Contents

ABS

Limited mandate

Consolidation on the cards for new entrants to ABS scene?

The number of firms expanding into the ABS broking and advisory space shows no sign of letting up - it is estimated that as many as 35 agency brokerages are now involved in the European ABS market alone. While it makes sense for these firms to operate in the current climate (see SCI issue 122), there is scope for consolidation, should the firms in question not have a 'plan B' in place.

"The majority of structured credit and ABS advisory services are recent entrants to the market and while at present there may be no shortage of demand for their service, it is very much a short-term business plan," says Dean Atkins, managing partner of Structured Credit Trading Solutions. "The same applies for the increasing number of agency brokerages that are focusing on ABS: bid-offer spreads aren't going to remain this wide forever - therefore they are going to need a plan B for when they narrow."

Atkins expects to see a lot of consolidation occurring in both the advisory services and agency-brokerage sectors. "Both sorts of firms will have to have a stage two and stage three in their business plan. I imagine within the next 18 months a number of advisory and agency-brokerages will consolidate in order to gain critical mass, and I expect some of them will disappear all together," he adds.

Several independent advisory firms have indeed set out stages two and three in their business plans, such as investing in the assets they currently advise on. Agency-broking, meanwhile, has very few business overheads to contend with, especially as many new recruits are opting for commission-only salaries.

According to one London-based head-hunter, some are on a fixed salary, but many will be on no salary at all. "I've certainly not heard of any bonus guarantees in this line of work," he notes. "For the time being it's a home for many in the industry, and somewhere for them to weather the storm." He adds that the teams of brokers are also generally very manoeuvrable.

"I'm sure that many of the advisory firms will do OK, but I would agree that a number of them will have to consolidate," says another European head-hunter. "However, agency brokers that have moved into ABS will likely move back into what they originally did, rather than consolidating with other brokers."

Besides the eventual narrowing of the bid-offer spread, other factors potentially threaten the agency-brokerage model. First is that when banks start leveraging their balance sheets again, many of the brokers will likely be pushed out of the market, as their competitiveness will be eroded.

Second, under the EU CRD, securitisation investors will now have to prove certain due diligence requirements, which may mean that brokers and/or dealers will in turn be required to provide accompanying documentation for the securities they're trading. "The infrastructure that this would necessitate, plus the not-insignificant non-compliance penalty, may force some dealers to exit the market or only focus on the instruments that they want to trade - thereby narrowing liquidity in the market," notes one ABS analyst. "Brokers/dealers will also have to begin disclosing the price that was paid for bonds in the secondary market, which means that they'll no longer be able to block positions anymore."

He suggests that, as a result, issuers may start targeting the US investor base in order to circumvent the CRD rules.

AC

Trading

Compression catalysts

Limited time left for negative basis opportunities?

Current trends point to continued compression in the cash-CDS basis, suggesting that profitable trades that arose out of market dislocation could soon disappear. However, while it may entail greater scrutiny of the sector, opportunities can still be identified - with European LT2 bonds being one current pick.

The availability of cash-CDS basis packages has declined by around 30% since end-2008 and in some specific segments, such as European investment grade names, the basis has tightened significantly. "The basis has compressed because the market is less concerned about systemic risk and banks aren't being forced to sell assets," explains Jochen Felsenheimer, co-head of credit at Assenagon.

He adds: "And there are technical factors that will continue driving the basis less negative, such as the introduction of CDS clearing houses (because they serve to push up the price of CDS). The best time has gone for basis trades, now that spreads have begun tightening, but older deals still offer yield."

Value also remains in certain other segments of the market. "There is a reason why some names, maturities, currencies and so on trade wider," Felsenheimer continues. "For example, we looked at the basis on a single-A name that was trading at -70bp in euros, but bought it in a different currency that was trading at -270bp. Switching between currencies is one way to capture relative value opportunities."

However, finding these pockets of value isn't obvious and involves screening a broad range of names to identify the right combinations of underlying and hedge. Not only is it necessary to know where specific bonds are trading, but it is also important to ensure that the bond and CDS are equal from an economic perspective and that the appropriate hedge ratio is in place.

Assenagon is creating a basis portfolio that provides an efficient return while fulfilling all the necessary UCITS III regulatory requirements (see SCI issue 134). Felsenheimer says: "The fact that we don't have to optimise the basis means that we're not forced to buy the market. In terms of extension risk, for instance, the question is how much you're compensated for the exposure. Our fund is actively managed and so we're getting paid for eliminating a variety of risk factors, such as default, currency, interest rates and so on."

The cash-CDS basis in European names plummeted to an all-time low in February on the sell-off following the UK government's variation in terms of the Bradford & Bingley subordinated debt, effectively making LT2 debt into UT2 debt (see SCI issue 125). But recently the extreme pressure on subordinated debt - in CDS and bonds alike - has been alleviated, according to Puneet Sharma, European high grade credit strategist at Barclays Capital. He expects valuations to continue to improve, due to resilient Q1 results for European banks, continued macroeconomic improvements, encouraging trends in issuance and bond buybacks supporting tighter valuations.

"Importantly, tighter valuations should help bonds more than CDS, given the current dislocation and the supportive macro variables at present," Sharma explains. "We therefore believe current trends support a basis compression. We also believe it is important to distinguish within the LT2 space between bullets and callables."

For callable LT2 bonds, as well as the perceived pitfalls affecting the entire LT2 capital structure, the additional danger of extension risk exists. However, Sharma suggests that this is already priced in for European banks and so the extreme basis there isn't justified.

"LT2 callable bonds have been a particularly battered asset class, and this is reflected both in very wide cash valuations, as well as the basis to CDS," he notes. "Callables have suffered some specific headwinds over and above those affecting LT2s generically. In particular, Deutsche Bank's decision in December 2008 not to call one of its LT2 bonds resulted in a widespread sell-off as LT2 callable bonds went from being priced to the call to being priced to the maturity date. A number of banks have upcoming call dates, and lingering concerns around extension are perhaps slowing a snap-back in the basis between callable LT2 and sub CDS."

Consequently, Sharma recommends that basis trades be undertaken only in the bonds of institutions that have strong capital ratios, robust and profitable franchises, are systemically important and operate within more solid banking systems. Some examples include: an LT2 callable basis trade in SANTAN 4.75% €14-€19 at -419bp; an LT2 bullet basis trade in CS 6.375% €13 at -118bp; and a senior basis trade in DB 5.125% €17 at -70bp.

CS

Investors

SEC brings CMO fraud charge

The SEC has charged 10 brokers with fraud for falsely marketing investments in MBS derivatives as safe and suitable for retirees and others with conservative investment goals. The SEC alleges that the brokers enriched themselves with millions of dollars in commissions and salaries, while the investors suffered millions of dollars in losses.

"These brokers disguised the risks of investing in these derivatives of mortgage-backed securities, exposing their customers to substantial losses as the subprime crisis emerged," says Robert Khuzami, director of the SEC's Division of Enforcement. "They disregarded their customers' needs and used deceptive and misleading tactics to enrich themselves at their clients' expense."

According to the SEC's complaint, filed in the federal district court in West Palm Beach, Florida, the 10 brokers worked for Irvine, California-based Brookstreet Securities Corp, which has since gone out of business. The SEC alleges that the brokers did not clearly define the risks to customers before investing their money in particularly risky CMOs.

The SEC's complaint names William Betta, James Caprio, Troy Gagliardi, Barry Kornfeld, Clifford Popper, Alfred Rubin Steven Shrago, Travis Branch, Russell Kautz and Shane McCann. The SEC alleges that contrary to the representations they made to their customers, the defendants invested in risky types of CMOs that were highly sensitive to changes in interest rates and jeopardised customers' yield and principal. They were not all guaranteed by the US government as the defendants told their customers.

The SEC further alleges that the defendants told customers that they only sparingly would use margin. In fact, they heavily margined customers' accounts, resulting in the more than US$36m in losses.

Rosalind Tyson, director of the SEC's Los Angeles regional office, notes: "These brokers took customers primarily interested in protecting their money and pushed them into risky derivative investments through blatant misrepresentations."

According to the SEC's complaint, the defendants portrayed particularly risky types of CMOs as secure investments to defraud more than 750 customers, ultimately costing them more than US$36m in losses. Meanwhile, the 10 brokers received US$18m in commissions and salaries related to their customers' investments in CMOs.

The SEC's complaint alleges that the defendants violated the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The Commission seeks permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest and financial penalties.

CS

Monolines

Monoline commutes/restructures CDS exposure

Syncora Guarantee on 28 May successfully executed a master transaction agreement - the 2009 MTA - with all 25 of the financial institutions that are counterparties to its CDS transactions and certain financial guarantee insurance policies (SCI passim). The 2009 MTA effectively commutes or restructures US$56bn of the monoline's CDS exposure. The New York Insurance Department ordered Syncora to take these steps by no later than 29 May to remove the impairment of its capital and return to compliance with its regulatory required minimum surplus to policyholders.

The 2009 MTA provides for the effective commutation of Syncora's financial guarantees of CDS relating to ABS CDOs with an aggregate par approximating US$15bn and case basis loss reserves in accordance with statutory accounting principles (SAP) approximating US$4.6bn. This represents 100% of Syncora's CDS exposure for which it has reserves or expects losses with respect to ABS CDOs.

Additionally, approximately US$40bn of CDS exposure with no loss reserves will be novated to Syncora Capital Assurance (drop-down company), a newly-formed, wholly-owned New York financial guarantee insurance subsidiary of Syncora Guarantee. The monoline has agreed, under limited circumstances, to insure certain principal and interest claims relating to these novated CDS.

The execution of the 2009 MTA by all 25 counterparties allows Syncora to use certain segregated funds (aggregating approximately US$853m as of 31 March) allocated for restructuring of counterparty obligations pursuant to the terms of the Master Commutation, Release and Restructuring Agreement. However, the agreement remains subject to satisfaction of substantial closing conditions, including the successful consummation of the offer pursuant to the RMBS Transaction Agreement (SCI passim), which includes the tender of eligible RMBS that in the aggregate total 72 remediation points.

Under the 2009 MTA, counterparties will effectively commute certain CDS and related financial guarantee policies in exchange for consideration consisting of: US$1.2bn in cash; the issuance of short-term surplus notes of Syncora Guarantee in the aggregate principal amount of US$150m; the issuance of long-term surplus notes of Syncora Guarantee in the aggregate principal amount of US$475m; the transfer to such counterparties of the approximately 40% of the outstanding shares of the common stock of Syncora Holdings following the transaction; and certain additional consideration totalling approximately US$50m. Syncora has formed the drop-down company to reinsure on a cut-through basis certain of its public finance and selected global infrastructure business, pursuant to a quota share reinsurance treaty between the two firms; and to novate from Syncora substantially all financial guarantee insurance policies issued on CDS (that are not subject to commutations covered by the 2009 MTA).

