Contents

CLOs

Missing the point?

Potential inclusion of CLOs in TALF receives mixed response

The potential expansion of TALF documentation to include triple-A corporate CLOs has received a mixed response from structured credit market participants. While some say the inclusion of CLOs is a logical and welcome development for the market, others suggest that it misses the original point of the programme and could create more problems than it solves.

"I believe it is far too early to be starting to consider triple-A CLOs for TALF," confirms Jason Pratt, md at Peritus Asset Management. "There are so many factors that the Fed will have to take into account, such as who is going to analyse the CLO tranches with all the potential stresses and how likely it is that the triple-A CLOs will maintain that high rating, given the uncertainty surrounding rating agency methodology at the moment."

He continues: "The original objective of the TALF was to restart lending by accepting newly-originated, consumer-orientated transactions. The (potential) inclusion of triple-A corporate CLOs would be difficult to justify, as it is not consistent with the programme's original purpose."

Subscriptions for funding for the first round of the TALF began yesterday, 17 March, with eligible collateral including auto, student loan, credit card and SME loan collateral. The second phase is slated for 24 March and is expected to include ABS backed by rental, commercial and government vehicle fleet leases, as well as ABS backed by small-ticket equipment, heavy equipment and agricultural equipment loans and leases (see also Research Notes). CLOs and other credit portfolio structures are an asset class under consideration (as is private label mortgage securitisation), but clarification on the details of such a plan has not yet materialised.

The argument for the inclusion of CLOs is strong, however. S&P data shows that in the CLO sector alone approximately US$242bn of mostly speculative grade corporate loans is due to mature between 2011 and 2014.

"If the general scarcity of corporate financing continues for the next several years, an extended drought in new CLO issuance may further reduce funding sources and put an additional burden on companies that are already under considerable financial stress," says Ratul Roy, structured credit strategist at Citi.

Meanwhile, it is predicted that any new CLOs structured specifically for the TALF would be of a higher quality than those seen in recent years, as new loans are considered to have better protection, spread and leverage than those originated for CLOs in the past - thereby reducing the risk to the taxpayer.

Roy suggests that the programme should go further than accepting CLOs and also include secondary loan assets to some degree. "This would indirectly help secondary market CLO spreads and thus provide a support to primary CLO spreads," he says.

But the whole idea of the TALF still remains open to criticism. "As a point of stimulus, you have to consider whether or not TALF is really going to spur lending at the consumer level," notes Pratt.

"The last time I checked you normally need a job before you buy a car. I don't think TALF is doing any more than keeping structured credit origination staff on the desk at the moment. Given that I have many colleagues out there, I'm happy about this, but I don't see it as a major catalyst to support credit flows," he concludes.

AC

Regulation

Retention tension

EC's new ABS rule counterintuitive to primary market revival

The European Commission has agreed, under its CRD amendments (see last week's issue), that issuers must retain 5% of any securitised paper on their balance sheets. But the move may not help to reopen European primary markets, despite the regulators' wish to do so.

Issuers will be given the option of retaining either a vertical slice of the risk across the whole capital structure or 5% of the equity tranche, under the EC's proposal. If the issuer fails to adhere to the 5% rule, regulated investors will have to set aside an additional penalty equal to 1.5 times the compulsory regulatory capital when investing in ABS under Basel 2.

Although the 5% retention level - which is likely to come into force in 2010 - is at the lower end of the discussed 10%-15% level originally put forward by the EC, for the most part the proposals have been met with a muted response. This is because issuers are also likely to be given a further choice, whereby they can ignore the 5% retention level if they provide a representation of full due diligence of the portfolio instead.

According to one structured credit investor, given the choice, most issuers will opt for the latter option - portfolio due diligence representations. He expects that issuers that take this option in place of the 5% retention rule will most likely make the originators lead manager on the deal, as they will be best positioned to carry out the due diligence.

"Making the issuer retain 5% of a deal is not a viable way of getting deals done," he says. "To begin with, it would be very difficult to create a sustainable client business. Moreover, it would mean that balance sheets of issuing banks would become clogged up with retained chunks of securitisations at a time when regulators are trying to get banks to reduce the size of those balance sheets."

The investor continues: "It's a nice idea, but it's just not practical. If the European Union wants to re-open the primary market, this is not the way to do it."

According to European credit analysts at Barclays Capital, it is up to investors to take responsibility for pressing through any reforms needed by the ABS market via their industry representation. "New investors will only continue to come into the sector if and when ABS can prove that it has performed in line with expectations, despite all the challenges it faces," they suggest. However, they add that a focus on the revival of new primary ABS issuance in the short term, government-guaranteed or otherwise, might delay any of these solutions and reforms.

AC

CDS

AIG names bailout beneficiaries

AIG has publicly identified certain CDS counterparties that received payouts from the insurer following the granting of an emergency US$85bn loan by the FRBNY in September last year. Goldman Sachs tops the list of banks that benefitted the most, with a total payout of US$12.9bn, closely followed by Société Générale with US$11.9bn, Deutsche Bank with US$11.8bn and Barclays with US$7bn.

Maiden Lane III, a financing entity set up in November to purchase the securities underlying certain CDS contracts from the counterparties and to allow the cancellation of the contracts (see SCI issue 117), made payments to counterparties totalling US$27.1bn. Meanwhile, municipalities received a total of US$12.1bn from AIG Financial Products in satisfaction of guaranteed investment agreement (GIA) obligations.

AIG states that the public aid was also used to satisfy obligations to financial counterparties related to its securities lending operations - securities lending counterparties received US$43.7bn. The remaining balance of the bailout money was used by the insurer for the funding of Maiden Lane II and III, debt repayment and capital support for some of its businesses.

AIG's report does not clarify which banks have residual CDS exposures, however.

AIG chairman and ceo Edward Liddy says that the counterparty and collateral information shows that billions in government assistance flowed to dozens of financial counterparties and municipalities during a time of acute stress in the economy. He also says that AIG's disclosure of the counterparties does not change its commitment to maintaining the confidentiality of its business transactions.

"Our decision to disclose these transactions was made following conversations with the counterparties and the recognition of the extraordinary nature of these transactions," he adds.

There is some speculation that the US government will gradually strip AIG of its potentially profitable businesses and leave behind a shell that will be maintained until its CDS exposures are no longer a threat to the financial system.

AC

Documentation

Negative surplus to test bankruptcy definition?

A regulatory filing by Syncora Guarantee last week tests the definition of Section 4.2(b) of the ISDA Credit Derivatives Definitions, according to US credit strategists at Barclays Capital. According to that clause, a 'bankruptcy' means that a reference entity "becomes insolvent or is unable to pay its debts or fails or admits in writing in a judicial, regulatory or administrative proceeding or filing its inability to generally pay its debts as they become due".

Since the term insolvent is not defined elsewhere in the Definitions, it is not clear cut as to what constitutes insolvency. In its 8-K, Syncora stated that it "filed its 2008 Annual Statement, which included its unaudited SAP financial statements with the NYID and reported therein a policyholders' deficit, determined in accordance with SAP, of approximately US$2.4bn at 31 December 2008".

"This negative surplus could potentially indicate insolvency on a balance sheet test of liabilities exceeding assets, although an argument can be made that there are many companies with liabilities exceeding assets that are generally not viewed as being insolvent," the BarCap strategists explain. "In addition, while the company has failed this test under SAP accounting, which is used in the insurance industry, it has not officially done so under GAAP accounting yet. However, in the insurance industry, a negative surplus is specifically viewed as a measure on which a finding of insolvency can be made and therefore provides a possible barometer in the absence of a formal definition of insolvency in the ISDA Definitions."

The strategists add that the insurance code states that the NYSID superintendent may proceed against the monoline but does not obligate him to do so. Syncora acknowledges in the 8-K that, based on its current balance sheet, this could occur: "If the transactions contemplated by the 2009 MTA and the related agreements and the Transaction Agreement are not consummated, Syncora Guarantee is expected to continue to report a policyholders' deficit and may therefore be subject to action by the NYID."

Consequently, while there are arguments for and against Syncora's being insolvent, the better position is that the monoline's disclosure appears to meet Section 4.2(b) of the bankruptcy definition, the strategists conclude.

Separately, BroadStreet Capital Partners' BCP Voyager Master Funds SPC, acting on behalf of the Distressed Opportunities Master Segregated Portfolio fund, has launched an offer to acquire 56 different classes of RMBS insured by Syncora Guarantee with an aggregate notional value of US$5.9bn. The fund has arranged financing of up to US$385m for the offer.

It is acquiring the RMBS in consideration for either cash or a combination of cash and a certificate generally representing the economics of the RMBS securities without the benefit of the Syncora Guarantee insurance policy. If the offer is completed, it will significantly reduce Syncora Guarantee's statutory loss reserves for RMBS, the monoline confirms. Upon completion, Syncora will receive shares in the fund and certificates representing the insurance cashflows on the RMBS acquired by the fund in return for the financing provided by Syncora for the offer.

The closing of the offer and related financing are conditioned upon approval of the New York State Department of Insurance, the execution and consummation of a Master Transaction Agreement among Syncora Guarantee and certain financial institutions to restructure and commute certain of its obligations and the tender of a minimum amount of RMBS.

The offer will expire, unless extended by the fund, on 7 April. Holders of the RMBS securities that participate in the offer before 24 March will be eligible to receive a premium for their early participation in the offer.

CS

Indices

Positive returns for hedge fund index

Both gross and net monthly returns for January 2009 in the Palomar Structured Credit Hedge Fund (SC HF) Index moved into positive territory for the first time since last May.

The latest figures for the index were published this week and show a gross return of 2.07% and a net return of 1.75% for the month of January (compared to -0.61% and -0.73% respectively in December). However, the gross and net indices still show negative annualised returns since outset of -9.84% and -11.59%. For more Index data click here.

The objective of the Palomar SC HF Index is to produce an index that represents the risk and return of investable hedge fund investments in the structured credit area. It currently tracks 19 funds and represents over US$7.5bn of assets under management.

The index aims to provide a monthly measure of the performance of the universe of open, investable structured credit hedge funds. The Palomar SC HF Index is calculated in two formats - as gross asset value and as net asset value.

The Palomar SC HF Index is compiled and run by Palomar Capital Advisors and published exclusively by Structured Credit Investor. Palomar Capital Advisors is a financial advisory firm specialising in structuring, managing and placing alternative investment products, specifically credit-related securities. It is an independent firm based in Zurich, Switzerland, owned and controlled by its investment professionals.

Monolines

Monoline faces class action over restructuring

Aurelius Capital Master, Aurelius Capital Partners, Fir Tree Value Master Fund, Fir Tree Capital Opportunity Master Fund and Fir Tree Mortgage Opportunity Master Fund have filed a class action against MBIA in relation to losses following the monoline's restructuring and subsequent split into two separate entities in February (see SCI issue 124).

The class action relates to RMBS, CMBS, ABS, CDOs, international public finance obligations, GICs and MTNs guaranteed by MBIA Insurance financial guaranty, amounting to US$241bn (as of 31 December 2008). According to the plaintiffs, the action arises out of a "massive fraudulent conveyance transaction engaged in by the MBIA Defendants in breach of their covenant of good faith and fair dealing with their financial guaranty policyholders".

MBIA is accused by the plaintiffs of stripping over US$5.4bn of assets from MBIA Insurance in a "calculated and cynical" effort to enrich structurally junior economic stakeholders of the parent company MBIA Inc, including its senior executives and shareholders, while leaving some US$241bn of policyholders stranded in a denuded insurer that will be unable to meet its obligations as they come due.

