Contents

CMBS

CMBS disputes rise

Legal precedents needed to clarify servicer decision-making process

Barclays Capital Mortgage Servicing (BCMS) has been replaced by CB Richard Ellis as special servicer on the Gemini (Eclipse 2006-3) transaction, amid allegations that it was not acting in the interests of all parties to the deal. The move is the first in what is expected to be a slew of disputes over the restructuring of failing CMBS deals. However, the creation of legal precedents may ultimately help clarify the decision-making process for servicers.

With the property market as it is, it is difficult for a servicer to decide what course of action to take in a default situation. "The servicing standard requires servicers to maximise recoveries in a timely manner, but the wording is vague and so it is hard to balance the wishes of the different noteholders in the capital stack," confirms Dirk Van den Beukel, portfolio manager at NIBC. "The issue is that senior noteholders are likely to prefer a quick resolution even if that crystallises losses on junior notes, whereas junior noteholders may prefer holding out longer to receive their coupons and maximise the option value of their positions."

Nevertheless, the market is likely to see further investor/borrower disputes in the coming months, as more and more loans in European CMBS deals begin failing. Indeed, LTV breaches in a number of deals triggered investor notices last week, initially leading to the designation of a controlling party on the deals.

For example, both senior LTV and whole loan LTV triggers have been breached in the REC 5 transaction (currently at 107.14% and 113.72% versus thresholds of 77.68% and 82.14%, according to ABS analysts at HSBC). The trustee on the deal has notified investors of a meeting on 13 March.

Elsewhere, the trustee of Titan 2006-4FS announced that its new controlling party is the IG1 (a subordinated non-securitised tranche) noteholder, while Epic (More London) confirmed that the Class F investors are now the controlling party on the deal.

However, the creation of legal precedents could serve to help the decision-making process for servicers, according to Van den Beukel, given that historically disputes have been rare in the European market. "It is difficult to strike a balance for servicers," he adds. "A firesale of properties in a dysfunctional property market makes little sense, but timeliness of recoveries remains important nonetheless. Of course, a servicer's ultimate course of action depends on the deal, but investors are pricing in time-consuming work-out periods in some cases."

CMBS notes are typically structured with a legal maturity some years after the legal maturity of the underlying loans, allowing for the servicer to workout the loans in case of default of the loan. The length of this tail period depends on the jurisdiction of the properties. Whether these periods are long enough remains to be seen: workouts could be quite time consuming in some southern European countries, for instance.

Mark Nichol, securitisation analyst at Barclays Capital, agrees that the lack of precedents in European CMBS makes it difficult for everyone from investors to special servicers to take decisions with any certainty. "Without precedents, special servicers may be unsure what actions they can take unilaterally and their possible legal exposure to noteholder litigation," he explains. "Similarly, without practical evidence of special servicers' likely course of action and timing, it is difficult for investors to price bonds. We believe litigation may be useful to set precedents for European CMBS if it serves to end some of the current confusion."

One particular area of confusion is whether the servicing standard incorporates the concept of net present value (NPV). That is, whether the special servicer's job is to maximise loan recoveries (full stop) or to maximise loan recoveries on an NPV basis.

"Resolution of this point is critical to the function of the special servicer, in our view, as the two interpretations would probably lead to opposite courses of action," notes Nichol. If recoveries are to be maximised on an NPV basis, then early enforcement would probably produce the highest NPV in a falling market, even at moderate discount rates. If recoveries are to be maximised full stop, then in cases with long-dated bond maturities recoveries could probably be maximised by waiting for bank lending to return and allowing inflation to lift property values for as long as possible.

Servicing agreements are not generally publicly available, but one for a UK CMBS conduit transaction indicates that "the 'Servicing Standard', being the maximisation of recoveries of funds, [takes] into account: (i) the likelihood of recovery of amounts due in respect of the Loan; (ii) the timing of recovery; (iii) the costs of recovery; (iv) the interests of the Issuer". Nichol suggests that individually none of these points explicitly says that recoveries should be maximised on an NPV basis.

"On aggregate, however, the meaning may be interpreted as referring to a probability-weighted NPV calculation. Indeed, the mathematical expression of a function to maximise recoveries on an NPV basis would probably contain each of the four points," he says.

This also raises the question of whether special servicers should disclose the discount rate they used in taking decisions. Such transparency could be useful to promote consistent behaviour among special servicers, aiding investors in pricing bonds and promoting secondary liquidity.

CS

Operations

Two-fold boost

Securitisation market to benefit from government scheme launches?

Two government initiatives were formally launched over the past week, both of which are expected to boost the structured finance markets. It is anticipated that the UK's Asset Protection Scheme will stabilise asset prices and become a catalyst for more securitisable collateral, while the TALF in the US will facilitate purchases of triple-A rated ABS. However, the UK scheme has been criticised for only helping the ABS markets in the short term.

RBS kick-started the UK government's Asset Protection Scheme last Thursday when it confirmed it would place assets with a par value of £325bn and a carrying value net of impairments and write-downs of £302bn into the scheme. Lloyds Banking Group is expected to follow suit in the coming days, once it has sorted out discrepancies with the UK Treasury.

"The Asset Protection Scheme should be beneficial for the securitisation market in the short term, as it will help stabilise prices for the highest quality tranches," says Andrew Bristow, executive director at Threadneedle in London. "However, the scheme still does not address the core of the problem for the long-term, i.e. the current lack of a deep investor base."

But Bristow acknowledges that some investor appetite is returning to the market, despite sentiment remaining fairly fragile. "Investors are clearly worried about adding to their portfolios when the economic backdrop is so uncertain. However, there continues to be buying interest for prime triple-A benchmark RMBS, and also to some extent there has been buying going on in the mezzanine and subordinated tranches of deals that will only help improve price discovery and transparency below the most senior level," he adds.

Other market participants agree that the UK Asset Protection Scheme is a positive step towards restoring investor confidence in the UK banking sector. Meanwhile, the required commitment from participating banks to increase the amount of lending they provide to 'creditworthy' homeowners and businesses may provide a renewed flow of assets available for securitisation, according to Fitch.

"Although the securitisation markets remain closed at the present time, such an increased flow of assets could be used for the purposes of the government's proposed guarantee scheme for asset-backed securities, which is due to commence in April 2009," says Stuart Jennings, structured finance risk officer for EMEA at the agency. "The guarantee scheme offers the chance for a revival of primary structured finance issuance to investors."

Indeed, rumours are already circulating that the first UK government-guaranteed RMBS is being prepped. However, the level at which the asset class would trade is as yet unclear.

"In reality I would expect government-guaranteed RMBS to trade at a premium to government-guaranteed financial FRNs, but obviously inside spreads that we are currently seeing for triple-A rated prime UK master trust RMBS - which are currently trading at around 275bp to 325bp over Libor," notes Bristow.

Meanwhile, the latest terms and conditions of the TALF (see News Round-up) have also been welcomed by the structured finance community. The scheme will initially focus on vanilla ABS transactions, but other types of securities - such as CLOs and CDOs - are also under consideration.

Securitisation analysts at Barclays Capital expect that most TALF issuance will initially come from auto finance companies, particularly independent finance companies and the 'Detroit Three'. In addition, they see the potential for issuance from foreign captives now that the executive compensation restrictions have been removed.

"We expect limited participation in TALF from credit card issuers (which can fund cheaper through deposits and TLGP) and student lenders (which will likely continue to tap ED funding, despite the increased attractiveness of haircuts and funding levels for government-guaranteed ABS)," the analysts conclude.

AC

Regulation

Foreclosure closure

National auction mooted to address spiraling home prices

The US House of Representatives is expected to vote on the 'Helping Families Save Their Homes Act of 2009 (H.R. 1106)' - which would enable bankruptcy judges to cram down mortgages secured by principal residences (see SCI issue 119) - as early as today, 4 March. However, an alternative proposal to deal with foreclosures has been put forward: an industry-led national bulk home auction programme.

The implementation of bankruptcy cramdown legislation will serve to reduce investor confidence in the US regulatory framework, according to Ron D'Vari, ceo of NewOak Capital. "One lesson from emerging markets is that increased regulatory volatility and interference leads to a higher cost of financing, so we have to be careful not to destroy our legal framework and essentially let the chips fall where they may," he says.

Like loan modification, cramdown can be successful when a servicer undertakes it on a voluntary and economic basis, albeit every loan is different. The caveat is that the process can ultimately be used as a delaying tactic by the borrower, who can exercise the option to remain in the property for an extended period - thereby causing economic damage to the lender against the backdrop of continuing declines in liquidity and prices.

Instead, D'Vari suggests that drastic action - such as establishing a national auction for foreclosed property - is necessary in order to address the price/demand imbalance and set a floor for house prices. "Such an auction would involve lenders dealing with all their delinquent borrowers and either modifying them on economic terms or foreclosing in the same expediency as typical of delinquent renters."

Under the proposal, the foreclosed properties could be auctioned off on set nationally-publicised periodic dates, creating a buying frenzy among end-users (ultimate residents only). "The objective would be to clear the overhang in inventory and kick-start the flow of home prices, meaning that every sale afterwards would realise an upside," D'Vari explains. "However, meaningful foreclosures should be emphasised, where there is some flexibility in terms of the borrower renting during a transition period until an alternative can be found."