Syncora will capitalise the drop-down company with cash and qualified investment securities in an amount of US$541.5m in return for which the company will issue to Syncora 100% of its common stock, a short-term surplus note in the principal amount of US$150m and a long-term surplus note in the principal amount of US$200m. The two companies agree not to write any new business, except in very limited circumstances. They will also agree to limitations on its ability to issue equity securities, make certain distributions, merge or consolidate, transfer or create liens, pay dividends and incur indebtedness.

AC

Operations

DTCC to establish European Warehouse subsidiary

The DTCC has filed applications to establish a limited purpose trust company that will house the functions of its Trade Information Warehouse for credit derivatives. The new trust company will also establish a subsidiary in Europe to facilitate the offering of regulated Warehouse services in Europe.

The new company, to be called The Warehouse Trust Company, has filed applications for membership in the Federal Reserve system and with the New York State Banking Department (NYSBD) to form a limited purpose trust company and will become a wholly-owned subsidiary of DTCC Deriv/SERV, which operates DTCC's automated services for OTC derivatives. It is expected that in the new company, the Trade Information Warehouse for credit derivatives will become subject to a collaborative global regulatory scheme involving interested regulators in Europe as well as the US.

"In filing this application to create The Warehouse Trust Company, DTCC is responding to the expressed intentions from regulators globally to bring added risk protection and regulatory oversight to the credit derivatives market," Donald Donahue, DTCC chairman and ceo, explains. "Our goal, as the operator of the only global trade repository for credit default swaps, is to align our infrastructure in a manner that is consistent with concerns of regulators and market participants and will allow us to continue, and possibly expand, the vital role we play in bringing greater certainty, transparency and reduced risk in the post-trade of OTC derivatives and the servicing of these instruments throughout their life-cycle."

As a market-neutral utility, DTCC says it has been working with all proposed CDS central counterparty (CCP) solution providers. Peter Axilrod, DTCC md, business development and DTCC Deriv/SERV, says: "Linking to the Warehouse's central infrastructure will not only accelerate implementation of CCP processing for OTC derivatives, but will also allow these service providers to focus their development more clearly on margining and risk management without any extraneous operational concerns."

By connecting to the Warehouse, market participants will be assured that life-cycle events for cleared and non-cleared transactions are processed identically and simultaneously, removing the risks that would be created by non-identical or non-simultaneous processing of these events. Market participants can also integrate their own operations with CCPs more efficiently by using the same infrastructure. This will help avoid the potential risks associated with trying to incorporate two separate, and perhaps inconsistent, operational infrastructures, the DTCC notes.

CS

Operations

FSA updates on UK stress tests

The UK FSA has issued a report that clarifies how stress tests have been used within the UK. It has also confirmed that the FSA will not be publishing details of the stress-test results.

The UK authorities have not applied stress testing in the same way as in the US. Instead, over the last eight months since the intensification of the financial crisis, the FSA has:

• Greatly increased the use of stress tests as an integral element of its ongoing supervisory approach
• Begun the process of embedding this revised approach in its intensive supervisory regime
• Used stress tests to inform policy decisions such as access to the Credit Guarantee Scheme (CGS) and the Asset Protection Scheme (APS), working closely with the other tripartite authorities.

The stress tests are used within the context of the FSA's current regulatory framework for UK bank capital. On 19 January the regulator published a statement saying that it expected UK banks to maintain Core Tier 1 capital, as defined by the FSA, of at least 4% of risk weighted assets after applying an FSA-defined stress test. This current framework will remain in place until the Basel accord, which is implemented through EU capital requirement directives, has been modified to reflect the lessons learned from recent events.

The stress tests incorporate a recession scenario more severe than the recession the UK suffered in the 1980s and 1990s, with a peak-to-trough fall in GDP of 6% and growth not returning before 2011 and only back to trend in 2012. Unemployment is assumed to rise to 12%, house prices to fall 50% peak-to-trough and commercial real estate prices to fall 60% peak-to-trough.

The stress tests analyse all the relevant variables which may affect an institution's capital adequacy. These include its revenue generation potential, given scenarios for GDP growth and interest rates, the probability of default and possible losses given default within its loan book, and possible declines in the market value of assets held in the trading books, as well as any known firm-specific events. The tests have been applied where appropriate at the group level.

The tests look forward over five years, but with greater detail over the first three. They are used to identify if at any time in the next five years there is a danger that under the stress scenario a bank's level of capital will fall below the 4% Core Tier 1 minimum.

In evaluating the institution's ability to meet the minimum requirement under the stress scenario, the FSA may consider actions that management could propose to take if and when the stress develops. Such actions may include the evolution of the balance sheet size, capital raising and asset sales.

The stress tests used are not forecasts of what is likely to happen but are deliberately designed to be severe. Their purpose is to consider whether an institution would be able to sustain adequate capital and liquidity under conditions, which at the time the stress is conducted are considered unlikely to arise. They therefore aid the FSA's determination of whether firms are able to comply with its regulatory framework, the authority says.

Credit strategists at BNP Paribas note that although this represents a real test in their view, they remain static tests and these assumptions are merely in line with the base case of the bank's admittedly bearish economists. "However, the crucial results are not disclosed and it remains unclear to us if every bank passed the stress test and to what extent some banks may have been asked to raise capital," they add. "In blunt terms, some disclosure is better than none, but we still feel we do not have enough disclosure to feel that UK banks will not need any additional capital in coming years."

Meanwhile, CEBS has committed to coordinating a Europe-wide stress testing on the aggregate of the banking sector to be completed by September 2009.

AC & CS

Regulation

IASB issues fair value exposure draft

The IASB has published for public comment an exposure draft on its guidance on fair value measurement. If adopted, the proposals would replace fair value measurement guidance contained in individual International Financial Reporting Standards (IFRSs) with a single, unified definition of fair value, as well as further authoritative guidance on the application of fair value measurement in inactive markets.

The IASB's starting point in developing the exposure draft was the equivalent US standard, SFAS 157 Fair Value Measurements, as amended. The proposed definition of fair value is identical to the definition in SFAS 157 and the supporting guidance is largely consistent with US GAAP.

The proposals deal with how fair value should be measured when it is already required by existing standards. They do not extend its use in any way, the Board notes.

To ensure consistency between IFRSs and US GAAP, the proposals incorporate recent guidance on fair value measurement published by the FASB (SCI passim) and are consistent with a report of the IASB's Expert Advisory Panel published in October 2008 on fair value measurement in illiquid markets. This project forms part of a long-term programme by the IASB and the FASB to achieve convergence of IFRSs and US GAAP. It is also consistent with requests from G20 leaders to align fair value measurement in IFRSs and US GAAP.

According to Reval ceo and co-founder Jiro Okochi, the IASB's new exposure draft signals the end of blaming fair value accounting rules for the financial crisis, but it is just the beginning for companies that didn't leave themselves enough time to prepare for the challenges compliance will require. "Companies will, no doubt, go through the same stages of denial, acceptance and then sometimes sheer panic as US companies have under FAS 157," he comments. "The main challenge will be to find observable credit information to calculate proper fair values under the standard."

CS

ABS

Global ambition

ABS community gathers in London

The IMN-ESF Global ABS conference was held on London's Edgware Road this week - a far cry from the Palais des Festivals et des Congrès in Cannes last year, but perhaps a more fitting location given the more realistic tone pervading this year's panels. Gone is the "cautious optimism" that was bandied around in 2008; in its place a realisation that the securitisation market is broken and that it won't be fixing itself any time soon.

Panellists at the conference therefore called for European governments to take heed of the US' TALF programme, as lack of funds to purchase assets remains one of the key barriers to a recovery (see last week's issue). Issues over transparency, rating stability and a continued pressure to sell because of bank deleveraging were also cited as continuing problems.

According to Alistair Jeffery, chairman and ceo of Bluestone Capital Management, the shock of 2007/2008 is receding and the market has moved on to begin a five- to 10-year repair project, during which the wreckage can be tidied up. "The distressed debt market will play a significant role in this process and will be at the forefront of bringing liquidity back to the sector," he said. "The key is repatriating assets to cleanse damaged balance sheets and move portfolios to operators that are better equipped to manage them. As RTC drove new issuance after the S&L crisis, so the market is likely to see elements of securitisation technology used to clean up the mess now."

Secondary opportunities
Nevertheless, opportunities still appear to exist in the secondary ABS market. Around 30%-40% of non-retained transactions are now estimated to be distressed under the traditional classification of being valued at 70% of par.

According to Pius Sprenger, head of European ABS trading at Deutsche Bank, European ABS offers significantly more opportunities than US ABS because the US market is much more actively traded and well analysed by a broad investor base, despite having been ravaged by the subprime fallout. "The introduction of the ABX index in the US gave price guidance and allowed a balance between buyers and sellers to emerge. After Lehman's default an already thinly traded European ABS market nearly closed down," he said.

Sprenger added: "I see value in current-pay first cashflow UK non-conforming deals, which are currently trading in the 50s - to lose money on this trade, all underlying loans would have to default with loss severities of 65%. There are also hidden treasures at the A/BBB levels, which essentially represent implicit call options. For instance, German mezzanine SME CLOs are currently trading at 30c at the super-senior level, which implies that eight companies out of 10 will default - which is a highly unlikely scenario."

But Alex Maddox, head of securitised products at Citadel, commented that hedge fund managers are unlikely to get heavily involved in the European ABS market in the near term, especially as when buying an asset-backed bond in the US market it is cheaper and there is a lot more clarity about the product you are buying. Ope Agbaje, director of European fixed income - structured products at Neuberger Berman Europe, agreed: "The key to recovery is still transparency. I just can't say that enough."

Secondary liquidity
At a traders' and investors' roundtable, panellists - when asked how satisfied they are with liquidity in the market - gave answers ranging from two to three out of a possible five. "In the past two to three months, the senior part of the capital structure has been fairly liquid; however, in the mezzanine part of the structure liquidity is still not there," Attilio di Mattia, ABS portfolio manager at Aurelius Capital Management noted.

Paulo Binarelli, CDO portfolio manager and ABS/RMBS analyst at P&G Alternative Investments, concurred: "In the secondary market for mezzanine paper it's difficult to find prices and we have to rely on a small number of counterparties." However, he conceded that he has seen some recent interest in mezzanine bonds in those asset classes where risks are lower and extension risk is very low.

The traders highlighted the difficulty of valuating portfolios. Rob Ford, portfolio manager at Twenty Four Asset Management, said valuations for ABS was always - and still is - very difficult. "It's not a subject you can approach with any benchmarking: this task has only got more difficult as we have gone through the credit crunch," he stressed - citing the wider bid-offer spreads, the large number of new firms trading the bonds and also the number of non-position taking brokers.

