Contents

Structuring/Primary market

Rebalancing the books

Renewed focus on portfolio restructuring activity

Regulatory capital trades have been a feature of the market since the late 1990s. But accounting reclassification issues and the prospect of mass downgrades have fuelled a renewed focus on portfolio restructuring activity in recent weeks.

Most banks/financial institutions moved structured credit assets, both on an asset-by-asset and portfolio basis, from the trading book to the hold-to-maturity book to isolate them from mark-to-market volatility when the accounting reclassification rule came into force in November 2008 (see SCI issue 111). The majority of these assets were fundamentally sound, but were suffering from significant valuation issues.

But once the assets have been transferred onto the hold-to-maturity book, it is impossible to sell them again. "If you try to sell even one asset, the entire book could be reclassified to available for sale," explains Olivier Renault, structurer at StormHarbour Securities. "This is a big issue because asset prices have rallied significantly since the beginning of the year; meaning that they are now closer to where they were originally marked, but some holders therefore can't hit the bid."

Martin Knocinski, regulatory and accounting specialist at UniCredit, confirms: "With respect to banks' intentions to free up regulatory capital, reclassifications of trading assets were obviously counterproductive. On the one hand, reclassifications allowed banks to 'freeze' assets' book values and thus avoid immediate write-downs. On the other hand, assets that were classified out of the trading book into the banking book required much more regulatory capital."

Indeed, regulatory capital requirements could potentially make this situation even worse. While these assets may currently have high ratings and consequently a low capital charge under Basel 2, the ongoing changes in rating agency methodologies - combined with increasing defaults and lower recovery rates - will likely result in downgrades. If holders can't sell these assets, there is a danger that they will be stuck with them on the way down and their capital charges will rocket.

"If you can't sell, you can hedge the downside risk using other means," notes Renault. "For example, one strategy is to buy first-loss protection on a portfolio of highly rated assets. Many of the big players are undertaking similar trades. The alternatives are to provision for increasing regulatory capital charges or simply hope that the downgrades don't impact your portfolio too badly."

Generally, regulatory capital is a key focus for financial institutions at present, given that the old rules are under pressure (see separate News Round-up stories). Regulatory capital levels have traditionally been set by reference to rating agencies in line with the first dollar of loss - which means that some assets carry a low rating, even though they have a low expected loss.

There is consequently the possibility that regulatory capital requirements could be far in excess of the economic capital expected on the position. "In that case, it makes sense to restructure a portfolio to better align regulatory and economic capital to reflect expected loss rather than probability of default. With increasing scrutiny and the prospect of potentially higher regulatory capital ratios being imposed, this trend could potentially become a necessity for some," explains Paul Levy, partner at Prytania Investment Advisers.

He adds: "There is a line between the efficient use of balance sheets and regulatory arbitrage; the existence of this is one of the downsides of having prescriptive rules."

Upon the assets being downgraded, the changes to regulatory capital requirements are significant. "The risk weights under the standardised approach for securitisation exposures become more onerous the further down the rating scale the assets drop. For example, if a billion dollar of triple-A assets are downgraded to double-B, the charge increases to US$280m from US$16m. It's not clear that this is economically the right number, given the prescriptive rules, but it's the consequence of the reliance on external ratings prescribed by Basel 2 securitisation framework," Levy continues.

To the extent that the assets are healthy but carry a low rating, it should be possible to resecuritise the exposure to free up capital. Conceptually, the restructuring would create a large highly rated (triple-A or double-A) piece that would be retained by the holder and a small unrated piece, which would be sold to a third party. Even though it could be expensive to sell the first-loss piece, the overall regulatory capital savings can be substantial.

"In doing so, it may cost US$50m to take the position back to a US$16m regulatory capital requirement, but the position now carries its own intrinsic subordination through the repackaging," Levy notes. "A number of different tweaks could be added to this basic structure, depending on the holder's requirements, but it would still have to have rating agency sign-off. As with any securitisation, a more diversified portfolio typically achieves better treatment - and, by adding subordination, you're reducing the frequency of default."

