News Round-up
Monolines hit ...
A round-up of this week's structured credit news
Monolines hit ...
The monoline sector was last week battered by negative rating agency action once again. Moody's struck first by placing the triple-A insurance financial strength ratings of Ambac and MBIA on review for possible downgrade. But S&P went several steps further by lowering its ratings on Ambac, MBIA, CIFG and XLCA, and putting FGIC's on review.
Moody's notes that the most likely outcome of its review would be a downgrade to the Aa rating category for Ambac and MBIA (although a downgrade to the single-A rating category is also possible for MBIA). The rating action reflects the agency's growing concerns regarding the overall credit profiles of the two monolines, including their significantly constrained new business prospects and financial flexibility, coupled with the potential for higher expected and stress losses within their insurance portfolios.
MBIA indicated that it disagrees with Moody's decision. Jay Brown, MBIA chairman and ceo, states: "When Moody's affirmed our rating with a negative outlook in February, we believed that it would refrain for six to 12 months from taking additional ratings actions unless the environment or MBIA's position changed materially. Since then, there have been no material adverse changes in the environment, and we believe our capital position has improved. Thus, we are surprised by both the timing and direction of this action and can only conclude that the requirements for a triple-A rating continue to change."
S&P downgraded Ambac and MBIA to double-A from triple-A and placed the ratings on credit watch with negative implications. The rating actions reflect the agency's belief that these entities will face diminished public finance and structured finance new business flow and declining financial flexibility. In addition, it believes that continuing deterioration in key areas of the US residential mortgage sector and related CDO structures will place increasing pressure on capital adequacy.
Resolution of the negative credit watch will depend on clarification of ultimate potential losses, as well as future business prospects, the outcome of strategic business decisions, and potential regulatory developments.
Ambac responded by saying it disagrees with and is disappointed by the actions taken by S&P. "Our frustration stems, in part, from the ever-changing criteria for triple-A financial strength ratings," the monoline explains in a statement. "Less than three months ago, S&P affirmed our triple-A rating and removed Ambac from credit watch negative, citing our successful capital raise and moratorium on new structured finance business production. At that time, Ambac had claims paying ability greater than US$700m in excess of S&P's stated requirements. S&P stated today that it is no longer basing our rating on claims paying ability, but rather on the diminished flow of new public finance and structured finance business we are experiencing."
Ambac notes that it had been accelerating its efforts to launch a new triple-A rated financial guarantor utilising Connie Lee, a fully-licensed financial guarantee subsidiary of Ambac Assurance Corporation. Connie Lee would be recapitalised with surplus capital from Ambac Assurance and, potentially, from one or more third parties. Ambac Assurance currently has substantial excess capital available under both Moody's and S&P's capital models, the monoline stresses.
According to Barclays Capital research, it is surprising that S&P left the new ratings on review for further downgrade, despite the fact that under double-A capital requirements, both companies now have over US$2bn of excess capital above the rating agency minimums for the double-A financial guaranty rating.
"This leaves open the questions of how low ratings can go and whether MBIA and Ambac could be on the same slippery slope as FGIC, which now resides at Baa3/BB," the BarCap analysts note. "Overall, we suspect that MBIA and Ambac can hold onto double-A ratings, but it could be some time still before we know if this will ultimately be the case."
The following day S&P lowered its ratings on CIFG to single-A minus from single-A plus and on XLCA from single-A minus to triple-B minus. The ratings remain on credit watch with negative implications.
The downgrade of CIFG reflects the agency's view that it has lagged the industry in par volume in recent years and has generally failed to develop a strong franchise. Because of this, and given S&P's opinion that total insured business volume will be off for the industry in the near term, the agency believes that the company is highly prone to damage to its franchise.
To improve CIFG's situation, management is evaluating a long-term plan to restructure the company with a focus on the US public finance market and selective participation in global structured finance and the global infrastructure markets. In S&P's opinion, the future strategic direction of the company and the stability of the rating will largely depend on the results of this restructuring effort.
The downgrade of XLCA's rating reflects S&P's current assessment of potential losses on the monoline's 2005-2007 vintage RMBS exposure, direct and indirect, which is higher than previous estimates. In the agency's view, XLCA's combined capital cushion is inadequate at the previous rating level to absorb those losses, resulting in a shortfall of approximately US$500m.
