its capital enhancement plan. If a regulator initiates insolvency proceedings and CIFG's CDS contracts terminate at current valuations, the company's IFS ratings would be considered in default.
If CIFG successfully remediates the SF CDO exposures without impairing its capital base, Fitch believes there could be significant upward rating migration of the current IFS rating. Such action will need to consider the on-going business plan that ownership and management will formulate before resolution of a rating action can be determined.
Fitch currently believes that expected losses on CIFG's insured SF CDOs will ultimately fall within a range of US$2.6bn to US$3.6bn. These totals reflect the agency's current estimates of the range of future losses that CIFG would be expected to incur over the life of these transactions, stated on a present value basis.
The range of outcomes reflects the unknown magnitude of US residential mortgage losses on SF CDOs insured by CIFG. From a present value perspective, Fitch discounts the expected future loss rates by 5% over a two-year period for CDO-squareds, five years for mezzanine SF CDOs and seven years for high-grade SF CDOs.
CDS counterparty risk analysed
The most significant systemic risk posed by CDS is the effect the failure of a major CDS counterparty - such as a large universal bank or securities firm - would have on the operational integrity and pricing in the markets for CDS and, potentially, the underlying securities, Moody's says. In a report designed to dispel some common misperceptions about the CDS market and to examine its true risks, the rating agency concludes that the sheer size of the market in notional terms and its exposure to credit events among underlying securities do not, in and of themselves, pose undue concern.
"The notion that credit default swaps represent this US$62trn long credit exposure is not an accurate depiction of the market, nor particularly helpful to investors in determining where the true risks lie," says Moody's avp/analyst Alexander Yavorsky, one of the authors of the report, referring to the oft-cited figure for the notional amount of CDS contracts outstanding.
He explains that, unlike the cash bond market - in which credit losses result in a permanent loss of value - the CDS market, in its entirety, is a 'closed system'. Absent the failure of a major counterparty, the losses of one party ultimately equal the gains of another. For individual firms, losses on sold protection are also usually offset by gains on acquired protection and vice versa, provided they run 'net flat' books and have in place proper risk management techniques - including concentration limits, margining, hedging and conservative provisioning.
Yavorsky says a more useful number when looking at the CDS market is the gross replacement value of outstanding contracts, which at just over US$2trn is under 3.5% of the notional amount. This replacement value functions in a similar way to a loan loss reserve for firms with derivative payables, which at current levels could accommodate losses in line with those experienced in 2001, when corporate defaults spiked, the US experienced a recession and the major global equities markets underwent a correction. Practically speaking, however, any substantial increase in credit losses would almost inevitably lead to a further widening of credit spreads, which is usually one of the most severe stress tests for a typical investment bank or securities firm.
More concerning to Moody's than an increase in underlying credit losses is the potential for market disruption through the failure of a major bank or broker-dealer. If a large CDS counterparty failed, this would very likely have a substantial market-wide re-pricing effect on the cost of CDS protection and, by extension, the underlying cash bonds.
The effect of this would be especially problematic for firms needing to replace the CDS trades they had with the failed counterparty. Until the trades were replaced - an operationally challenging and unprecedented undertaking - the firms that lost protection would be left with unhedged exposures amid what is likely to be a very volatile market environment.
"A great deal of uncertainty exists about what operational, market liquidity and pricing issues such a spike in demand for protection might introduce," Yavorsky says, adding that the untested nature of the market in such a scenario is itself a risk.
Moody's also notes, however, that the systemic importance of the largest CDS dealers provides powerful incentives to regulators to prevent their disorderly failure, as demonstrated by the recent case of Bear Stearns. The more important the role played by an institution, the more likely regulators will consider it to be too systemically important to fail.
Moody's report also provides a general overview of risk management practices employed by securities firms in managing both CDS and other exposures.
CMBS recovery rates revised
S&P has revised its recovery rates for CMBS collateral in re-REMICs and CRE CDO transactions. Both resecuritisation vehicles generally have static pools, sequential-pay cashflow waterfalls and extremely limited or no excess spread.
Such structures also typically lack the embedded safeguards that some other structured finance transactions have, such as overcollateralisation (OC) and interest coverage (IC) financial tests. Additionally, they lack the ability to defer interest, commonly known as the payment-in-kind (PIK) feature.
Many static resecuritisations rated by S&P are backed primarily by speculative-grade collateral and they frequently include several subordinated tranches of the same CMBS transaction in the collateral pool. Because the underlying CMBS collateral has experienced losses, the performance of these static resecuritisations has been worse than the agency's initial expectations.