Such restructuring is not a new concept: banks have traditionally bought protection on their super-senior tranches of their investment grade loan exposures (for example, via JPMorgan's Bistro programme of the late 1990s). Under Basel 1 rules, the super-senior tranche then carried the 20% risk weight of the counterparty (as opposed to the previous 100% risk weighting of the corporate loans).

If a small enough first-loss piece was retained, this could prove efficient with regard to return of regulatory capital. But with the change to Basel 2, the focus has shifted in favour of distributing first-loss tranches.

However, the rapid change in ratings of structured finance assets and consequent strain placed on regulatory capital has brought these techniques back in vogue. "Investors want to get solutions in place as quickly as possible in order for their balance sheets to look as healthy as possible," Levy concludes.

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ABS

Esoteric alternatives

IP ABS launched while another joins the pipeline

A US$250m intellectual property (IP) securitisation of milestone payments tied to a new hepatitis C drug has been launched. While it remains unclear whether this deal signals a recovery in the market for esoteric ABS, another transaction structured along the same lines is currently being prepped.

The completed deal was structured by Morgan Stanley for Vertex Pharmaceuticals - a global biotechnology company. Vertex is selling the rights to certain milestone payments tied to the launch of its hepatitis C virus (HCV) protease inhibitor drug candidate, telaprevir, in Europe. The milestones anticipated for telaprevir include US$100m related to regulatory filing and approval and US$150m related to launch of the product.

One European lawyer confirms that her firm is currently working on a pharmaceutical IP ABS that is along the same lines as the Vertex transaction. Although the deal is at very early stages, she says it promises to be innovative.

"There are two schools of thought as to why investors should be looking more closely at these deals," the lawyer says. "First, they are relatively easy to understand in that the underlying asset is tangible, and they are more transparent. Second, in pharmaceutical IP deals, the assets - theoretically - are not correlated to the recession."

However, it is unlikely that a ready investor base for such deals will be available. Historically, esoteric ABS deals have been sold in two different ways: via ABCP conduits or with a monoline guarantee.

"For issuers, it was generally easier to approach a bank ABCP conduit that showed an interest in the deal and explain it to them, rather than approach a number of different investors, which would be very time-consuming," says Malcolm Dorris, partner at Dechert in New York. "On the other hand, if a deal had the monoline guarantee, investors didn't need to fully understand the deal as the guarantee was enough."

Dorris suggests that without the presence of triple-A rated monolines, or ABCP conduits to actively book the deals, issuance of esoteric ABS is going to remain tough. "Although I think it's terrific that a deal is being done, it is not representative of the wider securitisation market where non-TALF esoteric asset class issuances are very few," he says.

There is also a question over the classification of such deals. "Depending on who you talk to, a deal such as the Vertex transaction will - or will not - be called a securitisation," comments Dorris. "While it has elements of a securitisation, such as the bankruptcy-remote SPV that issues bonds backed by the specific assets, it does not have any of the diversification criteria that define securitisation. Consequently, deals such as this are unlikely to get a rating - and if they are, it would probably be below investment grade."

The investor base for such assets is also likely to be very different to those investors currently buying TALF-eligible ABS. "Morgan Stanley [which has completed a number of one-product pharmaceutical transactions in the past] has been creative in cultivating an investor base for this sort of deal that is very different to those currently buying up TALF ABS deals," continues Dorris. "It is most likely that high yield or niche investors would buy into this."

Vertex anticipates, based on projected development and commercial timelines for telaprevir, and assuming successful development, that it will earn the milestones prior to April 2012.

AC

Structuring/Primary market

PPIP side-step

Banks finding other ways to dispose of troubled assets?

A downgraded CLO has been retranched into new securities with triple-A ratings, using a similar process to the re-REMIC technology that recently regained popularity in the CMBS and RMBS space (SCI passim). As the launch of PPIP funds draw closer, speculation is growing that banks will utilise proprietary solutions to divest troubled assets - with the potential for re-REMIC technology playing an increasing role.

Morgan Stanley has reportedly repackaged the downgraded Greywolf CLO I - a deal arranged by Goldman Sachs and managed by Greywolf Capital that was launched in 2007. The new transaction comprises of two tranches: a US$87.1m senior tranche and a US$42.9m junior piece likely rated Baa2 by Moody's.