The company has presented various strategies to address the capital shortfall, but management has been unsuccessful in its efforts, S&P says. It adds that the monoline's franchise is impaired due to its scaled-back underwriting activity and concerns about its ability to address prospective capital needs.
The placement on credit watch of both CIFG and XLCA reflects S&P's view that there is execution risk in the monolines' restructuring plans. Should the restructurings prove unsuccessful, the agency believes the monolines would effectively be in runoff, in which case the ratings could go lower.
Meanwhile, the negative watch placement of FGIC addresses S&P's concern about the magnitude of projected RMBS and related CDO losses when compared with claims-paying resources. Furthermore, restructuring scenarios under consideration raise the concern that the surviving corporate entity and the remaining policyholders maybe disadvantaged compared with other classes of policyholders - in particular, municipal policyholders. S&P says it expects to know more about the company's direction in the next several weeks and will take rating action as necessary as information becomes available.
Finally, amid the negative rating action, S&P also affirmed its double-A ratings of Assured Guaranty. The stable outlook reflects the company's conservative underwriting and investment policy, limited non-prime mortgage risks and strong capital profile.
... while S&P downgrades US$12.5bn of wrapped CDOs ...
S&P has lowered its ratings on 22 US CDO tranches insured by MBIA and four US CDO tranches insured by Ambac after it lowered its financial strength ratings on the two monolines - see above story. In all, the 26 CDO tranches with lowered ratings come from 20 CDO transactions and represent an issuance amount of US$12.514bn.
The agency explains: "The triple-A ratings previously assigned to the CDO tranches with lowered ratings were based on full financial guarantee insurance policies provided by Ambac or MBIA that guarantee the timely payment of interest and principal. Because Standard & Poor's underlying rating (SPUR) for these insured CDO tranches, without giving benefit to the insurance policy, are below triple-A, we are lowering them in connection with the Ambac and MBIA downgrades."
For CDO tranches with a SPUR lower than triple-A, S&P lowered the CDO rating to the greater of the monoline financial strength rating and the SPUR for the CDO tranche. Eleven of the 26 downgraded CDO tranches have a SPUR of either double-A plus or double-A and have been downgraded accordingly; while fifteen of the downgraded CDO tranches have a SPUR that is lower than double-A and have been downgraded to double-A and placed on credit watch negative to match the ratings on the monolines.
At the same time, S&P affirmed its triple-A ratings on 38 insured US CDO tranches that have a SPUR of triple-A. Additionally, it has lowered and affirmed other ratings assigned to confidentially rated insured CDO tranches.
S&P says it is conducting a separate analysis to determine the impact that the monoline downgrades will have on the ratings assigned to synthetic CDO transactions that have counterparty or reference obligation exposure to Ambac or MBIA.
... and analyses monoline downgrade impact
The downgrades of monoline bond insurers MBIA and Ambac have broad ramifications for diverse sectors of the global financial markets, S&P notes in a report. After taking a close look, the agency's analysts expect the effects to vary from sector to sector, as well as within each sector. And while some areas are expected to feel the impact immediately, others will more likely have a delayed effect.
S&P expects that the deterioration of the creditworthiness and the resulting downgrades of MBIA and Ambac, with recent downgrades of other monoline bond insurers, to add to the pressures on certain broker-dealers' and banks' financial performance. Nevertheless, in the agency's opinion, the impact - in the form of additional write-downs - is likely to be small.
Most financial institutions with material exposure to bond insurers already have written down the value of their coverage, partly because of the widening credit spreads on the bond insurers during the past several months.
Also, in some cases, remaining exposures have been further hedged. Although the write-downs of monoline protection have been substantial (more than US$20bn so far disclosed for the largest US and European financial institutions), the downgrades of monolines likely will represent further negative input to the banks' internal valuation models (see also this week's Research notes for more).
In recent months, S&P downgraded the broker-dealers and banks most exposed to the downturn in the debt markets and, in particular, to sub-prime securities such as ABS CDOs. In the agency's opinion, its current ratings on these issuers have sufficient leeway to absorb expected incremental additional write-downs from a wide range of sources, including credit erosion in the monoline sector. Thus, it does not currently anticipate ratings on other financial institutions changing as a direct result of the current downgrades of the monolines.