In the cases where losses have exceeded our original expectations, some transactions have been left with insufficient credit enhancement. As a result, S&P has adjusted its ratings accordingly, often including the investment-grade classes and some that were originally rated triple-A.
Based on this trend, S&P has reassessed its rating assumptions for CMBS resecuritisations, including the recovery rates it assigns to lower investment-grade and speculative-grade CMBS collateral. Accordingly, current recovery rates used in resecuritisation transactions for CMBS securities rated triple-B plus and lower should be adjusted downward to better account for the risks inherent in these lower-rated assets.
S&P's CDO rating methodology plays a significant role in rating and surveilling CMBS resecuritisations. The agency derives its ratings through a dual approach that relies primarily on CDO Evaluator 2.4.3, which it supplements with real estate analysis.
The real estate analysis focuses on delinquencies, specially serviced loans and loans on the servicers' watchlists. S&P says it will continue rating CMBS resecuritisations in this manner, but will begin to weigh the real estate analysis - which it believes to be more predictive of future performance - more heavily when determining its ratings.
CDS CCP gears up
Clearing Corporation (CCorp) and DTCC have signed an agreement that facilitates central counterparty services (CCP) for the OTC credit derivatives marketplace (see SCI issue 85). Under the agreement, CCorp members will benefit from CCorp's netting and risk management processes and will leverage the asset servicing capabilities of DTCC's Trade Information Warehouse.
The agreement with DTCC will allow CCorp members to utilise CCorp as the CCP guarantor for OTC contracts in credit derivatives while continuing to utilise the Warehouse as the 'golden' record for net open positions and for post-trade event processing. The initiative is targeted to launch in Q308 and will be fully implemented in several product specific phases in 2008-2009.
"Through the use of multilateral netting, margin collateral and daily marking-to-market of positions, CCorp's clearing facility will improve capital efficiency, increase regulatory transparency, lessen direct counterparty risk and reduce systemic risk relating to the multi-trillion dollar market in credit default swaps," says Michael Dawley, chairman of CCorp.
CCorp's CDS clearing initiative will be open to all qualified clearing participants that satisfy its requirements relating to credit worthiness and experience in the CDS market. At present, CCorp's clearing participants hold a significant portion of the positions in this marketplace.
At first, the clearing initiative will support CDX High Yield and Investment Grade indices. CDS products, such as iTraxx indices, index tranches and single name products are scheduled for subsequent roll outs throughout 2008 and 2009.
In the initial phase joint CCorp and DTCC Warehouse members, whose OTC credit derivative trades are stored in the Warehouse, can elect to replace their bilateral agreements with a new CCP guaranteed trade backed by the CCorp. Value-added services provided by CCorp in its role as a CCP include multilateral netting of contracts, trade guarantees, collecting forward-looking margin to protect against adverse price moves and performing daily marking-to-market of cleared positions to collateralise losses. The Warehouse then provides further post-trade asset management services, including credit default management and centralised net settlement of quarterly payment obligations between counterparties, which is offered in partnership with CLS Bank International.
Real estate SME CLO closed
Lloyds TSB has closed its third synthetic SME CLO. The privately-placed £1bn-equivalent transaction, dubbed Doncaster Gold, references 6,575 loans concentrated in the UK real estate industry.
Rated by Moody's, the deal comprises €147.5m Aaa, €112.5m Aa3, €68.75m A3 and €25m Baa2 rated CLNs below a super-senior CDS. The first-loss tranche is equivalent to 2.75% of the initial pool balance. Legal final is in 2018.
Synthetic excess spread of 1.8% will be available after the yearly loss allocation to replenish the first-loss piece only, up to the maximum threshold amount. In addition from the second annual CDS payment date onwards, available synthetic excess spread up to €8.125m or 0.65% of the initial pool balance will be trapped in a synthetic excess spread ledger.
The reference portfolio can be replenished for two years on the quarterly replenishment date, subject to certain portfolio criteria and the stop replenishment trigger not being breached.
IIF clarifies MTM position
Over the last six weeks the Institute of International Finance (IIF) has engaged in informal consultations involving market participants, central bank and finance officials, securities and banking regulators, auditing authorities and accounting standard-setters regarding the application of fair value accounting in illiquid conditions. Views differ widely, both within the industry and within official circles, about how best to address a number of complex and important valuation issues (see last week's issue).
While further discussions are necessary to move towards a consensus, at this juncture the IIF says that the following key points have emerged:
• Fair value accounting remains an essential element of global capital markets, as it fosters transparency, discipline and accountability.