The creation of the auction would have to be led by the industry, given the political difficulties potentially associated with it. Nonetheless, D'Vari argues that such a mechanism could help bring decision-making to a head by creating competition and activity in the housing market.

The programme would reward good borrowers and new home owners with clean records. Additionally, further delinquent borrowers that lose their homes should be able to find affordable rentals consistent with their true income.

According to Glenn Schultz, head of ABS and mortgage research at Wachovia Securities, an important consideration when discussing home inventory sales and prices is a recognition of the existing dual auction processes for homes. First is a quantity-clearing auction process that occurs primarily for owner-occupied homes and largely reflects owner-to-owner transactions.

Second, with respect to homes in foreclosure or REO, a price-clearing auction mechanism is at work. The aggressiveness of this mechanism depends on overall supply and the home price outlook of mortgage servicers.

Generally, in a rising home price environment, months to liquidation extend as servicers seek to maximise the value of their REO inventory. However, in a declining price environment, servicers seek to minimise potential losses by slashing prices and reducing the time to liquidation before prices drop even further.

A recent Wachovia analysis shows that, as annual foreclosure rates have increased, the average months to liquidation has declined from 19 months in 1999 to seven months in 2007. Furthermore, it estimates that the current foreclosure overhang is about 838,000 units, which would take around five months to work off at present rates.

Schultz argues that an increase in foreclosure activity alters the dynamics of the housing market from a quantity-clearing market to a price-clearing market. "Unfortunately, the nature of excessive REO inventory pushes the dynamic even further to become a Dutch auction, whereby the auction begins with the highest asking price and is bid lower," he notes. "When Dutch auction participants believe that the supply of goods entering the process will continue to increase, bids become nominal. Consequently, as foreclosure inventory increasingly dominates existing home sales, the intensity of the negative feedback loop increases."

D'Vari concurs: "The longer the current situation drags on, the lower home prices will become; there needs to be real capitulation, where buyers set the price and not the government. We're experiencing a classic credit crunch, with write-downs now impacting loans made to good borrowers (whereas historically they have impacted loans to bad borrowers). We need to stop the vicious downward home price cycle - the 'National Bulk Home Auction Programme (NBHAP)' will help to do that."

CS

CDS

AIG's 'strategic importance' explained

AIG confirmed on Monday, 2 March, an US$62bn Q4 loss due to asset revaluations and a write-off of tax credits and goodwill. Further details also emerged on the US government's third attempt at a rescue plan for the insurer, as well as on its counterparty risk exposures.

The government's latest proposal includes a repayment of the amount (US$38bn) currently drawn under the government credit line by transfer of the ownership of American Life Insurance Company and American International Assurance to the government (Fitch's expectation is that the value of this exchange will be US$20bn-US$25bn), a securitisation of its expected future profits on designated blocks of life insurance policies (Fitch's expectation is that the value of this exchange will be up to US$6bn) and a number of other asset sales. These actions are expected to reduce the interest costs for AIG, while a line of US$25bn remains in place. Additionally, the existing US$40bn preferred shares are to be made more junior, with a 10% non-cumulative coupon plus a new US$30bn equity line.

AIG revealed that it is exposed to US$1trn of counterparty risk with 12 financial institutions - hence why the government regards it as being strategically important. Analysts at Credit Derivatives Research explain that, as the super-senior protection that AIG wrote on these bank's loan portfolios increases in risk, AIG suffers mark-to-market losses and the banks demand more collateral. Without government support, therefore, collateral needs could skyrocket or, even worse, the insurance could become worthless as AIG fails.

"Should this insurance fail, the banks that bought the protection would suddenly face significant capital calls (both regulatory and economic)," the analysts add. "Investors have already marked the books down in an economic sense, but the actual transfer of capital via a regulatory call would likely only be met with a sovereign backstop."

Fitch notes that AIG Financial Products' portfolio of CDS and other derivative contracts could generate material cash and/or capital needs under various scenarios. At 30 September 2008, the notional value of the portfolio - excluding the multi-sector CDO portfolio - was US$306bn.

Fitch believes that the liquidity and capital strain associated with the multi-sector CDO portfolio, which had been the most troublesome portion of the overall portfolio, have been alleviated by the steps AIG and the FRBNY announced in November 2008. While AIGFP's plans to wind down its portfolio appear to be well-designed and implementation appears to be progressing according to plan, Fitch views the portfolio's sheer size as representing a material source of risk.

CS

Distressed assets

Hypothetical 'toxic' asset values analysed

S&P's market, credit & risk strategies (MCRS) team has released a report offering its perspective on the potential costs to both taxpayers and US financial institutions if authorities adopt and mandate participation in the much-discussed good bank/bad bank 'toxic' asset disposal programme. Among the report's key findings is that, depending on the ratio of senior-to-subordinated structured finance securities that major banks hold on their balance sheets, the NPV of the securities in question hypothetically could be worth as little as one cent on the dollar in a worst-case scenario to as much as 83 cents in a best-case scenario.

"Even if we optimistically assume a 50/50 portfolio balance between senior and non-senior RMBS, banks' RMBS holdings would still be worth anywhere from 34% to 65% of face value, depending on housing market fundamentals such as default rate and mortgaged property losses following default," the report says. "Even if we assume that structure-specific housing market fundamentals do not deteriorate any further from current conditions, if a given bank's RMBS portfolio comprises entirely non-senior tranches, we estimate the net present value of the portfolio, at best, to be just 35% of face."

To gain perspective on just how 'toxic' these assets might be, the MCRS analysts constructed a very simple portfolio from three US RMBS structures, including all remaining tranches associated with a 2005-vintage US prime mortgage-based RMBS structure, a 2006-vintage US Alt-A structure and a 2007-vintage US sub-prime mortgage RMBS deal. The collateral-based weightings of this hypothetical benchmark US RMBS portfolio are fixed at 50% prime, 30% Alt-A and 20% sub-prime mortgage-based structures.

The team then altered the portfolio's actual credit quality according to the constituent security-level balance between senior and non-senior tranches from the underlying prime, Alt-A and sub-prime deals. These senior-to-non-senior tranche portfolio ratios represent its theoretical good bank/bad bank balance sheet exposures on a sliding 10% incremental scale that ranges from 80%/20% to 0%/100% respectively.

The team then valued each hypothetical good bank/bad bank portfolio mix according to current mortgage pool performance statistics and a stress-tested scenario to arrive at a range of portfolio values, depending on housing market fundamentals. All portfolio weights and resulting weighted average security prices are calculated from actual outstanding RMBS tranche balances as of 30 November 2008.

The 2005 prime mortgage RMBS stress test applies a 3% annual prepayment rate (CPR), a 25% annual default rate (CDR) and assumed 30% losses on underlying collateral upon default, also known as loss severity (LS). The 2006-vintage Alt-A stress test applies a 6% CPR, a 50% CDR and a 60% LS. Finally, the 2007-vintage sub-prime stress test applies a 6% CPR, a 60% CDR and 60% LS.

CS

Technology

An ever-changing environment

Jordan Hu, founder & ceo, and David Sawyer, chief marketing officer, at RiskVal answer SCI's questions

This motivated us to expand our business model to cover structured credit products. In 2006 we had our first commercial engagement with one of the institutional banks.

We understand that structured credit products are complex instruments from both a valuation and a market data perspective. Therefore, in the early stage of product development, we formed a partnership with NumeriX to ensure we can leverage NumeriX's award-winning analytics library for product valuation.

We also joined Markit's Alliance Partner programme to ensure that we get the first look at any upcoming changes or events in credit data. These business alignments laid a solid foundation for RiskVal to build up a fully integrated front-to-back structured credit ASP/SaaS solution, RVCredit.

In 2007 we had an opportunity to service the structured credit trading operation at one of the world's largest prop desks with RVCredit. The new platform offers streamlined front office, middle office and back office STP-ready services. The successful deployment of RVCredit marks the readiness of RiskVal's structured credit service.

Jordan Hu and David Sawyer

How has your service/offering developed since then?
DS: The RiskVal key to success is to maintain the spirit of a dedicated world class trading desk development team. This means nimble, new technology, harnessed to intellectual feedback from the top minds in structured credit trading. And that adds up to a constant stream of new features.

JH: Being a financial software service provider, we constantly review our products and services to ensure that what we offer matches market demands and trends. 2007 and 2008 have been very challenging years for structured credit service providers. We have never experienced so many names defaulting in such a short period of time in such an extremely distressed market.

Here are some sample new features/enhancements to RVCredit:

• Risk management in RVCredit has been greatly enhanced to provide a full range of single name risks, correlation risks, index basis risks and scenario risks.
• Corporate events management has been a very successful feature. It provides functions to handle default events, such as:
- pre-settlement defaulted name management
- settlement date cashflow management and reporting for all affected positions
- notional adjustments for index and tranches.
In 2008 this feature was one of the most useful management tools due to the number of names that defaulted.
• Event of default (EOD) mark-to-market and P/L attribution. RVCredit's distributed infrastructure enables traders and the middle office to conduct the EOD mark-to-market process concurrently. RVCredit offers P/L attributions to compare daily 'estimates' versus 'full valuation' P/L. Attribution reporting provides a check-and-balance of the mark-to-market process. Attributions also offer a great degree of transparency in portfolio valuation.