"By guaranteeing payment of principal and interest on hundreds of billions of dollars of these 'toxic securities' - more than any other monoline insurance company - MBIA Insurance was already a central contributor to the present financial crisis," the plaintiffs state. "The MBIA Defendants have now compounded the crisis by stripping billions of dollars from an already-distressed MBIA Insurance and giving those billions of dollars to a new venture that seeks to profit the MBIA Inc parent company and its executives and shareholders at the expense of the most at-risk policyholders of MBIA Insurance."

They add that this "looting" of MBIA Insurance runs directly at cross-purposes to the Federal government's efforts to stabilise banks and insurance companies, since those types of institutions hold the bulk of the affected securities insured by MBIA Insurance.

MBIA has responded to the class action filing, saying that the complaint makes various broad-based and unsubstantiated allegations with regard to its restructuring. "All of MBIA's actions were approved by the New York State Insurance Department (NYSID) after a thorough examination, including an assessment by both the company's outside advisers and the NYSID of MBIA's ability to meet its obligations to all policyholders," the monoline says. "In addition, the Illinois Division of Insurance approved all transactions entered into by MBIA Insurance Corp of Illinois in connection with the transformation."

MBIA believes the allegations in the complaint are without merit and intends to defend it vigorously.

AC

Structuring/Primary market

CDO restructuring completed

Fitch has affirmed the ratings of Scute II following a significant restructuring of the deal. Earlier this year the manager, NIBC Credit Management, restructured the CDO-squared by cancelling the FX swap, re-denominating all notes in US dollars and creating and drawing on a subordinated loan to partially repay US$238m of the Class A notes.

The subordinated loan ranks equally with the Class B notes. NIBC CMI has proposed to draw an additional US$170m of the subordinated loan to further reduce the Class A notes on the next payment date, which falls today, 18 March.

The proposed draw on the subordinated loan and additional partial repayment of Class A notes will increase credit enhancement through subordination to approximately 57%. Consequently, it is expected that the transaction will be able to withstand the default of approximately 55% of the current portfolio at marginal recovery values.

However, Fitch says that the underlying portfolio is still highly susceptible to further credit deterioration and negative portfolio performance as it is overwhelmingly exposed to US structured finance CDOs (93% of the portfolio). On an adjusted basis, approximately 31% of the assets are treated as sub-investment grade. The weighted average portfolio quality is double-B plus and 38% of the portfolio is on rating watch negative.

The transaction is static, but may still become managed at the option of two-thirds of the Class B noteholders. Furthermore, the transaction documents provide for application of the Class A OC test during the reinvestment period only. Currently the Class A OC test is not applicable, which allows excess spread to be paid to the junior notes while the Class A notes are still outstanding.

As per the trustee monthly report dated 27 February 2009, the portfolio contained 138 assets from 58 obligors. The largest single obligor exposure is approximately 7% of the outstanding portfolio amount, with the three largest obligors accounting for approximately 16% of the outstanding portfolio amount. 10% of the portfolio, comprised entirely of US SF CDOs, is rated triple-C plus or below.

AC

NPLs

Call for clarity

Distressed timing and tactics discussed

The need for increased clarity around government intervention in the market was the main message from attendees at IMN's European Distressed Credit Investing Summit last week. However, plenty of advice was also on offer in terms of timing and tactics with respect to the distressed opportunity.

"There continues to be uncertainty around how government intervention will play out, which isn't helping the market. We need some structure to policymakers' efforts," said one panellist, Graham Martin, partner advisory at PricewaterhouseCoopers.

By way of an example, he explained that the Resolution Trust Corporation (RTC) was successful in addressing the value/pricing issue, as well as providing clarity regarding both the government's and tax payers' obligations. Another example is the Swedish crisis, where the government had the ability to force banks to disclose losses and regimented the process in terms of valuations. "But over the past 24 months there have been so many different initiatives that they have served to create confusion in the market," Martin added.

Another panellist, Jonathan Fragodt, head of European distressed illiquid credit at TPG Credit, pointed out that - in addition to retroactive assets - there should be a provision to help distressed but performing borrowers to refinance. Thanks to its support of a number of lenders, the UK government is estimated to control 45% of the UK mortgage market, so it is in a position to help. However, so far it is perceived to have been reactive and therefore has served to put the breaks on any progress.

TPG has two main strategies: in the US it buys performing mortgages and uses the FHA to modify them; and in the UK it buys non-performing loans and works with the servicer to create duration. Fragodt confirmed that there appears to have been a complete halt in bank lending. "The UK government's action has slowed down the resolution process - although its Asset Protection Scheme could ultimately be beneficial."

But one potential positive development could be the formation of a support network around an RTC-type vehicle. Monique Suter of Alpstar observed that the European market needs to develop a better infrastructure in terms of servicers and independent advisors/asset managers.

"Generally, Europe has never had an asset management industry to the extent of that in the US," she said. "The fact that there is a lack of independent asset managers has been problematic for prices: since there are few sellers and one side of the market doesn't mark-to-market, there has been pricing dislocation. But independent managers can spur prices - there needs to be enough of them to create an efficient market."

Against this backdrop, the timing of an investment in distressed assets becomes evermore important. "Timing is important in terms of how quickly the underlying cashflows can be accessed, which enables exposure to be reduced and allows flexibility in terms of decision-making," commented David Castillo, senior md at Further Lane Securities. "A lock-up is also necessary in terms of mitigating mark-to-market and liquidation risks - longer time horizons are important in order to realise the value of these assets."

Peter Coates, head of the European office at Lighthouse Partners UK, noted that his firm is generally cautious on Europe, given the lack of transparency and the fact that headline pricing hasn't declined as much as it has in the US. "There are opportunities in the US playing capital structure arbitrage, but Europe is 6-12 months away from experiencing distress in this area. Peak defaults are likely to occur sooner in the US," he argued.

Miguel Ramos, md at GSO-Blackstone, agreed that it's tough to get comfortable with European assets because of the lack of transparency on the underlying, as well as concentration between managers in later vintages. He added that, for some transactions, it might be better to wait for rating agency actions to play out before entering the market - with potential opportunities consequently arising in the second quarter.

Panellists highlighted that a number of funds came unstuck after entering the distressed credit space too early and with high leverage. But Coates suggested that the size of the opportunity and the diversity of assets on offer mean that there is no need to rush into the market. "We're balancing our short-term event-driven opportunistic activity (using managers to essentially force control positions) with other appropriate long-term distressed opportunities."

2009 is expected to see a significant rise in leveraged loans breaching their covenants and struggling to be refinanced. Panellists expressed interest in waiting to see how private equity houses will react; for example, under which terms they'll add cash to and/or restructure a loan.

Alpstar's Suter advised investing in high quality non-cyclical names or loans that already have a distressed story. "Uncertainty about the legal situation means that it might be better to invest in cov-lite loans, so there is less likelihood of covenants being breached," she added.

Stuart Mathieson, director at Babson Capital Europe, agreed that non-cyclical high performing loans are a good bet. "The market has bifurcated between high quality assets trading with yields of around 15% and those where investors are essentially waiting for them to default," he remarked. "CLOs have certain rights as secured creditors and so it is possible to limit the downside of a portfolio if you're selective. The aim is to have security over cash-generating assets, so it is important to understand the mechanics and be careful about funding requirements."

Ramos said that his firm is looking for specific situations at the double-A level in CLOs that offer value, such as structural or documentation features. However, he warned: "CLOs are difficult to price and so investors should be paid for the lack of liquidity, but it's important to be aware of sources of risk - both technicals and fundamentals have changed in the market."

Debtor-in-possession (DIP) financings were also highlighted as an area of opportunity. According to Lighthouse Partners' Coates, DIP financings in the US "are a no-brainer" and have become even more attractive to hedge funds since GE exited the market.

Jason Clarke, md at Strategic Value Partners (UK), concurred that the DIP market in the US is keenly priced and liquid because such financings are perceived to be super senior in the capital structure. But he pointed out that this isn't the case in Europe, where lenders charge eye-watering fees and tend to attach strategic constraints to the facility.

Looking ahead, with recovery rates likely to drop dramatically, the ability to work out loans is vital. Indeed, secondary loan trading is expected to begin picking up once clarification of certain legal issues and untested jurisdictions has occurred.

CS

Asset recovery group launched

The latest company and people moves

Alpstar has launched a strategic asset recovery group, whose focus is on the restructuring and recovery management of distressed fixed income assets. Alpstar decided to form a dedicated group after receiving a number of requests from pension funds, which needed help in restructuring their fixed income investments.

"Throughout the European continent, many fixed income investors - especially those in high grade - are now finding that their portfolios, on average, have fallen below investment grade - in some cases substantially so," says Michael Curtis, senior credit analyst at the firm. "These managers clearly need assistance to carve out and restructure these distressed assets, so that value can be captured in any recovery scenario. In some cases, we have been asked to add additional distressed assets where the value is obvious, as a way of making a play in the sector as well."

"Oftentimes clients want someone 'at arm's length' to perform the restructuring," adds Nicolas Bravard, co-founder of the Alpstar credit business. "Experience in distressed and asset recovery is essential, and that's our sweet spot."

Manager makes insurance solutions push
NewOak Capital has appointed Tom McAvity as md to market the firm's advisory, asset management and capital markets services to the insurance industry and design customised solutions for insurers, banks and pension and endowment funds.

McAvity brings extensive experience in managing the portfolios of insurance companies in the context of their liabilities. His previous experience includes positions as evp and cio with Scottish Re Group and vp, asset-liability management with Allstate Financial.

"With nearly 40 years of professional experience, including 20 years dedicated to the insurance industry, Tom brings NewOak Capital a unique and valued perspective on the challenges facing the insurance industry. Our goal is to be a solution provider for our clients in order to help them navigate through this most violent storm and Tom will play a role in leading this effort with respect to the insurance space," says James Frischling, president of NewOak Capital.

Structured credit portfolio handed to new team
Threadneedle has been appointed investment manager of the Allco Max Securities & Mortgage Trust (Max) for a portfolio of over A$900m of RMBS, CMBS, CDO and other loans and securities, including exposure to financial institutions and industrials.

The management of the Max portfolio will be led by Threadneedle's recently-appointed global ABS team, which includes Steven Fleming and Ashley Burtenshaw, both of whom are based in Australia. The London-based investment grade credit team, headed by David Oliphant, will also be involved in the portfolio's management.

"Rather than relying on the credit rating of securities, it is becoming essential for our clients to have the ability to effectively quantify, manage and report the risks in their portfolios," Fleming, co-fund manager of the Max mandate says. "As mortgage and structured finance portfolios continue to experience price devaluation and liquidity remains at a premium, the need for robust models and reliable information has never been more important."

Synthetic credit fund launched
Schroders has launched the Schroder Synthetic Credit Fund, which is aimed at capturing the extra returns currently available in investment grade credit. The fund, part of Schroders' Liability Driven Investment fund range led by Andy Connell, Schroders' head of LDI, provides passive exposure to credit markets using a synthetic credit overlay.

"With credit spreads at historic highs, we are seeing a generational opportunity for returns in investment grade credit markets," says Connell. "Schroder Synthetic Credit Fund offers investors access to additional returns without the capital outlay. This allows clients to participate in credit markets without having to materially alter their current asset allocation."

Fund adds two key staff
Cheyne Capital has made two new key hires in corporate credit and ABS. Stephen Best has joined the firm as partner and senior credit analyst responsible for the financial and telecoms sectors in Cheyne's corporate credit team, while Nicolas Vocos has been appointed as an ABS analyst, responsible for modelling and analytics in its ABS group.