• Under current fair value accounting, there is already latitude to use mark-to-model approaches where observable market inputs are not available. Appropriate use of such latitude is fully consistent with fair value accounting and has been embraced by accounting standard-setters.
• There is a need for clarification on a number of fronts, such as pricing inputs in illiquid markets. Furthermore, for some products in particular circumstances, there is merit in considering other refinements in valuation methodologies and greater flexibility regarding the transfer of assets between accounting categories (that is trading versus held to maturity).
• However, there is a view that applying new techniques, or greater flexibility, in current circumstances would be fraught with difficulties. There is the risk that, however well-framed the proposals, the intentions of those advocating changes could be misunderstood by investors at this stage.
What is crucial, and what most parties can support, is that at this time a thorough dialogue among the parties should be pursued in order to address both the many issues that require clarification and the unintended consequences that have arisen, the IIF says. Additionally, the meaningful medium-term improvements that could help fair value accounting play an even more constructive role for investors, and for the financial system more broadly, in both normal as well as extreme market circumstances should be considered. As a first step towards this end, the IASB has organised the experts group called for by the Financial Stability Forum (FSF) to look at valuing securities in illiquid markets.
The IIF's Board of Directors established a Committee on Market Best Practices (CMBP) last October to address weaknesses in financial markets and to formulate proposals to assist in the rebuilding of market confidence through the development of a set of industry best practices. The issue of valuation of assets has been important from the outset of the CMBP's work, given the uncertainties involved, the declining availability and quality of market inputs for valuation and the difficulty of making model assumptions when underlying economics are changing rapidly. Further, there is evidence of possible unintended consequences from fair value accounting at times when certain products have migrated from liquid markets where they could be valued in a relatively straightforward way, based on market prices, to illiquid markets where valuation requires extrapolation from market inputs, modelling or other techniques.
It has been and it remains the view of the Institute that fair value accounting has been very useful in promoting transparency and market discipline and continues generally to be a reliable accounting method for securities in liquid markets. The IIF's recent efforts have sought to generate an open debate about strengthening techniques, including mark-to-model, used to arrive at fair values that would be useful, relevant, accurate and transparent.
The IIF's actions to facilitate a dialogue under the guidance of its Board of Directors have brought forward a number of ideas. These include alternative valuation methodologies for illiquid market conditions, involving the use of underlying discounted cashflow - a concept already present in existing accounting standards. Other concepts for discussion revolve around the potential benefits and costs of seeking both more consistency between FAS and IAS, and more flexibility in determining the circumstances under which firms would be allowed to transfer certain assets (again carefully circumscribed) from the 'trading' to the 'held to maturity' category.
The IIF's Committee on Market Best Practices will be considering these, as well as many other issues, as it prepares its final report, which is expected to be released in July following its review and endorsement by the IIF's Board of Directors.
Comments requested on rating identifier
S&P has requested comments on the proposed addition of an identifier to signify that a rating is on securities that have been issued out of a securitisation structure. In light of the recent market dislocation, some market participants have requested that rating agencies provide a means for identifying structured finance ratings and differentiating them from other types of ratings.
"To address this concern, we now propose to add an 's' subscript to all existing and new ratings on securitisations," says senior criteria officer Calvin Wong. "The purpose of the identifier is to provide greater transparency and insight to market participants by distinguishing structured finance ratings from the more traditional corporate and government ratings."
Wong explains that, subject to market feedback, S&P proposes adding a subscript to the long- and short-term issue and issuer ratings on ABS (including ABCP programmes), RMBS, CMBS and CDOs. "The subscript would appear after the traditional rating symbol. For example, the rating symbol for a 'AAA' rated asset-backed note would change to 'AAAs'," he adds.
S&P rating actions taken
S&P has taken rating actions on various US and European synthetic CDO transactions.
Of the affected US deals, the agency lowered 101 ratings, 29 of which remain on credit watch negative; and affirmed 11 ratings and removed them from watch negative. The actions are a result of the agency's review of the ratings on all of the classes that it had previously placed on credit watch negative to determine the appropriate rating action, following SROC results.
S&P also took action on 153 European CDO tranches. Specifically, the ratings on 122 tranches were removed from watch with negative implications and lowered; one tranche was lowered; one tranche was lowered and placed on credit watch negative; 28 tranches were lowered and remain on watch negative; and one tranche was raised.
Of the 152 tranches lowered, 39 reference US RMBS and US CDOs that are exposed to US RMBS, which have experienced recent negative rating actions; and 113 have experienced corporate downgrades in their portfolios.