Which market constituent is your main client base? Do you focus on a broad range of asset classes or only one?
JH: For RiskVal's structured credit solution, we target the buy-side active portfolio managers as our main client base, including hedge funds, banks' prop desks and insurance companies. We currently cover single name CDS, LCDS, loans, credit indexes, tranche CDOs, bespokes, corporate bonds and most liquid fixed income instruments such as interest rate swaps, treasury bonds and bond futures. We are working with Markit to integrate CMBS and ABS cashflow data, so that we can cover CMBX and ABX in the near future.

How do you differentiate yourself from your competitors?
DS: That's a great question, and one we discuss often. We focus on the front office desks as we love to work directly with front-line traders.

Most of our competition comes from internally developed spreadsheets, sometimes using third-party models, but spreadsheets present traders with maintenance and development headaches. Vendor systems that have integrated portfolio abilities tend to be focused much more in the middle and back office.

A few firms and a very few vendors offer large, in-house developed trading systems, but the cost of these runs literally into millions.

Which challenges/opportunities does the current financial environment bring to your business and how do you intend to manage them?
JH: Obviously, the current market turmoil is bringing many challenges to our clients. The first example was the traditional Copula model, used to fit the base correlation for tranche CDOs, no longer working properly.

The industry has been searching for an enhanced Copula model with stochastic recovery. This feature has been working in RVCredit since Q408.

In addition, the recent credit crunch raised concerns about individual firms' EOD portfolio valuation. Both regulators and investors are looking for third-party portfolio valuation services to improve valuation transparency. With RV Credit as a fully integrated ASP solution, we are offering just that service as a value-add to the industry.

What major developments do you need/expect from the market in the future?
JH: Clearly, the increased issuance of government agencies is going to contribute to a very active marketplace going forward, and we see some of our clients gearing up for this. More importantly, the update in regulations around CDS will create new needs for our clients. We are already working with partners to help with the new standard CDS contract with the 100/500 coupon shift.

We are also, along with the rest of the industry, expecting a stronger regulatory environment. This is leading to an increased demand for real-time portfolio valuations.

Since our portfolio valuations were created to answer intense front office real-time questions, and since we already perform EOD calculations for first-tier banks, we find that the oncoming regulatory requirements match up well with our existing capabilities. Of course, we will always keep pace with whatever new twists are required by the ever-changing environment.

Structured credit trading team expands

The latest company and people moves

BNP Paribas has appointed Sebastien Cottrell to the firm's structured credit trading team in the US. He will be based in New York and report to Olivier Renart, head of US structured credit, and Romain Blanchard, who is based in London and leads the firm's global efforts to expand and integrate its structured credit market-making platform.

Cottrell joins BNP Paribas from Blue Mountain Capital Management, where he was a structured credit trading portfolio manager. He was also a trader in structured credit at Merrill Lynch and Bank of America.

Renart says: "Sebastien is a great addition to the structured credit team. His trading experience, especially in CDX, is a nice complement to our existing client offering and will further enhance our presence in the US."

Ex-securitisation head forms risk advisory
Tony Gioulis, ex-head of securitisation Europe at nabCapital, has founded European Risk Capital. An investment banking practice, the new firm specialises in structured capital raising and risk advisory activities, primarily focusing on financial services and real estate. European Risk Capital's core activities spread across a diverse range of sectors, from consumer finance and structured bank capital to commercial property, insurance and emerging markets.

As managing partner, Gioulis' main responsibilities comprise strategic origination and transaction execution, with special emphasis on long-term relationships. He joined the London office of nabCapital in 2004, with a mandate to establish a major structured debt player in the UK and the Eurozone.

New manager for Cohen CLOs announced
Allied Capital Corporation has taken on the management contracts of three CLOs - Emporia Preferred Funding I, Emporia Preferred Funding II and Emporia Preferred Funding III - and certain other related assets from Cohen & Company. The Emporia funds together have approximately US$1.2bn in assets and are composed of middle market and broadly syndicated senior secured loans.

As collateral manager of the Emporia funds, Allied Capital expects to earn management fees on an annual basis and may also earn certain incentive fees in future years. Allied is not an investor in the Emporia funds. In connection with the acquisition of these management contracts, the firm has hired the majority of the team responsible for managing the Emporia funds from Cohen & Company.

With the addition of the Emporia funds, Allied Capital's middle market senior loan assets under management increase to approximately US$2.4bn. Separately, its portfolio company, Callidus Capital, manages approximately US$3.5bn of primarily broadly syndicated senior loans.

"Over the last several years, we have expanded our reach and experience in the senior loan market, and we continue to seek attractive organic growth and acquisition opportunities," says Rob Long, md and head of asset management at Allied Capital.

Amherst adds senior hires
Amherst Holdings has hired Joseph Walsh as president and Ramon de Castro as chief risk officer to help oversee the company's ongoing expansion in its core RMBS business and growth into new securitised product offerings. Walsh and de Castro will be based out of the company's New York City and McLean, VA, offices respectively.

Walsh was previously md in the private equity business at Fortress Investment Group and will be president of Amherst Holdings and its subsidiaries, including Amherst Securities Group. His primary responsibility will be to develop and execute strategies for new business lines and opportunities. Prior to working at Fortress, Walsh spent nine years at RBS Greenwich Capital, where he was an md and head of mortgage and asset-backed origination, finance and trading.

As chief risk officer of Amherst Holdings and its subsidiaries, de Castro's primary focus will be to manage the day-to-day risks encountered by Amherst Securities in the conduct of its business. He is also responsible for credit and fraud risk management.

De Castro spent the past 18 years at Fannie Mae, where he most recently worked as svp of capital markets. At that position, he led the trading and investment activity of all mortgage assets for Fannie Mae's retained portfolio, including asset selection, relative value and risk analysis, trade execution and coordination of hedges in the agency and derivatives markets.

Strategist changes role
Siobhan Pettit, head of structured credit strategy at RBS in London, has been named head of corporate credit research at the bank.

RBS exits key areas
RBS has stated it will discontinue all illiquid proprietary trading activities and correlation trading, in both equity and credit markets. It will drastically scale back activity in structured real estate, leveraged and project finance, and exit lending in these areas entirely. All businesses, and notably GBM's asset finance businesses, will be managed within strict capital guidelines.

Highland hits back at UBS...
Highland Capital Management has stated that the UBS suit against it is completely without merit. UBS recently filed a complaint against Highland Capital Management and its two funds, Highland CDO Opportunity Master Fund and Highland Special Opportunities Holding Company, in the Supreme Court of the State of New York.

Highland Capital says it does not believe that UBS has any recourse to Highland Capital for any decrease in the value of the referenced portfolio. "In fact, among other things, the relevant agreement states that 'The Servicer [Highland Capital] will not be liable to UBS for any decrease in the value of the Collateral Portfolio.'"

Highland Capital says it will vigorously defend its position and its interests against these assertions. "The firm is committed to protecting its brand and reputation from further allegations and is evaluating the best course of action," it stated.

... and comments on CDO opportunity fund
Highland Capital has also commented on the Highland CDO Opportunity Master Fund, which is winding down. "Highland Capital had a significant economic interest in the fund. Of the US$550m of total fund NAV lost in 2008, approximately US$300m of exposure was from Highland Capital and its employees," it says.

During 2008 the value of the CLO tranches referenced in the fund decreased significantly. "As the market for corporate loans fell, as reflected in the S&P loan index, from US$94 at the beginning of 2008 to US$62 at year-end, and as default rates rose from less than 2% towards double digits, the value and prices of these equity and mezzanine tranches fell sharply," explains Highland.

"These CLO tranches, which were generally priced in the US$70 range in the first quarter, fell to the US$50 range by the end of the second quarter, to the US$30 range by the end of the third quarter and to approximately US$10 by the end of the year. As the market deteriorated, Highland worked to de-lever the CDO Fund. However, despite efforts to reduce short-term liabilities, which were reduced by over US$392m, and to raise additional capital, the dramatic and rapid drop in values outpaced Highland's actions," it continues.

The firm adds that the performance of the fund was consistent with other structured product funds in the industry.

Ambac recruits ABS specialist
Ambac has appointed Gregory Raab as chief risk officer, assuming the role from David Wallis, who was promoted to the role of president and ceo in October 2008. Raab will be responsible for managing Ambac's US$430bn of net insured par outstanding and will drive key decisions surrounding risk management and loss mitigation.

Credit, Surveillance and Capital Planning, and Risk Analysis will report to Raab. In addition, Raab will be a member of Ambac's executive management team.

Raab brings more than 20 years' experience in strategy development, risk management, securitisation and structured finance. He comes to Ambac from GE, where he established a Centre of Excellence to source, analyse and acquire discounted ABS securities. Before joining GE, he was ceo and chief risk officer of Axon Financial Services, where he launched and managed a SIV with US$14bn of assets

Galapagos evolves
Further details have emerged about Calypso Technology's acquisition of Codefarm's portfolio construction and management platform known as Galapagos (see SCI issue 122). Codefarm founder Jeremy Mabbitt has assumed the role of vp of technology for the new Galapagos business unit, while John Mooren and Steve Gibson have been appointed as general manager and vp of sales respectively.