When asked if the posting of a trade by a dealer improved liquidity, the consensus among panellists was that it was not very popular, as in some cases a one-off opportunistic trade with a broker, if posted, could move the whole market unnecessarily. "People are posting trades for a reason - generally to benefit their business," Ford continued. "While transparency is very important, while there is any level of opaqueness, posting of trades is not very helpful."

Primary hopes?
Primary issuance of ABS is unlikely to return for the foreseeable future, panellists agreed, as current market clearing levels do not make economic sense for the issuer or for the investor. Significant government intermediation will therefore be necessary in Europe, they said.

The ECB was praised for its efforts in keeping banks going over the past two years with its repo facility, however. Neil Ryan of Wachovia Bank International noted that the number of banks looking to make use of the ECB's repo facility shows that it is a worthy programme. "The ECB has done a lot in this crisis - they were ahead of the curve in the early part of the crisis...we now need to help the ECB as the ECB has helped the market."

Sooner or later banks will have to be taken off the "drip" that the ECB provides. Ryan suggested that the ECB may get private investors involved to ensure a soft landing when the current programme comes to an end. But, he added: "Ultimately, until the private investors' own assets come back to par, they are not going to look at other assets."

Servicing opportunities
In a separate panel, Bluestone's Jeffery noted that there is a risk premium being charged by many investors due to the taint associated with structured products. "This may drive more activist strategies as investors seek to capture value by unwinding structures or lobbying to influence management of the underlying loans," he said.

Jeffery added: "A healthy servicer role should include developing strategies to align their interests with those of investors. In turn, this can be a good way for servicers to invest in the lower parts of the capital structure."

He explained that the asset performance characteristics of whole loans are very sensitive to servicing, so the key is to ensure continued intensive servicing and contingency planning before it's needed. "Servicing fees have traditionally been structured off-market, but in our experience investors are receptive to paying higher fees to ensure that servicers are invested in troubled whole loan portfolios."

AC & CS

ABS

Equity house targets ABS/MBS

Rochdale Securities, an institutional equity trading firm, has established a fixed income sales and trading division. The fixed income team will initially focus on ABS, MBS and other related securitised products, and intends to expand into other fixed income sectors in the near term.

Rochdale's fixed income group will be led by Michael Glover, Brandon Dunn and Brett Houghton, who together have more than 50 years of experience in the sales and trading of securitised products.

Glover joins Rochdale from Lehman Brothers, where he was an md and most recently global head of securitised products sales. He was also a member of the fixed income operating committee at Lehman. Prior to Lehman, Glover was a senior mortgage and structured finance salesperson at JPMorgan.

Before joining Rochdale, Dunn worked at UBS, where he was an md and most recently head of US structured products sales.

Houghton has spent his career trading and investing in catastrophe bonds, insurance-related securities and other esoteric asset-backed products. He was previously with Lehman Brothers, where he led the esoteric ABS trading desk, and has also spent time at Aon Benfield Securities as an md in charge of the asset management business.

ABS

Structured finance lawyer hired

James Rumball has joined Ogilvy Renault as a partner in its business law group. Rumball has over 12 years of experience in securitisation and other structured finance transactions. He will be based in the firm's Toronto office.

Rumball's practice has focused mainly on complex structured finance transactions and securitisations, as well as swaps and other derivatives, secured and asset-based lending and corporate and commercial finance matters. He has acted regularly for investment banks, asset originators, lenders, borrowers and credit rating agencies in the Canadian structured finance market, as well as for other users of securitisation and structured finance technology in private financings.

CDO

Former BAIS broker alleges improper promotion of CDOs

A FINRA arbitration claim, Case No. 09-02485, has been filed by a former Banc of America broker against the firm, alleging that Banc of America Investment Services (BAIS) improperly promoted sales of risky products - including CDOs - to its customers.

According to the complaint, BAIS "engaged in fraudulent practices which were in conflict with its investment clients, particularly with ... CDOs." When the broker voiced his concerns over the sales of the CDOs, the complaint alleges that he was constructively terminated. Moreover, it alleges that "upper level BAIS management gave specific instructions to its employees to conceal the fraud associated with all of BAIS's collateralised debt obligation investments, including but not limited to failing to secure collateral; fraudulent overvaluing of collateral; and concealing puts related to derivative provisions in the investments".

Under NASD Rule 2310, brokerage firms are required to provide their customers with suitable recommendations in light of their other security holdings and financial situation and needs. Moreover, financial advisors are required to conduct adequate due diligence before recommending an investment product to their customers.

CDO

Private equity firm hires TRUPS CDO expert

Jim Brennan, former lead analyst for trust preferred CDOs at Moody's, has joined private equity firm StoneCastle Partners as a director working on the firm's fund management and advisory businesses. While at Moody's, Brennan co-authored Moody's rating methodologies and monitoring approach for trust preferred CDOs.

He also assisted the financial institutions group with analysis of regional banks. Prior to Moody's, Brennan served as an analyst covering fixed income products in the investments division of Mutual of Omaha.

CLO Managers

Other CDOs in DSCM's sights

Further details have emerged about Dock Street Capital Management's (DSCM) potential assumption of collateral management responsibilities for distressed CDOs currently managed by KBC Structured Investment Management (see last week's issue). Along with the Robeco High Grade CDO 1, other transactions believed to be under consideration by the newly-established manager are Wadsworth CDO and Jupiter High-Grade CDO V.

CLO Managers

Cohen's CDO manager rating withdrawn

Fitch has withdrawn the CAM2 CDO asset manager rating assigned to Cohen & Company Financial Management, as a manager of CDOs backed by trust preferred securities (TruPS). Since Fitch's downgrade of Cohen's CAM rating to CAM2 from CAM2+ on 5 August 2008, the company has experienced continued organisational and staffing changes, against a backdrop of market-wide underperformance of TruPS CDOs, Fitch notes.

Fitch views Cohen as facing several emerging and continuing challenges, including ongoing underperformance of managed TruPS CDOs and financial pressure, given reduced management fees. In an effort to offset reduced management fees, the company has expanded its institutional sales and trading operations, as well as its fund management businesses.

Fitch also notes that Cohen's announcement in February of its intent to merge with Alesco Financial may introduce changes to the company's strategy and/or organisational framework. Given the lack of future access to senior management, the agency does not believe it has sufficient information in order to maintain the CAM rating at this time.

CMBS

CMBS analyst recruited

Mark Nichol has joined Banc of America Securities - Merrill Lynch's structured finance research team as international structured finance analyst and senior director in the group. In his new role Nichol will be responsible for both structured finance and select corporate debt issuers in the real estate sector, along with his main coverage of CMBS and WBS, PPP and PFI bonds.

He reports to Alexander Batchvarov, head of Banc of America Securities - Merrill Lynch structured finance research. Nichol previously worked at Barclays Capital in London, where he was a securitisation analyst focusing on CMBS.

CMBS

Promotions made at CW Financial Services

CW Financial Services (CWFS) has promoted three of its staff to management positions. David Iannarone, md of CWCapital Asset Management (CWCAM) has been named president of CWCAM; Tad Philipp, md of CWCapital Investments (CWCI) has been named chief risk officer for CWFS; and Tom Nolan, md of CWCI has been named chief credit officer of CWFS. Iannarone and Philipp will report to Charles Spetka, ceo of CWFS, while Nolan will report to Philipp.

The CWFS management committee, which is responsible for strategic planning and oversight of the operations of CWFS and its companies, has now been expanded to six - representing the firm's key business lines and functions. "While we have always been committed to asset, credit and risk management, we had not formally created an infrastructure to integrate these functions at the management level," says Spetka. "With these appointments I feel our commitment is clear and our focus is equally shared on all fronts. Dave Iannarone, who has done an exceptional job leading and growing the CWCAM platform for the past four years, will now formally represent the group at the management level. And risk and credit management have now been consolidated under Tad Philipp and Tom Nolan, two of the most highly regarded 'risk' professionals in the industry."

David Iannarone spearheaded the formation of CWCAM, the firm's special servicing and asset management company, in 2005 through the acquisition and integration of the special servicing platforms of Allied Capital and CRIIMI MAE. During his tenure as md, Iannarone grew the firm to become the second largest special servicing operation in the US with over US$170bn in assignments, representing over 20% of the US CMBS market.

Iannarone is a 20-year veteran of the CMBS and commercial real estate industry. In the early 1990s, he pioneered CMBS and the packaging and selling of distressed assets while at the Resolution Trust Corporation's (RTC) Washington, DC office. Later, he moved to the public mortgage REIT, CRIIMI MAE Inc, serving as general counsel and then as evp/coo for the firm. Immediately prior to joining CWCAM, Iannarone was the director of capital markets for Allied Capital Corporation, responsible for managing the securitisation activities of the company.

Tad Philipp joined CWCI in October 2008 to develop and manage its risk management advisory platform, CW Risk Management Solutions (RMS). In this capacity, he led the development of the RMS valuation and advisory practices, and oversaw the development of proprietary risk management tools and systems that have served CWCI clients in its fund management business. Prior to joining CWCI, Philipp spent 17 years at Moody's, for much of that time as head of commercial mortgage-related ratings.

Tom Nolan joined CWCI in 2003 as md of the company's high-yield debt platform. In this capacity, he has been responsible for growing the platform and for oversight for the real estate credit underwriting process within CWCI. Under his direction, CWCI with its investor clients purchased approximately US$2bn of various below-investment grade bonds.

Prior to joining CWCI, Nolan worked at GMAC Commercial Mortgage Corporation (GMACCM) as md of the real estate debt investment group (REDIG), a group that was formed to invest primarily in high-yield CMBS.

Distressed assets

ABS opportunity fund aims for control rights

Henderson Global Investors is set to launch a European ABS opportunity fund, aimed at institutional investors. Managed by Jim Irvine, head of structured products, and Colin Fleury and Ed Panek, ABS portfolio managers, the fund has a five-year life and a target return in the region of 4%-5% over Euribor per annum, gross of fees over the fund's life.

The team aims to raise over €250m into the fund this year, with the first closing scheduled for 1 July 2009. The fund aims to capture the recovery in value of a portfolio of highly-rated tranches of ABS with a predominantly European focus. The fund will target securities that remain fundamentally robust, but trade at material discounts to par due to the illiquidity premium available under current market conditions.

The team will primarily select securities that rank at, or near, the top of the cash payment priority structure. In addition, particular consideration will be given to the acquisition of securities that are the controlling class in their respective transaction. This conservative approach will allow Henderson to be well positioned, should potential restructurings occur and maximise recovery in the event of a default.

