Contents

SIVs

Whistlejacket liquidated

Encouraging bids, but too early to draw conclusions

A portion of assets from Standard Chartered's defunct SIV, Whistlejacket, was auctioned last week and received bids that were better than expected. However, given the hype around the auction and prospects for further deterioration in some of the asset classes involved, the results may not provide the best indication for the future.

The SIV's receiver, Deloitte, reports that the assets were sold at an average price of 67.1% of the outstanding notional amount. This bodes well when compared to a similar auction that was carried out for a portion of Cheyne SIV's assets last year. In that instance the highest bid received by Deloitte for the assets was approximately 44% of face value.

"There was a lot of interest in the Whistlejacket portfolio liquidation, both theoretical and practical," confirms Neil Basu, managing partner of Pearl Diver Capital. "It's a positive sign that a good portion of the list traded, but it has to be taken into consideration that the total amount of securities that traded was small. I wouldn't say it's a turning point for the market."

Basu suggests that a lot of the hype around the Whistlejacket liquidation has been overplayed. "The structured finance market is now awash with broker-dealers, many of which have recently come onto the scene," he says (see SCI issue 122 for more on this). "I'd suggest that there was a buzz around the Whistlejacket liquidation simply because there were so many people actively looking at the list."

Initial estimates indicate that 54% of the US$6bn list traded. Of particular note were the CLOs with a notional value of US$300m, which received bids in the low 70s (% of par), following a bid range of 65%-72%. Eleven CLOs were included on the bid list, believed to be from managers such as Babson Capital, Octagon, New York Life Investment Management and KKR.

However, concern remains more broadly regarding the immediate future of CLOs. Downgrades of triple-A tranches following changes to S&P and Moody's rating methodologies for the asset class are still pending (SCI passim). And investors are wary about how CLOs will cope with rising defaults and expected EODs that are yet to play out.

Basu believes that prices for triple-A CLOs could come down further as the year progresses. "I don't believe that the market has fully taken on the implications of S&P and Moody's revised CLO methodology," he says. "Numerous triple-A tranches of CLOs are likely to see their ratings drop by at least two notches. Most market participants don't react until the very last minute and, from my point of view, I see little happening in preparation for the downgrades."

Meanwhile, a rally in the loan market has seen a number of flow names reaching the 80c on the dollar level and there is some hope that the rally will have a positive impact on the performance of CLOs. "I'd say it should add half a point of cushion to relevant CLOs and may temporarily bring some uplift to CLOs. But I'd remain wary of anything that is market-value based, as we've not yet seen signs of long-term improvements," concludes Basu.

AC

Documentation

EM 'test case' underway

CDS big bang transparency underlined

ISDA's EMEA Credit Derivatives Determinations Committee has voted to hold an auction for JSC BTA Bank, following its failure to repay a US$550m loan. The credit event has been hailed as a test case for the European emerging markets, but it also underlines the transparency provided for by the recent CDS 'big bang'.

BTA Bank announced on 23 April a moratorium on all principal debt payments in excess of US$10m, triggered by an acceleration of payment by two lenders (one of which is Morgan Stanley, who made the credit event determinations request). This followed the breach of a change of control clause after the borrower was taken over by the government of Kazakhstan.

The fact that all of the details regarding who's behind the request, the information that is backing the request and who voted in favour of the credit event are publicly available on ISDA's website is a significant step towards transparency around credit event determinations, according to Ashurst partner Chris Georgiou. "For example, the information backing the request includes a transcript of BTA Bank's investor conference call prepared by Morgan Stanley that is structured to make it clear that CDS have been triggered," he explains. "In other words, all the right boxes are ticked - the defaults are in excess of US$10m, the grace periods have expired, the exposures aren't in domestic currency or domestic law and so on."

Georgiou adds: "Morgan Stanley is not only a lender to BTA, but we assume that it also holds CDS positions referencing the bank and it is a member of the credit event determinations committee. Whilst that means that the economic incentives remain as Morgan Stanley can lay the risk of the loans off with the CDS payments, such increased transparency - while not removing potential conflicts of interest - must limit them."

Credit analysts at BNP Paribas believe that BTA's default is an important credit event for the European emerging markets debt space. First, it is the first sizeable default pertaining to Kazakhstan.

Second, they note that the lenders were prepared to risk their relationships within the country for the sake of defending their commercial interests. Third, the ensuing negotiations with BTA's creditors will present an important test in respect of the fairness and transparency of the restructuring process.

"Finally, we believe that the current situation is a portent of things to come and there will be more corporate and bank defaults emanating from the FSU space in the next six to twelve months," the BNP Paribas analysts add.

HSBC analyst Olga Fedotova agrees that, given the large size of BTA's external debt, its restructuring will likely serve as a benchmark for other emerging market issuers - as well as potentially setting the tone for other CIS debt amendments.

In terms of CDS settlement, she believes that a number of BTA contracts may be naked swaps, leading to cash settlement rather than physical delivery at auction. This marks a precedent in the emerging markets universe, she says.

Standard credit derivatives terms have historically stipulated physical delivery for emerging market names, but if the new 'big bang' protocols have been incorporated into the contract and there's an auction, cash settlement will apply based on the auction final price - although auction participants can deliver assets into the auction.

Fedotova's preliminary estimate for the recovery value of BTA senior debt is 30%, based on the assumptions of 100% NPLs on offshore loans, 30% NPLs on other loans, repayment of US$5bn deposits in full and preferential treatment of trade finance and DPRs. It does not, however, take into account the loss on the bank's recently announced 'speculative derivative transactions', which could have a significant negative impact on recovery.

"At current bond price level, some US$700m of such loss is priced in, according to our calculations," she explains. "Should this amount reach US$1bn, we estimate that recovery value could fall to as low as 16%. In either case, perpetual and subordinated Eurobonds could suffer a full loss."

The upside risk is that BTA's financial position is healthier than anticipated and therefore the recovery value will be significantly higher than estimated. The downside is that material discoveries during the ongoing audit could emerge and further undermine BTA's balance sheet, wiping out US$2.2bn of liquidity and a still-performing part of the bank's loan book.

CS

ABS

Chrysler bankruptcy a 'good test case' for auto ABS

The bankruptcy filing of Chrysler and subsequent impact on the auto ABS market will be watched closely over the next few weeks by securitisation professionals. While the bankruptcy has varying implications for the performance and ratings of the many billions of dollars of outstanding transactions, it is also expected to be a good test case for the auto ABS market.

In particular, the early amortisation of the Daimler Chrysler Master Owner Trust (DCMOT) 2006-A dealer floorplan ABS is likely to provide a good test case for the ABS market, according to securitisation analysts at JPMorgan. "Early amortisation of DCMOT 06-A most probably has been triggered," they suggest.

Investors in this trust will focus on the continued sales of Chrysler vehicles and the subsequent payment of loans to support payoff of the bonds. "We think full payment is likely," the JPMorgan analysts add. "Although Chrysler sales will no doubt be under pressure, we think the combination of government support - in the form of vehicle warranties and as a key player in the 'surgical' bankruptcy - and improving consumer confidence, leading to increased auto demand overall, will enable sales to stay at a level that will facilitate payoff of the bonds in 4-6 months."

The bankruptcy filing will also be a good test case for the return of 'money good' investing in the ABS market, as it will hopefully show that ABS structures work. "We think a successful outcome on this early amortisation event, which should be known in a relatively short timeframe, will encourage more distressed investors to look through to cashflows, and less to liquidity, and put money to work in the ABS market - particularly as yields in the liquidity sectors continue to collapse," the JPMorgan analysts continue.

Meanwhile, the rating agencies' view on the Chapter 11 bankruptcy filing is mixed for existing deals backed by the auto manufacturer. According to Fitch, deals that may see increased pressure include Chrysler Financial's outstanding dealer floorplan ABS and the rental car ABS issued by Dollar Thrifty Automotive Group (DTAG), due to their exposure to Chrysler vehicles in these pools.

Fitch is also focused on the affect of the bankruptcy on Chrysler's auto loan ABS. However, no immediate rating actions are being contemplated by the agency on these transactions at this time, given the evolving nature of the bankruptcy and minimal information available.