Even upgrades/downgrades for Asia Pacific
Fitch says that the number of upgrades and downgrades for Asia Pacific structured finance transactions in 2007 were evenly balanced, with 35 upgrades and 34 downgrades during the year.
"Until 2007, the vast majority of rating actions in the Asia Pacific region had been positive," says Alison Ho, director and head of Asia Pacific performance analytics. "Despite the increase in the number of downgrades in 2007, no Fitch-rated tranches of Asia Pacific structured finance transactions have defaulted to date."
Japanese CMBS transactions have traditionally demonstrated strong performance, driven by the high level of prepayments and the consequent increase in credit enhancement levels, and this was again the case in 2007. Fitch expects this positive performance trend to continue for the time being.
The majority of downgrades in the region during 2007 were in the CDO sector. Synthetic investment grade corporate CDOs, in particular static transactions, experienced negative rating actions due to significant negative rating migration in the reference portfolios - which was typically exacerbated by the limited amount of surplus credit enhancement in the transactions. Looking forward, following Fitch's release of its updated corporate CDO criteria, all existing transactions with exposure to corporate debt remain under analysis while the new criteria are implemented.
Some existing ratings have been affirmed, but downgrades have started to come through. Fitch expects the downgrades to be most severe in those transactions with portfolio concentrations or those with little or no surplus credit enhancement.
While 2007 was a relatively benign year in terms of ratings changes for Australia, in February 2008 Fitch placed two mortgage insurers on watch negative - PMI Mortgage Insurance and MGIC Australia. As a direct result of this rating action, Fitch placed 53 tranches of Australian RMBS on watch negative, pending the resolution of the RWN on the mortgage insurers. Fitch expects such counterparty risk, particularly that related to mortgage insurers, to be the main driver of ratings changes in 2008.
"Despite the effects of the current market turmoil, Asia Pacific collateral performance remained largely unaffected by the credit crunch through 2007," says Marjan van der Weijden, md and head of Asia Pacific structured finance. "Outside of CDOs, collateral performance in the region remains strong."
Global ABS portal launched
Lewtan Technologies has announced the availability of the Global ABS Portal, which provides free access to the most recent remittance reports and original prospectuses for public European securitisations.
"Having a free centralised point of access to public deal information will enable investors and regulators to easily access crucial information about public European securitisations," says Ira Keller, ceo of Lewtan. "Prior to Lewtan's Global ABS Portal, the only option available to find this information in one location was through commercial vendors."
Lewtan has extensive experience delivering effective, reliable financial-data portals, including its flagship ABSNet portal - a deal performance database that tracks, among other data, more than 17,000 European ABS. The Global ABS Portal leverages ABSNet's sourcing infrastructure to offer original prospectuses and remittance reports. The data accessed through the portal will be updated as new reports are published.
Caliber shares temporarily suspended
Caliber Global Investment Ltd has asked the Financial Services Authority to temporarily suspend its shares pending the announcement of its half-yearly results for the period ending 31 March 2008, which the permacap intends to make on 10 June 2008. This will be after the applicable two months deadline for half-yearly financial results introduced under the new requirements of the Transparency Directive.
BBA surprises over Libor
The British Bankers' Association (BBA) surprised many on 30 May by making no changes to its Libor fixing process. It was under pressure to update its Libor calculations - which would have been the first major revision in the benchmark's methodology for some ten years - following concern and criticism of the fixing process after both the dislocation in interbank liquidity since the onset of the credit crisis (manifesting in the significant Libor basis to official rates and noticeable increase in the variation of quotes supplied) and more recent loss of confidence around the integrity of quotes provided by participant banks.
Analysts at Deutsche Bank note that a further crucial problem is that the market for term interbank lending has been very thin since the crisis and therefore the legitimacy of Libor quotes has come under question, given that actual trading volumes are largely absent.
Libor currently serves as a rate index for over US$350trn worth of bonds and derivative contracts, having firmly established itself as the benchmark in the credit markets. In the European securitisation market, where the bulk of outstanding product (over €1trn) is structured as floating rate bonds, coupons are - with very few exceptions - indexed to Libor, meaning that its recent dislocation bears some impact. Nominal bond coupon payments have been accordingly enhanced, but this has come at the expense of available excess spread in deals with unhedged asset-liability basis, the DB analysts say.
The pressure on the BBA to make meaningful changes to the way Libor calculations is likely to remain, in their view. Ultimately, potential changes may include a greater emphasis on actual trades rather than survey-based quotes, improving the quality of quotes by making the bank poll anonymous and possibly also increasing the number of banks polled to include greater participation from US banks.