It is anticipated that at least 75% of the portfolio will be invested in RMBS or CMBS, and that at least 75% will be invested in the most senior tranches of securitisation structures.

Jim Irvine, head of structured products says: "We have already received positive response to the fund launch in early discussions with consultants and clients. There are two broad reasons for launching this fund right now. Firstly, there are swathes of ABS trading at discounts due to general market illiquidity as opposed to being fundamentally impaired or distressed. Secondly, Henderson's experience in structured products, real estate and credit gives us the capability to analyse and identify the right securities to build a robust portfolio."

The team is further supported by the recent arrival of Ganesh Rajendra from Deutsche Bank as head of advisory and research. During 2008 the structured products team expanded into the advisory business in response to greater demand from legacy risk holders of structured credit for specialist asset management and recovery expertise. Among the more notable recent achievements in this area was Henderson's advisory role to the receivers of the Sigma SIV.

Emerging Markets

EFH brings sukuk fund

European Finance House (EFH) has launched the EFH Global Sukuk Plus Fund with substantial seed capital from its anchor investor, the Qatar Islamic Bank (QIB). The fund is a Luxembourg-domiciled mutual fund launched from EFH's Shariah-compliant platform that invests in the rapidly growing sukuk market, an asset class that displays excellent investment characteristics, the firm says.

The fund is US-dollar based, actively managed to add value to investors and offers weekly liquidity with a simple, transparent and efficient structure. The fund will be targeting a broad range of professional investors and aims to reach US$200m, with a yield of 600bp over three-month Libor.

Mark Watts, head of asset management at EFH, comments: "Global credit markets are in disarray and by most traditional valuation metrics now look cheap. We are bringing this fund to the market now to enable investors to capture the value embedded in markets in a low cost and flexible way... The fund will act as an asset allocation tool for institutional and private investors alike."

Investors

Thames River Capital adds two in credit

Thames River Capital has added two new senior fund managers, Stephen Drew and Simon Ulcickas, to its global credit team.

Drew joins from Tudor Capital, where he worked from 2003-2008. Prior to this he was head of European credit trading at JPMorgan. At Thames River Capital he will be co-manager on both the Hillside Apex and High Income Funds, along with Bernt Tallaksen and Mehrdad Noorani.

After eight years with JPMorgan, most recently as executive director, Ulcickas joins Thames River as fund manager. At JPMorgan he focused on event-driven equities, equity-linked investments and special situations across several regions including North America, EMEA and Asia Pacific. Prior to this, he worked at KBC Financial Products as a risk arbitrage analyst.

Investors

Duo hired ahead of opportunity fund launch

Third Avenue Management, an investment adviser to private and institutional clients, has hired Jeffrey Gary and Thomas Lapointe for its investment team.

Gary has been named a portfolio manager and will be responsible for portfolio construction, as well as for identifying credit opportunities. He has more than 20 years of experience managing high yield, long/short credit and distressed investment portfolios. Gary was at BlackRock Financial since 2003, as the lead portfolio manager and head of the high yield/distressed investment team.

Lapointe joins Gary as a senior research analyst and will focus on identifying opportunities in high yield investments. He has over 17 years of investment experience and was previously responsible for managing approximately US$6bn in high yield assets as co-head of high yield investments for Columbia Management.

With the additions of Gary and Lapointe, Third Avenue Management intends to offer new products focusing on the credit area for both institutional and retail investors. It is also in the process of forming a new mutual fund, the Third Avenue Focused Credit Fund, which is expected to launch in August or September. The new fund will focus on performing credit opportunities and high yield investments.

Third Avenue's credit-focused investment strategy will soon be made available to qualified institutional investors, in the form of separate accounts.

Investors

GLC launches advisory business

Global Leveraged Capital (GLC), a private investment and merchant banking firm, has launched GLC Advisors & Co. GLC Advisors has been founded to deliver senior-level, objective advice with a capital markets perspective to debtors, creditors and other stakeholders of financially distressed companies.

GLC Advisors will be led by: Thomas Benninger, chairman of GLC Advisors, co-founder and managing general partner of Global Leveraged Capital and formerly global head of restructuring at UBS, Credit Suisse and Donaldson, Lufkin & Jenrette; Jeffrey Gelles, managing general partner of GLC Advisors and formerly md and head of restructuring and leveraged finance for TMT at UBS; and Soren Reynertson, managing general partner of GLC Advisors and formerly md in the restructuring and leveraged finance groups at UBS. Initially, they will be joined by eight professionals, all formerly with the UBS restructuring, leveraged finance and/or M&A groups.

Ratings

DBRS to re-enter European market

DBRS is planning to re-enter the European market, a panellist from the rating agency confirmed at the IMN-ESF Global ABS conference this week. DBRS closed its offices in London, Paris and Frankfurt in January 2008, with the loss of 43 staff.

Regulation

ICFR appoints director of research

The International Centre for Financial Regulation (ICFR) has appointed Richard Reid as its director of research with immediate effect. One of the principle objectives of ICFR is to fuel debate around regulatory reform through the provision of expert, independent research into the issues affecting financial regulation across the globe. In addition to directing the centre's research agenda, Reid will work to develop relationships with scholars and industry experts, and to position the ICFR as a global leader in regulatory thinking.

Before his appointment, Reid was an md of Citigroup's economics department in London. He was previously chief international economist for Donaldson Lufkin & Jenrette, where he developed thematic issues such as the impact of the 'New Economy' on equity markets and the changing structure of Europe's financial systems.

Structuring/Primary market

Restructuring and advisory group minted

FBR Capital Markets, a US middle-market investment bank, is continuing its expansion with the launch of a restructuring finance & advisory group. The new team will be led by senior md Kevin Phillips, who will lead the group from the firm's New York office.

The restructuring finance & advisory group will assist FBR Capital Markets' clients in restructuring their balance sheets, with a focus on leveraging the firm's access to the equity and fixed income capital markets in order to forge solutions outside of insolvency proceedings. The group will represent debtors and creditors, as well as buyers and sellers of distressed assets, in conjunction with the firm's M&A group.

Phillips joins FBR Capital Markets from Bank of America Merrill Lynch, where he co-headed and helped launch its restructuring advisory group. Prior to that, he was a director in Merrill Lynch's Energy & Power group.

FBR Capital Markets last month announced that it had expanded its institutional brokerage business by launching a new credit sales & trading platform.

Trading

CDS trader departs

Nigel Brady has left BNP Paribas, where he was a credit index trader. A spokesperson for the bank confirmed his departure, but was unable to give further details.

Trading

Jefferies updates on expansion plans

Jefferies has provided an update on the progress of its focused hiring effort to expand the firm in high yield, leveraged loans, distressed and special situations sales, trading and research.

Following the addition of Robert Harteveldt, a 24-year Bear Stearns veteran, as chairman of fixed income in July 2008, Jefferies has hired nine sales professionals, one trader and seven research analysts, expanding the distribution team to nearly 50 professionals dedicated to these products. During the next few weeks it expects to announce the additional hiring of three more traders, further extending the firm's presence in the leveraged loan, high yield and distressed markets.

With seven recent hires, the firm's high yield and distressed debt sales team has grown to 17 professionals. Danielle Bar-Illan and Richard Wright joined from Bear Stearns (JP Morgan Chase); Robert Hamill joined from Lehman Brothers; Michael Kasper joined from JPMorgan; Scott Haberman and Richard Reubenstone joined from Merrill Lynch; and Steven Rosen joined from Deutsche Bank.

Jefferies' sales team for performing and non-performing bank loans now totals five professionals, including two recent additions - James Wood from UBS and Richard Furlong from Bear Stearns (JPMorgan).

The firm's research teams for leveraged finance and special situations have grown to 25 professionals. Two senior publishing analysts have recently joined in leveraged finance, growing that team to 17 professionals, including 10 sector analysts.

Eric Toubin joined Jefferies from Bank of America, where he had been an analyst covering the technology section. Additionally, John Maxwell joined from Merrill Lynch to cover the gaming space.

Jefferies' special situations team has grown to seven analysts, who are focused on transaction-oriented ideas in all parts of the capital structure of leveraged companies. The five recent additions include: Spencer Alstodt, who joined the firm from Bear Stearns where he focused on capital markets transactions; Justin Brass, who joined Jefferies from Paul Weiss where he advised both debtors and creditors of bankrupt companies and companies undergoing reorganisations; Andrew Brausa, who joined from Citadel Investment Group where he focused on homebuilders and building material companies; Kevin O'Brien, who joined from Basso Capital Partners where he focused on power, utility and gaming companies; and Milun Patel, who joined from Credit Suisse where he focused on metal and mining, energy and automotive suppliers.

ABCP

Consumer assets are bulk of ABCP conduit holdings

Consumer assets continue to make up most ABCP conduit holdings, according to a recent review of US and Canadian Fitch-rated ABCP, as detailed in a new report. Over the past two years Fitch has also noted a significant falloff in ABCP conduit exposure to riskier assets such as RMBS, CDOs and certain auto-related transactions. The falloff in exposure to such assets is not surprising, according to Fitch, as in an on-going effort to allay investor concerns conduit sponsors have taken proactive measures to reduce, remove or provide more support to certain exposures.

In the report, Fitch also comments on the US CP market; specifically, trends in market outstandings and the role of government-sponsored funding facilities, such as the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) and the Commercial Paper Funding Facility (CPFF). To date, these programmes have had little to no impact on ABCP credit ratings, but have nonetheless provided liquidity and a certain measure of stability to the short-term market.

ABS

June TALF deals gather pace

The 2 June TALF subscription saw loan applications worth US$11.45bn, with some new collateral included - premium finance (property and casualty), servicing advances (for residential mortgages) and small business loans. Rates were set at 1.8692 to 3.0445, depending on the average life of the loan.

Strong demand for TALF transactions is emerging from traditional cash ABS investors, new investors lured by high leveraged yields and the TALF funds put in place by the traditional buyers, according to ABS analysts at Wachovia. Although difficult to quantify, they estimate that spreads would be 100bp-200bp wider on last cashflow (LCF) senior auto ABS without TALF.

"Recent bid list activity is beginning to include 2009 TALF bonds that have experienced spread tightening at 10x or more leverage. Such selling behavior could slow the downward trend in spreads, in our opinion," the analysts add.

However, they note that while spreads on subordinated credit card ABS have tightened substantially, auto subordinated tranche levels continue to lag. "A lack of demand for credit risk and the incentives provided by TALF leverage to buy triple-A bonds mean that the auto sub market could take some time to recover. The risk/reward profile of the TALF market is still superior at this time to the cash ABS subordinated market." A dysfunctional subordinated bond market has an adverse impact on issuers that could otherwise use it to reduce their residual credit risk and improve their financing.