Before joining Cheyne Capital, Best was a director at UBS Principal Finance, where he served on the credit committee with responsibility for credit selection and ongoing portfolio monitoring of a major managed CDO programme. Vocos was previously an associate in Deutsche Bank's structured credit products group, where he arranged and executed ABS on behalf of corporates, financial institutions and governments in the UK, Portugal, Greece and Spain. He was responsible for pricing and executing acquisitions of non-performing loans and was involved with risk management analytics and hedging of the RMBS/ABS proprietary portfolios.

Primus hires senior advisor
Primus Asset Management (PAM) has appointed John Chrystal as a senior advisor. Chrystal's primary responsibilities will be to advise PAM's management in optimising the value of Primus Financial Products' credit protection portfolio and to assist with the development of the company's new structured credit asset management initiatives (SCI passim). He will report to Thomas Jasper, ceo of Primus Guaranty.

Over the course of his career, Chrystal has held a number of senior positions in the credit markets. Currently, he is the senior partner of Fusion Solutions SPE 1, an affiliate of Fusion Advisory Partners, a boutique advisory firm focused on structured credit. Prior to Fusion, he was one of the founders of DiMaio Ahmad Capital, an investment management firm focused primarily on the corporate credit market.

Consulting firm makes credit push
Strategic consulting and expert services firm LECG has expanded its financial services sector, with the acquisition of The Secura Group and Bates Private Capital. The new sector will be lead by Peter Vinella, who joined the firm from Wilmington Trust Conduit Services, a subsidiary of Wilmington Trust that provided collateral and fund administration services to issuers, managers and investors in credit and structured financial products.

LECG's financial services sector is divided into four service lines: regulatory compliance; retail securities litigation and arbitration; governance and risk management; and credit and financial products. The industry segments that the new financial services sector will most strongly target include the credit and financial markets, structured financial products and derivatives, bankruptcy and restructuring, pre-merger due diligence and post-merger integration, risk management and regulatory compliance, Vinella says.

Vinella will work alongside LECG's William Isaac, former chairman of the FDIC; Mike Mancusi, former senior deputy comptroller of the currency; and Walt Mix, former commissioner of the California Department of Financial Institutions.

The firm has also recently hired Dan Borge, a financial risk management expert and former head of risk management for a leading international management consulting firm. He will serve in LECG's New York office, while Vinella will split his time between the firm's New York and Emeryville, California locations.

ABS research head hired
Barclays Capital is understood to have hired Reto Bachmann as co-head of European ABS research. Bachmann was previously head of European ABS strategy at UBS in London.

IIF sets up market monitoring group
The Institute of International Finance has established a market monitoring group (MMG), which will be co-chaired by Jacques de Larosière, former md of the IMF and former governor of the Banque de France, and David Dodge, former governor of the Bank of Canada. The MMG, whose membership consists of international finance leaders and highly experienced market practitioners, will contribute to the analysis of systemic stability.

The group's monitoring of vulnerabilities will focus on risks that have systemic implications; for example, liquidity and concentration risk, mispricing of risk, excessive leverage, crowded trades and the potential for contagion across regions due to the interconnectedness of markets. The MMG is expected to develop perspectives that will be shared widely with market participants, while also engaging in informal dialogue with the public sector.

IDC and Koscom team up
Interactive Data Corporation has made its international pricing and reference data available via Koscom to Korea's investment community. Koscom was established in 1977 by the Korean Ministry of Finance and the Korea Exchange to provide market participants with both information solutions and real-time market information.

It has facilitated the development of the Korean securities and futures market by providing an enhanced IT infrastructure. Through this agreement, Interactive Data's extensive international end-of-day pricing and corporate actions data is available to valuations firms, asset management funds and other financial institutions, including the member companies of the Korean Financial Investment Association (KOFIA).

Kevin Kwak, manager, financial information division, Koscom, comments: "This agreement, which gives access to Interactive Data's wide range of international content, will allow us to further strengthen our position as one of Korea's leading financial markets information providers."

QWIL reports
Queen's Walk Investment Ltd has reported a net loss of €20.6m, or €0.77 per ordinary share, for the quarter ended 31 December 2008, compared to a net loss of €37.7m or €1.28 per ordinary share in the previous quarter. However, the investment portfolio generated more cash than forecast, the company says.

Total cash proceeds were €8.1m versus an expectation of €7m. The company's cash position remains solid, with approximately €17.3m of cash on its balance sheet as at 31 December 2008, compared with €18.7m as at 30 September 2008.

Fair value write-downs of the company's portfolio fell in the quarter to €24.1m from €42.1m for the quarter ended 30 September 2008. The majority of write-downs made in the quarter reflect changes in discount rates, rather than actual performance of assets in the portfolio. The company's net asset value at quarter end was €4.12 per share compared to €4.95 per share in the previous quarter.

QWIL says it is ahead of schedule on its debt reduction programme, with gross debt falling from €40.5m at the end of September to €29.5m as at 28 February 2009. The company had agreed with its lenders a target outstanding loan amount of €33m for 31 March 2009 and €31m for 30 June 2009.

Queen's Walk invested €6.7m in investment grade bonds by 31 December 2008, since commencing its new investment programme in August. It made a further €0.7m of investments in the period to 28 February 2009.The investment grade bond portfolio recorded a cash-on-cash yield of approximately 20% in the quarter ended 31 December 2008.

The company has also taken steps to further mitigate risk in its SME portfolio and has purchased a put option on the German MDAX index as a partial hedge against increased defaults in the portfolio.

FSA acquisition approved
The shareholders of Assured Guaranty have approved both proposals submitted for approval at the company's special general meeting. Shareholders approved the issuance of Assured's common shares to Dexia Holdings in connection with Assured's acquisition of Financial Security Assurance Holdings, as well as the issuance of Assured's common shares to the WLR Recovery Fund IV in connection with the financing of Assured's acquisition of FSA (if Assured's management and board of directors decide to utilise this commitment for funding the acquisition).

Assured also announced that it has received regulatory approval from the New York State Insurance Department for the acquisition of FSA. Completion of the transaction remains subject to approval by the Oklahoma Insurance Department and is also contingent on confirmation from S&P, Moody's and Fitch that the acquisition of FSA would not have a negative impact on Assured's or FSA's financial strength ratings. The transaction is expected to close in Q209.

"We are pleased to have received both of these approvals, which were necessary for us to move forward with our acquisition of FSA," states Dominic Frederico, president and ceo of Assured Guaranty. "We are working to finalise the remaining requirements for this transaction on a timely basis and will continue to evaluate our options for funding the cash portion of the purchase price beyond the use of the existing equity commitment."

AC & CS

ISDA's auction protocol launched

A round up of this week's structured credit news

ISDA has launched its Auction Settlement Supplement and Protocol, the final stage of the process known as 'hardwiring' - the incorporation of auction settlement terms into standard CDS documentation (SCI passim). In combination with the changes in market practice that support standard coupons for CDS, the development will introduce greater certainty to transactional, operational and risk considerations for treatment of CDS, the association says.

"This is a major milestone in the ongoing refinement of practices and processes for the efficient, liquid and transparent conduct of the CDS business," comments Robert Pickel, executive director and ceo, ISDA. "Hardwiring is central to the many improvements ISDA and the industry are making to the CDS contract to further ensure that infrastructure and standards for transacting these important risk management instruments are straightforward, secure and widely implemented."

Key parts of the hardwiring process include incorporation into the standard documentation of: auction settlement provisions that eliminate the need for credit event protocols; resolutions of the determinations committees, comprising dealer and buy-side representatives to determine, for example, whether credit events have taken place; and credit and succession event backstop dates that institute a common standard effective date for CDS trades.

"The industry's commitment to hardwiring is critical to the success of the project," adds David Geen, general counsel, ISDA. "In recognising the benefits hardwiring will bring, we must also recognise the insight, hard work and commitment that both buy-side and sell-side participants and the regulatory community have invested in this process."

Potential six-notch downgrade for corporate CDOs
S&P has issued a request for comment on the proposed update to its criteria for rating cashflow CDO transactions backed by corporate loans or bonds and for synthetic CDO transactions that reference pools of corporate obligations. The most notable of the proposed changes is the addition of new qualitative and quantitative tests that would be applied to each rated tranche. If adopted, these changes are likely to have a significant negative effect on current outstanding ratings on many corporate CDO transactions, the agency says.

The new tests are additional to those S&P currently applies in its CDO Evaluator model and are therefore referred to as 'outside-the-default-model' tests. Each tranche must pass these tests, in addition to passing the standard model-generated default and cashflow scenarios.

Additionally, the agency is proposing to recalibrate its CDO Evaluator default model to target specific stressed default scenarios at each of its rating categories. S&P has adjusted the asset default rates, correlation and other model parameters to produce asset portfolio default results for triple-A rated CDO tranches that in its opinion are far in excess of the highest observed in history.

Furthermore, S&P has updated and created a new version of CDO Evaluator specifically to generate obligor default scenarios that it believes reflect extreme economic stress. The agency proposes that all triple-A rated corporate CDO tranches should be able to withstand this high degree of stress without defaulting.

Finally, it is proposing to augment its rating scenario analysis to test the tranche-level effect of changes in key asset characteristics (obligor and industry concentrations) and portfolio parameters (correlation, recovery, defaults and default bias). This approach reflects S&P's view that triple-A rated tranches should be able to withstand what the agency views as particularly stressful scenarios while also meeting new credit stability standards.

"Notwithstanding these significant revisions to these analytical 'inputs', our primary focus was not on any individual input assumption or stress test but rather on the combination of assumptions and stresses that would generate what we see as an appropriate targeted level of credit protection against future defaults," the agency states. "We believe that adding these quantitative and qualitative elements to the analysis - entirely apart from the Monte Carlo simulations run in CDO Evaluator - will provide a more robust analysis than using only simulation models. We also believe that by calibrating CDO Evaluator to the proposed targets, we will make it easier and more transparent for investors to interpret the results and relate the different ratings to their investment objectives."

If adopted, the updated criteria would apply to all new and existing corporate CDO transactions that contain well-diversified pools of corporate credits and have fairly uniform exposure to all credits. S&P has undertaken a preliminary assessment of the potential impact of the proposed new CDO Evaluator inputs by analysing 457 CDO tranches backed by investment grade assets and 215 CLO tranches backed by speculative grade assets. The results of the analyses showed potential downgrades of existing transactions in the range of one to six notches, on average.

S&P anticipates that it will take a few months to update all the outstanding ratings, depending on the volume and complexity of the affected transactions.

TALF-eligible auto deal marketing
NAROT 2009-A, a US$1.5bn auto loan ABS originated by Nissan and sponsored by Nissan Motor Acceptance Corporation (NMAC), was announced yesterday, 17 March. The deal is understood to be the first TALF-eligible transaction to hit the market. JPMorgan and Bank of America are lead managers.

Rated by Moody's, S&P and Fitch, the transaction comprises four rated tranches: Class A1 is rated P-1/A-1+/F1+ and Classes A2, A3 and A4 are all rated triple-A. The interest on the Class A1 notes will be fixed, while the remaining rated notes will be either fixed or floating-rate. The deal is expected to close on 25 March.

Meanwhile, Fortress Investment Group has confirmed that it is planning to take part in the first round of TALF, noting in its Q4 results presentation earlier this week that it has had active dialogues on various different levels regarding the programme. "We believe it represents a tremendous opportunity for investors," the firm's chairman and ceo Wesley Edens noted on a conference call.