Charles Marston, chairman and ceo of Calypso Technology, comments: "Galapagos is an excellent addition to the Calypso portfolio. There are clear synergies from this transaction, including an expected strong and seamless cultural fit among the staff, and a unique opportunity to leverage our combined talented resources to develop innovative solutions that relieve market pain - particularly in the areas of restructuring and capital efficient risk mitigation in the credit markets."

Galapagos represents the application of the academic concept known as evolutionary or genetic algorithms to the intractable optimisation problems inherent in the world of structured credit. It enables arrangers, managers, risk professionals and investors to explore the efficient frontier of risk and return.

Cantor promotes Matthews
Cantor Fitzgerald has promoted Shawn Matthews, executive md and head of the debt capital markets group, to ceo of Cantor Fitzgerald & Co, with overall executive responsibility for the firm's debt capital markets, investment banking and equity capital markets businesses.

Matthews' new role is his third promotion at Cantor Fitzgerald within 18 months. He was named executive md and head of debt capital markets in March 2008, following his promotion in September 2007 as senior md and co-head of mortgage-backed sales and trading.

In his new role, Matthews will focus on recruiting key professionals to the equities and investment banking sector, as well as continuing to build the firm's fixed income platform.

CME Group hires Boberski
CME Group has named David Boberski as md, OTC research and new product development. In this newly created position, Boberski will be responsible for identifying and developing new product opportunities in credit and interest rates, adapting existing CME Group products and services to the OTC markets, and educating CME Group customers on CME Group credit and interest rate products.

He will report to Julie Winkler, md, research and product development. Prior to joining CME Group, Boberski most recently worked as a consulting expert for the US Commodity Futures Trading Commission's Division of Enforcement.

Separately, CME Group is reportedly seeking regulatory approval to launch a European CDS clearing platform alongside its US clearing offering.

CRE CDO manager downgraded
Fitch has downgraded Capmark Investments' CRE CDO asset manager rating to CAM2 from CAM1-. Fitch has also placed the rating on rating watch negative. The downgrade reflects the adverse impact of current market conditions on the financial condition of Capmark Investments' parent company, Capmark Financial Group.

DB transactions under scrutiny
A class action lawsuit has been filed by Howard G Smith in the US District Court for the Southern District of New York on behalf of investors who acquired the 6.375% non-cumulative trust preferred securities of Deutsche Bank Capital Funding Trust VIII and/or the 7.35% non-cumulative trust preferred securities of Deutsche Bank Capital Funding Trust X, pursuant or traceable to materially false and misleading registration statements and prospectuses issued in connection with the October 2006 and November 2007 offerings of the securities. The complaint charges Deutsche Bank with violations of federal securities laws.

Specifically, the filing alleges that the registration statements issued in connection with the offerings were false and misleading and failed to disclose, among other things, that: (a) the company failed to properly record provisions for credit losses, RMBS, commercial real estate loans and exposure to monoline insurers; (b) the company's internal controls were inadequate; (c) the company's internal risk management systems were inadequate to limit the company's exposure to credit trading, equity derivatives and proprietary equity trading; and (d) the company was not as well capitalised as represented.

BONY Mellon completes Japanese acquisition
The Bank of New York Mellon has acquired JPMorgan Trust Bank Limited in Japan from JPMorgan Chase & Co. The transaction is a result of the company's acquisition of JPMorgan Chase's global corporate trust business in 2006.

The Bank of New York Mellon will introduce its corporate trust products in Japan, while continuing to provide the securitisation asset trustee services already offered by the trust bank. The trust bank currently provides asset securitisation-related services for corporate clients, including asset trustee, cash management and fiscal agency services.

ICMA and SIBA sign MoU
The International Capital Market Association (ICMA) and the Singapore Investment Banking Association (SIBA) have signed a joint memorandum of understanding (MoU) in order to develop cooperation between the two associations in addressing the issues that concern their members in the international financial markets.

Under the terms of the MoU, the two associations - which have previously cooperated on training and standards for primary market practice - will establish an exchange of information on the markets that each represents, covering the following broad topics:

• Law and regulation, including self regulation
• Planning, development and operation of efficient trading practices and mechanisms
• Clearing and settlement procedures
• Accreditation and training for market professionals.

AC & CS

REIT preps auction platform

A round up of this week's structured credit news

Annaly Capital Management has begun testing its new auction platform, FIDAC|Exchange, for its auction-related businesses. The move is expected to allow the company to continue meeting the needs of what has become a growing business in the securities market.

The CDO auction activity of its wholly-owned subsidiary, Fixed Income Discount Advisory Company (FIDAC), now exceeds US$40bn notional amount. FIDAC has conducted 44 CDO auctions since the beginning of 2008, consisting of over 5,800 individual securities. Other collateral auctioned by FIDAC includes prime, Alt-A, sub-prime, home equity, option ARMs and second lien RMBS, CMBS and a wide range of other ABS and derivatives.

FIDAC|Exchange is a web-based marketplace that enables FIDAC to safely and securely auction multiple securities to multiple potential buyers.

Over US$600bn of CDOs are currently outstanding, about half of them are already in event of default and only a third of that amount has been liquidated to date. "We expect EODs and liquidation activity to continue to rise," notes Michael Farrell, Annaly's chairman, ceo and president. "Moreover, financial institutions and other investment portfolios are in a position to restructure or otherwise liquidate many of their holdings. The market's increasing level of comfort with the auction process not only helps to set clearing prices for a wide range of performing and non-performing assets, but also demonstrates the degree to which the private market is willing and able to contribute to the process of clearing toxic assets from balance sheets."

Only senior triple-As escape Moody's CLO review
Moody's has placed all but the senior-most CLO tranches of US and EMEA cashflow CLOs on review for possible downgrade, affecting approximately US$100bn of securities. Included in the rating actions are junior triple-A tranches and those tranches rated Aa and below. Most CLO combination notes are also included.

The rating actions, which affect approximately 3,600 tranches totaling US$100bn from 760 transactions, reflect the revision of certain key assumptions that the agency uses to rate and monitor CLOs. These revised assumptions incorporate Moody's expectation that corporate default rates are likely to greatly exceed their historical long-term averages and reflect the heightened interdependence of credit markets in the current global economic contraction.

In its 4 February announcement, 'Moody's updates key assumptions for rating CLOs', the rating agency stated that it had increased its default probability assumptions for corporate credits in the collateral pools of CLOs by a factor of 30% across all rating categories. In addition, Moody's stated that assets with negative outlooks or that are on review for possible downgrade would be treated as if they had already been downgraded by one or two notches respectively. At the same time, the agency changed its calculation of the primary measure of industry and issuer diversification in CLOs (the Diversity Score) to increase the estimate of correlation in most pools of corporate credits.

Moody's has not placed any senior-most tranches of US and EMEA CLOs on review for downgrade at this time because of their underlying credit support, the presence of cashflow diversion and de-levering structural mechanisms, and the diminished reinvestment opportunities. However, negative rating actions on these tranches may occur as Moody's conducts its CLO review.

Moody's break-even default analysis indicates that the triple-A rated senior tranche of a typical CLO has enough protection to survive a 50% collateral default rate over the life of the transaction, under a 40% recovery rate assumption for a pool of mostly senior secured loans. The agency does not anticipate changes in the triple-A rating of the senior-most tranches of a typical CLO unless corporate credit conditions deteriorate further and realisation of the pessimistic scenario becomes more likely.

Moody's will conduct its CLO ratings review in two stages. In Stage I, which will begin immediately, it will use a parameter-based approach to calibrate the extent of downgrades to tranches currently rated single-A and below in the vast majority of cashflow CLOs. Any senior-most CLO tranches that appear to have significantly weaker than average structures and portfolios may be placed on watch for possible downgrade at that time as well.

In Stage II, which is expected to begin at the end of March, Moody's will perform a more comprehensive analysis by modeling each CLO individually. At that time, additional rating actions will be taken as necessary for all rated liabilities, including tranches currently rated Aa and triple-A. The agency expects to complete Stage II by the end of Q209.

Other than senior-most tranches, CLO tranches also excluded from the rating action are those from transactions that have been reviewed since the beginning of 2009, principal protected notes and certain tranches guaranteed by third parties. In addition, Moody's believes that CLO transactions with certain characteristics are not amenable to analysis using a parameter-based approach. These include older-vintage (pre-2003) transactions and others that have had considerable de-levering; CLOs with large (> 15%) structured finance concentrations; certain US SME CLOs; SME CDOs outside the US; and deals that have odd structures, cashflow characteristics or non-standard collateral pools that do not adapt appropriately to parameterisation. These transactions are expected to be addressed in the coming months.

CLOs/CDOs under consideration for TALF
The US Department of the Treasury and the Federal Reserve Bank of New York have launched the much-anticipated Term Asset-Backed Securities Loan Facility (TALF). While the scheme will initially focus on vanilla ABS transactions, other types of securities - such as CLOs and CDOs - are also under consideration.

The TALF will provide financing to investors to support their purchases of certain triple-A rated ABS. Under today's announcement, the Fed will lend up to US$200bn to eligible owners of certain triple-A rated ABS backed by newly and recently originated auto loans, credit card loans, student loans and SBA-guaranteed small business loans.