The ABS CDO segment, which many bond insurers entered during the high growth of sub-prime securities in 2005-2007, has potential for the largest additional write-downs due to pressure on monoline creditworthiness. A substantial amount of ABS CDOs - more than US$100bn, the majority of which are super-senior tranches - is hedged using protection that monoline bond insurers provide. Most of the coverage is concentrated in a small number of financial institutions that have already taken significant valuation charges to these tranches.
The following selective list of financial institutions that have disclosed significant write-downs of assets that have monoline protection illustrates the extent to which the institutions' internal models have already incorporated a loss in value of monoline coverage based on widening credit spreads and stressed cash-flow projections. The figures cited below do not represent the totality of these institutions' monoline exposure, but rather focus on the ABS CDO segment. S&P notes that the data are not directly comparable, due to differences in definition and reporting of ABS CDOs and monoline exposures.
Merrill Lynch disclosed that the notional amount of CDS purchased from bond insurers as protection for US super-senior ABS CDOs was US$18.8bn as of 28 March 2008. Merrill Lynch recorded write-downs related to these CDS of US$538m in Q407 and another US$800m in Q108.
Citigroup reported that it bought protection from monolines on US$10.5bn of super-senior tranches of high-grade CDOs, against which it recorded charges of US$1.5bn in Q108.
Morgan Stanley recorded a US$600m write-down in Q108 stemming from the widening of credit spreads on the monoline bond insurers.
Canadian Imperial Bank of Commerce (CIBC) has suffered losses due to the deterioration in credit and liquidity conditions, particularly on its exposure to US sub-prime securities. CIBC's US$4.7bn in write-downs of monoline protection to-date was on US$7.9bn of notional exposure, much of it to ACA Financial Guaranty Corp.
The Royal Bank of Scotland Group (RBSG) disclosed a notional amount of US$12bn in credit protection against RMBS and ABS CDOs in April 2008. RBSG has taken US$4.4bn in cumulative credit value adjustments on all the credit protection it purchased from monolines, including protection on segments outside of RMBS and ABS CDOs.
Credit Agricole reported US$9.9bn of notional credit protection related to ABS CDOs at 31 March 2008. The fair value of CA's credit protection across all asset classes was US$3.4bn, after US$3.9bn in cumulative write-downs of monoline coverage.
UBS disclosed that the notional amount of credit protection it purchased from monoline bond insurers at 31 March 2008 was US$24.6bn, of which US$11.6bn related to ABS CDOs. The fair value of its credit protection across all asset classes was US$6.3bn, after a cumulative credit valuation adjustment of US$2.6bn.
Societe Generale disclosed that, as of 31 March 2008, it had US$11bn in notional credit protection purchased from monolines to hedge ABS CDOs. The fair value of its credit protection across all asset classes was US$1.2bn, after cumulative write-downs of US$1.6bn of monoline protection and the effect of purchased hedges.
Notwithstanding the notable stress in the ABS CDO area, the majority of the estimated US$2.5trn in notional coverage from the monoline bond insurers is on high-quality underlying assets that have not suffered severe credit deterioration -principally high-grade municipal securities, as well as on corporate bonds, CDOs backed by corporate debt and credit card ABS. For banks and brokers, S&P currently views the impact of credit erosion in the monoline sector as manageable, despite the high notional amount of securities involved.
Globally, the agency expects the potential earnings impact of further write-downs of monoline coverage of banks and brokers for the rest of 2008 to be manageable in the context of its current credit ratings. S&P's recent downgrades of Merrill Lynch, Citigroup, UBS and Morgan Stanley - all with significant monoline hedges - partly reflected their continuing exposure to more risky assets and residual write-downs of securities, including those with monoline protection.
Carlyle launches bumper CLO
Carlyle Investment Managers has priced a €1.5bn low-levered arbitrage CLO via Goldman Sachs. The deal, CELF Partnership Loan Funding 2008-1, has been in the pipeline since the beginning of the year - at a slightly bigger size of €2bn-plus and with a fuller capital structure.