"Assuming the re-REMIC'd CLO is using collateral from Morgan Stanley's own books, the re-REMIC can be seen as an alternative avenue to rid the bank of its 'toxic assets'," says John Jay, senior analyst at Aite Group. "The bank may be able to make more revenue using this method than simply selling it via the PPIP."

He continues: "Morgan Stanley's client base for the issue is most likely bigger than the nine firms involved in the PPIP. If Morgan Stanley is able to sell the assets itself, it will also look better in the eyes of its clients, added to which it is making money on an asset they have previously written down."

However, other sources suggest that the Greywolf repack is simply a means of testing investor appetite for this sort of risk, or even a simple arbitrage exercise where the asset has been bought at a knocked down price and resold at a profit via the re-REMIC, as witnessed in the MBS space (see SCI issue 142).

Jay says that it is possible that the CLO re-REMIC is being used as a taster for investor sentiment, especially given the deal's size (US$120m). "But in this market nobody likes to do anything for free, so I don't think it is being done just to gauge investor sentiment," he adds.

"Who's not to say that banks have been buying CLOs and other structured finance deals at distressed prices over the past few months in the hope of selling them on for a better price, or in order to re-REMIC them?" Jay asks. "However, in many cases it is a question of capital efficiency. By re-REMICing a deal, the bank is changing the risk/return profile of the underlying deal(s). The bank may even choose to retain part of the re-REMIC - if the bank can squeeze more out of cashflows, then they will."

If Morgan Stanley manages to place its deal with investors, other firms are tipped to turn to the same methods of divesting troubled assets. "If Morgan Stanley is successful, others in the industry will sharpen their pencils and look at the same strategy," Jay confirms. "There's no reason why it couldn't be used by banks across the globe either."

"If there were to be another major firm to consider this strategy, I believe it would be Citi," suggests Jay. "The bank's shares are still lower than US$3, indicating that investors are still not overly confident with the firm's portfolio. It would make sense for Citi to give itself the broadest options in asset disposition through either PPIP or re-REMIC treatment."

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Regulation

Transparency to the fore

US investigation launched as CESR proposals published

The issue of transparency rose to the fore this week on both sides of the Atlantic. On the same day that CESR published its final report on the transparency of structured finance and credit derivatives markets, the US Department of Justice launched an investigation into whether the dealers that own Markit have unfair access to CDS price information.

"In any market, lack of transparency can lead to the appearance of smoke and, in the current political climate, a hint of smoke leads to the assumption of fire," notes Tim Backshall, chief strategist at Credit Derivatives Research (CDR). "Even if there was no advantage taken, the dealers leave themselves open to these suspicions by resisting efforts to move to centralised clearing and by maintaining control of a major CDS information provider and index manager like Markit. Our view is simply that picking apart the runs that are sent out and Markit data levels will show off-market levels, but in a market that is illiquid off-the-run this seems harsh."

However, CDR has raised its concerns over the index selection process and its "almost totally subjective nature" several times in the past. By way of an example, Backshall points to the Belo and Olin names.

"How they justified including these low debt illiquid names in the most liquid credit index seems unreal to us - perhaps this is what the DoJ is looking into," he suggests.

Markit confirms that it has been informed of an investigation by the Department of Justice into the credit derivatives and related markets. "We will work with the Department to provide any information requested of us," the firm says in a statement. "Markit strives to enhance transparency and efficiency in the credit derivatives market by making all our independent data products commercially available to all market participants."

Meanwhile, CESR says that it believes current market-led initiatives have not provided a sufficient level of transparency and consequently it recommends the adoption of a mandatory trade transparency regime for the corporate bond, structured finance and credit derivatives markets as soon as is practicable. It considers that an increased level of transparency would be beneficial to the market and that a harmonised approach to post-trade transparency would be preferable to national initiatives taken in this area.

In CESR's view any post-trade transparency regime for structured finance products should be seen as complementary to existing initiatives designed to improve transparency earlier in the transaction chain. In the case of ABS and CDOs, the Committee recommends that a phased approach should be used, so that the post-trade transparency regime would gradually apply to all ABS and CDO that are commonly considered as standardised.