Issuers and investors in the private sector are expected to begin arranging and marketing new securitisations of recently generated loans imminently, with subscriptions for funding in March to be accepted on 17 March 2009. On 25 March those new securitisations will be funded by the programme, creating new lending capacity for additional future loans.

The programme will hold monthly fundings through to December 2009 or longer, if the Fed chooses to extend the facility.

Teams from the Treasury and the Fed are analysing the appropriate terms and conditions for accepting CMBS, as well as evaluating a number of other types of triple-A rated newly issued ABS for possible acceptance under the expanded programme. The two organisations currently anticipate that ABS backed by rental, commercial and government vehicle fleet leases, and ABS backed by small ticket equipment, heavy equipment, and agricultural equipment loans and leases will be eligible for the April funding of the TALF.

Other types of securities under consideration include private-label RMBS, CLOs and CDOs, and other ABS not included in the initial rollout, such as ABS backed by non-auto floorplan loans and ABS backed by mortgage-servicer advances. As is the case for the current categories of newly originated loans, the TALF will combine public financing with private capital to encourage the private securitisation of loans in the asset classes eligible in the expanded programme.

Open source for CDS model
The ISDA CDS Standard Model has been launched as an open source project. The model has its basis in JPMorgan's CDS Analytical Engine, which was transferred to ISDA on 29 January 2009. The code underlying the model is widely used in the industry to price CDS contracts.

Making the code available as open source increases availability and transparency of CDS pricing, ISDA says. Along with the code, standard inputs to the model - such as recovery value and yield curve - will be described and made available in due course, together with an online discussion forum, which will allow for community input. Markit, in its role as administrator, will provide support for the maintenance and further development of the code, following open source principles and under the direction of ISDA.

Armins Rusis, evp and global co-head of fixed income at Markit, adds: "The standard model provides a critical piece of fixed-coupon CDS trading infrastructure, ensuring that counterparties calculate upfront fees in a consistent manner. A market standard valuation model that is freely available to all will enhance trade accuracy and help ensure continued operational improvements in the CDS business. Markit appreciates the opportunity to assist ISDA and the industry in this important undertaking for the CDS market."

Japan/Asia index rules amended
After consultation with the dealer community, Markit has amended two rules governing the Markit iTraxx Japan and Markit iTraxx Asia ex-Japan indices. The new rules will come into effect before next month's index roll into series 11 on 20 March 2009.

The first rule change introduces a maximum spread cut-off requirement to the eligibility criteria for constituents of iTraxx Japan. Entities with an average spread of 2,000bp or more over the last ten trading days of the month preceding the index roll will not be eligible for inclusion in the index. This new rule is designed to ensure that companies with very wide spreads or close to default are not included in the index.

The second rule change introduces a dealer vote on entities deemed necessary for inclusion and exclusion from the iTraxx ex-Japan IG and HY indices. Under the previous process, constituents of these indices were selected on the basis of liquidity lists submitted by dealers.

ICE plans H109 European CDS CCP launch
Following the meeting hosted by the ECB in Frankfurt on 24 February 2009, ICE Clear Europe has confirmed its commitment to working closely with its regulators and the industry to provide a central counterparty for European CDS contracts. ICE Clear Europe is a wholly-owned subsidiary of IntercontinentalExchange.

"We recognise the importance of a European regulated central counterparty for CDS, given the key role of European banks in the global CDS market," says Paul Swann, president and coo of ICE Clear Europe. "We are leveraging our domain knowledge in credit derivatives and over-the-counter clearing, and working together with regulators and market participants to deliver a solution that meets the requirements of the European market."

ICE Clear Europe, which is regulated by the UK FSA, anticipates a first-half 2009 launch for CDS clearing, subject to regulatory approval. It will establish a segregated risk pool, including guaranty fund and margin accounts, and dedicated risk management systems for the European CDS market, with the objective of bringing a common infrastructure to market participants.

Stress tests revealed
The Obama administration has released further details on its proposed bank stress-tests, although some analysts suggest that they arguably aren't stressful enough on a bank-specific basis. The aim is to assess by end-April how banks will perform under a more pessimistic macroeconomic environment than current assumptions over the next two years.

The macro assumptions included in the stress test for 2009 and 2010 respectively are: GDP -3.3%, +0.5%; unemployment 8.9%, 10.3%; HPI -22%, -7%. Only banks with over US$100bn in assets are required to participate and assessments include forecasts of revenue, expenses and loan losses.

Banks in a weaker position would be required to boost capital ratios to maintain adequate solvency. In such cases, the bank would be given six months to raise private equity and if unsuccessful would recieve convertible preferred capital under the capital assistance programme (CAP).

Existing TARP money can be repaid and replaced with CAP preferreds.

Ferretti first lien LCDS settled
Markit and Creditex, in partnership with six credit derivative dealers, have announced the results of the credit event auction conducted to facilitate settlement of LCDS trades referencing Ferretti first lien loans. The final price was determined to be 10.875%.

This price was determined following the initial bidding period. This is because there was no open interest from market participants for physical settlement during the initial bidding period, removing the need for a second phase of the auction process.

RBS puts £325bn into asset protection scheme
RBS has confirmed that it is to place assets with a par value of £325bn and a carrying value net of impairments and write-downs of £302bn into the UK government's Asset Protection Scheme. The assets are likely to be drawn from RBS' and its affiliates' portfolios of corporate and leveraged loans, commercial and residential property loans, and structured credit assets. The scheme may also accept synthetic assets and counterparty risk exposures associated with derivatives transactions with monolines and CDPCs.

RBS expects that the scheme will protect: £225bn of third-party assets, £44bn of undrawn commitments and £33bn in other counterparty risk exposures. The agreement will see RBS bear the first-loss amount relating to the assets in the scheme up to £19.5bn (after taking into account historic impairments and write-downs). Losses arising in respect of the assets after the first loss would be borne 90% by the Treasury and 10% by RBS. The scheme will apply to losses incurred on assets on or after 1 January 2009.

RBS will pay a participation fee of £6.5bn to the Treasury. This would be funded through the issuance of B shares, which will constitute Core Tier 1 capital. In addition, RBS will, over a period to be agreed, agree not to claim certain UK tax losses or allowances.

CDPC assumes continuation mode
S&P has lowered its issuer credit rating on Primus Financial Products to single-A from single-A plus and removed it from credit watch, where it was originally placed with negative implications on 26 September 2008. Concurrently, the agency assigned a negative outlook to Primus. At the same time, it affirmed its ratings on Primus' senior debt issues, senior subordinated debt issues and preferred shares, and removed them from credit watch with negative implications.

The lowered rating reflects the issuer credit rating's failure to pass the single-A plus rating capital test, according to Primus' capital model run result in the most recent report provided by the company. According to Primus' operating guidelines, Primus will formally transition from a 'normal' mode of operations to a 'continuation' mode of operations when the issuer credit rating falls below single-A plus. According to programme documents, in the continuation mode Primus will cease entering into new CDS other than risk-reducing swaps.

However, Primus has voluntarily been operating in a continuation mode in an effort to conserve capital in the current environment. According to programme documentation, entering continuation mode requires Primus' board of directors to determine who the manager will be as the swap portfolio amortises. S&P has been informed that the board has elected to retain Primus Asset Management Inc, the current manager, as the continuation manager.

Primus' issuer credit rating still passed the single-A rating capital test by approximately US$4m. In the capital model run, S&P assumes that Primus has to make a termination payment of approximately US$51.5m on the credit default swaps with Lehman Bros. Special Financing Inc, consistent with its ratings criteria for CDPCs.

The current increased capital requirement reflects additional downgrades in the issuer's credit portfolio. Primus has not experienced a new credit event since 17 December 2008.

S&P has removed Primus' ratings from watch negative because its CDS that have experienced credit events have been settled. Given the small margin with which Primus is passing its capital model test, it is likely that additional downgrades in the credit risk portfolio would warrant further rating action or renewed watch placements, however. A negative outlook has been assigned to Primus because the agency believes that the fundamental economic and business condition for this fully ramped credit derivative product company that sells credit protection mainly on single-name credits has greatly changed since it was originally rated.

Distressed assets sold via private/public partnerships
The FDIC has concluded the sale of US$1.45bn of performing and non-performing residential and commercial construction loans in distressed markets through the use of two private/public partnership transactions. These structured sales utilise the asset management expertise of the private sector, while retaining for the FDIC a participation interest in all future cashflows generated by the workout of the assets over time, the corporation says.

In the two recent transactions, the FDIC placed the loans - which were exclusively from the failed First National Bank of Nevada - into a limited liability corporation. The FDIC retained an 80% interest in the assets, with the winning bidder picking up an initial 20% stake. Once certain performance thresholds are met, the FDIC's interest drops to 60%.

The successful bidders on the two transactions were Diversified Business Strategies and Stearns Bank. In all, 18 separate bidders submitted 30 unique bids for both pools of loans.

The future expenses and income will be shared on the percentage ownership of the purchaser and the FDIC. "The FDIC is drawing on its previous successes and those of the Resolution Trust Corporation," comments James Wigand, deputy director, FDIC Division of Resolutions and Receiverships. "During the last banking crisis, when asset values were similarly difficult to ascertain, these types of structures ultimately resulted in superior recoveries relative to the then-depressed market valuations."

The FDIC hired the financial advisor Keefe Bruyette Woods to market the LLC to potential bidders.