ABS

Credit card act unlikely to impact ABS

The credit card reform bill that President Obama signed into law on 22 May is unlikely to have a detrimental impact on the rated credit card ABS market, according to S&P. The Credit Card Accountability, Responsibility and Disclosure Act of 2009 (the Credit CARD Act) aims to protect indebted consumers by restricting certain credit card lender practices, such as retroactive interest rate increases. The new law's restrictions and requirements may be onerous for the credit card lenders in the short term, since they will likely result in lower revenues and higher costs.

In addition to the Credit CARD Act, which takes effect in February 2010, the federal banking regulatory agencies' recently-adopted rules prohibiting unfair or deceptive acts or practices (UDAP) will become effective in July 2010. The Credit Cardholders' Bill of Rights, which would amend the Truth in Lending Act, is currently pending in Congress and, if signed into law, would also curtail certain credit card lender practices.

"We believe these new regulations are likely to result in lower yield (the total trust income for the collection period including cardholder interest payments and fees, interchange, recoveries and other miscellaneous income) and reduced excess spread ... for many credit card ABS trusts," says S&P. "However, we believe the impact on charge-offs (the card loss rate) and payment rates will likely be neutral to positive in the long run. This is because lenders are likely to place even more emphasis on credit quality at origination now that it may be more difficult to increase finance charges and fees to compensate for underwriting higher-risk accounts."

S&P says that while the more conservative underwriting may have a neutral to positive impact on payment rates owing to more creditworthy obligors, it does not expect that the lower finance charges resulting from the new rules will, in and of themselves, positively affect payment rates.

"We believe that offsetting factors, such as continued consumer debt burdens, a higher propensity to save in the current environment, and declining consumer wealth due to falling home prices, could result in overall lower payment rates," S&P note. "However, lower finance charges may allow banks to apply larger portions of the cardholders' payments to their outstanding balances if obligors' total payment rates stay the same, thereby enabling cardholders to payoff their credit cards sooner, potentially shortening the loss exposure period for the trust."

ABS

North American credit card trust losses rise ...

In the US losses on rated bankcard trusts totaled 9.4% and losses for retail cards hit 11.7% in April. In Canada, meanwhile, losses on the rated credit card receivables from five major Canadian trusts were 5.7%.

"US card ABS losses in April increased significantly," says S&P credit analyst Kelly Luo. "Losses among the bankcard trusts exceeded the monthly unemployment rate of 8.9% by 5bp and losses for US retail cards advanced to 11.7%, their highest level since we started tracking these receivables in January 2000."

While the 78% year-over-year increase in unemployment is higher than the 58.4% increase in US CCQI losses, the increase in losses exceeded the increase in the unemployment rate over the past six months by 10 percentage points. "Using Standard & Poor's chief economist's forecast that unemployment will continue rising and reach about 10.2% in the next 12 months in a baseline economic scenario, we expect losses in the US to increase to approximately 10.5%-12.5% over the next year," adds S&P credit analyst Ildiko Szilank. "Our forecast calls for aggregate CCQI losses to increase by approximately 20% in a baseline scenario and by approximately 40% in a pessimistic scenario over the next 12 months."

ABS

... while UK card trusts under increasing pressure

Delinquency and charge-off levels reported on UK credit card trusts increased further in April 2009 to reach new highs, according to Fitch. Fitch expects this deterioration to continue throughout 2009, with the rise in delinquencies supporting the agency's view that the UK economic downturn will continue to impact customers' ability to service their credit card debts, leading to further increases in charge-offs.

In its 'Credit Card Movers & Shaker (UK) - April 2009' report, Fitch details the increase in 60-180 day delinquencies, which occurred for nearly all of the trusts included in the index in April 2009. The Fitch Delinquency Index recorded a month-on-month increase of 30bp to 5.3% in March.

In line with the rise in delinquencies, the Fitch Charge-off Index (Fitch CI) increased to 9% in April from 8.4% - a new historical high. The rise in the Fitch CI was driven by an increase in charge-offs for all the trusts included in the index (with the exception of Gracechurch), driven largely by the roll-through of delinquencies to charge-offs.

The Fitch Monthly Payment Rate Index (Fitch MPRI) and the Fitch Yield Index (Fitch YI) both recorded substantial drops month-on-month in April 2009, of 150bp and 160bp respectively, to 15.8% and 19.5% - with each trust included in the index reporting a decrease in both monthly MPR and monthly yield in April 2009. Although the declines can be partially attributed to the lower day count in April, Fitch views the fall in the MPR in April 2009 as a reflection of the increased stress in the UK economy and the impact it is having on cardholders' ability to meet their monthly payment obligations.

Having previously increased for two months in a row, the Fitch Excess Spread Index (Fitch ESI) dropped in April 2009, down 40bp to 6.8% from its March value. Of the trusts included in the Fitch ESI, only the Sherwood trust reported three-month average excess spread values below its series' respective trapping triggers.

ABS

Italian leasing ABS delinquencies on the rise

The Italian leasing ABS market accounted for €18.4bn with 28 underlying receivables pools in Q109, says Moody's in its latest index report on the sector. The report covers performance data up to the end of March 2009 and details delinquencies and defaults for Italian leasing ABS transactions.

"Total delinquencies are currently 4.93%, which constitutes an increase of 1.8% over the past four quarters. Net cumulative defaults are at 1.72% as of Q109, which amount to a rise of 0.43% from Q108," says Olimpia da Silva, a Moody's associate analyst and co-author of the report.

In Q109, the sector displayed an average constant prepayment rate of 2.09%. The generally low levels in prepayments in this sector arise from the fact that prepayments are not a contractual provision in Italian leasing contracts, but have to be agreed with the originator on a case-by-case basis.

Typical Italian leased-backed securitisations hold a multi-pool portfolio that comprises three types of assets: auto, equipment and real estate. However, some transactions hold only single pools, which may also comprise these three types of assets.

While a relatively conservative consumer credit culture has left Italy less vulnerable to the recession from a private consumption perspective, its reliance on exports will amplify the shock. The majority of leases in this segment serve commercial purposes and delinquency levels are rising as revenues fall.

"The Italian economy contracted again in Q109, falling by 2.4% q-o-q (5.9% y-o-y). The main destinations for Italian exports - Germany, France, the US, Spain and the UK - are all in recession and the Italian economy is expected to contract further in 2009 and show zero growth in 2010," says Nitesh Shah, a Moody's economist and co-author of the report.

CDO

... while US CDOs have 'limited' exposure

S&P says its rated US CDO transactions have limited exposure to General Motors Corp, GMAC, Visteon Corp and Metaldyne Corp. "We expect only a modest direct impact on our rated cashflow, hybrid and synthetic US CDO transactions due to the defaults of Visteon and Metaldyne," says the rating agency.

CDO

US ...

S&P has lowered 432 ratings from 239 US synthetic CDO transactions. Concurrently, 238 of the lowered ratings remain on watch with negative implications, following the agency's monthly review of US synthetic CDO transactions.

Of the affected deals, 247 classes were from 195 CSOs and 185 were from 44 CMBS-backed synthetic CDO transactions. The downgrades reflect negative rating migration in the respective portfolios and SROC ratios that had fallen below 100%, as of the monthly review.

The downgrades of corporate-backed trust deals reflect recent credit events and negative rating migration in the underlying reference portfolios. The downgrades of the CMBS-backed deals reflect S&P's revised criteria, along with continuing stress in the commercial real estate market.

CDO

... and European synthetic CDOs impacted

S&P has taken credit rating actions on 315 European synthetic CDO tranches. Specifically, the ratings on: 182 tranches were lowered and removed from watch negative; 90 tranches were lowered and remain on watch negative; 17 tranches were raised and removed from watch positive; three tranches were removed from watch positive and placed on watch negative; four tranches were removed from watch negative; and 19 tranches were removed from watch positive.

Of the 275 tranches lowered and/or placed on watch negative: 33 references US RMBS and US CDOs that are exposed to US RMBS, which have experienced negative rating actions; and 242 have experienced corporate downgrades in their portfolio. The rating actions incorporate, among other things, the effect of recent rating migration within reference portfolios and recent credit events on several corporate entities.

CDO

ABS CDOs hit

S&P has lowered its ratings on 70 tranches from 22 US cashflow and hybrid CDO transactions. At the same time, it removed seven of the lowered ratings from watch with negative implications. The ratings on 25 of the downgraded tranches are 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 CDO downgrades reflect a number of factors, including credit deterioration and recent negative rating actions on US subprime RMBS.

The downgraded transactions have a total issuance amount of US$9.55bn.

CDS

GM CDS settlement should be 'easily manageable'

The DTCC reports that the net notional amount of CDS outstanding on GM is US$2.3bn as of 22 May, with an additional US$776m in protection held against indices that include the GM name. Credit strategists at BNP Paribas indicate that settlement payments on contracts registered with the DTCC should consequently be easily manageable.

GM's Chapter 11 filing should result in it emerging as a new company owned 60% by the US government, 12% by the Canadian government, 17.5% by the UAW health trust fund (with warrants to increase the stake to 20%) and10% by unsecured bondholders (with warrants for an increase to 25%). The federal government will make an additional US$30.1bn bankruptcy financing loan to the new GM, but does not plan to provide any additional assistance after that.

The newco should have liabilities reduced by more than half compared to the oldco and plans to cut production, closing 11 plants and idling three more, to become a leaner competitor in what is forecast to be a 10 million units-a-year US car market (down from 16 million). The Obama administration plans to have GM emerge from bankruptcy after a period of 60-90 days.

CDS

CDS notionals grow

CDS notionals rose significantly last week (by US$750bn or 2.65%, according to the DTCC), with single names seeing a US$215bn/1.42% net derisking - the largest since the March lows. Analysts at Credit Derivatives Research note that financials and consumer credits saw considerable derisking, while sovereign and basic materials saw the largest rerisking, leaving the latter as the only sector with a net rerisking since the start of the bear market rally. Protection buying was spread across all maturities as short-dated risk was reduced.

CDS

Americas CDS liquidity has reduced significantly

Fitch Solutions says in the latest edition of its Global CDS liquidity scores commentary that liquidity in the Americas CDS market has reduced significantly in the last two weeks, with its Americas CDS liquidity index closing at 10.06 on 29 May. Although the 20 May Federal Reserve Banks' economic forecast highlighted further deterioration, the market had been pricing in a more severe decline, consequently resulting in a fall in CDS liquidity after the Fed's announcement.

Furthermore, Fitch Solutions' analysis of CDS sector indices for the Americas shows a decline in liquidity across virtually every sector in the last two weeks, suggesting that the market driver is indeed macroeconomic. The exception to this trend was for the automobiles & parts sector, which showed a significant increase in liquidity from 10.91 to 10.16. This correlates strongly with the significant widening of the General Motors credit default swap, highlighting the recent hastening of the expected default of that entity.