One of the largest managed European CLOs to date, the transaction comprises four tranches. The €800m triple-A rated 5.1-year Class A1 notes priced at 165bp over six-month Euribor, the €292.5m triple-A 5.1-year Class A2s came at 150bp over and the €32.5m 5.3-year Class A2Bs at 300bp over. There is a considerable equity tranche of €375m.
Rating agency reforms agreed
S&P, Moody's and Fitch have reached agreements with the New York state attorney general Andrew Cuomo that should increase the independence of the rating agencies, ensure that crucial loan data is provided to the agencies before they rate loan pools and increase transparency in the RMBS market.
Under the agreements, the credit rating agencies will fundamentally alter how they are compensated by investment banks for providing ratings on loan pools. In addition, the ratings firms will all now require that investment banks provide due diligence data on loan pools for review prior to the issuance of ratings.
The agreements include the following:
• Fee reforms: Credit rating agencies are typically compensated only if they are selected to rate an RMBS by an investment bank. Credit rating agencies will now establish a fee-for-service structure, where they will be compensated regardless of whether the investment bank ultimately selects them to rate a RMBS.
• Disclosure reforms: Credit rating agencies will disclose information about all securitisations submitted for their initial review. This will enable investors to determine whether issuers sought, but subsequently decided not to use, ratings from a credit rating agency (see last week's issue for more on this.)
• Loan originator review: Credit rating agencies will establish criteria for reviewing individual mortgage originators, as well as the lender's origination processes. The credit rating agencies will review and evaluate these loan originators and disclose their originator evaluations on their websites.
• Due diligence reforms: Credit rating agencies will develop criteria for the due diligence information that is collected by investment banks on the mortgages comprising an RMBS. The credit rating agencies will receive loan level results of due diligence and review those results prior to issuing ratings. The credit rating agencies will also disclose their due diligence criteria on their websites.
• Credit agency independence: Credit rating agencies will perform an annual review of their RMBS businesses to identify practices that could compromise their independent ratings. The credit ratings agencies will remediate any practices that they find could compromise independence.
• Representations and warranties: Credit rating agencies will require a series of representations and warranties from investment banks and other financially responsible parties about the loans underlying the RMBS.
Robeco brings credit opportunity fund
Robeco is marketing a new fund, Credit Opportunity Obligatie, which aims to take advantage of current high credit premiums. The product offers investors indirect leveraged exposure to a broadly diversified portfolio of corporate bonds and ABS.
According to Robeco, the credit crisis has caused the average credit premium earned on a portfolio of corporate bonds to rise and the rate of return to reach historically high levels. This means that investors receive better compensation for the heightened risk of companies not meeting their obligations
The current credit premium offers opportunities, but also entails risk, notes the asset manager. As the rate of return is at historically high levels, a diversified portfolio can withstand more credit events before these actually result in losses.
Even though it is possible that corporate profits will decline as a result of the credit crisis, Robeco feels that credit-worthy companies generally have such strong balance sheets that they can absorb any resulting slowdown in profitability. A broad diversification of companies and sectors is, however, important.
In the current interest-rate scenario, the projected effective return will be approximately 7.2% per annum for the lifetime of the product. The repayment of the principal and the size of the coupon depend on the investment result of the underlying portfolio and movements in three-month interest rates.
The total portfolio will be made up of more than 100 companies and be well diversified across countries and sectors. Most of these companies have good credit ratings.
In order to be able to offer a potentially higher return, part of the portfolio can also be invested in companies with a lower credit rating, in emerging markets or in credit worthy European ABS. Both direct and indirect investments in ABS will only occur in European issues and won't make up more than 20% of the portfolio.
Asian SROC results in
May's SROC analysis has been completed for Asia-Pacific and Japanese synthetic CDOs.
S&P placed the ratings on five Asia-Pacific synthetic CDOs on credit watch with positive implications and the ratings on 14 other CDOs on watch negative, while another two CDOs have been taken off credit watch. At the same time, it has placed its ratings on 11 tranches relating to 10 Japanese synthetic CDO transactions on watch negative, one tranche on watch positive, affirmed its rating on one tranche and removed the rating of another from watch negative.
The SROC levels for the ratings placed on credit watch positive rose above 100% at a higher rating level during the end-of-month SROC analysis for May 2008, indicating positive rating migration within the reference portfolio. For those transactions that have been placed on credit watch with negative implications, the SROC decreased below 100% at the current rating level.