Index roll offers relative value opportunities
Structured credit strategists at Barclays Capital note that the forthcoming roll of the CDX index presents unique challenges and opportunities, as investors digest major CDS market changes (the re-couponing of CDS, the removal of the restructuring event from standard contracts and the introduction of central clearing).

"Given these distractions, as well as the generally difficult liquidity environment, we expect relatively limited opportunities in technicals-based roll trades and index arbitrage," they explain. "However, the roll does provide a backdrop against which to highlight interesting relative value trades in several off-the-run indices."

In particular, they see potential for compelling relative value trades in short-dated legacy indices, including CDX HY Series 3.

Close-out protocol launched
ISDA has launched the 2009 close-out amount protocol, which permits parties to agree upfront that in the event of a counterparty default they will use close-out amount valuation methodology to value trades. Close-out amount valuation, which was introduced in the 2002 ISDA Master Agreement, differs from the market quotation approach in that it allows participants more flexibility in valuation where market quotations may be difficult to obtain.

Industry participants observed significant benefits of the close-out amount approach following the default of Lehman Brothers, ISDA notes. In launching the new protocol, the Association is facilitating amendment of existing 1992 ISDA Master Agreements by replacing market quotation and, if elected, loss with the close-out amount approach.

"This is yet another example of ISDA helping the industry to coalesce around more efficient and effective practices, while maintaining flexibility," says Robert Pickel, executive director and ceo, ISDA. "The protocol permits parties to value trades in the way that is most appropriate, which greatly enhances smooth functioning of the market in testing circumstances."

The close-out amount protocol is a so-called 'evergreen' protocol and will remain open for adherence indefinitely.

Four-SPV Russian CLO completed
VTB has completed what are believed to be the first rated cash CLOs of non-SME corporate loans and bonds with the ultimate risk located in the Russian Federation. Amicitia, Gaudium, Opes and Salus Finance are four identical transactions of US$137.6m, retained by VTB Bank. All series share a pool of US$550m loans to Russian obligors, with each CLO comprising an A3 rated Class A tranche that priced at 450bp over three-month Libor.

Moody's says it has been advised that the four-SPV structure was designed to ensure compliance with certain regulatory limitations regarding single counterparty exposures.

At closing, the static portfolio of assets comprised 20 senior loans and nine publicly rated loan participation notes that relate to the metals and mining, banking, telecommunication and other industrial sectors. The highest concentration (26%) is in the metals and mining sector. Moody's has assigned credit estimates to all non-publicly rated loans in the portfolio.

ABX ...
Remittance reports for the February ABX distribution date show monthly aggregate 60+ day delinquencies climbing by 66bp, 91bp, 118bp and 224bp (compared with rises of 56bp, 54bp, 158bp and 167bp last month) for series 06-1, 06-2, 07-1 and 07-2 respectively. Index performance was overshadowed by servicing and seasonality, according to ABS analysts at Barclays Capital.

Defaults were 3-4 CDR lower for the 06 series and 1.0-2.5 CDR lower for the 07 series, primarily because the RAMP, RASC, BSABS and ACE shelves reported a more than 10 point decline in CDR. As a result of slower liquidations, the aggregate 60+ delinquencies rose more than they did last month. However, following last month's large decline in 60+, Carrington serviced deals continued to report 200bp-300bp lower 60+ delinquencies in February, suggesting that the servicer continued to expand loan modification activities this month.

Early stage delinquencies (30-59 days) fell by 40-60bp for the 06-1, 06-2 and 07-1 series and 10bp for the 07-2 series, likely because favourable seasonality started to kick in this month.

A noteworthy trend is the volatility in CDRs during the past three months, note structured finance analysts at JPMorgan. For the most recent February reporting date, it was down across the board anywhere from 91bp for 07-2 to 406bp for 06-2, while CDRs increased as much as 479bp for the 06-2 and as little as 114bp for 06-1 for January and fell in December.

"Every month, the 06-2 index has experienced the biggest swings up and down. More data points are needed to determine a meaningful trend and what is causing it," the analysts add.

Two single-A index constituents have been written down completely, with losses continuing to eat through the subordinate bonds and depleting subordination for more senior bonds. 56 bonds, out of 400, have been written down completely: 34 rated triple-B minus, 20 triple-B and two single-A.

The 07-1 index has been hit the worst, with 20 bonds written down and only nine deals having ABX constituents with no write-down. During the coming months the JPMorgan analysts expect write-downs to continue at a rapid pace, with the single-As being hit more aggressively.

... and CMBX delinquencies continue to climb
The pace of new CMBS delinquencies remained elevated in February, according to the latest CMBX remits. The average 30+ day delinquency rate increased by 26bp to 1.77% across Series 1-5, versus an average 28bp increase over the prior three months.

By property type, multifamily continues to show the greatest weakness, note CMBS analysts at Barclays Capital, followed by retail. By vintage, Series 3-5 continue to lag.

Outside of delinquencies, the analysts noticed a substantial increase in new, specially-serviced current loans, concentrated in Series 2 and 3 in the multifamily sector. "We expect further deterioriation in many of these loans, as the transfers appear related to fundamental credit issues," they note.

Hardwiring schedule revealed
ISDA has revealed the review and implementation schedule for the draft Auction Settlement Supplement and Protocol and for the Credit Derivatives Determinations Committee that are the constituent parts of its 'hardwiring' process (SCI passim). Through hardwiring, ISDA is incorporating into its standard documentation the auction settlement of contracts after a default or other credit event on a company referenced in CDS transactions.

ISDA proposes to publish the Auction Settlement Supplement and open the Protocol on 12 March. The Protocol would be open for adherence through to 7 April, with changes to the documentation covered by the Protocol taking effect upon its closure. In order to offer a longer timeframe for review and implementation by industry participants, ISDA extended the review and implementation schedule for the draft Auction Settlement Supplement and Protocol and the Credit Derivatives Determinations Committee.

The Auction Supplement will amend the ISDA CDS Definitions to incorporate the CDS settlement auction terms that are currently included in the auction Protocols. It will also include provision for the ISDA Determinations Committee, which will make binding determinations for issues such as whether a credit event has occurred; whether an auction will be held; and whether a particular obligation is deliverable. The amendments made by the auction supplement will apply to transactions entered into after the effective date, while the protocol will facilitate the amendment of existing transactions to reflect the new terms.

"Hardwiring is a critical part of the continuing evolution in operational efficiency for these valuable risk management tools," says Robert Pickel, executive director and ceo, ISDA. "Now more than ever, CDS are vital to companies' management of credit risk. The time and resources that ISDA and the industry are investing in refining processes surrounding these important hedging instruments demonstrate our commitment to their effectiveness, and reflect the significance of these instruments in helping achieve economic recovery."

EM CDO rating approach updated
Fitch has published its updated approach for rating CDOs with limited exposure to emerging market (EM) corporate assets. The criteria build upon the framework for rating corporate CDOs, announced in April 2008, and recognise the potential for additional systemic risk posed by concentrations of corporate assets from emerging market countries.

The criteria apply to diversified portfolios of corporate debt with exposures to emerging market assets of up to 50% of the portfolio. For portfolios containing concentrations in EM assets of greater than 50%, a portfolio-specific approach would apply.

The new criteria recognise the potential for additional portfolio default rate variability in portfolios with significant exposure to EM assets. The correlation structure is a simple additive approach, where a correlation add-on of 10% is assumed between any two EM assets, with an additional 10% if the assets are from the same region and a further 5% if they are from the same country. Beyond these assumptions the standard base correlation (1%) would also apply, as would any sector and industry correlation add-ons.

Fitch describes the correlation framework as reflective of its views of portfolio risk, rather than based on any empirical approach. "Fitch believes that a small amount of emerging market exposure in a well-diversified portfolio of debt from advanced economies can add geographical diversity and reduce the portfolio default rate," says Phil McDuell, md and head of structured credit for EMEA and Asia at Fitch in London. "However, it is also Fitch's view that larger emerging market exposures increase the default risk in the portfolio, especially in higher stress scenarios. The correlation framework was developed and tested to be reflective of these views."

The criteria are effective immediately and will be applied to review the rating of any corporate CDOs with exposure to EM corporate assets. Rating changes in the initial review are expected to be limited in addition to those that already resulted from the updated corporate approach.

Troubled company index rises modestly
The Kamakura index of troubled public companies for February changed only slightly from January, increasing modestly by 0.1% to 23.2% of the public company universe - still 0.8% below the recent peak of 24.0% reported for December 2008. Kamakura Corporation defines a troubled company as a company whose short-term default probability is in excess of 1%.

"On 3 February, Kamakura reported that Royal Bank of Scotland was among the rated companies with the largest one-month jumps in short-term default risk," notes Warren Sherman, Kamakura president and coo. "On 26 February, the bank agreed to a deal which could raise the UK government's ownership to 95%."

This month, among rated public companies, the companies showing the sharpest rise in short-term default risk were Chemtura Corporation, Arvinmeritor Inc, Belo Corporation, Alcatel-Lucent and Office Depot Inc.

Taunus 2009-1 closed
Deutsche Bank has closed a €2.1bn SME CLO, Taunus 2009-1. The revolving pool comprises corporate loans to German SMEs with an 0.56-year weighted average life and industry concentration in business equipment and services (16.6%), and building and development (12.3%).