Meanwhile, Brazil has overtaken Mexico as the most liquidly traded sovereign CDS. This is partially driven by Brazil's heavy external debt burden, which looks unlikely to improve with falling tax receipts and slowing growth.

In Europe, German automotives continue to hold the first and third most liquid spots, while three UK banks - Barclays, RBS and Lloyds TSB - display increasing liquidity. Market worries over the UK financial industry were renewed last week after the country released details of its bank stress tests, with harsher assumptions than those employed by the US regulators.

Korean entities continue to dominate liquidity in Asisan CDS, with six of the 10 most liquid names domiciled in the country. The top 10 is largely composed of companies in the financial sector and basic materials industry.

CDS

Trade bodies update on transparency efforts

ISDA's Board Oversight Committee (IBOC), the Operations Management Group (OMG), the Managed Funds Association (MFA) and SIFMA's Asset Management Group have submitted a letter to William Dudley, president of the New York Fed, in an effort to significantly reduce systemic risk and increase transparency. The ISDA initiatives outlined in this letter include commitments regarding credit, equity and interest rate derivatives, as well as collateral management.

With respect to credit derivatives, the letter highlights the industry's efforts to continue strengthening credit event settlement via the auction hardwiring that was completed on 8 April, as well as the progress made on the introduction of central counterparties - with US$600bn in US credit products having been cleared to date.

The industry is also seeking to identify and pursue further advances in collateral management, including portfolio-reconciliation best practices. A market-wide proposal for margin dispute resolution is scheduled to be completed and agreed on by September 2009.

"As our letter demonstrates, ISDA and the industry remain committed to increasing operational efficiency and reducing the sources of risk in the privately negotiated derivatives business," comments Robert Pickel, executive director and ceo at ISDA. "We have made substantial progress in a short period of time and intend to maintain this strong positive momentum as we move forward."

ISDA also continues to work closely with the MFA and SIFMA's Asset Management Group on outreach to buy-side participants towards greater coordination with the sell-side community in respect of the commitments being made to regulators.

CLOs

'Neutral' recommendation for double-A CLOs

Structured credit analysts at JPMorgan have upgraded their view to 'neutral' on double-A CLOs, closely following their recent upgrade to 'overweight' on triple-A CLOs. "While the current rally in prices has diminished the CLO premia somewhat to selected asset classes, we stand by our upgrades and continue to see value at the top of the capital structure," they note. "Our expectation is double-A prices increase another 5-10 points at the very least - even after the 10 point rally from the lows around US$25 last week."

A US$38.5mn US BWIC comprising double-A and split A/BBB bonds is said to have traded reasonably well last week, with all bonds traded and prices for the double-As ranging from the mid-20s to the high-40s and single-As from the high-teens to the mid-20s. A European double-A BWIC also traded, with an average cover in the 30s. Meanwhile, an OWIC is due on 4 June, comprising US CLOs and RMBS.

CLOs

US CLO deterioration moderates slightly

US CLO performance continued to weaken in April 2009, but the pace of deterioration appeared to moderate slightly from the previous month, according to S&P. CLO performance continued to follow default trends among speculative-grade corporate credits, but the senior O/C ratios for most 2003 through 2007 vintage US CLO transactions experienced a significantly smaller drop in April than they did in March.

Despite the trends among senior O/C ratios, the number of defaulting loan issuers reached ten in April, up from six in March. Consequently, the percentage of loans from defaulted obligors held by the average CLO increased significantly. At the same time, however, the percentage of loans from triple-C rated obligors held in the average CLO pool increased only slightly or levelled off.

"We have determined that this is only partly due to loans dropping out of the CLO triple-C buckets as they defaulted," says S&P. "The moderate rate of increase also reflects fewer new corporate loans entering the triple-C bucket in April, as the pace of speculative-grade corporate downgrades slowed from the rate recorded in the first quarter. "

CMBS

CMBS review continues

S&P has placed on watch negative 129 tranches in 27 European CMBS transactions due to its review of the transactions that closed between 1 January 2007 and 30 June 2007. At the same time, the agency has kept on watch negative 10 tranches in two European CMBS transactions affected by this review and already on watch negative for other reasons.

The affected tranches have a principal balance of about €9.53bn (for euro-denominated transactions) and £4.60bn (for sterling-denominated transactions). The watch placements affect approximately 73.5% (by number) of the transactions that closed during this period.

These rating actions follow S&P's ongoing review of all European CMBS transactions that it rates. Over the coming months, the agency will review transactions with original issuance dates in each half-year period going back to 2005.

"Even though we continue to believe that class A notes will not suffer an eventual loss, all else being equal, the risks to these tranches have, in our view, materially increased," S&P says. "We consider that downgrades, including of senior notes, could be possible in future."

The agency expects to resolve the majority of the watch actions in the sector, following a review of each CMBS transaction, not later than 30 September 2009. Based on the available information, it does not currently expect the average downgrade to exceed two rating categories.

Distressed assets

CDEs likely to increase

Fitch says that it expects an increased number of restructurings or debt exchanges in structured finance transactions to occur that investors will effectively be coerced to accept. The agency notes that, in the context of its rating opinion, coercive debt exchanges (CDEs) would be treated as tantamount to default of impacted notes.

Fitch's expectation is driven by the continued challenging environment for structured finance transactions globally, against the current adverse macroeconomic backdrop. The agency has published a criteria report that clarifies its approach towards determining when a CDE situation has arisen for a structured finance instrument.

Fitch determines when a CDE has occurred - for the purposes of its rating opinion - at its sole discretion. Such a determination is formed by taking into account the specific facts of each particular transaction. For an exchange or restructuring to be considered a CDE, there must be a material reduction in the economic position of existing noteholders and the exchange or restructuring would need to be either coercive or necessary, even if it is technically voluntary.

"Although, to date, there have been very few CDEs in structured finance, Fitch expects that the incidence of CDEs will gradually increase as structured finance globally continues to face a challenging performance environment, resulting in distressed transactions," says Stuart Jennings, md and structured finance risk officer for EMEA and APAC. "An increased volume of distressed transactions would likely see more attempts to restructure to avoid default."

"As potential missed coupon or principal payments loom, transaction parties may look to restructure their way out of imminent default. Fitch may in some cases determine that such restructuring constitutes a coercive debt exchange," says Lars Jebjerg, senior director in Fitch's structured finance risk group.

If Fitch determines that a CDE has occurred, the rating of the affected notes will temporarily be set to a level commensurate with a default upon execution. The ratings of the notes may subsequently be revised on the same day, if the agency believes that they will have a different credit profile following the CDE.

Indices

Troubled company index sees improvement

The Kamakura index of troubled public companies made a second consecutive dramatic improvement in May after reaching its worst point, 24.3%, in the current recession in March. The index decreased by 3.3% to 18.8% of the public company universe, the fourth largest decline in its 230-month history.

Credit conditions are now better than credit conditions in 23.5% of the months since the index's initiation in January 1990. In March, by contrast, credit conditions were better than only 3.6% of the monthly periods since 1990.

The index is based on expanded coverage of more than 26,500 companies in 30 countries, an increase of more than 2500 firms since the previous month. In spite of the increase in coverage, the absolute number of firms in the 'over 20%' default probability category declined by 85 firms.

Kamakura's president, Warren Sherman, comments: "In November of last year, we identified Thomson of France as showing one of the largest increases in default risk in our public company universe. Thomson defaulted selectively in May. Also in May, the rated public companies showing the sharpest rise in short-term default risk were Spanish Broadcasting System, Advanta, Eastman Kodak, Pioneer Corp (Japan) and Radio One Inc." General Motors ranked as the seventh largest increase in risk.

Investors

Senior credit investor risk perceptions improve

Fitch's European senior credit investor survey for March 2009 indicates a minor calming of investors' negative risk perceptions. Although the recession is anticipated to last longer in some key regions, asset class conditions are viewed as slightly better by respondents to the latest edition of the agency's quarterly survey.

"Overall respondents are less pessimistic than in December 2008 and fundamental credit concerns have lessened, albeit to a minor degree," says Trevor Pitman, Fitch's regional credit officer for Europe and Asia. In December, 90% of investors said that speculative grade corporate credit conditions would deteriorate significantly, but now only 46% believe that they will, with 29% believing they will deteriorate somewhat.

In the previous survey, 70% of investors believed that credit conditions for European financial institutions would deteriorate either significantly or somewhat. This time, no investors believed that they would deteriorate significantly and 46% believed some deterioration is possible.

An overwhelming majority of respondents are confident that major developed economy governments will fully support the senior debt obligations of all systemically important banks. In most structured finance asset classes, fewer investors believe that fundamental credit conditions will deteriorate as sharply as in December.

For example, ABS' conditions were anticipated to deteriorate significantly or somewhat by 73% a few months ago, but by 53% now. The percentage of investors believing that conditions will remain unchanged in this asset class is now 36% against 24% in December.

Similar patterns are shown by the survey for RMBS, CMBS and CDOs. In all of those asset classes a majority of investors still anticipate that conditions will worsen, but to a lesser degree than in December.

In December the factors which over 50% of investors suggested could pose risks to the European credit markets were hedge fund failures, housing market disruptions and lack of credit to corporates. In these cases investors believed there was a high degree of risk posed by these factors.

None of these areas received such a high risk assessment this time. The area of greatest 'high' risk now is the availability of global liquidity, with 40% of investors perceiving this.

Investors

Rabobank tender offer results in ...

The results of Rabobank's tender offer of Skyline 2007 mezzanine and junior notes have been released. The offer expired on 20 May, with the bank purchasing €8.9m of Class B notes at 68%, €29.2m of Class Cs at 62%, €56.6m of Class Ds at 40% and €15.5m of Class Es at 26% of par.

Investors

... while Clydesdale announces new offer

Clydesdale Bank has announced a tender offer, which will expire on 10 June, for the Class 3A1, 3A2 and 4A1 tranches of Lanark Master Issuer 2007-1 up to an aggregate amount of £100m. The price of the bonds will vary from 87% to 92% of par for the Class 3A1 and 3A2 tranches and between 84.5% and 89.5% for the Class 4A1 notes.

Clydesdale previously bought back £112.5m of Class 3A2 and 4A1 notes from the Lanark 2007-1 issue in March.

Operations

Two auctions settled, more announced/pending

The Syncora CDS auction took place on 27 May, followed by one for Edscha ELCDS the next day. Meanwhile, a raft of further auctions has been announced.

Syncora CDS were settled at a final price of 15, with 11 dealers participating. The settlement price for Edscha ELCDS was determined to be 3.75, with five dealers participating.