Concerns have also been raised about the impact of the bankruptcy on vehicle values for all transactions. Moody's says some of its ratings on Chrysler-backed deals may come under pressure if the decline in vehicle prices throughout the duration of the bankruptcy is greater than its expectation, or if the reorganisation is unsuccessful and is followed by liquidation.

"We believe that new and used vehicle prices are likely to decline as a consequence of Chrysler's bankruptcy. The manufacturer may be motivated to heavily discount new vehicles to encourage sales; the discounted new vehicles would negatively impact used car resale values. A bankruptcy may also raise concerns over the continuation of existing models," note analysts at Moody's.

"The risk that collateral value, as reflected by used vehicle prices, will decline is a key driver that will magnify losses in both retail auto loan and lease ABS to varying degrees," they continues. "In auto loan ABS, generally a limited percentage of the collateral pool is subject to repossession and resale and therefore exposed to market value risk, since only a fraction of the loan pool will default. However, with respect to auto lease ABS, 80% to 90% of the manufacturer's leased vehicles are turned in at lease termination. Turn-in rates are also likely to increase further when car prices decline, as the lessee's purchase option becomes more expensive than prevailing market prices."

Moody's has already taken several actions on auto loan and lease securitisations sponsored by Chrysler Financial over the past six months, driven by the performance of the underlying pools, as well as by the heightened risk of a bankruptcy. The most recent rating actions have taken into consideration a high likelihood of a Chapter 11 bankruptcy filing by the auto manufacturer.

S&P is currently reviewing the impact of the Chrysler bankruptcy on its US and Canadian ABS ratings. The rating agency has rated approximately US$16bn of transactions linked to Chrysler.

AC

CLOs

CLO EOD probabilities updated

Structured credit strategists at JPMorgan have updated their CLO event of default (EOD) probabilities using a new loan-level model. While the strategists' base case (i.e. no initial portfolio re-rating) remains relatively unchanged at around 10%, their market-implied stress case (i.e. re-rating loans based on current prices) yields a much higher 30% EOD figure.

More specifically, the base case implies that about 4% of JPMorgan's CLO universe would hit the EOD trigger within two years and 9% within three years. "This projection is comparable to our older, less-granular analysis (8%-10%) and suggests that relying on asset ratings alone tends to produce a fairly low likelihood of EOD (though we could have increased the likelihood somewhat with more punitive recovery and/or other assumptions)," the strategists note. "On the other hand, we believe using ratings alone is flawed, as the unprecedented increase in credit leverage (and bursting of that bubble) calls for incorporating market views of credit risk." Additionally, loan prices have rallied in recent weeks to a near-term high around US$80 for flow names.

Using JPMorgan's market-implied stress case, current prices suggest 11% of the CLO universe hits EOD within two years and 29% within three years. "However, we think the actual liquidation volume would be only a fraction (say 25% to 30%) of the loans challenged by event of defaults in CLOs, as we believe in many cases of EODs the controlling class would elect to accelerate rather than liquidate. While we can't forecast the behaviours of the controlling class over the next few years, we think up to US$30bn loans could be liquidated into the loan market over [this period]," the strategists conclude.

CS

Emerging Markets

'Substance over form' necessary for sukuk

In a new special report, Moody's looks at the future direction of sukuk, emphasising the need to focus on substance over form. The agency examines these issues, relevant Islamic principles and structural features from an analytical perspective. The report focuses on credit risk, but with reference to the Accounting Auditing Organisation for Islamic Financial Institutions (AAOIFI) recommendations made last year.

"As sukuk issuers begin to face distress, it is important that investors focus on the substance and not the form of their risk, which is a concern in Islamic finance," explains Khalid Howladar, senior credit officer for asset-backed and sukuk finance at Moody's and author of the report. "Most Islamic market participants are aware that sukuk should grant the investor a share of an asset or business venture, along with cashflows and risk commensurate to such ownership. While this is indeed the Shariah 'ideal', most current sukuk structures are designed to replicate conventional fixed income instruments."

The assets in the structure are commonly there for Shariah compliance purposes only and ultimately have no bearing on the risk or performance of the sukuk investments, particularly in a distress situation.

The disparity between the 'substance' and the 'form' of sukuk was highlighted by AAOIFI when it published six recommendations in February 2008. However, Moody's believes that the decline in sukuk market volume has been due more to prevailing global credit market conditions than as a direct reaction to the AAOIFI statements.

In the rating agency's view, AAOIFI's comments constituted a positive effort towards improving transparency and trying to bring the 'substance' of sukuk products closer to the tangible and risk-sharing principles on which there is a broad consensus. "It is in the implementation of these principles that matters become complex for investors," Howladar notes.

A number of terms such as 'mudarabah', 'musharakah' and 'ijarah' are widely applied for all types of sukuk, but the actual legal structure and risk characteristics can vary significantly even within a single type. "Until there is some broad standardisation, investors will need to look at each structure individually to understand the risk/return profile irrespective of the type of sukuk structure used," adds Howladar.

CS

Structuring/Primary market

Readying for redemption day

Andrew Smith, co-founder and president, and Karl D'Cuhna, senior md at Houlihan Smith & Company, answer SCI's questions

Q: When, how and why did your firm become involved in the structured credit markets?
AS: Houlihan Smith was founded in 1996 by Richard Houlihan and me. Richard, who was also the founder of Houlihan Lokey, has a background in restructuring and valuation and I have a background in investment banking, M&A and restructuring. Today the firm has offices in New York, Chicago and LA, and we have approximately 150 staff involved with the restructuring of distressed credit and hedge funds.

Our involvement on the valuation side of structured credit came about as we found ourselves with several hundred engagements with public companies, private equity firms and hedge funds, where we would also be asked to value portfolios of illiquid, Level 3 securities. The concept of being able to provide valuations of distressed, illiquid credits was a natural offshoot of our business.

Karl D'Cuhna joined the firm approximately three years ago from PricewaterhouseCoopers, where he was in the hedge fund group. He had an ideal background to lead our valuation and restructuring efforts, having been involved with large hedge funds that had invested in highly complex securities, which had now become illiquid credits.

KDC: At PWC I worked on the Freddie Mac re-audit for a year - that was the mecca in terms of mortgage structured products. I saw first-hand the derivatives desk, the different tools used and eventually things that would end up hurting them - creative methods to produce securities that generated profits.

Q: In your view, what has been the most significant development in the credit markets in recent years?
KDC: I'd say 2005-2006 was the crescendo of the structured market. Everything that could possibly be restructured and repackaged was being done, and there were a lot of fees being generated from that process.

Andrew Smith

What's more, there was plenty of demand for structured credit products. Hedge funds in particular wanted to generate a lot of alpha and there were plenty of options for them to choose from: CDOs, CDO-squareds, RMBS, CMBS - anything you wanted was available - anything that ultimately proliferated the crisis. Then, all of a sudden, people realised that the collateral supporting these structures was not all fine and dandy.

AS: What we've witnessed in the past six months is what I'd call the 'global true-up of cash'. Investors everywhere have reassessed their risk tolerance and are now essentially saying, across the board, "We want our cash back in our accounts. We no longer necessarily believe any mark or NAV that a fund manager or even a third party is giving us".

When you get the large securities frauds, such as the Bernie Madoff fraud in the US, the need for transparency and being able to get the cash back as proof that it exists adds to the domino effect. Redemptions are going to continue to cause a backlog of selling caused by the need of the ultimate investors wanting their cash back. I think this has been a significant development and remains a significant overhang, and will hinder any sort of recovery as the forced selling to fund redemptions will remain for a long time ahead.

KDC: Redemptions are still a big issue. 31 March was ugly. For some funds, I'd say 30 June will be a bottom, but for others the money is going to continue pouring out.

Karl D'Cuhna

Q: How has this affected your business?
AS: Many of the hedge funds that aren't officially in wind-down are essentially entering into forced restructuring because there is no way they will be able to sell their illiquid positions and meet any kind of orderly repayment to the investors that have submitted redemptions. Therefore, we are involved with the restructuring of hedge funds to accommodate investors that want out, and also those investors that are willing to stay in and take advantage of discounted valuations.

There are consensual ways to make these agreements, and they all require valuation skills. You also have to negotiate with the redemption investors against the investors that are willing to stay invested.

Some fund managers are indicating that they are heading for the exits too - handing the keys back to the investors or putting the securities into SPVs and liquidating trusts. This is a development that doesn't have a quick resolution and I think it will take months and years to resolve.