BIS Quarterly Review released ...
Bank for International Settlements has published its Quarterly Review, which presents an overview of recent developments in financial markets before turning in more detail to highlights from the latest BIS data on international banking and financial activity (see SCI issue 90 for information on CDS volumes).
Following deepening turmoil and rising concerns about systemic risk in the first two weeks of March, financial markets witnessed a cautious return of investor risk tolerance over the remainder of the period up to end-May 2008, according to the report. The process of disorderly deleveraging that had started in 2007 intensified from end-February, with asset markets becoming increasingly illiquid and valuations plunging to levels implying severe stress.
However, markets subsequently rebounded in the wake of repeated central bank action and the Federal Reserve-facilitated takeover of Bear Stearns. In sharp contrast to these favourable developments, interbank money markets failed to recover, as liquidity demand remained elevated.
Mid-March was a turning point for many asset classes, the BIS says. Amid signs of short covering, credit spreads rallied back to their mid-January values before fluctuating around these levels throughout May. Market liquidity improved, allowing for better price differentiation across instruments.
The stabilisation of financial markets and the emergence of a somewhat less pessimistic economic outlook also contributed to a turnaround in equity markets. In this environment, government bond yields bottomed out and subsequently rose considerably.
A reduction in the demand for safe government securities contributed to this, as did growing perceptions among investors that the impact from the financial turmoil on real economic activity might turn out to be less severe than had been anticipated. Emerging market assets, in turn, performed broadly in line with assets in the industrialised economies, as the balance of risk shifted from concerns about economic growth to those about inflation.
... and Asia Pacific CDS analysed
The latest BIS Quarterly Review also included a special feature on credit derivatives and structured credit in the Asia-Pacific region.
Nascent markets for credit derivatives and structured credit in Asia and the Pacific were poised for rapid growth when the global financial turmoil hit. While there has been no significant deterioration in the quality of the underlying names, credit markets in the region have been swept up in the global widening of spreads and aversion to structured finance, the BIS reports.
The BIS estimates that there are now 921 names from the region that can be traded in the form of single-name CDS contracts. In terms of the number of names from each economy, Japan, India, Taiwan (China), Australia, Hong Kong SAR and Korea dominate the market. There are also CDS contracts for names from Malaysia, Indonesia, China, Thailand and Singapore.
As is the case in Europe and North America, the CDS market in Asia and the Pacific is concentrated in borrowers considered to have some but not too much credit risk. Indeed, close to four-fifths of the traded names in the region have ratings between single-A and double-B. The typical maturity is five years.
Credit events tend to be defined so as to include bankruptcy, failure to pay and restructuring. Almost all large banks make markets for single-name CDS in the region. However, only a small number of names are traded every day - those that are part of a traded CDS index - and they trade at bid-ask spreads of 10bp-20bp.
The Asia-Pacific CDS market still tends to be limited to international investors, notes the BIS. One reason for this is that the local currency bond markets in the region still tend to accept only issuers with the highest ratings from the point of view of domestic investors, who would therefore see little need for protection in the form of CDS contracts.
From the perspective of international investors, however, what is highly rated by domestic rating agencies might not be so highly rated by international rating agencies. Depending on the economy, domestic triple-A names are often rated only single-A or triple-B internationally, and foreign investors would thus be interested in hedging the concomitant credit risks.
The history of CDOs in Asia is short compared to that in the US and Europe. As in those regions, the first Asian CDO deals were balance sheet transactions motivated by banks' efforts to economise on capital, and were issued by Japanese banks in the late 1990s.
Outside Japan, in December 2001, DBS Bank securitised US$1.5bn of CDS on corporate loans in the first Asian synthetic balance sheet CDO deal. Since then, the focus of CDO markets in Asia has shifted from traditional balance sheet CDOs to synthetic arbitrage CDOs and more recently to single-tranche arbitrage CDOs.
While Australia, Hong Kong SAR, Japan, Korea and Singapore have had the most active CDO markets in the region, a few banks in China, India and Malaysia have recently also completed several balance sheet CDO deals, drawing on their own loan portfolios. The most popular forms of collateral have been corporate loans and bonds, but leveraged loans, distressed loans and ABS have also been used. Banks and insurance companies form the main investor base for CDOs backed by both Asian and global assets.