ISDA's Americas Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Visteon Corporation. The Committee also voted to hold an auction for Visteon.

On May 28, Visteon and certain of its US subsidiaries voluntarily filed petitions for relief under Chapter 11 of the US Bankruptcy Code. The petitions were filed in the US Bankruptcy Court for the District of Delaware.

In response to the bankruptcy filings of Visteon Corporation and R.H. Donnelley Inc, Markit LCDX index dealers have also voted to run credit event auctions to facilitate settlement of LCDS trades referencing both companies, which are constituents of series 8, 9, 10 and 12 of the Markit LCDX index.

Similarly, the Americas Credit Derivatives Determinations Committee voted to hold an auction for General Motors Corporation, which filed on 1 June voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the US Bankruptcy Court for the Southern District of New York (see separate News Round-up stories). Markit LCDX index dealers also voted to run an auction to facilitate settlement of LCDS trades referencing the company, which is a constituent of series 8, 9, 10 and 12 of the index.

Two other determinations requests have been filed with the Determinations Committee regarding potential bankruptcy credit events in respect of Dex Media East LLC/Dex Media Inc and Joint Corp. Dex Media is an affiliate of RH Donnelley and filed Chapter 11 petitions at the same time as RH Donnelley. Joint Corp is a Japanese real estate developer, which has filed for bankruptcy protection with liabilities of US$1.7bn.

Ratings

GM bankruptcy already reflected in auto ABS ratings ...

A high likelihood of a GM bankruptcy was already reflected in Moody's ratings of GM vehicle-related ABS and, as a result, the agency says it is not taking further rating actions at this time. The bankruptcy of GM does not affect the RMBS, including servicer-advance related deals, sponsored by Residential Funding Company (RFC) and GMAC Mortgage - each subsidiaries of Residential Capital, which in turn is owned by GMAC.

Moody's notes that GMAC and its subsidiaries were not part of the bankruptcy filing and it does not expect any disruption to ABS and RMBS servicing as a consequence of GM's bankruptcy. Capmark, an entity owned by an investment consortium which includes GMAC with a minority share, is a master and special servicer for several pools of commercial mortgage loans. The GM filing will not impact the CMBS deals where Capmark is a master or special servicer.

Ratings

Moody's introduces new format for presale reports

Moody's has introduced a new presales report/new issue report format for EMEA ABS and RMBS, which it says will provide unprecedented transparency into the ratings process as well as Moody's opinions on credit quality and expected transaction performance.

Moody's reports include the amount of data received, disclose key assumptions and explain the rationale for key assumptions that drive ratings. The reports also include the newly-introduced volatility scores, providing investors with a clear indication of the level of disclosure and inherent quality of the data that underpins ratings, the agency says.

Parameter sensitivities also show investors how the initial rating might have changed under different assumptions. Additionally, in order to compare a new transaction with precedent transactions in the sector, the benchmark analysis section examines relevant variables and portfolio characteristics for selected transactions in the sector.

Finally, to understand an originator's history in the securitisation market, information in the credit analysis section examines whether precedent transactions performed within Moody's expectations and the reason behind any variances. Lists of performance triggers and counterparty rating triggers may assist in investors' monitoring efforts.

Real Estate

CRE CDOs downgraded

S&P has lowered its ratings on 233 tranches from 32 commercial real estate (CRE) CDO transactions. All of the lowered ratings either remain on watch with negative implications or were placed on watch negative. The downgraded tranches had an initial issuance amount totaling US$10.19bn.

Additionally, the agency placed its ratings on 10 other tranches on watch with negative implications. At the same time, it withdrew ratings on three tranches from two transactions following their complete paydown.

The transactions affected by these rating actions are cashflow and hybrid CDOs collateralised largely by rated tranches from CMBS transactions. The downgrades and the continuing watch negative placements are a reflection of the ongoing stress in the commercial real estate market, S&P says. Commercial mortgage delinquency rates have risen significantly in the last few months and the volume of troubled loans outstanding has increased as a result of falling property values, the struggling economy and the general inability of borrowers to refinance maturing loans in a market with constrained liquidity.

The downgrades also reflect S&P's application of revised criteria for assessing the probability of default for structured finance (SF) assets with ratings on watch negative held within CDO transactions. As a result of stress in the commercial real estate market, a significant proportion of the CMBS assets held within the CRE CDO transactions affected by these downgrades currently have ratings on watch negative.

RMBS

Prime borrowers under pressure

ABS analysts at Wachovia note that prime mortgages are increasingly driving delinquency rates and that the market has moved from an underwriting problem to an employment and income problem.

They had previously indicated that an unemployment rate above 8% would affect the prime borrower cohort and in this month's commentary on the recent MBA mortgage delinquency report Jay Brinkman, the Mortgage Bankers Association's chief economist, points out that the problem is shifting "somewhat away from subprime and option ARM/Alt-A loans to prime fixed rate loans". Brinkman adds: "More than anything else, this points to the impact of the recession and drops in employment on mortgage defaults."

Default rates have increased significantly across all credit cohorts and vintages. "We believe that the spike in liquidations (CDR) is due to the expiration of the foreclosure moratorium. Although it is too early to realise liquidations due the lifting of the moratorium, we believe that servicers are aggressively liquidating their REO portfolios in anticipation of further foreclosure activity," the Wachovia analysts argue.

Equally, delinquency rates in the Alt-A/B and subprime sectors appear to have stabilised somewhat. "We believe that these credit cohorts, especially the 2005-2007 vintages, are experiencing 'delinquency burnout'," they continue. "That is delinquency rates are already high and pool factors are low. As a result, there are very few borrowers left to go delinquent. That said, in a rising unemployment environment, 'all bets are off'."

RMBS

AOFM mandates three further RMBS

The Australian Office of Financial Management (AOFM) has selected three RMBS in its second selection round for the allocation of mandates where it acts as a 'cornerstone investor'. The participants in the proposed transactions are: Commonwealth Bank of Australia as arranger and joint lead manager, and Australia and New Zealand Banking Group and National Australia Bank as joint lead managers, of an issue for Members Equity Bank; Macquarie Bank as arranger and joint lead manager, and ANZ and HSBC Bank Australia as joint lead managers, of an issue for Firstmac; and NAB as arranger and joint lead manager, and Deutsche Bank as joint lead manager, of an issue for Resimac.

The first selection round facilitated the issuance of Series 2009-1 REDS Trust, Liberty PRIME Series 2009-1 and Challenger Millennium Series 2009-1 Trust. All three deals involved an AOFM investment of A$500m. Further AOFM investment mandates are expected to be announced in due course.

RMBS

Prime RMBS 'well placed' to withstand recession ...

Following the FSA's announcement that it is stress testing bank's capital against the impact of a 50% peak-to-trough fall in house prices (see separate News story), Fitch says that triple-A prime UK pass-through RMBS are well placed to withstand a recession of an even greater magnitude.

In a special report published earlier in the year, the agency calculated the loss coverage for all vintages of UK prime pass-through RMBS across a variety of house price decline and mortgage default scenarios. "The report identified that triple-A prime UK pass-through RMBS of 2003-2007 vintage had a loss coverage of 9.2x when factored against the agency's central expectation of a 30% peak-to-trough UK house price decline and increasing defaults based on the performance of prime mortgages during the recession of the early 1990s," says Francesca Zwolinsky, director in Fitch's RMBS team.

"Notwithstanding, Fitch analysis showed that triple-A prime pass-through RMBS were well placed to withstand a significantly deeper recession, with the breakeven point being a scenario of 60% house prices declines in combination with a default rate of 30% - equivalent to approximately 4x-5x the default rates seen during last recession," Zwolinsky adds.

This analysis was specific to UK prime pass-through transactions and was not applied to the master trust transactions due to the complex nature of the structures. However, Fitch evaluated the collateral of each master trust programme on a loan-by-loan basis against its house price and default rate predictions and performed an in-depth cashflow analysis, whereby the ratings were further stressed assuming the occurrence of a number possible events, including various prepayment speeds, the inability of originators to replenish the trusts and a breach of a non-asset trigger. The agency found that under such stress, negative rating migration was expected to be minimal and confined to the lower-rated tranches only.

While notes assigned a rating equal to, or greater than, single-A are not expected to show any negative rating migration under this stress scenario, 62% of the total outstanding triple-B notes by value and 75% of the total outstanding double-B notes by value faced the possibility of downgrade.

RMBS

... despite increase in delinquencies

Key performance measures for UK prime RMBS indicate that delinquencies continued increasing in Q109, says Moody's in its latest index report for the sector. Outstanding repossessions decreased marginally during Q109, while cumulative losses increased.

In the report, Moody's says that the overall pattern is of a marked deterioration in the performance of several UK prime master trusts since Q108. "This can partly be attributed to the slowing housing market making it more difficult for borrowers to either refinance their way out of arrears problems or sell their property," explains Daron Kularatnam, a Moody's senior associate and co-author of the report. "However, the low interest rate environment that has prevailed from the economic downturn and the method used by most lenders to report the number of months that a loan is delinquent has been a significant factor, artificially increasing the amount of serious delinquencies."

Moody's cautions that, with the UK economy in recession and unemployment, personal insolvencies and house possessions all rising sharply, the performance of prime mortgages is likely to continue to deteriorate. "Transaction activity in the housing market is low and consumer confidence is depressed, pointing towards continued falls in house prices," says Nitesh Shah, a Moody's economist and co-author of the report.

RMBS

Dutch NHG-backed RMBS on watch

Fitch has placed 11 tranches from eight Dutch RMBS backed by Nationale Hypotheek Garantee (NHG) on rating watch negative. These actions reflect changes to the agency's analytical treatment of such deals, following the review announcement made by the agency on 1 December 2008.

In particular, Fitch has reduced the scope of the credit given in its analysis to the respective seller's commitment to repurchase defaulted loans that WEW does not consider to be compliant with the terms of the NHG guarantee. The affirmed tranches are not affected by the criteria revision as no credit was given to the repurchase commitment. This criteria revision is intended to provide for greater protection from counterparty exposure and the risk of counterparty default, given the recent weakening credit profiles of numerous financial institutions.

Under the revised criteria, recoveries assumed at rating scenarios above the seller's IDR would be lower since they would no longer incorporate the possibility of repurchase of non NHG-compliant loans by the seller. As a result NHG-backed notes currently rated triple-A could face rating migrations down to the single-A category and in some cases the triple-B category, but in principle not lower than the rating of the seller. This criteria change, once implemented, will therefore impact the ratings of the notes on RWN.

The changes have also resulted in an increase in triple-A credit enhancement from 1.4% to 7% for Fortis Group's €4.3bn NHG-backed Goldfish Master Issuer 2009-1 new issuance.