KDC: We've had a huge up-tick in all kinds of services linked to the sector: M&A, restructuring, valuations. Restructuring is a hot topic right now - those hedge funds facing redemptions want answers.

Q: Will you be involved with the PPIP?
AS: We are getting involved with the PPIP. We are having active, ongoing discussions at the Treasury level to be a subcontractor for the PPIP for valuation of CMBS and RMBS, as well as other illiquid securities that they have a need to value. As an independent firm, we can do that without a conflict of interest.

We have proprietary models for valuing illiquid securities that are widely acknowledged. We've valued billions and billions of dollars of illiquid securities and issued independent reports that have been reviewed and endorsed many times. This is because we have staff that is trained to make sure inputs, methodologies and assumptions are highly transparent and documented, so a third party can understand the conclusions.

Q: What is your strategy going forward?
KDC: Our strategy is to be aggressive and to be ahead of our hedge fund clients and prospective clients, and to keep preaching what we have been saying for a long time: best practices and best execution - that's the ultimate way to operate your business. And in the world today where transparency is king, funds are learning the hard way.

AS: We'll also be continuing to broaden out our product line in terms of valuation expertise. Another big area for valuation growth is the investor classes, such as endowments and pension funds. They have invested in alternative funds and are trying to get a handle on what their exposure is, particularly for Level 3 positions.

They are not necessarily pleased with the marks and numbers they are getting from the asset managers themselves. In some cases they are hiring us directly to make those valuations.

KDC: We have a new broker-dealer division with five people in it. We currently do matched trades of illiquid securities, where we have either a buyer of specific securities or sellers that have an interest in selling. We have completed our first trades in that business and see it as a growth area as well.

Q: What major developments do you need/expect from the market in the future?
KDC: The structured world is on its head right now. I think that what got us here was too much structure and too much creativity. I think in future it's going to be the opposite - a move towards simple structured products that have less risk.

Highly-structured securities, such as CDOs or CLOs, could come back, but in a different form. However, there's so much that needs to happen before people start thinking again about those sorts of assets.

The top of that list is the impact of the government programmes, and how they are going to facilitate liquidity in that space. Eventually, I imagine the higher quality items will be the first ones to return to the space. Certain products will never come back though - such as CDO-cubeds and CDO-squareds.

We've been dealing with a hedge fund, for example, who did not want us to bother valuing one portion of its portfolio because they had already marked it down to zero. In cases such as these, where the portfolio contains such highly structured assets, the cost of valuing it quarterly would probably exceed the value of the portfolio.

I believe there's going to be a cleansing of the system, however. There will be those that want to sell and those that want to buy.

Right now the bid-ask spread is too high and buyers are looking for super-distressed levels - and why not? It's warranted, given the distress that is out there. Eventually, though, people are going to want to bid up on certain items.

AS: There's currently a complete mismatch of risk-reward and the discount for lack of liquidity is just enormous at the moment. We believe that within the distressed world there are a certain number of credits that are mispriced, and this presents a historic buying opportunity for those investors that can take a longer-term view.

About Houlihan Smith
Houlihan Smith & Company, Inc. is a US investment banking firm that specialises in providing financial opinions, valuation services and corporate advisory to public and private businesses. Established in 1996, Houlihan is a registered broker-dealer and FINRA member.

AC

Duo charged over CDS insider trading

The latest company and people moves

The SEC has charged Renato Negrin, a former portfolio manager at hedge fund investment adviser Millennium Partners, and Jon-Paul Rorech, a salesman at Deutsche Bank, with insider trading in CDS of VNU, an international holding company that owns Nielsen Media and other media businesses.

The SEC's complaint alleges that Rorech learned information from Deutsche Bank investment bankers about a change to the proposed VNU bond offering that was expected to increase the price of the CDS on VNU bonds. Deutsche Bank was the lead underwriter for a proposed bond offering by VNU.

According to the SEC's complaint, Rorech illegally tipped Negrin about the contemplated change to the bond structure and Negrin then purchased CDS on VNU for a Millennium hedge fund. When news of the restructured bond offering became public in late July 2006, the price of VNU CDS substantially increased and Negrin closed Millennium's VNU CDS position at a profit of approximately US$1.2m.

"This is the first insider trading enforcement action involving credit default swaps," says Scott Friestad, deputy director of the SEC's division of enforcement. "As alleged in our complaint, Rorech and Negrin checked their integrity at the door and schemed to engage in insider trading of CDS to the detriment of investors and our markets."

James Clarkson, acting director of the SEC's New York regional office, adds: "CDS may still be obscure to the average individual investor, but there is nothing obscure about fraudulently trading with an unfair advantage. Although CDS market participants tend to be experienced professionals, there must be a level playing field with even the most sophisticated financial instruments."

The case was handled by the SEC enforcement division's hedge fund working group, which is investigating fraud and market manipulation by hedge fund investment advisers. The SEC has brought more than 100 cases involving hedge funds in the past five years, including more than 20 this year alone. It has already brought more enforcement actions involving hedge funds in the first four months of this year than all of last year.

The SEC's complaint charges Negrin and Rorech with violations of the antifraud provisions of the Securities Exchange Act of 1934 and seeks a final judgment ordering them to pay financial penalties and disgorgement of ill-gotten gains plus prejudgment interest. Millennium has agreed to escrow the amount that the SEC is seeking as ill-gotten gains pending a final judgment in this case.

Deutsche taps Barclays for CDS trader
Deutsche Bank has hired Timothy Fischer as an md in global credit trading within its global markets division. Fischer will be based in New York and trade high yield bonds and credit derivatives. He will report to Nick Pappas and Ray Costa, co-heads of investment grade, high yield and distressed debt trading for the US.

Fischer will join the bank from Barclays, which acquired Lehman Brothers' North American investment banking, sales and trading divisions in September 2008. At Lehman Brothers, Fischer was co-head of high yield trading for North America. Prior to that, he traded high yield debt at CIBC and Scotia Capital.

In March, Deutsche Bank also announced the hires of Masaya Okoshi and Sean George, both mds in credit flow trading.

Retail CDS brokerage prepped
A new retail CDS brokerage is expected to launch this month, upon authorisation from the UK FSA. Called Traccr, the platform aims to provide retail professional traders access to the credit derivatives markets.

Traditionally, the CDS markets have been available exclusively to volume players. However, the growing liquidity, ease of use and transparency of credit derivatives has drawn the attention of retail traders. Traccr's target customer base consists of high net-worth individuals and professional traders that want to learn to trade CDS for their own personal account.

Farooq Jaffrey founded Traccr last year and currently serves as chief executive and head broker of the company. Jaffrey previously worked at leading CDS brokerage firms, including Merrill Lynch, Bankers Trust and WestLB. He was also head of business development at CreditTrade, where he was instrumental in establishing the structured credit brokerage business and latterly in marketing CDS electronic trading platforms.

Services include provision of a CDS trading simulator, real time credit derivatives news and research, and educational programmes. The trading simulator gives novice and professional traders practical trading experience, with the ability to both sell and buy credit protection on corporate and sovereign credit, as well as sample credit indices.

Pair named for CDS platform
Knight Capital Group has appointed Andrew Scott as md to oversee the operations of NetDelta, its CDS platform that reduces counterparty risk, and Michael Shapiro, director, who is responsible for leading NetDelta's sales effort. Scott is an eight-year veteran of Merrill Lynch, where he was the lead attorney for credit derivative products and a senior representative for key industry and regulatory initiatives. Prior to joining Knight, Shapiro was responsible for sales, business strategy and product development for TradeWeb's credit derivatives trading platform, including leading a global effort to increase post-trade business for CDS and interest rate swaps.

"Knight is very pleased to have Andrew and Michael on board at NetDelta," comments Steven Sadoff, evp and chief information officer at Knight Capital Group. "Both are professionals who have been involved in building out the infrastructure of the CDS market. Their talent and experience are an important addition to the NetDelta team as we develop the business."

He adds: "NetDelta is in prime position to help participants minimise counterparty risk in the CDS market. Credit derivative volumes have grown exponentially over the past few years and, with such growth, comes operational challenges. NetDelta can help its platform participants address concerns regarding risk management, trade settlement and balance sheet usage. Indeed, counterparty risk management has become increasingly important, and both the industry and regulators are actively looking for ways to reduce systemic risk in the market. We believe NetDelta has a solution that addresses risk concerns without hindering the ability of market participants to invest and trade CDS."