In recent years, some banks from the region have structured synthetic CDOs by drawing from their own portfolios a geographically diversified collateral pool with a substantial amount of Asian exposure. In contrast to balance sheet CDOs, only a few arbitrage CDO transactions have relied on collateral pools consisting mainly of regional assets. This is partly because within-region diversification benefits are rather limited.
So far there have been no actual losses from default in traded names from Asia and the Pacific during the current financial market turmoil. There is also still no evidence of any significant deterioration in the credit quality of these names. Indeed, average credit ratings in the region have drifted upwards.
The structured investment vehicles and the more complex CDO structures that have caused so much trouble in the US and European credit markets have not been seen in Asia. Yet the recent turbulence in global financial markets has, to some degree, spilled over into the region's credit markets.
This spillover has been most evident in the spreads on traded CDS indices. In the case of CDS spreads, one explanation for the spillover is that the spreads are driven primarily by risk premia rather than expected losses from default, and these premia depend largely on the changing risk aversion of global investors.
CDS novation service launched
Markit has announced a new electronic novation consent service for clients in the credit derivatives market. The new service aims to support commitments made by the Operations Management Group (OMG) to the Federal Reserve Bank of New York in March this year.
"This initiative aims to support commitments made by major market participants to the New York Fed to improve trade accuracy and achieve greater operational efficiency," explains Jeff Gooch, evp and co-head of trade processing at Markit.
The novation consent service will link Markit Trade Manager, a comprehensive cross-asset class trade workflow and reporting service used by major buy-side institutions, to the DTCC). The new link, which is an extension to the existing link between Markit and DTCC, is scheduled to go live in August 2008. The new service complements the existing Markit Wire novation service for the interest rate and equity derivative markets.
"Markit's electronic solutions for novations and allocations will enable PIMCO to achieve operational efficiency and mitigate risk quickly and efficiently across the major OTC derivative asset classes," says Ric Okun, svp at PIMCO.
CMBS mis-pricing analysed
A study commissioned by the Commercial Mortgage Securities Association (CMSA) presents new data on the mis-pricing of CMBS compared to their fair value and returns relative to risk profile. The study predicts that CMBS will perform well in a deteriorating recessionary environment and concludes that current spreads for most CMBS vintages are still far wider than their fair value - an irrational market reaction that presents significant arbitrage opportunities for investors.
"There are no skeletons in the CMBS closet," says Jun Han, founder and principal of JHP Capital and the author of the study. "Market fears and the liquidity crunch have dramatically distorted the value of commercial mortgage-backed securities, creating one of the best environments in history for investing in CMBS."
The study performed multiple stress tests on CMBS bonds based on three historical and worst-case recession scenarios. It analysed all 19,583 commercial mortgage loans in the 675 CMBS bonds that make up the four CMBX indices, which account for approximately 39% of fixed rate conduit CMBS outstanding.
The study concludes that investors have strong reasons to be optimistic:
• Fixed-rate, investment grade CMBS perform very well in the study's stress-tested analysis, with minimal defaults, credit losses or yield degradation. No CMBS rated double-A or higher are expected to incur any loss under the study's recession scenario, while 99% of single-A rated CMBS should be free of losses and the remaining 1% should incur only a small loss.
• The risk of CMBS downgrades is very limited. For example, 98% of triple-A rated CMBS and 94% of single-A rated CMBS are at no risk of downgrade in a recession scenario.
• Current CMBX index spreads unreasonably imply a 'doomsday scenario', with such spreads implying that future defaults and losses would be many times the levels of historical experience. Incredibly, when applying the spreads at which the CMBX 4 index has recently traded, the implied annual collateral default rate was over 100% for triple-A rated CMBS on 20 March, compared to a historical CMBS average of less than 1%.
"Just how off-target is the CMBX market? We can actually put a dollar value on it," Han adds. "When applying a worst case 1986 stress test scenario, spreads on the CMBX 4 index of almost 1,200bp over T-bills were almost twice as high as would have been expected at fair value. This demonstrates the kinds of distortions and limitations of ceding the determination of value of the nearly US$1trn CMBS market to an untested and volatile derivatives index during an unprecedented credit and liquidity crisis."