Volatility implied ahead of index roll ...
The latest DTCC data indicates that index trades accounted for the largest change (decrease) in notional outstanding in both percentage and absolute terms (87% and US$775bn respectively). Analysts at Credit Derivatives Research suggest that such a significant decrease is perhaps due to index hedgers and arbitrageurs beginning to terminate ahead of the 'big bang' and CDS clearing.

Tranche volumes also shrank, by 3.44% or US$121bn, the largest drop since CDR has been keeping records. "With the ICE Clearing CDX contracts now and the ongoing rolls from legacy to on-the-run instruments, we fear we are seeing signs of illiquidity in even the index markets," the analysts explain. "Going into the roll, when many index arbs will look to cover and potentially top-down capital structure arbs, we would fear some significant volatility as demand and supply potentially become unhinged over the next few weeks."

The most active index positions were traded on the IG 6 and Main 6 indices, as correlation desks lifted hedges (bought back index delta protection) on bespokes and rolled into IG 9 (which saw net protection selling). Notably the scale of risk addition in IG 9 was small relative to the risk reduction in the older vintages, with CDR inferring from this that many investors were terminating positions rather than rolling them.

... while index composition change analysed
BNP Paribas' credit trading relative value team has performed an analysis of the upcoming Markit iTraxx roll, breaking down the impact of the composition change and curve effect. The compositional impact on the indices is significant for the Main index as the substitutions were all based on rating downgrades with, as a result, the exclusion of much wider credits. The overall change, including the six-month curve effect, results in the index spread being 23bp tighter than Series 10.

For the HiVol index, the composition impact is much less, tightening by 5bp at the five-year maturity. At the10-year maturity, the new series should be 8bp wider than Series 10, as the 5/10-year curves of the new constituents are significantly steeper.

The theoretical overall change for the Crossover index will be significantly tighter, by 123bp, due to the curve effect and the improvement in the credit quality of the index. Because of the general steepness of the curve at the short end (3/5-year), the curve impact is significantly higher at the three- and five-year point than at the 10-year point for all the indices, according to BNPP.

Finally, theoretical values of Series 11 highlight that the new index will trade significantly tighter than Series 10 (see last week's issue), particularly for the Main, HiVol and Crossover indices. At present, buying protection on all of the indices is on an upfront cash basis, as current spreads are significantly above their coupon rates.

Constituents reduced for new XO
Markit has announced that Series 11 of the Markit iTraxx Crossover, which starts trading on 20 March 2009, will comprise 45 constituents instead of 50. This is to ensure that only the most liquid eligible entities are included in the index.

MTM accounting explained ...
FASB chairman Robert Herz last week testified about mark-to-market accounting before the US House of Representatives Sub-committee on Capital Markets, Insurance and Government Sponsored Enterprises. He appeared at a hearing convened by Committee Chairman Paul Kanjorski on 'Mark-to-Market Accounting: Practices and Implications'.

"Many investors have made it clear that, in their view, fair value accounting allows companies to report amounts that are more relevant, timely and comparable than amounts that would be reported under alternative accounting approaches, even during extreme market conditions," Herz stated in his testimony.

He underscored the importance of neutral, independent standard setting to capital market investors and noted that, after gathering extensive input about fair value from a diversity of capital market participants, the prevailing view urged the FASB not to suspend or weaken mark-to-market accounting rules. "While bending the rules to favour a particular outcome may seem attractive to some in the short run, in the long run a biased accounting standard is harmful to investors, creditors and the US economy," Herz explained.

Addressing misconceptions that mark to market is a broadly applied rule, Herz noted that mark-to-market accounting generally only applies to trading accounts and derivatives that don't qualify as hedges. Additionally, he clarified that the use of fair value for measurement depends on both the nature of a financial asset and its intended use by an institution.

Meanwhile, FASB looks set to propose giving companies more scope for judgement with respect to the application of fair value accounting, although whether this will result in the wholesale suspension of FAS 157 is unclear. The Board is also expected to discuss whether to allow companies not to take impairments if they are unlikely to sell the asset. It will vote on these issues at its 2 April board meeting, with a view to allowing retroactive application to Q1 results if the proposals are agreed upon.

... while IASB updates on treatment of embedded derivatives
The IASB has clarified the accounting treatment of embedded derivatives for entities that make use of the reclassification amendment issued by the IASB in October 2008. The reclassification amendment allows entities to reclassify particular financial instruments out of the 'at fair value through profit or loss' category in specific circumstances.

The amendments to IFRIC 9 and IAS 39, announced last week, clarify that on reclassification of a financial asset out of the 'at fair value through profit or loss' category all embedded derivatives have to be assessed and, if necessary, separately accounted for in financial statements.

The amendments form part of the IASB's response to views received in the round-table discussions organised jointly with the US FASB in November and December 2008. Participants asked the IASB to clarify the accounting treatment of embedded derivatives in the reclassification amendments in order to avoid divergence in practice.

The amendments set out in embedded derivatives apply retrospectively and are required to be applied for annual periods ending on or after 30 June 2009.

CME CDS trading gets green light
CME Group and its associated joint venture CMDX have received a special exemption from the SEC for clearing and trading CDS through CME Clearing and the CMDX platform. The SEC exemption allows CME Group to use its existing clearing membership structure to offer CDS clearing services backed by CME's financial safeguards package of approximately US$7bn. Clearing members that are registered FCMs or broker-dealers will be able to clear CDS trades on behalf of their qualified customers.

CME Group's clearing of CDS is to be based on the Markit CDX and iTraxx indices. Both CME Group and CMDX have now signed agreements to license Markit's CDS indices and its Markit RED (Reference Entity Database) identifiers. The licensing agreements with Markit will allow Markit RED users to identify their single name CDS trades and reference entities on the CME Clearing and CMDX platforms, facilitating participants' migration of new and existing CDS contracts to CME Clearing.

Survey reveals loss expectations
A survey by S&P's valuations scenario services group reveals higher than anticipated loss expectations of participants in the UK RMBS market and striking disparities between their valuation input assumptions.

The results from the survey of over 20 European financial institutions (buy- and sell-side) reveal an aggregation of expected loss severity on UK non-conforming RMBS at 46% under current credit conditions, compared with 66% under a worst-case scenario. The aggregation of respondents' expectations of loss severity on UK prime RMBS is 25% under current conditions, but this more than doubles to 54% under a worst-case scenario.

Michael Thompson, md of S&P's market, credit and risk strategies group, says: "This survey quantifies a central problem for the structured finance market at the moment - namely the disparity and inconsistency around valuations input assumptions. In addition to the disparity between current and worst-case loss severity expectations, market participants expect default rates on non-conforming UK RMBS to be 4% under current conditions and 21% under a worst-case scenario."

In an effort to increase the transparency surrounding how the market accounts for key valuation inputs, survey participants were invited to provide their views on the delinquency, default rate, loss severity and recovery lag assumptions they currently use to value UK prime and non-conforming RMBS. S&P is collating the data from this and future surveys and hopes that, over the coming months, the increasing volume of data will help it create a useful benchmark for the benefit of investors.

CIBC MAV II CDS terminated
CIBC has terminated all of its leveraged CDS transactions in connection with the MAV II vehicle after not receiving the C$19.3m additional collateral requested under its trigger event notices. The bank was the swap counterparty for four transactions that are not subject to the 18-month moratorium period applicable to all other CDS transactions entered into by the vehicles. The collateralisation triggers on these transactions were breached on 3 March 2009.

The total amount of additional collateral demanded by CIBC stood at C$95.4m for MAVI and C$19.3m for MAVII. The resulting reduction in collateral supporting the MAV II notes is capped at C$107,742,597 (or approximately 1.1% of the vehicle's assets).

DBRS has confirmed the ratings of the MAVI and MAVII Class A-1 and Class A-2 notes, however, as it considered the potential for transactions not subject to the 18-month moratorium to unwind when assigning a single-A rating to the notes and so no rating action is warranted at this time.

The MAVs comprise one other transaction that retained the original collateralisation triggers and is not subject to the 18-month moratorium period. The Class 15 Ineligible Asset Tracking Note is unrated by DBRS and is secured by a leveraged CDS with RBS as swap counterparty. Unlike the CIBC transactions, these trades were siloed from the MAVs and, as such, the performance of the RBS transactions will not affect the notes.

DBRS confirms that the breach of the collateralisation triggers for transactions not subject to the 18-month moratorium does not count as a breach of any of the five spread-loss matrices that all of the other leveraged CDS transactions reference. As such, a partial or total unwind of these transactions would not be the first step toward the MAV I and MAV II transactions converting from a spread-loss regime for collateral calls to a mark-to-market regime.

US CLOs downgraded
Moody's has taken rating action on 361 notes issued by 122 US cashflow CLOs issued in 2007. The rating actions are a result of Moody's applying its revised assumptions for the sector, including a 30% stress to the underlying portfolio default probability, the modified treatment of ratings on review or with a negative outlook and a change in the calculation of the diversity score. The actions also reflect a general consideration of the credit deterioration in the underlying portfolios, the agency says.

The ratings of all affected CLO tranches remain on review for possible downgrade. Moody's will continue to review these transactions with additional detailed deal analysis in the second stage of its review of the sector, which will commence in the second quarter of 2009. During Stage II, ratings on all CLO tranches may be subject to additional rating actions as necessary.

Turner Review urges 'macro-prudential' approach
The UK Financial Services Authority (FSA) has published the Turner Review of global banking regulation. Lord Turner, chairman of the FSA, was asked to review the events that led to the financial crisis and to recommend reforms.

The Review identifies three underlying causes of the crisis - macro-economic imbalances, financial innovation of little social value and important deficiencies in key bank capital and liquidity regulations. These were underpinned by an exaggerated faith in rational and self-correcting markets, the report suggests.

It stresses the importance of regulation and supervision being based on a system-wide 'macro-prudential' approach rather than focusing solely on specific firms. Among its recommendations are:

• Fundamental changes to bank capital and liquidity regulations and to bank published accounts;
• A central role for much tighter regulation of liquidity;
• Regulation of 'shadow banking' activities on the basis of economic substance not legal form: increased reporting requirements for unregulated financial institutions, such as hedge funds, and regulator powers to extend capital regulation;
• Regulation of credit rating agencies to limit conflicts of interest and inappropriate application of rating techniques;
• National and international action to ensure that remuneration policies are designed to discourage excessive risk-taking;
• Major changes in the FSA's supervisory approach, building on the existing Supervisory Enhancement Programme (SEP), with a focus on business strategies and system-wide risks, rather than internal processes and structures; and
• Major reforms in the regulation of the European banking market, combining a new European regulatory authority and increased national powers to constrain risky cross-border activity.

The Turner Review distinguishes between those areas where the FSA has already taken action, those where the FSA can proceed nationally and those where international agreement needs to be achieved. It also recognises that there may be alternative specific ways to achieve the essential objectives of effective regulation.

In addition the report highlights areas where it is premature to recommend specific action, but where wide-ranging options need to be debated. These include product regulation in retail (for example, mortgage) and wholesale (for example, CDS) markets.

Lord Turner warns that the transition to higher bank capital will need to be managed carefully. UK banks are now capitalised at a level that will enable them to absorb severe stresses and the short-term priority is to maintain bank lending to the real economy.