Citadel expands in investment banking
Citadel Securities has recruited three senior investment bankers in preparation for the launch of its investment banking division.

Todd Kaplan, who joined Citadel in March, will assume the role of head of investment banking for Citadel Securities, reporting to Rohit D'Souza, ceo of Citadel Securities. Brian Maier joins as head of industry groups and Carl Mayer joins as head of leveraged finance. Both men will report to Kaplan.

Kaplan comments: "Now more than ever, corporations are looking for sound, actionable advice. With Citadel Securities' unique set of assets, I look forward to building our investment banking operation as we provide innovative products and services to a broad group of clients in an increasingly complex environment."

Previously, Kaplan held senior management and coverage positions at Merrill Lynch, including head of global leveraged finance, capital markets & financing, global principal investments and corporate finance.

Maier is also a veteran of Merrill Lynch and Goldman Sachs, with experience encompassing extensive management and origination responsibilities across industries and products. Most recently, he was group head of consumer industries and equity private placements at Merrill Lynch.

Mayer also joins the firm from Merrill Lynch, where he was head of leveraged finance capital markets and a member of the origination capital committee. Prior to Merrill Lynch, he served as md in high yield capital markets at Deutsche Bank.

Monoline sues Merrill Lynch
MBIA and LaCrosse Financial Products have filed a lawsuit against Merrill Lynch. The lawsuit seeks the rescission of certain CDS contracts and related insurance policies issued to Merrill Lynch, as well as damages resulting from Merrill Lynch's misrepresentations and breaches of contract in connection with MBIA's US$5.7bn in gross exposure to a series of structured product transactions that Merrill Lynch arranged and marketed between July 2006 and March 2007.

More specifically, the suit seeks to void the policies and CDS where Merrill Lynch is the counterparty and to recover damages for MBIA's losses where the CDS contracts and related policies were issued to third-party counterparties other than Merrill Lynch. LaCrosse is an SPV that entered into the CDS contracts with Merrill Lynch and others that were in turn insured by MBIA.

MBIA believes that Merrill Lynch's effort to market the CDS contracts to MBIA was part of a deliberate strategy to offload billions of dollars in deteriorating US sub-prime residential mortgages that Merrill Lynch held on its books by packaging them into CDOs or hedging their exposure through swaps guaranteed by insurers. Based upon Merrill Lynch's misrepresentations regarding, among other things, the credit quality of the collateral underlying the CDOs and the level of subordination protection, MBIA - through LaCrosse - insured over US$5.7bn of credit default protection on the super-senior and senior tranches of four CDOs. As a direct result of Merrill Lynch's misrepresentations and breaches of contract, MBIA says it now faces expected losses on these four CDOs presently estimated to be in excess of several hundred million dollars.

Manager expected to acquire several CDOs
S&P says it is closely monitoring all outstanding CDO transactions that DB Zwirn & Co and Fortress manage, following reports that Fortress may be in discussions to replace DB Zwirn & Co as the investment manager of D.B. Zwirn's funds and accounts.

The CDOs that DB Zwirn & Co currently manages are: Bernard Global Loan Investors, Bernard National Loan Investors and Parkridge Lane Structured Finance Special Opportunities CDO I.

Fortress' CDO transactions are: Fortress Credit Funding I, Fortress Credit Funding II, Fortress ABS Opportunities, Fortress Credit Investments I, Fortress Credit Investments II, Fortress Credit Opportunities I, Newcastle CDO IV, Newcastle CDO V, Newcastle CDO VI, Newcastle CDO VII, Newcastle CDO X, Eurocastle CDO II, Eurocastle CDO III and Duncannon CRE CDO I.

Broker adds in EM fixed income
Knight Libertas has appointed Daniel Mullineaux as md, global head of emerging markets fixed income. Knight Libertas is an institutional fixed income broker-dealer providing trade execution, investment research and capital markets services across a broad range of fixed income securities.

Mullineaux is an eight-year veteran of UBS, where he most recently was md and head of emerging markets debt sales for the Americas. He managed a sales force covering debt, rates, derivatives and foreign exchange for clients in the US and Latin America. At Knight Libertas, Mullineaux reports to Gary Katcher, evp and head of global institutional fixed income at Knight Capital.

Knight Libertas has hired four further employees, adding to the current emerging markets fixed income team. Stephen Kenny and Max Nair, who both most recently worked for UBS, will be responsible for sales in Knight Libertas's Greenwich office. Paul Quinn will join the emerging markets trading operation in Greenwich from UBS, while George Urumov, formerly of HSBC Bank, will trade emerging markets debt in London.

Primus announces new board director
Primus Guaranty's shareholders have re-elected Frank Filipps and Thomas Hartlage to its board of directors and have appointed David Czerniecki to its board to fill a vacancy. The company's board now has nine directors.

Filipps and Hartlage were elected as Class II directors with a term expiring in 2012, and Czerniecki was appointed as a Class I director with a term expiring in 2010. Czerniecki will serve on the board's finance and investment committee.

Czerniecki has served on the board of directors of Primus Financial Products since February 2005. He is currently md of XL Investment Management, a subsidiary of XL Capital. Prior to assuming his current position at XL Investment Management, he served in senior executive capacities for other XL affiliates, including md of XL Capital Investment Partners, senior md of XL Capital Assurance and president and cio of XL Portfolio Advisors.

SIFMA and LIBA to merge
The London Investment Banking Association (LIBA) and SIFMA have announced their intention to bring together their London-based operations into a single independent European organisation. This new association will work under the leadership of Jonathan Taylor, LIBA's director general.

It is expected to be a unified, influential voice in issues affecting the international, European and UK capital markets, and will coordinate closely on global market and regulatory issues with SIFMA's Asian and US operations. The new European entity will be linked with a new body, the Global Financial Markets Association (GFMA), which will address global strategy. Tim Ryan, ceo of SIFMA US, will be the ceo of the GFMA.

Lewtan Technologies and Thomson Reuters tie up
Lewtan Technologies, provider of ABSNet, has announced that Thomson Reuters will utilise its ABSNet cashflow library to expand its Valuation Risk Service. This is expected to give Thomson Reuters' clients additional coverage of structured finance instruments in Europe in order to help strengthen transparency and develop better evaluated prices in the marketplace in light of the current financial crisis.

Thomson Reuters is utilising Lewtan's ABSNet cashflow library to provide model support in conjunction with observable price data for European MBS coverage. Market dislocation in global ABS/MBS/CMBS bond prices has required investors to acquire additional data on both the evaluated prices themselves and underlying credit performance. Lewtan says it provides both deal models to form independent pricing valuations, as well as underlying credit performance data on both the bonds and the collateral supporting these transactions.

AC & CS

TALF loan requests jump

A round up of this week's structured credit news

The amount of TALF loans requested at the 5 May facility (for settlement on 12 May) totalled US$10.6bn, comprising US$2.2bn auto, US$5.5bn credit card, US$2.4bn student loan, US$86.6m small business and US$456.1m equipment ABS transactions. Rates for one-year, two-year and three-year fixed are 2.0850, 2.4960 and 2.9625 respectively, while the floating rate was set at 1.40125.

Two prime auto loan, one auto lease, one motorcycle, one equipment and one credit card ABS for a total of US$4.7bn were announced last week. Demand was said to have been overwhelming with a number of the deals oversubscribed, resulting in price guidance moving tighter.

Triple-A credit card ABS spreads tightened by 5bp (subordinate spreads tightened by 50bp-100bp), while student loan spreads came in by 15bp-20bp. Additionally, triple-A Markit ABX tranches rallied by one to four points over the week.

Over 100 apply for PPIP role
The US Treasury department says it has received more than 100 unique applications from potential fund managers interested in participating in the legacy securities portion of the PPIP. A variety of institutions applied, including traditional fixed income, real estate and alternative asset managers (see last week's issue).

Successful applicants must demonstrate a capacity to raise private capital and manage funds in a manner consistent with the Treasury's goal of protecting taxpayers. It will also evaluate the applicant's depth of experience in investing in eligible assets. Finally, the applicant must be headquartered in the US.