But the recent inaction, coupled with the likelihood that Libor will remain elevated relative to official rates for a long time yet, could potentially see a gradual shift to benchmarking away from Libor. The analysts believe that deals may be structured based on rates that exhibit a more stable and closer relationship to official rates and therefore arguably serve as a better measure of bank liquidity compared to current Libor rates, which have built in credit premiums since the crisis.
Indeed, Overnight Indexed Swaps (OIS) in the US and the Euro Overnight Index Average (EONIA) in the Eurozone have been talked up as possible alternatives, with both indices reflecting daily effective overnight rates based on volume-weighted trades in the interbank market. Any such shift in indexing European securitised bonds will have no precedence. The analysts expect any such change in asset-backed benchmarking to be more structure-friendly, but by definition less investor-friendly unless coupons are commensurately adjusted.
Asscher Finance affirmed
S&P has removed from credit watch with negative implications and affirmed its ratings on the CP and MTNs issued by Asscher Finance. At the same time, it removed from watch negative and affirmed the vehicle's issuer credit rating, where it remains on outlook negative. The European mezzanine and income notes remain on watch negative.
The SIV is managed by HSBC, which is responsible for purchasing assets, managing the portfolio and overseeing the issuance of CP and MTNs.
The ratings on Asscher were originally placed on watch negative on 25 February 2008, since plans to restructure the vehicle existed but had not yet been completed. Asscher has now completed the transfer of assets to Malachite Funding (the new HSBC vehicle). Under the restructuring proposal, senior noteholders from Asscher will be paid as their debt comes due via issuance from Malachite.
Troubled company index improves
Kamakura Corporation says that its monthly index of troubled public companies showed strong improvement in May, after deteriorating in nine of the previous 10 months. The firm's troubled company index decreased significantly in May to 12.7%, down from 13.7% in April.
The 1% decline is the biggest monthly improvement in credit quality since January 2007. At the current 12.7% level, the index shows that credit conditions are better than 48.7% of the monthly periods since the start of the index in January 1990.
Kamakura defines a troubled company as a company whose default probability is in excess of 1%. The index covers more than 20,000 public companies in 30 countries using the fourth generation version of Kamakura's advanced credit models.
"The sharp reversal in the steady deterioration of credit quality that we have seen for the last year came in all but the most troubled companies," says Warren Sherman, Kamakura president and coo. "In May, the percentage of the global corporate universe with default probabilities between 1% and 5% fell 0.5% to 8.8%. The percentage of companies with default probabilities between 5% and 10% was down 0.1% to 2.0% of the universe in May."
The percentage of the universe with default probabilities between 10% and 20% was down a significant 0.3% to 1% of the universe. The percentage of companies with default probabilities over 20% was the only category that did not improve. The most troubled companies remained at 0.9% of the total universe in May.
Lower cash coverage for speculative-grade companies
European speculative-grade companies recorded lower cash coverage to make interest payments in the Q108 than in 2007, when they were already at record thin levels, according to a recent report published by S&P. The report, entitled 'Lending Standards In Europe Continue To Loosen Despite A Small Reduction in Leverage', highlights deteriorating ratios, with three different measures of cash coverage falling since last year and ongoing aggressive structures, despite the liquidity crunch.
"Thin credit metrics mean that companies have less of a cash cushion if market conditions change or additional capital needs to be invested in the business, resulting in a greater risk of default," says S&P research analyst Taron Wade.
Lenders should be vigilant in a market where defaults are expected to rise from record lows, demanding structures that provide an appropriate interest coverage cushion at a time when economic difficulties are already beginning in Europe. One good sign for senior lenders, however, is that senior leverage has fallen to 4.4x debt to EBITDA, a level well below the 5.2x multiple average of 2007 and below the 4.5x average of 2006.
In addition to cash coverage and leverage, the report comments on recent credit quality trends. "Ratings or credit estimates of companies that have issued speculative-grade debt in the first quarter of 2008 have not improved relative to transactions outstanding in 2007," adds Wade.
In Q108, of the 14 newly rated transactions or those assigned credit estimates, 92.9% were in the single-B category, compared with the existing broad market in which 78% of companies are assigned single-B category ratings or credit estimates.
Although a large majority of the transactions underwritten during the first quarter have credit estimates or ratings in the single-B category, investors may have found comfort because many of the companies either operate in strong sectors, have well-diversified portfolios and/or benefit from good market positions in certain geographies. In addition, many have adequate liquidity positions to meet debt repayments in the short term. Higher equity contributions for leveraged buyouts from sponsors have also given lenders some comfort.
CS