G20 agrees financial system reforms ...
The G20 finance ministers and central bank governors have agreed further action to restore global growth and support lending, as well as reforms to strengthen the global financial system. To this end, G20 members have completed the immediate steps outlined in the Washington Action Plan while making certain further recommendations.

These recommendations suggest that:

• all systemically important financial institutions, markets and instruments are subject to an appropriate degree of regulation and oversight, and that hedge funds or their managers are registered and disclose appropriate information to assess the risks they pose;
• stronger regulation is reinforced by strengthened macro-prudential oversight to prevent the build-up of systemic risk;
• financial regulations dampen rather than amplify economic cycles, including by building buffers of resources during the good times and measures to constrain leverage - although it is vital that capital requirements remain unchanged until recovery is assured;
• strengthened international cooperation to prevent and resolve crises, including through supervisory colleges, institutional reinforcement of the Financial Stability Forum and the launch of an IMF/FSF 'Early Warning Exercise'.

In addition, the G20 has agreed to: regulatory oversight of all credit rating agencies whose ratings are used for regulatory purposes and compliance with the International Organisation of Securities Commissions (IOSCO) code; full transparency of exposures to off-balance sheet vehicles; the need for improvements in accounting standards, including for provisioning and valuation uncertainty; greater standardisation and resilience of credit derivatives markets; the Financial Stability Forum's sound practice principles for compensation; and the relevant international bodies identifying non-cooperative jurisdictions and to develop a tool box of effective countermeasures.

Among the proposals to restore global growth is a key priority to restore lending by tackling, where needed, problems in the financial system head on, through continued liquidity support, bank recapitalisation and dealing with impaired assets in a common framework. The G20 also reaffirmed its commitment to take all necessary actions to ensure the soundness of systemically important institutions.

... while IIF urges immediate action
The Institute of International Finance (IIF) has highlighted the key pillars of economic and financial policy needed to address today's global crisis. Immediate action is needed to break the damaging negative feedback loop between the financial crisis and the global recession, the IIF says in a letter to UK Prime Minister Gordon Brown as the host of the forthcoming Group of 20 Summit in London and to the other leaders who will be attending.

"It is imperative that a clear signal emerge from the G20 Summit of the specific joint actions to be taken, not only to fight the sharp decline in economic activity seen around the globe, but also to stave off any intentional or unintentional protectionist measures, which would severely deepen the crisis and endanger future prosperity," says Josef Ackermann, IIF chairman and chairman of the management board and the group executive committee of Deutsche Bank.

The IIF forecasts that global growth this year will be close to negative 2% - a remarkable swing from solid growth of over 3.5% in 2006-2007. Against the backdrop of negative growth, the public sector must compensate where scope exists by increasing aggregate demand, with a focus on stimulative measures that will have immediate effect, accompanied by clear medium-term plans for fiscal consolidation. It added that further monetary policy easing may also be necessary.

The institute adds that the continued uncertainty surrounding the magnitude and valuation of 'toxic' assets has become the fault line of the financial crisis. IIF md Charles Dallara states: "Market instability and lack of confidence point clearly to the benefits of a 'bad bank' approach, where troubled assets are completely removed from banks' balance sheets. Hesitation over up-front fiscal costs and difficult pricing issues fails to recognise that the real long-term costs to the economy of inaction may well be much greater than the net fiscal imbalances over time that are created by a 'bad bank' approach. Action is needed now and a pragmatic approach weighing both mark-to-market and cashflow valuations can lead us out of this thicket."

At the same time, the IIF points out that firms are strengthening their practices in such areas as risk management, liquidity management and governance. According to the institute, the industry not only recognises the need for fundamental reform of compensation practices, but is actively moving to align compensation with shareholder interests and long-term firm-wide profitability.

The Summit is also called upon to promote a comprehensive package of financial regulatory reforms designed to establish a more efficient and effective architecture based on heightened global cooperation. To further this goal the IIF called for the establishment of a Global Financial Regulatory Coordinating Council, reporting to the Financial Stability Forum. Comprised of regulators and central banks, this Council would play a central role in harmonising standards; enhancing cross-border cooperation; coordinating supervision; and macro-prudential oversight of the banking, insurance and securities industries. Noting that the commitment to establish colleges of supervisors for major international financial services groups is important, the IIF suggests the Coordinating Council can ensure that these colleges operate effectively.

In addition, the reform agenda needs to explicitly address a range of issues that can strengthen the regulatory and supervisory system. The IIF says a special high-level dialogue should be established under the auspices of the G20 to take up all issues regarding fair-value accounting; commit to convergence of major accounting standards; and set a firm time-table for early completion.

Low loan recovery values typical of distressed cycle
Aleris' recovery of just eight cents (see last week's issue) is probably the most dramatic example of low values being seen even for secured loans, according to structured credit strategists at Citi. This is particularly apparent in auctions where the auction mechanism is skewed towards finding the cheapest asset (and, hence, the lowest recoveries).

Several reasons contributed to the low recovery for Aleris, the Citi strategists say. The most prominent one was a significant debtor-in-possession (DIP) facility, which is senior to the legacy loans held by a CLO. The most senior DIP loans trade in the 90s, while the debt that is created by rolling up legacy secured debt trades only in the teens.

The other reason for low recovery in many loans is a top-heavy capital structure. In the case of Tribune, for example, like many 2006-2007 LBO companies, the company 'optimised' its capital structure to consist of mostly loan debt and limited bond debt.

"These recovery values are at unprecedented low levels, but the general trend is in line with history," the Citi strategists note. "Recoveries tend to be small in the early part of the distressed cycle and improve as we start coming out of it."

Basel Committee set to strengthen capital levels
The Basel Committee on Banking Supervision has announced that the level of capital in the banking system needs to be strengthened to raise its resilience to future episodes of economic and financial stress. This will be achieved by a combination of measures, such as introducing standards to promote the build up of capital buffers that can be drawn down in periods of stress, strengthening the quality of bank capital, improving the risk coverage of the capital framework and introducing a non-risk based supplementary measure, the Committee says.

Additionally, the regulatory minimum level of capital will be reviewed in 2010, taking into account the above and other relevant factors to arrive at a total level and quality of capital that is higher than the current Basel 2 framework. Strengthening the global capital framework in this manner is expected to enhance confidence and lay the foundation for a more resilient banking system.

The Committee notes that current reactions in the marketplace regarding capital levels have been highly pro-cyclical. It says that it won't increase global minimum capital requirements during this period of economic and financial stress.

Moody's downgrades Theta
Moody's has downgraded Theta Corporation's counterparty rating from Aa2 (on review) to Baa2, as well as the ratings of its MTN and CP programmes from Aa2/Prime-1 and Prime-1 to Baa3/Prime-3 and Prime-3 respectively. The rating actions taken are due to: (i) the application of revised and updated key modelling parameter assumptions that Moody's uses to rate and monitor ratings of corporate synthetic CDOs; (ii) continued deterioration in the credit quality of Theta's CDS reference portfolio and cash bond portfolio since the last rating action; and (iii) continued price decline of Theta's cash bond portfolio.

Moody's rating actions also take into account the substantial exposure to the structured finance and financial sectors, and the price volatility of Theta's underlying cash bond portfolio. Theta may need to liquidate portions of its cash bond portfolio to meet CDS credit event payments as they arise. The unprecedented illiquidity in the market for these assets may affect the vehicle's ability to liquidate assets without crystallising additional losses to its capital.

Theta's bond portfolio based on notional values includes exposures to credit cards (23% of the portfolio); financials (10%); prime RMBS (9%); CDO/CLOs (15%); and Kaupthing/Lehman/Washington Mutual (43%). Based on bond price marks provided by Theta's manager Gordian Knot, as of 6 March 6, its bond portfolio exposures to credit cards is 35%; financials 10%; prime RMBS 16%; CDO/CLOs 18%; and Kaupthing/Lehman/Washington Mutual 21%.

Moody's analysis considered scenarios under which the price of non-CDS assets could range. The range was from 0% to 60% of current mark-to-market estimates. The analysis also took into account CDS premiums that Theta would receive on its CDS portfolio, as well as potential reductions in such premiums due termination of the CDS as a result of credit events.

For the MTN and CP ratings, Moody's also takes into account the amount of capital available to support the ratings if Theta were to issue such debt securities. To assess the performance of the company going forward, Moody's will continue to monitor the mark-to-market value of Theta's cash bond portfolio and its ability to meet CDS credit event payments as they arise.

Theta is currently in restricted operation, following a breach in one of its liquidity tests. The breach is due to Theta's liquid assets, which include cash, cash equivalents and liquidity facilities, being less than the largest anticipated 15-day sum of net cash outlays plus the largest single-A entity CDS exposure (which increased because of a merger of two such reference entities). During restricted operation, the vehicle is limited to entering into transactions that would improve failing tests or to meet payment obligations that are pari passu or senior to the senior debt holders.

There are currently no debt securities outstanding under the MTN and CP programmes. Usage of the debt programmes is at the discretion of the issuer as market conditions permit.

Updated Dutch RMBS approach puts senior notes at risk
Moody's has updated its rating methodologies for rating Dutch RMBS. The rating agency is updating its modelling approach for Dutch RMBS (MILAN), as well as making changes to the analysis of key credit risk issues in relation to loans benefiting from the national mortgage guarantee scheme (Nationale Hypotheek Garantie). Moody's has also announced that it is in the process of revising its methodology for set-off on insurance-linked mortgage loans and set-off on deposits with mortgage loan originators in the Netherlands.

While the updates to the MILAN methodology in themselves will not result in any rating actions on existing transactions, Moody's has flagged 15 deals for further review based on the updated NHG approach and off-set approach. For these the agency expects the combined methodology update to typically have a one- to two-notch downward impact on senior notes, although on a transaction-by-transaction basis the downward impact could be larger (single-A range) depending on single or combined exposures to unrated insurance companies in relation to the available credit enhancement.

Moody's updated MILAN methodology for rating Dutch RMBS forms part of its periodic reviews of its models aimed at refining risk assessments and addressing specific product and market-related developments. The amendments outlined in the revised modelling approach relate to updates of certain parameters within the Dutch MILAN model implemented by Moody's during 2007 and 2008. In particular, Moody's has refined the Dutch default frequency curve used in the model - to allow for a greater differentiation between high-LTV and very-high-LTV loans - as well as its analysis of both standard interest-only mortgage loans and interest-only mortgage loans with periodic additional collateral.

Meanwhile, Moody's updated approach to NHG mortgages in rating Dutch RMBS updates its criteria for assessing loans that are backed by an NHG guarantee. The new approach to these transactions takes into account the benefit of such guarantees, as they may reduce substantially the severity of loss upon a borrower's default. Nonetheless, Moody's believes credit enhancement and structural features are necessary to obtain a triple-A rating on the most senior notes backed by NHG loans to cover residual sources of risks such as: (i) the mismatch of the amortisation of the NHG guarantee with the actual loan amortisation; (ii) set-off risk; (iii) risks related to non-compliance with NHG criteria; (iv) representations and warranties and creditworthiness of the originator; and (v) creditworthiness of guarantee provider.

Balloon risk increases in MFH CMBS ...
Fitch says in a new report that ongoing declines in market values and the lack of funding in both bank and capital markets are increasing the balloon risk of German multifamily housing (MFH) CMBS transactions. On 16 March 2009, the agency took negative rating action on the four largest CMBS transactions entirely secured by MFH collateral - GRAND, German Residential Funding, Windermere IX (Multifamily) and Immeo Residential Finance No.2 - to reflect this increased risk.