The Treasury expects to inform applicants of their preliminary qualification around 15 May. Once a fund receives preliminary qualification, it can begin raising the expected minimum of US$500m in private capital which will serve as the investment that, pending further approval, will be matched with taxpayer funds. The Treasury anticipates opening the programme to smaller fund managers in the future, which may result in a lower minimum private capital raising requirement.

Auction determined for Syncora
ISDA's Americas Credit Derivatives Determinations Committee has resolved that a failure to pay credit event occurred in respect of Syncora Guarantee. The Committee also voted to hold an auction for Syncora.

The event in question occurred on 30 April under the qualifying policy issued by Syncora for the Class A certificates of SunTrust Acquisition Closed-End Seconds Trust Series 2007-1 (STACS 2007-1). A Certificateholder Distribution Statement issued by the trustee for STACS 2007-1 shows that no payment was made by Syncora pursuant to the qualifying policy.

IOSCO ABS/CDS recommendations released
The International Organization of Securities Commissions' (IOSCO) Technical Committee has published 'Unregulated Financial Markets and Products - Consultation Report', prepared by its Task Force on Unregulated Financial Markets and Products. The report contains interim recommendations for regulatory action designed to improve confidence in the securitisation process and the market for CDS. The Task Force was established by the Technical Committee in November 2008 in response to concerns expressed by the G20 regarding the crisis and the pivotal role that certain unregulated market segments and products had played in the evolution of capital markets.

Kathleen Casey, chairman of IOSCO's Technical Committee, comments: "The Task Force has focused on these particular areas of unregulated financial markets and products due to the significance of securitisation and CDS to credit availability in the real economy, their contribution to the management of individual and systemic risks, their recent rapid growth and the important role they play in global markets. "

In proposing these interim recommendations IOSCO believes that a measured regulatory response is required, taking into account industry initiatives, to strengthen the operation of the securitisation and CDS markets. IOSCO further believes that implementing these regulatory actions may assist in restoring confidence in, and promoting the fairness, efficiency and orderliness of international financial markets.

"Based on the responses we receive to this consultation paper and further reflection by Technical Committee members, IOSCO will finalise its recommendations and consider how best to implement those recommendations in the interest of fostering consistent regulatory approaches across markets," Casey adds.

For the securitisation market, wrong incentives, inadequate risk management practices, and regulatory structure and oversight issues are cited as concerns. The interim recommendations to tackle these issues include sponsors retaining a long-term economic exposure to the securitisation; enhancing transparency through disclosure by issuers of all checks, assessments and duties that have been performed or risk practices that have been undertaken by the underwriter, sponsor and/or originator; mandating improvements in disclosure by issuers, including initial and ongoing information about underlying asset pool performance; strengthening investor suitability requirements, as well as the definition of a sophisticated investor in this market; and encourage the development of alternative means to evaluate risk with the support of the buy-side.

For CDS, regulatory structure and oversight issues, as well as counterparty risk and lack of transparency were cited as concerns. The interim recommendations to tackle these issues include: providing sufficient regulatory structure for the establishment of CCPs to clear standardised CDS, by requiring appropriate financial resources and risk management practices to minimise risk of CCP failure; CCPs making available transaction and market information that would inform the market and regulators; encouraging market participants to work on standardising CDS contracts to facilitate CCP clearing; and facilitating appropriate and timely disclosure of CDS data relating to price, volume and open-interest by electronic trading platforms, data providers and data warehouses.

Largest monthly deterioration recorded for CMBX
CMBS credit performance recorded the largest monthly deterioration to date last month, according to Barclays Capital securitisation analysts, led by loans backed by pools of multifamily properties. With close to 100% of remittances reported, the 30+ days delinquency rate had a 48bp jump to 2.45%. The pace of recent credit deterioration has intensified, as the prior three-month average monthly increase was 23bp.

2007 and after vintage multifamily loans experienced a 307bp increase to 7.61%. Across the Markit CMBX index, this led to underperformance across Series 3 and 4. The BarCap analysts expect the pace of credit deterioration to escalate in future months as delinquencies in other property types emerge.

Outside of multifamily, the retail (and increase of 53bp) and hotel (51bp) sectors showed the most deterioration. In retail, geographical economic weakness and exposure to bankrupt retailers are the common themes, the analysts note.

Assured IFSR downgraded
Fitch has downgraded Assured Guaranty's insurer financial strength rating (IFSR) to double-A from triple-A, citing the continued negative credit migration within the combined insured portfolio - primarily related to structured finance - outpacing the company's ability to build capital resources through earnings retention. Additionally, Fitch has downgraded the IFSR of Assured Guaranty Re to double-A minus from double-A, and the debt ratings of the US holding company Assured Guaranty US Holdings. All affected ratings are on rating watch evolving.

With close to US$18.4bn of net par in force as of 31December 2008, mortgage-related exposures are a particular area of concern and potentially represent a material source of credit risk, says Fitch. Additionally, AGC has exposures to US$7.3bn of TruPs CDOs and certain other structured finance transactions that have been subject to ratings downgrades. The agency says these adverse credit developments, in the aggregate, have created pressure upon the monoline's capital position with respect to its current ratings level.

Greater alignment expected between credit risk and spreads
Fitch says that the recent trades for the Whistlejacket bid list at tighter levels than prevailing secondary market spreads for structured finance securities may be a sign that liquidity and investor interest in the sector is improving (see separate News Analysis story for more on this). Consequently, secondary market prices may begin to place a greater weight on credit risk fundamentals, compared to liquidity concerns, general negative sentiment and other price determinants, which have dominated market prices for most European structured finance securities since the global credit crisis began in July 2007.

"Government initiatives, such as the recently announced guarantee scheme for UK RMBS, that address specific investor concerns - for example, about extension risk - may reduce the impact of non-credit related risks on pricing," says Ian Linnell, head of structured finance for EMEA at Fitch. "Such initiatives may therefore encourage a greater alignment between market prices and the value implied by the fundamental credit risk."

"Uncertainty about collateral credit performance and related rating actions are two drivers of secondary market prices, but there are many others," adds Stuart Jennings, Fitch's structured finance risk officer for EMEA and Asia Pacific. "Extension risk, relative liquidity and general interest rate trends are factors which heavily influence pricing and may more than outweigh credit concerns in the current disrupted market."

Fitch notes that most European investment grade structured finance securities continue to have secondary market prices that are quoted at substantially below par. This highlights a continued apparent disconnection between secondary market prices quoted at a significant discount to their face value and the credit profile reflected in the ratings assigned to the affected securities.

Fitch continues to expect that impairment levels on most European investment grade structured finance securities will be minimal. Such a disconnection may indeed partially reflect a fundamentally different credit view on the part of investors to that assumed in rating analysis. Contrary to its credit view for investment grade securities, Fitch expects a much greater extent of impairment for non-investment grade securities, given the impact of the deep global economic recession.

Fitch emphasises that it is difficult, if not impossible, to distinguish the relative importance of different price determinants in secondary market pricing. Therefore, successfully carving out implied credit losses from secondary market pricing is unlikely, given that prices continue to reflect a multitude of other factors alongside credit risk.

EM Q1 ABS issuance buoyed by Mexican CLNs
A handful of transactions have kept securitisation alive in the emerging markets during the first quarter of 2009, S&P reports. These include a diversified payment rights (DPR) transaction issued by a Brazilian bank and three credit-linked note deals in Mexico.

In March the rating agency assigned a single-A rating to the US$100m floating-rate notes from series 2009-1 issued by International Diversified Payment Rights Co (Banco Bradesco). The transaction is a securitisation through a true sale of Brazil's Banco Bradesco current and future DPRs, which take the form of US dollar-denominated SWIFT MT100 series payment order messages.

S&P also assigned a triple-B rating to the US$150m floating-rate notes from Series 2009-A and 2009-B issued by IBK DPR Securitizadora (Banco International del Peru). The transaction is a securitisation of all current and future DPRs in the form of US dollar and SWIFT MT100 category payment order messages that Banco Internacional del Peru Interbank receives.

In Mexico, S&P assigned global scale point-in-time ratings and local scale (CalVal) ratings to three credit-linked note transactions. The agency assigned triple-B plus global scale point-in-time ratings to MXTIIE's Bonos series 2009-1, AXTIIE's Bonos series 2009-1 and TVTIIE's series 2009-1.