Cross-asset valuations platform launched
Markit has launched what it says is the first multi-bank, cross-asset client valuations platform, an initiative that was first announced in February last year (see SCI issue 77). Dubbed Markit Valuations Manager, the offering provides a secure, standardised view of OTC derivative positions and derivative and cash instrument valuations across counterparties on a single electronic platform. Subscribers to the firm's portfolio valuations service will be able to view the bank counterparty valuations alongside its independent valuations.

Currently, portfolio managers receive numerous statements from their counterparties in multiple formats, requiring many hours of manual consolidation. A recent survey of 50 asset managers conducted by Markit highlighted the urgent need for an electronic, secure valuations process.

17% of respondents to the survey said that a single file delivery of counterparty statements would save them between 50 and 1,000 hours of work a month. On average, respondents estimated time savings of more than 49 hours a month.
More complete position information and a standard statement format across all counterparties ranked as the most important improvements required, followed by an efficient price challenge mechanism.

66% of respondents said they received their counterparty statements by email, underlining the potential security risk of misplaced or incorrectly forwarded emails. And over 65% of respondents said they were under pressure to conduct more frequent reconciliation with counterparties and provide more frequent NAV computation to investors.

The new platform incorporates a dispute mechanism and workflow tools with full audit trail to enhance the price challenge process. Markit Valuations Manager is integrated with Markit's Trade Processing PortRec service to enable full lifecycle support for OTC derivative positions, including counterparty position data delivery, normalisation, reconciliation and valuation.

Markit is launching the platform with six banks - Bank of America, Merrill Lynch, Citi, Credit Suisse, Goldman Sachs, JPMorgan and UBS - and expects to add additional participating banks over the coming months.

Global CDO completed
Dresdner Kleinwort has arranged a global CDO for LBBW. Two series of notes were closed - a €464m A2 Moody's-rated note and a US$308.2bn A3 Moody's-rated note. The deal is backed by leveraged loans and ABS.

Special servicing tracker introduced
To help investors size up the portion of US CMBS that are made up of troubled loans, Moody's has introduced a Specially Serviced Loan Tracker (SSLT). The offering is a measure of specially serviced loans as a percentage of the total balance of US conduit and fusion CMBS deals outstanding. It should be used in tandem with Moody's Delinquency Tracker (DQT), which tracks loan delinquency rates.

Loans in special servicing, by definition, are troubled or problematic loans, as loan servicers transfer loans to special servicing upon default or imminent default. "Monitoring changes in the pace and magnitude of loans becoming delinquent and entering special servicing provides a useful warning signal for likely sector performance," says Michael Gerdes, a Moody's svp.

Moody's SSLT for January 2009 is 1.82%, up 17 percentage points from the month before, and up 128 percentage points from a year ago. Moody's SSLT tracks all loans in US conduit and fusion deals issued in 1998 or later (including deals not rated by Moody's).

Moody's says it expects more downgrades than upgrades in commercial real estate finance as it proactively conducts ratings sweeps of US conduit, fusion, large loan and single-borrower deals and CRE CDOs. The sweeps will be completed by 31 March 2009.

"Thereafter, we expect a period of relative ratings stability, as the numerous downgrades anticipate forecasted increases in delinquency," adds Gerdes.

KOPS expands for government stress tests
Kamakura Corporation has expanded its Kamakura On-line Processing Service (KOPS) to include government-mandated capital stress tests for major financial institutions both in the US and in other countries. The newly expanded KOPS programme includes stress tests of capital values, asset values, deposit volumes and profitability with respect to macro factors such as home prices, unemployment rates, foreign exchange rates, stock indices and gross domestic product.

The expanded KOPS valuation service makes use of the macro-factor sensitivity of default probabilities and credit spreads for the full range of counterparties, from retail borrowers to small business, public companies and sovereigns. In addition, KOPS processing uses both client-specified default models and standard Kamakura default models in which macro economic variables drive default probabilities, credit spreads, collateral values and recovery rates. It also allows 'delayed recovery' that is consistent with current market conditions.

"Over the last year, senior management at Merrill Lynch, UBS and Citigroup has publicly attributed their risk management issues to a lack of visibility at the board level to the macro factor risk exposure that the institution was taking," says Warren Sherman, Kamakura president and coo. "The current emphasis of bank regulators in the US and other major OECD countries on stress testing capital with respect to these macro factors is both necessary and desirable. Existing Kamakura clients have had this capability for more than six years. This expansion of the KOPS service allows major institutions that have not previously had access to this technology to employ it quickly on an outsourced basis, with the option to bring the processing in-house in the future."

The expanded KOPS service makes use of the Kamakura Risk Manager enterprise-wide risk management system, which is able to stress test the movements of macro factors at transaction level for all transactions on the balance sheet, or any subset of those transactions, for a major financial institution, corporation or government-related financial services organisation. Default models are macro factor-driven for all classes of borrowers, from retail to SME to sovereigns.

Risk reporting platform launched
Interactive Data Corporation has released BondEdge Fixed Income Strategist, a new package of capabilities designed for the analytical risk reporting and trade analysis needs of fixed income strategists focused on serving institutional investors. Fixed income strategists and their teams can use this offering in their efforts to gain insight into client portfolios, identify new trading opportunities, analyse risk characteristics of the portfolios and seamlessly share consistent information with groups across their enterprise.

BondEdge Fixed Income Strategist is available via the BondEdge Next Generation Platform, which is built on the Microsoft.NET framework and provides a highly intuitive, flexible user interface. It delivers a comprehensive suite of analytical and reporting tools that include automated market and book value-oriented reporting and simulations, scenario-based cashflow analysis and tools designed to respond to various regulatory and rating agency requirements.

"With the continued volatility in the financial markets, it is critical that fixed income strategists have access to sophisticated risk management tools designed to support their efforts to provide informed, timely advice to their clients," comments Keith Webster, md of Interactive Data Fixed Income Analytics. "By offering a set of capabilities designed specifically for fixed income strategists, we can help this type of user more efficiently leverage the power of BondEdge to enable them to provide a more comprehensive service for their clients and identify new trading opportunities."

Further CSOs ...
Moody's has downgraded another 109 notes issued by CSOs. The rating actions are the result of: (i) the application of revised and updated key modelling parameter assumptions that Moody's uses to rate and monitor ratings of corporate synthetic CDOs; and (ii) the deterioration in the credit quality of the transaction's reference portfolio.

... and CDOs downgraded
Moody's has downgraded its ratings of a further 70 notes issued by 17 CDO transactions which consist of significant exposure to Alt-A, Option-ARM and sub-prime RMBS securities, CLOs or CMBS. The rating actions reflect the agency's updated assumptions and projections on these asset classes.

CDS spreads reach new wides ...
CDS spreads made new 2009 wides on Monday in the major indices as egregious economic data and concern over AIG saw sentiment tank and technicals overwhelmed in the credit and equity markets. Wideners outpaced tighteners by over 8-to-1, according to Credit Derivatives Research, with financials underperforming non-financials and energy names the hardest hit in corporates as oil prices fell significantly.

Spreads continued to push wider after the equity close, with CDX IG ending at its widest since 16 December and CDX HY 11 seeing its lowest price since contract inception (off 14 points from its highest price of 2009 alone), CDR analysts confirm. In addition, low beta underperformed high beta as insurers pushed Ex-HVOL wider.

According to the analysts, the IG 11 curve is now offering more DV01-neutral carry in the 5s10s steepener. "We note that eight of the 10 widest names in IG 11 are now financials, dominated by the insurers, so a steepener bet (to us) seems like a bullish view on multi-line insurance credits (either government support implied by AIG or a miracle in the markets)."

In Europe, meanwhile, XOver reached yet another contract wide yesterday (3 March), being offered at 1150bp before retreating to close at around 1140bp.

... particularly for high yield names
Based on S&P's CDS Indices, spreads for entities in the high yield arena continued to experience significant widening, while spreads for higher grade credits widened more moderately. Over the last week, index spreads for the S&P 100 CDS Index fluctuated between 130bp and 139bp, closing yesterday at 134bp.

Index spreads for the S&P CDS US Investment Grade Index fluctuated between 299bp and 319bp, closing yesterday at 319bp. Meanwhile, index spreads for the S&P CDS US High Yield Index fluctuated between 1313bp and 1388bp, closing yesterday at 1388bp - the index's highest spread this year.

FDIC raises bank failure expectations
The FDIC is to raise the fees paid by financial institutions, as well as levy an emergency premium in a bid to collect US$27bn this year. The FDIC expects bank failures to cost the insurance fund around US$65bn through to 2013, up from an earlier estimate of US$40bn.

The emergency premium, to be levied on the roughly 8,500 institutions, equates to 20bp for every US$100 of insured deposits (compared to an average premium of 6.3bp paid by banks last year). In addition, the FDIC has raised the regular insurance premiums for banks to between 12bp and 16bp, up from 12bp to 14bp.

Securitisation credit quality decreases sharply
Turbulence in the capital markets caused a sharp drop in the overall credit quality of global structured securities in 2008, according to S&P, spurring an average 3.2-notch rating decline for the sector over the course of the year. The decrease came on the heels of a 0.52-notch global rating decline in 2007 and reflected unusually severe deterioration in the credit quality of underlying collateral, particularly mortgage assets, as well as high leverage and scant liquidity.