MFH as an asset class is well suited to CMBS because it typically generates stable cashflows and benefits from extremely diversified tenant bases. Consequently, the performance of MFH transactions to date has, with a few isolated exceptions, been stable. However, certain smaller loans are beginning to struggle.

"As improvements in rental levels and occupancy rates are failing to materialise, and operating expenses are increasing, several borrowers are facing significant risk of payment default. This is particularly the case for smaller loans securitised in multi-borrower transactions, as they are generally run by less experienced property managers," says Mario Schmidt, associate director in Fitch's EMEA CMBS performance analytics team.

The largest risk for the sector as a whole, however, is the substantial balloon risk. To some extent this reflects the intensity of acquisition activity from around 2004 onwards and the homogeneity of bank finance, much of which was recycled into the CMBS markets.

"Over €11bn of Fitch-rated large loan MFH CMBS is scheduled to mature before 2013. Added to this is a host of smaller loans featuring in CMBS conduits, as well as several others that were not securitised or are in transactions not rated by Fitch. This concentration of refinancing dates will surely test the liquidity of German MFH," adds Gioia Dominedo, director in Fitch's EMEA CMBS team.

The refinancing difficulties that are expected to be caused by the sheer size of the portfolios in question are compounded further by the terms of the loans.

"Scheduled amortisation is negligible for most of the loans. This may have been because of the ambitious sales targets set by borrowers, although business plans are increasingly reaching their limits. Exit balances will be somewhat larger than originally envisioned," concludes Stefan Baatz, director in Fitch's EMEA CMBS team.

... while downgrades likely for EMEA CMBS
Updated central scenarios for the commercial real estate (CRE) and CMBS markets in EMEA mean that an increased number of downgrades for CMBS in the region are likely in 2009, says Moody's in a new rating methodology report. The report describes the rating agency's surveillance approach using the Moody's Real Estate Analysis (MoRE Analysis) framework, as well as outlining the adjusted central scenarios for the respective EMEA commercial real estate and CMBS markets over 2009-2012, the impact of those central scenarios on MoRE Analysis and the ensuing rating implications.

Given the current negative outlook in relation to CRE lending and investment markets, CRE prices and occupational markets, Moody's anticipates that 20% to 30% of all Moody's rated senior EMEA CMBS notes are likely to be downgraded by one to four notches, and 50% to 60% (including junior Aaa notes) and junior notes will probably be lowered by three to seven notches. The agency aims to place most of the affected transactions on rating review for possible downgrade during the next 2-3 weeks and intends to finalise its property-by-property and loan-by-loan analysis of all outstanding EMEA CMBS deals against the background of its current central scenarios during the course of H109.

Moody's expects that property values will decline further in 2009, while the extent of further declines will differ by property type, property market and property quality. "For the UK and Germany, which account for approximately 79% of all outstanding EMEA CMBS, Moody's assumes further value drops from the end-2008 levels of 15% to 25% and 10% to 20% respectively," says Jeroen Heijdeman, a Moody's analyst. "Values will likely bottom out over the course of 2010 and there will be moderate value growth only from 2011 onwards."

For properties securing UK CMBS, which are generally of a better quality than the market average, Moody's expects peak-to-trough value declines of 35% to 45%. The rating agency expects commercial properties reaching their end-2008 values only in 2014.

Moody's says in the report that EMEA CRE also faces headwinds from the occupational markets. "Given the negative outlook for all EMEA economies, rental levels are likely to decline, while vacancy rates and tenant defaults will increase, putting pressure on the performance of securitised CRE loans and on property values," adds Oliver Moldenhauer, a Moody's avp - analyst.

The agency says that it will incorporate further value declines into its ongoing surveillance analysis for EMEA CMBS on a property-by-property basis. Furthermore, against a background of only limited finance being available and further falling property values, Moody's has significantly increased its assumptions in relation to the refinancing risk of loans maturing from 2009 to 2012.

The rating agency anticipates a continuing tiering of loans into those that have a realistic chance of being refinanced and those that do not. Only loans that are lowly levered, secured by properties that have favourable rental cashflow characteristics, benefit from strong sponsorship and have a relatively small size will have a good chance of being refinanced.

According to Moody's, EMEA CMBS transactions that are most affected by potential downgrades are those with exposure in the most adversely performing property markets; with significant refinancing exposure in the near future (2009-2011); that comprise highly levered loans; that closed in 2006 and 2007; that are less diversified; that show below average property and/or rental cashflow quality; and/or that are subject to below average tenant and/or sponsor quality.

Free coupon conversion offered for CDS big bang
RiskVal is offering a free CDS 100/500 coupon conversion service for the upcoming CDS 'big bang'. For a limited time, the RiskVal portfolio valuation solution team will provide pro bono professional services to help convert legacy CDS portfolios to the new standards.

Portfolios sent in for analysis will have each position returned re-couponed into 100bp and 500bp fixed coupon standard CDS contracts, maintaining risk profiles, payment schedule and present value. This analysis offers clients a first look at how their portfolios may be exposed to the benefits of greater trade compression as part of the move to standardised CDS premium payments.

RiskVal's portfolio valuation team will assume each position's notional is US$1m. The newly converted portfolios will match notional with the original CDS positions. Optionally, clients that provide notional will be able to view notional aggregated maturity buckets. The weighted average coupon will result in the same cash flow schedule, with a coupon effective date as of the last IMM maturity date. Risk profiles of the old and new positions will be identical. Coupon cash accruals in the old positions may need to be settled with counterparties independently.

CRE CDO delinquencies continue to rise
15 newly delinquent loans led to an increase in US commercial real estate loan (CREL) CDO delinquencies to 5.4% for February 2009, up from 3.8% in January 2009, according to the latest CREL CDO delinquency index (CREL DI) from Fitch. This 1.5% change is the largest one-month increase in the index since its inception, exceeding the previous record of 1.1% set last month.

"With CREL CDO delinquencies increasing 1.3% on average over the last two months, the default rate for year-end 2009 could exceed Fitch's initial base expectation for the life of the transactions if this pace continues," says Fitch senior director Karen Trebach. "Fitch has taken negative rating actions on 16 of its 35 Fitch-rated CREL transactions since September of last year, with more downgrades and negative rating watches likely as transactions are reviewed."

25 CREL CDOs contained at least one delinquent loan with individual delinquency rates ranging from less than 1% to 20.4% of the CDO par balance, as of the February 2009 reporting period. In addition to the classes from five transactions that Fitch placed on RWN last month, the agency has placed classes from an additional CDO on RWN based primarily on the rise in delinquent loans within the CDO since last month. The increase in delinquencies for these CDOs is expected to ultimately result in reduced credit enhancement for the rated bonds relative to their current ratings and resulting in downgrades.

As recently as late-2008, the delinquency rate was below 3%, as many asset managers exercised their right to repurchase the poorer performing loans in their pools. However, with the continued illiquidity in the commercial real estate capital markets, asset manager repurchases have diminished with none reported in the past two months, according to Trebach.

Extensions have also helped to keep the delinquency rate low, as they often serve as the early stages of a workout. Nevertheless, extensions are becoming harder to justify, as the deepening recession has continued to impact real estate fundamentals over the last few months. Consequently, delinquent assets are now remaining in CDOs, resulting in the higher delinquency rate.

ABS CDOs downgraded
Moody's has downgraded its ratings of 193 notes issued by 55 CDO transactions that have significant exposure to ABS. The agency also confirmed the ratings of 48 notes.

The rating actions are a response to credit deterioration in the underlying portfolio due to: expectations of increased losses in the underlying RMBS and ABS assets; and updates in the key assumptions Moody's makes when rating these transactions.

REIT repurchases CRE CDO debt
Gramercy Capital reports in its Q408 results that it repurchased US$55m of investment grade CRE CDO bonds previously issued by the company's CDOs, generating gains on early extinguishment of debt of US$43.9m for the quarter. For the year, the company generated US$77.2m of gains from the repurchase of US$127.3m of CRE CDO bonds.

Spanish RMBS KPIs released
Moody's has released its key performance indicators for the Spanish RMBS market in Q408. Fourteen Moody's-rated transactions closed during the period, with a total issuance of €31.48bn.

In Q408, the total number of outstanding transactions was 190, with an outstanding transaction balance of €148.4bn. Weighted-average delinquencies greater than 60 days past due represented2.64% of the outstanding pool balance, up from 0.86% in Q407. Furthermore, weighted-average delinquencies greater than 90 days past due represented1.68% of the outstanding pool balance, up from 0.37% in Q407.

Cumulative defaults (artificial write-offs) increased from 0.08% to 0.40% within the past 12 months. Moody's notes that the deteriorating performance observed in the indices is likely to continue, especially for younger vintages and transactions with high LTVs.

TALF anti-fraud team formed
A multi-agency task force is being formed to deter, detect and investigate any instances of fraud affecting the Term Asset-Backed Securities Loan Facility (TALF), which is set to begin operations next week.

Task force members will include Neil Barofsky, special inspector general for the Troubled Assets Relief Programme (TARP), the Federal Reserve Board's inspector general and representatives from the FBI, Financial Crimes Enforcement Network, US Immigration and Customs Enforcement, IRS Criminal Investigation, SEC and the US Postal Inspection Service. The group will receive regular briefings on the TALF programme, identify areas of vulnerability and share leads on cases identified.

SME CDOs on watch negative
Moody's has placed on review for possible downgrade the ratings of 84 notes issued by 20 CDO transactions backed by generally non-granular portfolios of European SME CDOs. The rating actions reflect the revision of certain key assumptions that the agency uses to rate and monitor SME CDOs.

These revised assumptions incorporate Moody's expectation that European corporate default rates are likely to greatly exceed their historical long-term averages and reflect the heightened interdependence of credit markets in the current economic contraction. Specifically, the changes announced include: (1) a 30% increase in the assumed likelihood of default for corporate credits in CDOs; and (2) an increase in the default correlation applied to corporate portfolios as generated through a combination of higher default rates and increased asset correlations.

CLO's ramp-up test definition changed
Amendments to Euroloan CLO have not resulted in Moody's ratings on the deal to be downgraded or withdrawn. The amendment agreement changes the definition of the 'Moody's CDOROM Ramp Up Test', a test based on the latest version of CDOROM, and thus will allow the issuer to complete the ramp up of the collateral portfolio.

The liquidation and servicing agent, Merrill Lynch, requested that Moody's provide its opinion as to whether the ratings on the Moody's-rated securities issued by the affected transactions would be downgraded or withdrawn as a result of the amendment. The agency believes that the amendment does not have an adverse effect on the ratings of Euroloan CLO. However, Moody's did not express an opinion as to whether these actions have, or could have, other effects that investors may or may not view positively.

Further CRE CDOs on review ...
Moody's has placed 52 US CRE CDOs on review for possible downgrade due to weakening commercial real estate market fundamentals and updates to revised key modelling parameter assumptions. The transactions placed on review represent the final phase of a US CRE CDO ratings sweep previously announced on 19 December 2008. Moody's anticipates completion of the 52 reviews by 31 March.

The impacted transactions are revolving cashflow CDOs with collateral quality and coverage tests that are backed by a significant percentage of non-CMBS collateral, such as whole loans, B-notes and mezzanine debt. Moody's is concerned about the likely future performance of this non-CMBS collateral: rapid economic deterioration is expected to stress property cashflows over the next few years, increasing term default risk.

For loans with near-term maturities, refinance risk will also rise as cashflows deteriorate and higher risk premiums are required to secure financing. The whole loans, B-notes and mezzanine debt included in these CRE CDOs were often backed by transitional assets where future income growth was expected to occur to facilitate refinancing the existing debt at maturity. Absent an expanding economy, the likelihood of this future income growth is more remote, the agency says.