At the same time, it assigned mxAAA ratings to each of the three credit-linked note deals. The transactions were sponsored by Merrill Lynch.

Counterparty credit rating changes drove most of the rating activity for the first quarter. Meanwhile, following the downgrade of MBIA to triple-B plus from double-A, S&P lowered ratings on 19 emerging market ABS future flow transactions and on five Mexican RMBS.

In Kazakstan, S&P lowered its stand-alone and/or underlying ratings on four BTA DPR Finance Co and seven Kazkommerts DPR Co financial future flow transactions. All 11 transactions are backed by Kazakhstan's DPRs.

Fitch updates RMBS cashflow analysis
Fitch has updated its cashflow analysis criteria for analysing RMBS to incorporate the impact of the latest structural innovations in the EMEA RMBS industry. However, the core Fitch approach remains unchanged.

"Despite having reached a certain level of homogeneity over the past several years, EMEA RMBS structures still tend to differ depending on the jurisdiction, on the asset quality and the originator's objectives," says Michele Cuneo, senior director in Fitch's EMEA RMBS team.

Some of the latest structural developments covered by the criteria include swaps providing credit enhancement, unhedged structures and notes backed by excess spread. In addition, the updated criteria report specifies the agency's approach on revolving RMBS transactions and other structural features, such as pro-rata note amortisation and permitted portfolio variations.

"The report also details Fitch's assumptions regarding the individual risk factors affecting the cashflows generated by the portfolio, from default distribution to delinquency and prepayment, providing a clear and transparent insight into our rating methodology," adds Gregg Kohansky, md and head of Fitch's EMEA RMBS team.

Supplemental risk measures applied to EMEA CMBS ...
Moody's has published a report showing how its supplemental risk measures for structured finance transactions will work in practice within the EMEA CMBS sector. The report, entitled 'V Scores and Parameter Sensitivities in the EMEA CMBS Sector', applies the measures to typical transactions across the various sectors of EMEA CMBS.

Specifically, the sectors are: small multi-borrower CMBS (granular loan pool), large multi-borrower CMBS (typically three to 20 loans) and single-borrower CMBS. In the report, Moody's concludes that it expects the typical transactions in each sector to be assessed V scores of medium assumption variability. V Scores are intended to rank transactions by the potential for significant rating changes owing to uncertainty around the assumptions.

The second supplemental measure being applied by Moody's is a parameter sensitivity analysis, which provides a quantitative calculation of how the initial model-indicated rating of a structured finance security could vary if key assumptions were to change. To illustrate the parameter sensitivity analysis for typical large multi-borrower and single-borrower CMBS transactions, the model-indicated rating of a class assessed initially as Aaa might migrate to Aa2 if, instead, the initially assumed default probability were increased by 100% and if simultaneously the Moody's value (initial model property value) were decreased by 20%.

... and to CDOs
Moody's has published two reports showing how its supplemental risk measures for structured finance transactions will work in practice within the global cashflow structured finance and corporate synthetic CDO sectors.

In the first report, Moody's concludes that it expects V scores for typical structured finance CDOs (deals that are backed primarily by pools of mortgage-related assets) to reflect high assumption variability. In the second report, the agency concludes that it expects V scores for typical corporate synthetic CDOs to reflect medium/high assumption variability.

Moody's notes that it has rated only a handful SF CDOs in the past 12 months, and the composition of the underlying portfolios has varied a great deal such that it is extremely difficult to define a representative portfolio or structure for SF CDOs. Therefore, a sample parameter sensitivity analysis for the sector is unavailable.

Nevertheless, Moody's intends to provide a parameter sensitivity analysis for each new SF CDO transaction rated. It expects the two key parameters it will analyse to be the mean cumulative loss rate and the Moody's asset correlation (MAC).

In terms of a parameter sensitivity analysis for synthetic CDOs, meanwhile, Moody's includes the following example. If a mean cumulative default rate of 2.3% and recovery rate of 35% were used in determining the initial rating of a typical corporate synthetic CDO transaction, and these were then changed to 4.3% and 25% respectively, the initial model-indicated rating for the senior certificates might change from Aaa to Aa2.

CDS volumes remain light ...
The latest DTCC data shows that CDS volumes remained light in the week ended 1 May, with a US$194bn rise in gross notionals. Single names were mixed, showing a US$21bn of re-risking (protection selling), while indices dominated again with a net de-risking (protection buying) of US$216bn (including tranches). European indices dominated the de-risking and US indices saw the largest degree of re-risking.

Analysts at Credit Derivatives Research suggest that the widespread nature of the de-risking in the Markit iTraxx index appears to have been driven by systemic management of a dealer's book.

... but liquidity continues to improve
The latest liquidity scores commentary from Fitch Solutions shows that liquidity in the US CDS market continues to improve, with the Fitch Americas Liquidity index closing at 9.70 on 4 May. This highlights that the US market has now successfully implemented the CDS 'big bang' and is beginning to benefit from the changes to standardisation of quoting conventions, Fitch says.

The index closed at 9.65 on 30 April, which is the second-lowest liquidity score since the index started in March 2006. The lowest score - and therefore the most liquid day - was 9.57, which was recorded on 19 September 2008, following Lehman Brothers' bankruptcy.

In terms of sovereign CDS, the liquidity of swaps on Mexico significantly increased from 24 April following the outbreak of swine flu, reaching a low of 5.69 on 30 April. However in the last few days, liquidity has fallen off, suggesting that financial markets believe the worst is over from a Mexico standpoint, with the liquidity score closing at 6.12 on 4 May.

For the Americas, the financial sector continues to dominate liquidity in the US market, with General Electric Capital Corporation retaining top spot. Macy's Inc makes a return to the top five ahead of its Q109 earnings announcement on 13 May.

Meanwhile, the dominance of telecoms companies in the top five for the European CDS market appears to be receding, with the automotive industry becoming more prominent. Daimler is back again on top spot, with GKN Holdings entering the top five for the first time, as the industry continues to suffer from falling demand for new cars.

Finally, Korean names continue to dominate liquidity in the Asia Pacific, including Samsung Electronics, Woori Bank and Korean Development Bank.

DB closes US CLO
Deutsche Bank has closed Blue Ridge CLO 2009-1, a managed cashflow CLO backed by corporate loans originated by the bank and its affiliates. Fitch has assigned a triple-A rating to US$1.29bn of Class A senior secured floating-rate notes. The deal has an equity tranche sized at US$387m.

As of the closing date, all of the portfolio collateral had been identified. Investment grade rated loans represented approximately one-third of the total portfolio, contributing to a Fitch weighted average rating factor (WARF) of 19.3, or BB/BB-. Additionally, approximately 67% of the portfolio is comprised of senior unsecured loans and 33% senior secured loans.

The transaction documents permit the servicer to trade and reinvest principal proceeds for a period of three years. As such, the documents provide for portfolio guidelines in order to maintain certain characteristics of the closing portfolio throughout the reinvestment period.

Fitch says the analysis of the deal included additional scenarios that incorporated sensitivities to recently observed softness in US corporate recoveries, as well as depressed loan market prices.

Market value CLO restructured
S&P has lowered to single-D, removed from watch negative and withdrawn its ratings on the Class B and C notes issued by the Eurocredit Opportunities I transaction. At the same time, the ratings were reinstated to double-A for the Class Bs and triple-B minus for the Class Cs, following the restructuring of the deal.

The restructuring of the transaction includes changes in the coupon payment frequency, a maturity extension and the removal of the market value triggers that were originally embedded in the Eurocredit Opportunities I documentation. The documentation changes have transformed the transaction from a market value into a static sequential-pay cashflow structure.

On 2 February 2009, an overcollateralisation failure occurred under the terms and conditions of the original notes. Under the original trust deed, the issuer provided a plan to remedy the overcollateralisation failure. As part of that plan, the issuer fully prepaid all of the outstanding VF notes and fully redeemed all of the outstanding Class A notes on 23 February 2009.

After this prepayment and redemption of the VF notes and the Class A notes, the Class B noteholders became the controlling class. In addition, as part of the plan, the issuer sought and obtained extraordinary resolutions from the holders of each class of the original notes still outstanding, under which each such class of noteholders consented to the amendment and restatement of the terms and conditions applicable to all the relevant classes of notes and to the investment manager advances, which were at that time due and unpaid.