These factors - along with volatile debt and equity markets, the difficulties facing some key financial institutions (including monoline insurers) and the resulting government bailouts - led to unprecedented rating volatility for structured finance securities. Overall, S&P downgraded approximately US$1.9trn (19.4%) of the roughly US$9.8trn original issuance amount of outstanding global structured securities in 2008.

Last year's chain of events also resulted in the highest relative annual defaults among both investment grade and speculative grade global structured securities in the roughly 30-year history of the structured market (notwithstanding a peak in 1988 among speculative grade securities, resulting primarily from the small sample size at the time). The amount of defaulted securities in 2008 reached approximately US$112bn, 1.1% of the total outstanding issuance amount of global structured securities.

Still, although the absolute level of defaults increased significantly during 2008, the relative default behaviour of ratings remained in line with historical patterns. That is, higher ratings continued to experience lower average default rates and vice versa.

S&P believes that credit performance and default rates for the rest of 2009 will depend, in large part, on the success of government stimulus packages across the globe and the health of the global economy - specifically, the unemployment picture and any stabilisation in various housing markets.

SROC results in for Japan ...
S&P has lowered its ratings on 51 tranches relating to 44 Japanese synthetic CDO transactions and removed its ratings on 35 of the 51 tranches from credit watch, while keeping the ratings on the other 16 on watch negative. At the same time, the agency raised its ratings on two tranches relating to two Japanese synthetic CDO transactions, and removed the ratings from credit watch with positive implications.

The upgrades are mainly attributable to the rating migration of reference entities, including the rating upgrade of GMAC from SD to triple-C on 4 February 2009 and that of Clear Channel Communications from SD to single-B on 24 December 2008.

... and Asia-Pacific
S&P has lowered 51 ratings on 50 tranches of Asia-Pacific (excluding Japan) synthetic CDOs. The ratings on two other CDOs were raised and removed from credit watch with positive implications. At the same time, 23 ratings of the downgraded CDO tranches were kept on watch negative and 28 ratings of the downgraded CDO tranches were removed from watch negative.

The downgrades reflect the increased credit risk of underlying portfolios in the respective transactions.

BIS Quarterly Review released
The latest BIS international banking statistics indicate that international banking activity continued to reflect the tensions on bank balance sheets in Q308. BIS reporting banks' total gross international claims actually grew by US$248bn to US$37.5trn, driven largely by greater inter-office activity. Lending to other (unaffiliated) banks fell, however, reflecting the severe market strains following the failure of Lehman Brothers on 15 September. With interbank markets effectively shut down by end-September, banks sought dollar financing elsewhere: their liabilities to official monetary authorities soared in the third quarter, reflecting in part their use of central bank swap lines.

The latest BIS international debt securities statistics show that borrowing in the international debt securities market rebounded in Q408 as the turmoil in financial markets subsided. Net issuance of international bonds and notes increased to US$624.3bn, up substantially from US$253.3bn in the third quarter. Financial institutions recorded the largest increase, as their borrowing was supported by government guarantee schemes for bank bonds in Europe as well as in the US.

Even more important was greater issuance of mortgage-backed bonds in the UK, as well as in Belgium, Germany, Italy and Spain. The notable increase in issuance coincided with the introduction of government-led policy initiatives that included asset purchase programmes and swap facilities, the BIS explains.

The Quarterly Review also included a special feature entitled 'Assessing the risk of banking crises - revisited'. Historically, unusually strong increases in credit and asset prices have tended to precede banking crises, according to the report.

Whether the current crisis could have been anticipated by exploiting this relationship is explored by its authors, Claudio Borio and Mathias Drehmann of the BIS, by assessing the out-of-sample performance of leading indicators of banking system distress developed in previous work, also extended to incorporate explicitly property prices. The authors find that the indicators are fairly successful in providing a signal for several banking systems currently in distress, including that of the US. They also consider the complications that arise in calibrating the indicators as a result of cross-border exposures.

Negative outlook for bond insurers
With the global structured finance market largely dormant, most bond insurers are focusing on the US public finance market. Even so, S&P's outlook for the monoline industry is generally negative.

"Investors in wrapped paper and in debt and equity have apparently lost confidence in insurers in general, especially amid ongoing credit deterioration globally," explains S&P credit analyst Robert Green. "Market acceptance is uncertain for companies that have been downgraded in a market that came to expect triple-A ratings. In addition, we believe competition from new or alternative sources may increase."

Another factor that could be giving investors pause for thought may be the commutation strategies of many companies that settled some CDO claims with the counterparty on a discounted basis (SCI passim). And continued losses in domestic sub-prime mortgages and related ABS CDO exposures cannot be ruled out.

RMBS CDO liquidated
Nautilus IV, an RMBS CDO that triggered an event of default as a result of the Class A-1 overcollateralisation ratio falling below 100% on 2 September 2008, has been liquidated. The final distribution was made on 15 December 2008.

The proceeds from liquidation were insufficient to pay the Class A-1S notes in full, with the notes receiving about US$43m in principal distributions on the final payment date. The rest of the notes did not receive any principal distributions.

Interest proceeds were used to make distributions to the trustee, preference share paying agent, administrative expenses, senior collateral management fee and to the hedge counterparty. Principal proceeds were used to make interest distributions the Class A-1S, A-1J and A-2 notes.

Fitch has affirmed and withdrawn all ratings on the transaction.

CS & AC

Trading

Trading ideas: hammered

Dave Klein, senior research analyst at Credit Derivatives Research, looks at a capital structure arbitrage trade on Humana Inc

The Obama administration delivered its budget outline to Congress last week. Among the items included was a proposal to require Humana Inc (HUM) and others to enter into a competitive bidding process for Medicare Advantage plans.

Humana's stock was hammered, dropping by over 15%. Unless there is a significant change to a company's capital structure, a drop in equity should be reflected in a widening of CDS spreads. This has not been the case with Humana, as the company's CDS outperformed equity.

We recommend buying CDS protection and buying stock in the company, betting that either CDS will catch up to equity or the market has overreacted and a recovery in the company's stock will be forthcoming. When legislation is pending, it can be risky to judge fair value based on past trading behaviour. However, we believe the disconnect between CDS and equity in this case is big enough to warrant equity outperformance in the short term.

Delving into the data
Our first step when screening names for potential trades is to look at where equity and credit spreads stand compared to their historical levels. To judge actual richness or cheapness, we rely on a fair-value model and consider the empirical relationship between CDS, implied volatility and share price.

Exhibit 1 plots five-year CDS premia versus fair value over time. If the current levels fall below the fair-value level, then we view CDS as too tight or equity as too cheap. Above the line, the opposite relationship holds.

Exhibit 1

Humana's stock took a dive last week, which resulted in its fair value CDS jumping wider. The company's CDS now trades quite tight to fair value.

Exhibit 2 charts Humana's market and fair CDS levels (y-axis) versus equity share price (x-axis). The green diamond indicates our expected fair value for both CDS and equity when CDS, equity and implied vol are valued simultaneously.

Exhibit 2

The blue circle indicates the current market values for CDS and equity. The red line is the modelled relationship between CDS and equity.

With CDS too tight compared to equity, we expect a combination of equity rally and CDS widening. Even if equity does not recover, Humana's CDS is still trading far tighter than when equity traded in a similar range.

Risk analysis
The main trade risk is if the name begins trading under a different regime and the current vol-equity-CDS relationship no longer holds.

Each CDS-equity position does carry a number of very specific risks.

Recovery and 'default' stock price assumption: in the default scenario the cheapest-to-deliver CDS obligation may have a different than expected market value and the stock price might not fall as assumed.

CDS present value (PV): the CDS PV is an expected value, but not necessarily a realised outcome. In practice, the CDS may trade on an up-front or running basis.

Corporate actions: spin-offs and private equity buyouts, for instance, could radically change the equity-CDS relationship, leaving investors with a mishedged position.

Government actions: bailouts, stimulus packages and other governmental interventions have distorted the credit-equity relationship among certain names. The Obama administration's budget outline places Humana at risk and the old equity-CDS relationship may no longer apply.

Mark-to-market: in our view, credit and equity markets operate largely independently and this can lead to trade opportunities. At the same time, any relative mispricing may persist and even further increase, which could lead to substantial return fluctuations. Additionally, the trade faces a fairly substantial bid-offer to cross in CDS.

Overall, frequent rehedging of this position is not critical, but the investor must be aware of the risks mentioned above.

Liquidity
Liquidity (i.e. the ability to transact effectively across the bid-offer spread) in the equity and CDS markets drives any longer-dated trade. Our data on liquidity, created from the volume of bids, offers and trades that we see each day, reassure our trading in HUM. Humana is a reasonably liquid name and CDS bid-offer spreads are around 20bp.

Buy US$10m notional Humana Inc 5-Year CDS at 320bp.

Buy 45,000 shares Humana Inc at US$24.85 to pay 320bp of carry.

For more information and regular updates on this trade idea go to: www.creditresearch.com

Copyright © 2009 Credit Derivatives Research LLC. All Rights Reserved.

Note: This article is intended for general information and use, and does not constitute trading advice from Structured Credit Investor (see also terms and conditions, below, section 12).