... while SF/CRE CDOs downgraded
Fitch has taken various actions on 47 structured finance (SF) and 97 commercial real estate (CRE) CDOs. The rating actions resolve the 'under analysis' status issued on 14 October 2008, following the agency's announcement of its proposed criteria revision for analysing SF CDOs.

Fitch assigned rating outlooks to all classes, except for those classes rated triple-C and lower. Negative outlooks were assigned to classes in transactions with a significant portion of the underlying portfolio comprised of RMBS and other SF CDOs that are expected to continue to face negative pressure as the housing market stabilises.

Asia ex-Japan CDOs on watch
S&P has placed the ratings on 18 Asia-Pacific (excluding Japan) synthetic CDOs on credit watch with negative implications. In addition, four CDOs were kept on watch negative, while 16 CDOs were taken off watch negative. The 18 transactions have been placed on watch negative due to a fall in their SROC to below 100% at the current rating level in the end-of-month analysis for February 2009.

Collateral management solution launched
Misys has launched a solution for collateral management - Misys Summit FT Collateral Management - to meet the needs of financial institutions looking to closely manage counterparty risk. The solution enables banks and investment managers to make better decisions on trade viability and the level of collateral required through real-time tracking and assessment of collateral levels, which the firm says is an essential service in current market conditions where collateral values can change quickly.

Financial institutions are seeking to move from managing collateral on a weekly or monthly basis to managing in real-time to prevent sudden losses, according to Misys. The functional strength of its new collateral management module allows firms to better define underlying agreements, collateral eligibility and terms, and provides an integrated application to view, assess and manage the collateral process. Additionally, it enables firms to manage repo collateral and margins, calculate market valuations and margin - on-schedule or on-demand - and also includes a wide range of valuation options to improve valuations of derivatives positions and collateral requirements.

Isabel Schauerte, analyst at Celent, comments: "Solutions that help value and manage collateral on a near-real-time basis will be one of the areas of IT investment in 2009. The importance of the collateral management function within banks and hedge funds has grown in the last year and there is a broad desire for a single, integrated platform that allows for straight-through processing of collateral management activities. Market participants are also interested in increasing the transparency of post-trading pricing and, by consolidating multiple activities of the collateral management function into one system, a reduction of errors and inefficiencies can be achieved."

Liquidity scores available to buy-siders
Fitch Solutions has extended the launch of its liquidity scores and percentile rankings for widely traded CDS assets to buy-side market participants, with the aim of helping them strengthen their liquidity risk management procedures and meet regulatory commitments. Buy-side users are able to benefit from new features, including regional sector scores for corporate assets in Asia Pacific, Europe and the Americas, as well as global sovereigns.

To coincide with the launch, and in a step to further enhance transparency in the CDS market, Fitch will also make publicly available a fortnightly list of the top five most liquid CDS corporate names in Europe, North America and Asia-Pacific, as well as the top five most liquid global sovereigns.

As of 13 March, Korea Development Bank, British Telecom, General Electric Capital Corporation and the United Mexican States were the most liquid CDS names according to Fitch's liquidity scores.

"Our research has highlighted that, whilst global CDS market liquidity hit an all-time low in January, liquidity has begun to return to the market during this year and - for the first time - the Americas region became more liquid than Europe earlier this month," comments Thomas Aubrey, md Fitch Solutions in London. "Better understanding the relative liquidity of an asset remains a critical market issue and through this launch the buy-side community will now be able to assess the relative liquidity of global CDS assets and the global CDS market."

The liquidity scores and rankings are derived from Fitch's proprietary statistical model that provides a unique insight into the liquidity of the CDS market, covering over 3,000 of the most widely traded CDS assets. Each asset is assigned a score, representing the most through to least liquid names, and then given a global percentage ranking according to its liquidity profile against the overall CDS universe.

Portfolio valuation tool revealed
GoldenSource Corporation has revealed a new data solution, GoldenSource for Derivatives, to help financial institutions accurately value portfolios and manage risk for derivatives products. A preconfigured solution for risk management, the tool allows for a 360-degree view of instrument, issuer and counterparty exposure, creating what the firm describes as a local CDS warehouse capability.

GoldenSource for Derivatives is expected to increase transparency and auditability for derivatives portfolios held by banks, brokers and asset managers by feeding trading and risk management systems with accurate data. The solution was developed in response to client demand for instrument-level transparency and in anticipation of increased regulatory and repository requirements.

"With a 360-degree view of activity, a firm can increase their transparency not just at a simple counterparty level but at a total corporate hierarchy level," comments Mike Meriton, president and ceo of GoldenSource. "The complexity of derivatives instruments make it difficult to understand quickly how changes in underlying data, such as a counterparty credit rating, can impact values across portfolios unless all data is linked. GoldenSource is unique in its ability to handle the diverse nature of derivatives data, since we can source, validate and distribute all terms and conditions data, client and counterparty details, as well as transaction related data throughout the life cycle of a derivatives contract."

GoldenSource for Derivatives organises, archives, stores and categorises all attributes of a wide range of exchange-traded and OTC derivatives, including any underlying securities' characteristics. The product provides flexible integration with document management, trading and risk systems, allowing firms to build a trusted repository of all derivatives-related data.

Role of market stability regulator discussed
SIFMA president and ceo, Tim Ryan, has testified before the House Financial Services Committee on perspectives on regulation of systemic risk in the financial services industry.

"While there is no single commonly-accepted definition of systemic risk, we think of 'systemic risk' as the risk of a system-wide financial crisis characterised by a significant risk of the contemporaneous failure of a substantial number of financial institutions or of financial institutions or a financial market controlling a significant amount of financial resources that could result in a severe contraction of credit in the US or have other serious adverse effects on economic conditions or financial stability," Ryan said in his testimony.

He continued: "We agree with Chairman Bernanke that [the financial markets stability regulator's] mission should include monitoring systemic risks across firms and markets, rather than only at the level of individual firms or sectors; assessing the potential for practices or products to increase systemic risk; and identifying regulatory gaps that have systemic impact. One of the lessons learned from recent experience is that sectors of the market, such as the mortgage brokerage industry, can be systemically important, even though no single institution in that sector is a significant player."

SIFMA believes that, although the financial markets stability regulator's role would be distinct from that of the functional regulators, it should have a more direct role in the oversight of systemically important financial organizations - including the power to conduct examinations, take prompt corrective action and appoint or act as the receiver or conservator of such systemically important groups. These more direct powers would end if a financial group were no longer systemically important.

"We believe that all systemically important financial institutions that are not currently subject to federal functional regulation, such as insurance companies and hedge funds, should be subject to such regulation. But we do not believe the financial markets stability regulator should play that day-to-day role for those entities," Ryan concluded.

Re-REMIC assumptions updated
S&P is refining and adapting its methodology and assumptions for rating resecuritisations of US RMBS transactions. The agency says that market participants are increasingly interested in such transactions, also known as re-REMICs (SCI passim).

As a general matter, the agency says it will rate transactions that include underlying securities that are on credit watch with negative implications as resecuritisation collateral, provided there are multiple underlying securities in such proposed resecuritisations. Its analysis focuses on the credit quality of the underlying securities' collateral, including multiple stress scenarios. Additionally, S&P will request information on the acquisition cost of recently acquired collateral and consider that information in its analysis; under certain circumstances it may limit the amount of securities it rates triple-A.

S&P notes that senior classes issued by a resecuritisation may be better able to withstand deteriorating performance of the underlying mortgage loans and potential future negative rating actions on the underlying securities. "For instance, if we were to lower the rating of an underlying security, we may or may not take a corresponding rating action on the senior class of the resecuritisation, depending on our view of the level of credit support available to that class," the agency says.

CS & AC

Operations

Term ABS Loan Facility (TALF) to the rescue?

Deutsche Bank securitisation research analysts Karen Weaver and Katie Reeves find that – while the TALF programme is likely to 'work' – in order for the ABS market to be restored, investors will need to believe in the creditworthiness of securitisations

On 3 March the Federal Reserve Bank of New York (FRBNY) announced a first 'subscription date' for the TALF loan programme of 17 March and final terms and conditions. Will TALF open up the new issue ABS market in a meaningful way and, if so, for what asset classes is it likely to have the greatest impact?

TALF programme economics (required investor returns, haircuts, programme fees and TALF loan rates), the availability of other funding alternatives such as the Federal Deposit Insurance Corporation (FDIC) Temporary Liquidity Guarantee Program (TLGP), and sector-specific issues will combine to dictate the ultimate take-up of the programme. If it does not result in new transactions early on, we would expect to see the FRBNY make changes to the TALF programme economics.

So, in that sense, we do expect the programme to 'work'. Investors will take advantage of the availability of financing and a defacto put option (as further described herein), and some issuers will take the opportunity to re-enter the market. However, this is distinct from having the market be completely revived, which we do not believe can occur until investors gain confidence in the creditworthiness of the transactions themselves.

The first iteration of this programme will provide for TALF loans collateralised by ABS backed by auto loans (retail, lease and dealer floorplan), credit card loans, student loans and small business loans. However, on 10 February Treasury Secretary Timothy Geithner announced the intention to eventually substantially expand the size and scope of the TALF programme to other asset classes, including CMBS, and potentially RMBS and corporate debt.

To accommodate that expansion, the programme size would increase from US$200bn to US$1trn of TALF loans. In terms of truly injecting new credit into the financial system where it is most needed, we think that second stage (expansion to mortgage-related programmes) would have a much more meaningful impact, as those are the sectors where credit availability has been most constrained.

Restarting the ABS market
When the FRBNY initially unveiled the TALF programme back in November 2008, it was one of the first public acknowledgements of the role that securitisation has played in the process of extending credit to consumers. At approximately 70% of GDP, consumer spending will have an outsised impact on how quickly the US economy pulls out of recession.

And over the past several quarters, consumer spending has declined. In Figure 1, a recent 11% year-over- year drop in retail sales is put in historic context.

Looking just at autos, sales have also declined steadily - and precipitously - over the past year, as shown in Figure 2.

What is not specifically clear is how much of the consumer pullback is voluntary, because people have recognised a need to rebuild their wealth and/or are concerned about job security. Many consumers have turned more defensive; for example, the Conference Board's consumer confidence indicator dropped to an all-time low of 25 in February.

But, with the TALF programme, the government is betting that at least some of the pullback in spending is due to lack of access to credit. The administration's goal with TALF is to jump-start the primary new issue ABS market and, in turn, stimulate increased lending to consumers and small businesses.

In Figure 3, we show the volume of credit card, auto and student loan ABS issuance over the past ten years and how much of it has evaporated in recent months. So in 2009, ABS year-to-date issuance is essentially at zero. Before looking at the factors that will either help or impede the success of TALF, we first review the basic parameters of the programme.

TALF programme mechanics
Under the TALF programme, the FRBNY will make available non-recourse loans to 'eligible borrowers' who purchase triple-A rated 'eligible ABS securities'. The TALF borrower then pledges the ABS as collateral for the TALF loans.

For purposes of the programme:

• An 'eligible borrower' is any US company (business entity or institution) organised under US law, or a US branch or agency of a foreign bank, or an investment fund that is organised and managed in the US and conducts significant operations in the US. The borrower must also keep an account at a primary dealer.
• The ABS must have been issued on or after 1 January 2009. Repackagings of previously issued ABS are not eligible. Over 95% of the credit exposure on the underlying collateral must be exposures to US-domiciled obligors.