The ratings on the existing notes have been lowered to single-D and removed from watch negative because the existing terms have been amended with respect to coupon payment, coupon frequency as well as the original maturity of the notes.

Stress testing systemic risk
The BIS has published a working paper entitled 'A Framework for Assessing the Systemic Risk of Major Financial Institutions', which proposes a framework for measuring and stress testing the systemic risk of a group of major financial institutions. Systemic risk is measured by the price of insurance against financial distress, which is based on ex ante measures of default probabilities of individual banks and forecasted asset return correlations.

Importantly, using realised correlations estimated from high-frequency equity return data can significantly improve the accuracy of forecasted correlations, the paper notes. The stress testing methodology, using an integrated micro-macro model, takes into account dynamic linkages between the health of major US banks and macro-financial conditions.

The results suggest that the theoretical insurance premium that would be charged to protect against losses that equal or exceed 15% of total liabilities of 12 major US financial firms stood at US$110bn in March 2008 and had a projected upper bound of US$250bn in July 2008.

Dramatic improvement for troubled company index
The Kamakura index of troubled public companies showed dramatic improvement in April, after reaching its worst point in the current recession in March. The Kamakura global index of troubled companies decreased by 2.2% to 22.1% of the public company universe.

The 2.2% decline in the index is the 12th largest decline in the 229-month history of the troubled company index. Kamakura Corporation defines a troubled company as a company whose short-term default probability is in excess of 1%.

The all-time high in the index was 28.0%, recorded in September 2001. Credit conditions are now worse than credit conditions in 89.9% of the months since the index's initiation in January 1990. The all-time low in the index was 5.4%, recorded in April and May, 2006.

The index is based on expanded coverage of more than 24,000 companies in 30 countries - an increase of more than 300 firms since the previous month. Kamakura reports that the expanded corporate coverage had no significant impact on the level of the index. The increase in coverage this month is predominately made up of German, Austrian and Swiss public firms.

This month, among rated public companies, the firms showing the sharpest rise in short-term default risk were Seat Pagine Gialle in Italy, Dune Energy, Barzel Industries and Citadel Broadcasting Corp.

EC's AIFM directive criticised
The European School of Management and Technology (ESMT) has criticised the European Commission's proposed directive on alternative investment fund managers (see also last issue). According to Professor Jörg Rocholl at ESMT, the directive risks creating an administrative structure that will harm the international competitiveness of the system, fails to resolve the risks that remain and is ineffectively tarring a number of different industries with the same regulatory brush.

"The business of hedge funds is characterised by the substantial use of leverage to exploit primarily short-term arbitrage opportunities. Demanding substantial information from hedge funds is tantamount to shutting the stable door after the horse has bolted. Information relating to short-term positions will likely become obsolete as soon as it is produced, failing to achieve the transparency that is sought, whilst placing an unnecessary burden on Europe's financial industry," he says.

He continues: "Creating a paper trail will do nothing but open the door to regulatory arbitrage. Offshore funds will be unaffected until 2014, whilst the US industry can expect a serious shot-in-the-arm and migration of talent to its shores. The international principles set out in the G20 warranted industry consideration, and a response that created a more uniform international financial environment. We can expect the response from the US to be more benign - New York must be popping open the champagne corks!"

CMBS special servicers under pressure
The increasing speed and magnitude of defaults, coupled with rising special servicing volume is placing significant pressure on the resources of both US CMBS special and master servicers, according to Fitch in a new report. CMBS special servicing volume has increased five-fold since the end of 2007, with US$23.7bn as of 31 March compared to US$4.6bn at 31 December 2007.

The pace of special servicing transfers will continue to grow throughout this year, according to Fitch md Stephanie Petosa. "The sharp rise in special servicing raises the question of servicer preparedness," she notes. "Fitch is concerned that the rapid rise in specially serviced loans will affect special and master servicers' ability to address loan-level issues with the quality CMBS market participants have come to expect."

Preparedness is an important area of focus for Fitch's servicer reviews this year, particularly in light of the pressure that servicers will continue to face for the rest of this year and into 2010. With Fitch projecting loan defaults to eclipse 4%, additional loan defaults and the expectation of further increases in specially serviced loans will continue to stress the resources of CMBS servicers, Petosa says.

Greek mortgage support measures 'positive'
Fitch says that mortgage support measures announced last week by the Greek government may have a positive impact on the revival of the domestic housing market. However, the agency notes that their effectiveness ultimately lies on the Greek banks' discretion to extend credit amid the current financial conditions, while regulatory supervision is required to oversee prudent new loan underwriting.

The new government measures are intended to stimulate mortgage credit demand by reducing transaction costs, as well as by expanding the tax deductibility scope for residential mortgage loans originated in 2009 and 2010.

"Mortgage debt penetration in Greece stands below Eurozone average and is significantly lower than countries like the Netherlands, where a full tax deductibility regime has promoted market growth over time," says Lara Patrignani, senior director in Fitch's European structured finance team in London. "Given also that transaction costs in Greece have traditionally been high by international standards, both of these measures have the potential to stimulate the country's mortgage and property market."

Moreover, in an apparent effort to support mortgage credit supply, the Greek government announced that it separately guarantees loan amounts granted in excess of 75% loan-to-value (LTV) ratio and up to 100% LTV for loans disbursed by the end of 2010. Fitch is cautious about the latter measure; a guarantee for high-LTV loans means that the state itself would be liable for up to the first 25% of credit losses under the new scheme. This could lead to more aggressive loan underwriting from Greek lenders, which have recently been reducing mortgage origination volumes in light of ongoing funding challenges and elevated credit concerns.

Crucially, LTV is the single most important criterion in Greek mortgage underwriting. Apart from an indicative 75% LTV limit recommended by Bank of Greece (BoG), existing regulatory guidelines also impose a 40% limit on a borrower's debt-to-income (DTI) ratio. In Fitch's view, however, both LTV and DTI regulatory guidelines have been largely ineffective as it is ultimately down to the lenders' discretion to override them.

"Given that for a creditworthy customer Greek banks would anyway exceed the 75% LTV threshold, the new scheme may effectively encourage underwriting of marginal credits," says Spyros Michas, associate director in Fitch's European structured finance team in London. "The possibility of excessive risk-taking is there, raising the need for adequate regulatory supervision aimed to preserve responsible lending, while increased credit is flowing through the economy."

Overall, Fitch expects continuing deterioration in Greek mortgage asset performance. As the new measures aim to stimulate new lending without addressing existing mortgage borrowers, there is no immediate rating impact on the outstanding Greek mortgage-backed issues, securitisations (RMBS) and covered bonds. However, the agency will consider the potentially inferior credit risk profile of high-LTV-guaranteed loans when assigning new ratings to Greek transactions.

SROC results in for Asia ...
S&P lowered its ratings on 30 tranches relating to 26 Japanese synthetic CDO transactions and removed the ratings on 20 of the 30 tranches from credit watch, while keeping the ratings on the other 10 on watch with negative implications. At the same time, the agency affirmed its ratings on two tranches and removed the ratings from watch with negative implications. In addition, S&P raised its ratings on four tranches and removed the ratings from watch with positive implications, where they had been placed on 10 April.

Meanwhile, S&P also lowered the ratings on 39 Asia-Pacific (excluding Japan) synthetic CDOs. Eighteen of the downgraded CDOs remain on watch with negative implications, while 21 ratings were removed from watch negative and affirmed. In addition, the ratings on two other CDOs were taken off watch negative and affirmed.

... and Europe
S&P has taken credit rating actions on 351 European synthetic CDO tranches. Specifically, the ratings on: 269 tranches were lowered and removed from watch negative; and 82 tranches were lowered and remain on watch negative.

Of the 351 tranches lowered and/or placed on watch negative: one references US RMBS and US CDOs that are exposed to US RMBS, which have experienced negative rating actions; and 350 have experienced corporate downgrades in their portfolio. These actions incorporate, among other things, the effect of recent rating migration within reference portfolios and recent credit events on several corporate entities.

CSOs impacted
Fitch has downgraded 410 tranches (affecting 305 public ratings and 105 private ratings) and affirmed 124 tranches (affecting 100 public ratings and 24 private ratings) from 290 synthetic corporate CDO transactions. In addition, the agency has assigned recovery ratings to the notes rated triple-C and below.