RMBS

Australian mortgage delinquencies decrease

Fitch says in its latest report on the topic that Australian mortgage delinquencies have primarily decreased from Q408 to Q109.

"This is the first decrease in arrears from the fourth quarter of a year to the first quarter of the next year recorded in the 10 years of Dinkum Index Data," says Leanne Vallelonga, associate director in Fitch's structured finance RMBS team.

"Increases usually occur due to seasonal Christmas credit spending; however, the combination of historically low interest rates and the Australian Government's A$1,000 payments to eligible families in December 2008 has provided a buffer that is sufficient to counter the normal seasonal effects."

The agency notes that Australian mortgage performance - as measured by mortgage delinquencies - improved in Q109, evidenced by the decrease in the Fitch Dinkum Index for 30+ day delinquencies to 1.52% in Q109 from 1.75% in Q408, which is the measure for full-documentation loans. Most of the decrease in arrears can be attributed to a greater decline in the 30 to 59 days arrears bucket. The performance of conforming low-doc loans for 30+ day delinquencies also improved to 3.65% in Q109, off its historical peak of 3.95% in Q408.

However, non-conforming low-documentation 30+ day delinquencies bucked the Q109 trend and once again set a new record high of 19.79% - more than five times higher than conforming low-documentation 30+ day delinquencies. This is solely attributable to an increase in non-conforming low documentation loans for 90+ days delinquencies from 11.61% in Q408 to 12.90% in Q109.

Fitch believes the non-conforming sector continues to suffer from an inability to refinance with the practical closure of the low-documentation origination market. The agency expects its low-documentation index to deteriorate at a consistently faster speed than the full-documentation index.

Technology

CDS post-trade event management tool released

Fiserv has released the latest version of its multi-asset, post-trade processing solution - TradeFlow Release 2.4. The new release expands upon the range of activities that can be handled by TradeFlow for the post-trade event management support of OTC credit derivatives. TradeFlow will now enable clients to manage all aspects of the post-trade event management lifecycle, including trade confirmation, post-trade event management and payment processing.

TradeFlow's new and expanded capabilities can help clients to address a key business concern, to reduce operational risk and potential losses by streamlining the processing of OTC derivatives using full event lifecycle management, Fiserv says. TradeFlow 2.4 supports the handling of post-trade events, including terminations, as well as existing business processes to support trade capture, enrichment, validation and confirmation via DTCC Deriv/SERV and payment processing via SWIFT.

"The spotlight on OTC derivatives processing has never been greater following a recent recommendation from derivatives industry participants to establish seven key goals to improve the efficiency and transparency associated with derivatives processing," said Geoff Harries, vp, product strategy, investment services from Fiserv. "Streamlining the trade lifecycle to process multiple, complex events can significantly mitigate the risk associated with processing derivatives. TradeFlow enables clients to simplify this process, resulting in reduced risk and increased operational efficiency."

TradeFlow provides a single interface for monitoring post-trade processing across a number of different asset classes and market infrastructures to support complex investment strategies. This latest innovation complements the existing capabilities to support equities, fixed income, money markets and FX confirmation and settlement processing.

Indices

'Old' indexes: the forgotten treasures?

Citi's structured credit strategy team discuss off-the-run trade ideas

Investors looking to take a view on a portfolio of credits are at a disadvantage in the current market. Liquidity of single name CDS, indexes and tranches has started to dry up and there is almost no bespoke activity to speak of. Among the reasons for this drop in trading, investors typically mention a decrease in the number of participants (both dealers and hedge funds), concerns about counterparty risk in the aftermath of the Lehman collapse and the introduction of the SNAC CDS contract, which required some investors to stay on the sidelines.

Another important factor is the absence of any meaningful structured synthetic activity, which used to facilitate index and tranche trading. As one can see in Figure 1, based on their gross and net notional outstanding, the most active index series were the IG8 and the IG9, which were 'on-the-run' series during the peak of the CSO boom.

The main reason for greater interest in older indexes is the decline of CSO activity. In the current environment where the bespoke market is both rich and illiquid, investors should consider trading the off-the-run indexes and tranches that can provide better liquidity and still offer ways of taking views on credits and differences in portfolios.

Another catalyst for this increased activity is the deterioration of certain sectors and defaults by a number of formerly investment grade credits. Given the differences in portfolio compositions, specific indexes and tranches (along with the range of maturities) provide one way of hedging sector and single name exposure, either in the short term or on a forward basis (as in a steepener). Below, we discuss possible trading strategies in more detail.

Indexing relative value
There are three types of relative value trades one could consider when looking at the off-the-run index series. Tranche investors should look at matching maturities of the older and newer index series, creating a pure relative value trade, taking a view on the few non-overlapping credits.

An alternative would be simply taking outright risk in tranches of the older index series, with a high enough subordination below the tranches. Lastly, the trades can be done with CDX indexes either as flat notional long/short pairs of two series having the same maturity date, or as a curve trade on two maturities of the same series.

Cross-series tranche trades
In our view, trading index series against each other is probably the most interesting strategy. Figure 3 shows the universe of legacy indexes. Different index series with matched maturities provide probably the most interesting trades.

Not accounting for the three-year tranches, one should consider trading the five-year series IG8-IG12 versus the seven-year series IG4-IG8 or the seven-year series IG10-IG12 versus the 10-year series IG4-IG6 (see Figure 2). To proceed further, one simply has to look at the difference in the composition of the tranche series in question and compare their tranche pricing to see if there are any good relative value trades.

One should also keep in mind the tranche thickness, which could vary depending on the index series due to the recent defaults. While the composition of all index series includes Fannie Mae, Freddie Mac and Washington Mutual, some also have Tribune and Idearc.

One of the more interesting trades is trading the seven-year IG5 versus the five-year IG9 (the most active tranche series). Both indexes have the same maturity, but the IG5 trades slightly wider. This is mainly attributed to the larger number of names in distress, compared to the IG9 (see Figure 3).

In a nutshell, the IG5 has some of the former LBO and auto credits, while the IG9 has some of the distressed financials and basics. Keep in mind a small difference in attachment levels due to the default of Idearc, as a consequence of the CDS succession event at Verizon. A comparison of the spreads in the senior-enough tranches (either 7-10s or 10-15s) of the two index series argues in favour of going long the seven-year IG5 versus the five-year IG9 (see Figure 4).

Taking short-dated risk
Another trade is to go long junior mezzanine tranches of the older index series. For example, the five-year series 3 matures in March of 2010 - less than 11 months from now. The composition of the IG3 has some wider spread credits in it (see Figure 5); however, because of such a short tenor, we do not foresee many defaults.

Even accounting for a very low recovery (say 20%), the 3%-7% tranche is protected up to three defaults; the 7%-10% tranche up to nine defaults. Selling protection on either one of the tranches presents a good opportunity, in our view.

Index steepeners - maybe not
At first glance, it seems that there are some interesting opportunities (see Figure 6). The older index curves are much more inverted; however, a closer look could dissuade one from considering a relative value trade here, as a single default could change the shape of the curve dramatically. Going through with a specific example, compare the steepness of the IG5 5s-7s curve (at 70bp) to the IG9 3s-5s (at 15bp).

The trades have similar maturities, but the IG5's curve is much more inverted. Typically, the indexes fully price in the probability of a near-term default - hence, a single default in the IG5 with a low (20%) recovery, dis-inverts its index curve by 10bp, nearly enough to offset its relative difference compared to the IG9. Hence, the steepness of the newer indexes simply accounts for their cleaner composition in comparison to the older ones, as should be the case, and in our opinion, there are no easy trades to take advantage of this market dislocation.

Overall, we do not think that trading index series against each other provides enough value. Bid-offers are wide and one or two defaults could completely wipe out the difference.

© 2009 Citigroup Global Markets. This Research Note is an extract from 'Global Structured Credit Strategy', published by Citi on 13 May 2009.

Trading

Trading ideas: credit therapy

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright short on Alcoa Inc

The Chicago Purchasing Managers Index for May came in at a 'surprisingly' low 34.1. To wrap this with a bit of perspective, the floor of the first recession of the 21st century was set at 35.1 and the recession of the early 1990s didn't even come close, with a low set at 41.1.

Though Armageddon may have been avoided, a serious recession has not been. Manufacturing makes up roughly 12% of US GDP and a pending rebound looks uncertain at best. Restrained production lines, combined with already depressed metal prices will put significant pressure on heavily indebted companies, such as Alcoa.

Alcoa loaded up on debt during the heady days of the credit boom (increasing its total debt by 55% since September 2005) and is paying the price now with massive interest expense, plus large capex amid disappearing revenue. Given the recent rally in its credit spread, we highly recommend buying protection on Alcoa.

The first quarter of 2009 was an absolute disaster for Alcoa and we believe it is only a precursor of more to come. Hit by a global slump and rapidly falling metal prices, the company turned in negative operating results, with revenues down 41% (year-on-year) and 27% (quarter-on-quarter).

Exhibit 1 demonstrates the severity of the decline. Not surprisingly, the drop in sales coincided with a sharp fall in Aluminium prices.

Exhibit 1

Alumina makes up a vast majority of Alcoa's revenue and therefore Alcoa is at the mercy of the capricious commodity market. We do not see clear evidence of any sort of rebound in Aluminium prices.

As the exhibit shows, LME Aluminium is barely up from its lows set back in February. This will keep pressure on Alcoa's revenue generation ability for the remainder of the year.

Alcoa's extensive capital expenditure commitments, combined with large interest expense will drain any and all cash generated from the business. According to its first-quarter review, capex for the quarter was US$471m of a total planned US$1.8bn. There was not a hint of management's expectation to reduce this number, even with the operating loss of US$480m.

Alcoa's interest expense for the last four quarters totaled US$422m. Due to its sharp decline in earnings, Alcoa's interest coverage is quickly moving south, with LTM interest coverage now at 4.6X (Exhibit 2).

Exhibit 2

If the company turns in a couple more negative quarters, the weight of the combined expenses will drive the company's cashflow far into negative territory. The mounting downside risk is not fully accounted for in its current credit spread due to the credit rally of recent months.

We see a 'fair spread' of 670bp for Alcoa based upon our quantitative credit model due to its equity-implied factors, margins, leverage, free cashflow and interest coverage. The model ranks each issuer on a scale of 1 to 10 using eight factors (1 = poor credit, 10 = good credit).

The single name credit rally pushed Alcoa's credit spread down to just above 400bp from a wide near 1200bp. In recent weeks our spread expectation dislocated from the current spread, creating a 200bp differential. Given Alcoa's weak fundamentals and the uncertainty over the global recovery, we recommend buying credit protection (Exhibit 3).

Exhibit 3

Buy US$10m notional Alcoa Inc 5 Year CDS protection at 405bp.

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).