Additionally, at least 85% of the dollar amount of the underlying loans of the ABS collateral must have been originated according to the following guidelines:

• Auto loans (which includes retail loans and leases relating to cars, motorcycles, light trucks and recreational vehicles (RVs)) - must have been originated on or after 1 October 2007. There are no loan origination date restrictions for auto wholesale dealer floorplan loans, but new floorplan ABS must be issued to refinance an existing auto dealer floorplan ABS maturing in 2009 (financing amount is limited to the amount of the maturing ABS). Prime auto loan and lease ABS refer to pools where the weighted average FICO score is at least 680. Pools will be considered sub-prime if the weighted average FICO is lower than 680 or the FICO data is not disclosed.
• Student loans (FFELP and private student loans) - must have been disbursed on or after 5 January 2007.
• Credit cards - the related credit card ABS must be issued to refinance an existing card ABS scheduled to mature in 2009 (and the amount of TALF financing available for any given card ABS trust will be limited to the amount of card ABS maturing in 2009). There are no 'loan' origination date restrictions. 'Prime' credit cards are defined as credit card ABS pools where at least 70% of the receivables have a FICO score of at least 660. Pools will be considered sub-prime if they don't meet that cut-off or if the data is not disclosed.

TALF loan characteristics
TALF loans will have three-year maturities. Like other government initiatives to resuscitate the credit markets, the programme is meant to be temporary; no new TALF loans will be made after 31 December 2009, unless the FRBNY decides to extend the programme.

TALF loans will be pre-payable without penalty and may also 'travel with' the related ABS, should that ABS subsequently be sold. However, in practice, this feature will be of limited utility unless the programme is extended.

Procedurally, when an ABS loan is sold with a TALF loan, the FRBNY will effectively cancel the existing loan and issue a new TALF loan. So, unless the current programme is extended, there will be limited ability to 'transfer' loans.

The FRBNY will make both fixed-rate and floating-rate TALF loans, and there is no limit to the number of loans an investor may request on a given loan subscription date. Investors must take fixed-rate TALF loans for fixed-rate ABS and floating-rate TALF loans for floating-rate ABS.

Interest for TALF loans will be payable monthly. The TALF loans themselves are not required to be marked to market.

Procedurally, TALF borrowers must work through one or more primary dealers, so the FRBNY interfaces with a limited universe of dealers, rather than every individual investor. The Bank of New York Mellon (BNYM) will act as the custodian bank for the FRBNY and in that capacity will accept the collateral and process and apply the payments on the related ABS.

TALF loan economics
From the TALF borrower's point of view, the costs of the programme are the following:

• Payment of a non-refundable one-time up-front administrative fee to the FRBNY of 5bp of the loan amount
• TALF loan interest and principal (see Figure 4), and
• The margin (haircut) associated with the specific asset class, also as shown below.

The TALF loans will bear a rate equal to the three-year Libor swap rate +100bp for a fixed-rate TALF loan on a fixed-rate ABS deal. The rate will be one-month Libor +100bp for a floating rate TALF loan that is issued in association with a floating-rate credit card, auto or private student loan ABS deal. For FFELP student loan ABS, the TALF loans will bear a rate of one-month Libor +50bp.

The FRBNY will lend to each borrower an amount equal to the value of the pledged ABS, minus a haircut per the schedule shown in Figure 4. The average lives are to be determined based on specific prepayment assumptions (specified by the FRBNY) for the different asset classes. For example, for prime retail auto loan ABS, a 1.3% ABS assumption is specified.

The TALF borrower/ABS investor gets the return associated with the principal and interest on the related ABS bond. Additionally, and a key feature of the programme, is that they also have a put option in that the investor has the right to surrender the collateral at any time, in payment of the loan amount.

To the extent the proceeds of the collateral are insufficient, the investor will lose their margin. This will be most meaningful for longer-dated asset classes (e.g. student loans). Losses in excess of the haircut amount are borne by the TALF programme (the Treasury and the FRBNY).

If a borrower fails to pay required principal or interest on the TALF loan, FRBNY will enforce its rights on the collateral following a 30-day grace period. A US$20bn subordinated loan from TARP will be available as the facility's first-loss position in excess of the haircut amount.

Estimating new ABS issuance post-TALF
Ultimately the amount of new issue volume that is generated in cards, autos and student loans will probably not amount to the US$200bn initial programme size in 2009, for several reasons discussed further below. However, the US$200bn programme size is a good maximum starting point. If we look at the volume of ABS in these asset classes that was issued in the second half of 2007, combined with the first half of 2008 (see Figure 5), the US$200bn would have accommodated about a year of new issuance in those better times.

However, there are various TALF programme restrictions, as well as factors outside of the TALF programme (many of which are asset-class specific) that could cause new TALF-related volume to be lower. Key among these are:

Programme economics and competing funding alternatives - For investors to be interested in the programme, they will need to make a certain return, which means a certain minimum ABS coupon amount. Today, many consumer ABS have been trading in the secondary market at levels that are wider than where many issuers would be willing to do a new deal. Many of the large bank card issuers have access to the FDIC's TLG programme and/or have been funding themselves with a combination of, for example, deposits, the Fed's discount window or the FHLB system.

FFELP student loan issuers have been able to sell loans directly to the Department of Education at attractive levels compared to ABS secondary market levels. When considering just funding alternatives, we think the non-bank auto ABS issuers are likely to be much more aggressive TALF users than their bank card and student loan counterparts.

With that said, we do expect to see at least some credit card and student loan ABS offered under the programme. The FRBNY recently removed a requirement (that had appeared in earlier drafts of the TALF programme) that the ABS issuers accessing the TALF programme adhere to the executive compensation requirements of the TARP. For banks either not yet accepting TARP money or who are eager to pay back TARP money, those comp requirements were a disincentive to participating in the TALF programme.

With that condition taken out of the TALF, we think that credit card issuers will now be incrementally more willing to participate, in the spirit of getting the market back up and running. Doing a TALF securitisation will also allow for off-balance sheet accounting treatment, which is not available under the TLGP.

The programme is limited to triple-A issuance - Volumes shown in Figure 5 include lower-rated ABS as well, which provides credit enhancement to the triple-A bonds and historically was sold to investors. For prime credit card ABS, the sub triple-A part of the capital structure has typically been in the neighborhood of 15% of a given deal. For sub-prime auto deals, the subordinated portion will typically be even higher.

Additionally, at least one sector faces new challenges earning a triple-A rating. Specifically, in recent weeks, Moody's has indicated that in the current environment, it will not assign a triple-A rating to a Big Three dealer floorplan deal, no matter how much credit enhancement is included in the transaction. So far S&P and Fitch have not taken the same specific stance, although given the disarray in the auto sector overall, we would not be surprised to see changes to their approach as well.

In order to be TALF-eligible, a transaction must be rated triple-A by at least two of the three rating agencies selected by the FRBNY for this programme (Fitch, Moody's and S&P).

Limits related to refinance needs - For cards and auto dealer floorplan ABS, issuance is constrained to the amount maturing in 2009. Issuers in these two segments of the market can only access the TALF programme up to the dollar amount of existing outstanding issuance that is maturing in 2009. For the ten major issuers that we cover in our monthly Credit Card ABS Monitor, we estimate that there is US$58bn maturing in 2009, well below the US$94bn of new credit card ABS issuance that was seen in H207 and H108 (see Figure 5).

Maturity/tenor issues - TALF loans are three-year loans, which may be prepaid without penalty for ABS that are shorter than three years. However, for ABS longer than three years (student loan ABS frequently falls into this category), the investor will have to consider their exit strategy when the TALF loan has to be paid back.

Liquidity - The FRBNY has established this programme as a temporary programme to be in place for as little time as possible beyond what is necessary to restart the ABS market. To that end, as it stands now, no new TALF loans will be made after 31 December 2009. This will impede liquidity for investors who would prefer to have the flexibility to sell their ABS (with the TALF-related loan) post-2009.

When one considers all of those factors, and then further considers that we are in a general climate of deleveraging (both at the consumer level and system-wide), we think it is likely that TALF-related volume in these three asset classes is ultimately less than the US$200bn.

Conclusion
The announcement of final TALF terms, and a start date, is a positive for the ABS market and is likely to result in some new ABS transactions in short order. We think some issuers will choose to pay a premium to do a transaction (versus other funding sources) in the spirit of getting the market going again. And there has been no shortage of interest from investors who welcome the availability of financing and a limit on their downside risk.

The degree to which issuers are willing to bring new offerings depends on the combination of funding alternatives, as well as underlying loan growth (or shrinkage, as the case may be). Those issuers (non-banks) that do not have access to programmes such as the TLGP, or deposits, will likely be more aggressive in issuing TALF transactions. The intended expansion of the programme to asset classes such as CMBS and jumbo mortgages is likely to be more important to the overall US credit landscape because, unlike in some of the consumer ABS asset classes (prime credit cards, FFELP student loans), funding alternatives are particularly scarce.

The TALF is a tool targeted at the new issue market and, in crafting the TALF, the FRBNY has left itself with the ability to tweak the terms (haircuts, etc). We do not think the FRBNY will be shy in changing terms if that's what is needed to spur transactions. So, in that sense, the programme is likely to 'work' - the monies will be disbursed.

However, this is distinct from saying that the TALF will restart securitisation. In our mind, the TALF put option is like securitisation with training wheels. For the ABS market to truly be restored, investors will need to believe in the creditworthiness of the securitisations they buy - either based on their assessment of collateral and structure, or on rating, or both.

Failing that, as TALF comes online, we expect to see a disconnect between positive tone in the TALF-eligible new issue market and tone in the ABS secondary market (for pre-TALF legacy transactions). And it is difficult to see how this confidence comes back into the market while the overall macro-environment, especially the labour market, is as weak as it is today.

© 2009 Deutsche Bank Securities. All rights reserved. This Research Note was first published by Deutsche Bank Securities on 6 March 2009.

Trading

Trading ideas: overnight underpriced

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

The equity and credit markets have reconnected on the back of sustained equity outperformance. One company bucking the trend was FedEx Corp.

When FedEx's stock got hit at the beginning of the month, its CDS barely budged. Since then, both CDS and equity rallied but FDX's equity lagged. With our adjusted directional credit model pointing towards a CDS sell-off and our CSA model finding FedEx CDS far too tight, now is an excellent time to buy FedEx protection and go long its equity, especially given that FedEx is due to announce earnings today, 18 March.

Delving into the data
Our first step when screening names for potential trades is to look 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

FedEx's CDS has remained tight to fair value since the beginning of the year. Recently, its stock dropped dramatically while its CDS held steady. This led to a sizable disconnect between the company's market and fair levels in CDS, equity and equity vol.

We note that selling equity puts was the best hedge against CDS the week before last. The continued CDS outperformance relative to equity made a straight equity hedge more attractive. Selling at-the-money puts remains reasonable but is more of a delta play now since we do not expect much movement in ATM vol.

Exhibit 2 charts FDX's market and fair CDS levels (y-axis) versus equity share price (x-axis). The red circle 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. We also note that our adjusted directional credit model points towards deterioration in FDX CDS.

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.

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 FedEx. FedEx is a moderately liquid name and CDS bid-offer spreads are around 15bp-20bp.

Buy US$10m notional FedEx Corp 5-Year CDS at 150bp.

Buy 30,000 shares FedEx Corp at US$40.50 to pay 150bp of carry.

For more information and regular updates on this trade idea go to: http://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).