The rating actions reflect the continued deterioration in portfolio credit quality, particularly in relation to defaulted assets and assets rated triple-C or below. Since the agency's prior rating actions on the transactions in October 2008, a total of 24 reference entities have been subject to credit events. Recovery expectations based on the ISDA auctions and market prices are lower-than-anticipated for these names, as they average 14.4%.

Fitch analysed the transactions using the portfolio credit model and additionally considered the size of the lowest credit quality buckets relative to the remaining credit enhancement available to the notes. Downgrades of notes to the double-C and triple-C categories reflect high percentages of triple-C and lower-rated names in excess of available credit enhancement. For notes that are deemed highly likely to experience losses due to credit events, but where actual recovery valuations are outstanding, a rating of single-C has been assigned. For the 124 tranches that have been affirmed, the action reflects low exposure to the defaulted names, lower levels of negative portfolio credit quality migration and the notes' relatively shorter terms to maturity.

Fitch has assigned recovery ratings, in most cases of RR6, for notes rated triple-C or below to reflect the expectation that further credit events would likely result in the tranches being completely written down, given the relative thinness of the notes. For notes rated above triple-C, Fitch has, in most cases, assigned negative outlooks to reflect the expectation of further negative portfolio credit quality migration and additional credit events.

ABS CDOs downgraded ...
S&P has lowered its ratings on 73 tranches from 19 US cashflow and hybrid CDO transactions. At the same time, it removed 19 of the lowered ratings from watch with negative implications. The ratings on 49 of the downgraded tranches remain on watch with negative implications, indicating a significant likelihood of further downgrades.

The watch placements primarily affect transactions for which a significant portion of the collateral assets currently have ratings on watch with negative implications or have significant exposure to assets rated in the triple-C category.

The 73 downgraded tranches have a total issuance amount of US$10.361bn. All 19 affected transactions are mezzanine structured finance (SF) ABS CDOs, which are collateralised in large part by mezzanine tranches of RMBS and other SF securities. The downgrades reflect a number of factors, including credit deterioration and recent negative rating actions on US sub-prime RMBS.

... and ratings withdrawn
S&P has withdrawn its ratings on 658 classes of notes from 23 cashflow and 64 hybrid CDOs. The transactions are backed by mezzanine RMBS, high-grade RMBS securities and CDO-squareds. The deals previously triggered events of default (EODs), after which the controlling noteholders subsequently voted to accelerate the maturity of the notes and liquidate the collateral assets.

The affected tranches have a combined issuance amount of US$93.46bn. S&P previously lowered its ratings on the 23 transactions to single-D because the proceeds from the liquidations have not been sufficient to make par payments to the rated notes. It also previously lowered its ratings on the 64 hybrid CDO transactions to single-D because the transactions did not have proceeds to pay back par payments to the noteholders after making the termination payments on the credit default swap contracts.

US$52.9bn CRE CDOs downgraded ...
Moody's has concluded a review of 160 US CRE CDOs rated during the period from 2002 through to 2008, resulting in the downgrade of all rated classes by one to 15 notches. The outstanding balance of Moody's-rated tranches for these reviewed transactions totalled US$83.1bn, which represents approximately 92% of all outstanding Moody's-rated and monitored CRE CDOs by dollar volume.

Moody's upgraded nine tranches, representing an aggregate balance of US$301m. However, the agency also downgraded 1,085 tranches, representing an aggregate balance of US$52.9bn. At the same time, it confirmed the ratings of 151 tranches, representing an aggregate balance of US$29.9bn.

The CRE CDOs reviewed include resecuritisation transactions comprised primarily of CMBS, as well as CRE CDOs comprised of non-CUSIP collateral, such as whole loans, B-notes, mezzanine loans and other real estate collateral, structured on a cash or synthetic basis. Moody's review incorporated revised modelling parameters and credit drift in the CMBS collateral resulting from its recent downgrades of 2006 through to 2008 vintage CMBS conduit and fusion deals, and 1997 through to 2008 vintage CMBS large-loan and single-borrower deals.

The revised parameters in Moody's model for rating and monitoring CRE CDOs are related to asset correlation, default probability and recovery rate. These revisions are generally consistent with recent revisions to key parameters for rating and monitoring other CDO transactions backed by ABS.

Moody's review incorporated updated asset correlation assumptions for the commercial real estate sector consistent with CDOROM v2.5, which was released on 3 February 2009. These correlations were updated in light of the systemic seizure of credit markets and to reflect higher inter- and intra-industry asset correlations.

... while others are on review
Fitch has placed on rating watch negative 137 classes from 19 CRE CDOs. In addition, the agency has revised the rating outlook to negative from stable on 15 classes from six of the same transactions and on 46 classes across 11 other CRE CDOs.

Fitch took rating actions on these transactions earlier this year, following the implementation of its revised 16 December 2008 criteria report entitled 'Global Rating Criteria for Structured Finance CDOs'. Since that time, the magnitude of actual and expected rating downgrades of the underlying collateral - primarily US CMBS bonds from the 2006 through 2008 vintages - has exceeded the agency's expectation.

The CRE CDOs placed on watch negative are generally those that contain in excess of 25% US CMBS from the 2006 to 2008 vintages and that were initially composed of collateral rated in the triple-B category (mezzanine transactions). The ratings of CRE CDOs with significant exposure to CMBS B-piece bonds already account for a high probability of default; therefore, a negative migration of the below investment grade collateral in these transactions has less of an impact than negative migration from investment grade collateral to below investment grade for the mezzanine transactions.

Fitch revised the rating outlooks to negative for all classes not placed on RWN given their exposure to US CMBS from the 2006 to 2008 vintages. Of the affected transactions, the highest rated class placed on RWN is currently rated in the triple-B category.

European LSS hit
S&P has lowered its credit ratings on eight European loss-based leveraged super senior (LSS) notes and taken various credit watch actions on several of them. Specifically, the agency lowered its ratings on the Series 35 and 36 notes issued by Chess II, as well as the Series 2007-31 and 2007-36 notes issued by STARTS (Cayman). It also lowered and placed on watch negative the ratings on the Series 37 notes issued by Chess II and the Series 2008-1 notes issued by STARTS (Ireland), as well as lowering and removing from watch negative the ratings on the Series 04/2006 notes issued by IRIS SPV and the Series 2007-11 notes issued by STARTS (Cayman).

These rating actions follow credit events and S&P's assessment of a deterioration in the credit quality of the assets in the underlying reference portfolios. These factors have, in the agency's opinion, increased the probability that the portfolio loss triggers for these tranches will be breached. Accordingly, it has lowered the ratings to a level it believes is consistent with the tranches' loss probability.

CS & AC

Trading

Trading ideas: time to change the channel

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

We look at Viacom Inc (VIA), a name whose CDS handily outperformed its equity over the past couple of weeks. Viacom reported earnings last week, topping estimates, but its equity now trades below pre-earnings levels while its CDS trades significantly tighter than a month ago.

Given the overall credit outperformance of the past few weeks, we look for a pullback. With VIA credit and equity so far apart, we believe now is an excellent time to make a relative value bet on the name.

Delving into the data
Exhibit 1 charts VIA's market and equity-implied fair value CDS over time. Since the middle of April, Viacom's CDS moved from trading too wide of fair to almost 50bp tight of fair.

Exhibit 2 charts VIA's market and fair CDS levels (y-axis) versus Class B equity share price (x-axis). The green circle shows current market levels.

The yellow square indicates current fair values when vol is also considered, and the red square indicates expected values in three months, taking our directional credit model into account. With CDS too tight compared to equity, we expect a combination of equity rally and CDS widening.

Exhibit 1

Our directional credit model indicates significant widening of CDS based on weak equity-implied default risk, implied vol, margin and accrual factors. Taking an outright short position by buying CDS protection is tempting, but we believe the credit-equity disconnect is large enough to warrant a relative value trade.

Exhibit 2

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 Viacom. Viacom has good liquidity in the CDS market and bid-offer spreads are around 10bp.

Buy US$10m notional Viacom Inc 5-Year CDS at 142bp.

Buy 55,000 shares Viacom Inc Class B shares at US$19.20.

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).