CRE CDO delinquencies rise
Five repurchased assets during the month contributed to a noticeably higher US commercial real estate loan (CREL) CDO delinquency rate for May 2008 of 1.08%, up from last month's rate of 0.69%, according to the latest CREL CDO Delinquency Index from Fitch Ratings. The delinquency index includes loans that are 60 days or longer delinquent, matured balloon loans and repurchased assets.
The overall delinquency rate for CREL CDOs went above 1% for the first time since Fitch began its asset delinquency index. The rate is approximately three times the US CMBS April loan delinquency rate of 0.35% reported in May 2008.
The CREL CDO Delinquency Index is anticipated to be more volatile than the CMBS delinquency index, given the smaller universe of loans and the more transitional nature of the collateral. The Fitch CREL CDO Delinquency Index tracks approximately 1,100 loans and 340 rated securities/assets (US$23.8bn in 35 CREL CDOs), while the Fitch CMBS delinquency index covers approximately 42,000 loans (US$562bn in nearly 500 CMBS transactions).
The May 2008 delinquency index encompasses 17 loans and includes six loans that are 60 days or more delinquent, six matured balloons and five repurchased assets, including three rated assets. Of the loans that are 60 days or more delinquent, two loans are in foreclosure (0.08%).
Asset managers reported five repurchased assets (0.20%) in May 2008, up from last month when there were none reported. The repurchased assets consist of three real estate bank loan interests (0.18%), including two interests from the same issuance, which are backed by land and contributed to two different CDOs.
The other two repurchased assets (0.02%) include a whole loan and a mezzanine interest from the same CDO. The mezzanine loan was reported as 30 days delinquent last month.
Despite this month's uptick in repurchased loans, Fitch still predicts fewer in the near term. Repurchases of troubled loans will be limited to the few issuers with liquidity remaining within their balance sheets.
Although not included in the delinquency index, 16 loans - representing 1.08% of the CREL CDO collateral - were 30 days or less delinquent in May 2008. This statistic is up significantly from last month's total of 0.36%. Multi-family properties (0.49%) comprise the largest percentage of these loans.
While only three rated assets are included in the Index, 12 other rated assets were considered credit impaired. These assets are mostly sub-prime RMBS assets and serve as collateral for two CREL CDOs.
The impaired assets are equivalent to 0.40% of all CREL CDO assets, but 8% and 2.4% of their respective CREL CDOs. The two most junior rated tranches from one of these CREL CDOs are on rating watch negative, due to the sub-prime exposure.
Fitch noted 14 reported loan extensions in May 2008, which is down from last month's total of 25. Approximately half of the extensions were a result of options contemplated at closing, while the other half were modifications from the original loan documents. These loan extensions, which are typically between one to six months, continue to reflect the lower available liquidity for CRE loans - especially those typically found in CREL CDOs, which tend to be backed by transitional and/or highly leveraged CRE collateral.
Caliber releases Q2 results
Caliber Global Investment Ltd has published its results for the second quarter ended 31 March 2008. They reveal a company only NAV of US$0.59 per share (compared to one of US$0.91 at end-December) and a consolidated NAV of US$4.7 per share (US$3.15).
Estimated company only NAV at 30 April 2008 is US$0.48 per share and the consolidated NAV is US$4.81 per share. At current market levels, the first distribution may be delayed beyond March 2009.
The permacap says that the continued decline in company only and consolidated NAVs is largely due to unrealised losses and reflects the depressed market prices for assets in the company's portfolio. In respect of the ongoing disruption in the financial markets and the illiquidity of the company's asset portfolio, neither NAV should be taken as a guide to the likely disposal price in the current environment or in the future.
The investment manager continues to believe that the consolidated NAV does not represent the fair NAV of the company. The net assets of certain of the company's various non-recourse funding facilities were negative at 31 March; that is, the market value of the assets was less than the amount of the third-party borrowings.
As discussed in the year-end report, the investment manager believes that a more commercially accurate NAV excludes those facilities from the calculation. The greater decline in the consolidated NAV relative to the company only NAV reflects the protection afforded to the company by the non-recourse nature of the SPVs.
As of 31 March 2008, the investment portfolio of approximately US$176.2m (compared to 31 December 2007's figure of US$251m) comprised 170 (181) individual investments at an average position size of US$1m (US$1.4m). The reduction in portfolio value was largely a result of decreases in the market value of the company's holdings.
During the quarter, securities with a market value of US$20m were sold and there were no security purchases. The sales reflected a desire to improve cash balances to satisfy the company's obligations.
Court approves Canadian restructuring
An Ontario court has approved the plan to restructure the Canada's estimated US$32bn ABCP market.
"Instead of reorganising a single debtor, Justice Colin Campbell has agreed to the restructuring of an entire market - a completely new concept in Canadian financial history," says Xeno Martis, partner at Fasken Martineau DuMoulin, which served as counsel to the group of 20 debtor trusts involved in the financial restructuring. "The judge has shown that the debtor companies are almost incidental to the work that has to be done to breathe life back into the market."
Canada's ABCP market came to a complete stand-still in August 2007, largely as a result of the collapse of the US sub-prime mortgage market, creating a huge tangle of litigation among institutional and retail holders of ABCP debt. "The Judge's view of the inter-relatedness of the ABCP market to the entire Canadian economy shows a sophisticated understanding of the potential domino effect of the market collapse and an appreciation for the economic harm that could be caused by the mega-insolvency," adds Alfred Apps, partner at Fasken Martineau DuMoulin.
"Justice Campbell also rightly exerted his leverage to force those subject to orders to remain in a standstill until third parties figure out their status in the litigation," Apps continues. "Recognising that an entire market was in jeopardy, he has also wisely extended release of claims as widely as possible to prevent further meltdown. This entire decision is infused with practicality and reasonableness. With this blueprint, Canada's market will be able to move forward."
JPM launches processing solution
JPMorgan has launched an OTC derivatives processing solution designed to help financial institutions handle higher volumes, lower position breaks and reduce credit risk.
The bank is offering the new automated reconciliation technology globally, representing the latest enhancement to its derivatives collateral management (DCM) solution. JPMorgan DCM covers many of the post-trade functions of the collateral management value chain, such as Credit Support Annex (CSA) management, margin call processing, re-hypothecation, settlement and custody.
This new technology, which is designed to work in conjunction with TriOptima's triResolve automated position reconciliation service, increases the efficiency and risk management of trading records, JPM says. As such, the bank suggests that with TriOptima's triResolve functionality, JPMorgan DCM clients will receive these additional benefits:
• Automated OTC position reconciliations.
• Early warnings for discrepancies, better risk mitigation and greater reconciliation transparency.
• Identification and resolution of booking errors and discrepancies in trade valuations, trade populations, single-sided records, splits and structured trades.
Fed addresses weaknesses in OTC market
The Federal Reserve Bank of New York has hosted a meeting of major market participants and their domestic and international supervisors to review the industry's strategy for addressing weaknesses in the operational infrastructure of the OTC derivatives market. The 9 June meeting was the fourth with major dealers on this topic and the first to include buy-side clients and industry associations.
Starting in September 2005, industry participants implemented a number of initiatives to improve the operational performance and infrastructure of the OTC derivatives market. Through these initiatives, market participants have significantly expanded automation, with 91% of credit derivatives trades being confirmed on electronic platforms, and reduced the number of credit derivatives confirmations outstanding more than 30 days by 86%.
Market participants and regulators agreed on the following agenda for bringing about further improvements in the OTC derivatives market infrastructure:
• further increasing standardisation and automation of credit derivatives trade processing, with the objective of moving towards matching on T+0,
• developing a central counterparty for credit default swaps that, with a robust risk management regime, can help reduce systemic risk,
• promoting greater certainty in credit event management by incorporating an auction-based settlement mechanism into standard credit derivatives documentation,
• reducing the volume of outstanding credit derivatives trades via multilateral trade terminations to help reduce operational risk, and
• extending infrastructure improvements to OTC equity, interest rate, foreign exchange, and commodity derivatives as guided by the March 2008 policy statement by the Presidents Working Group on Financial Markets.
Market participants reaffirmed their commitment to the objectives laid out in their 27 March 2008 letter to regulators. They also agreed to detail their next steps for addressing these priorities to regulators by 31 July.
CS & AC