Andrew Bristow, executive director at Threadneedle in London, agrees that increased price transparency would facilitate liquidity in the ABS sector. But he points out that additional measures are needed to sustain this liquidity, such as enforced disclosure of performance data for the underlying mortgage or asset pools.

Rob Ford, partner and portfolio manager at TwentyFour Asset Management, says that his views about post-trade reporting are divided. "As an investor, it should appeal enormously," he explains. "But my concern is that, while a recently posted price may be helpful, it could do more harm than good whilst markets remain less liquid. For example, it could remove risk appetite from the market, as other market participants may be able to deduce the price at which holders own the bonds they're offering. Alternatively, as is often the case in current markets, when an asset is passed through from one investor to another with the intermediary taking no risk, both sides of the trade will be shown, indicating how much was made - which may lead to breakdowns in relationships between counterparties."

There is also the question of the mark-to-market implications of post-trade reporting, according to Ford. "If one price is posted, potentially in a forced sale situation, will everyone else have to mark-to-market at that same price? This could plunge the market into a situation where heavy negative mark-to-market losses return."

Alan Packman, md and head of ABS/CDO trading at Aladdin Capital Management UK, adds that every price has to be taken in its own context. "It's difficult to extrapolate prices from one deal to another because there are so many different variables involved."

With regards to ABCP, on the other hand, CESR has concluded that additional post-trade transparency is "not one of the pressing topics" for participants in these markets and so there is no need for a post-trade transparency regime in this sector. However, the Committee is of the view that a post-trade transparency regime should cover all credit default swap contracts that are eligible for clearing by a central counterparty (CCP) due to their level of standardisation, including single name CDS.

Such a regime should minimise any potential drawback on liquidity by allowing for delayed publication and/or the disclosure without specified volumes, if the transaction exceeds a given threshold. When setting the thresholds, the initial issuance size (total value) and/or turnover of a particular transaction would need to be taken into account, according to CESR.

At this stage, however, the Committee concedes that its proposal does not include all the details needed for an effective post-trade transparency regime for non-equity markets. For example, the details of the phased approach for ABS and CDOs and the exact conditions for the delayed publication of information on large trades remain unclear. But CESR says it is ready to assist the European Commission in developing the necessary details "to ensure that any possible drawbacks on liquidity of these markets can be avoided".

Jean-Paul Servais, chair of the Belgian Commission Bancaire, Financière et des Assurances (CBFA) and chair of the CESR MiFID Level 3 Expert Group, explains: "The recent market turmoil has highlighted the need for more transparency in the non-equity markets. We think that it might be helpful in improving current market conditions, supporting liquidity in normal times and contributing to greater accuracy in valuations."

He adds: "CESR has been closely following the progress of the market-led initiatives, but after careful reflection has drawn the conclusion that they have not provided a sufficient level of transparency. As such, anticipating the upcoming MiFID review of the Commission, CESR wanted to seize the opportunity to improve the current situation and ensure that any changes are implemented in as consistent a manner across Europe as possible, to ensure a level playing field and real transparency given the nature of our integrated markets."

Separately, CESR has released a consultation document seeking comments on the conclusions it has drawn for setting common standards for presentation of historical and performance information, following the approval of the EC's credit rating agency regulation. Legislation is expected to enter into force by October 2009 and to apply by March 2010.

CS

Clearing

CDS CCP segregation/portability rights explored

An ad hoc group comprising eight buy-side and eight sell-side constituents has delivered a report to the supervisors of the major OTC derivatives dealers, in which the rights of customers with regard to the segregation and portability of CDS positions and associated initial margin is explored. Responses from CME Clearing, ICE Trust US, Eurex Clearing, ICE Clear Europe, LCH.Clearnet/NYSE Liffe and LCH.Clearnet were solicited on various matters relating to the protection of customer positions and related margin in the event of a clearing member's (CM) default. The working group was formed in May and coordinated through the ISDA Board Oversight Committee.

The group acknowledges that the report is not an exhaustive analysis of all potential legal issues and that there are a host of business, operational and other legal considerations relevant to the determination of which clearing structure is optimal for any particular CM or customer.

Many of the issues discussed in the report would only arise in a worst-case scenario of a liquidation of the CM and no transfer of customer positions and related margin to a successor. But there is reason to believe that the failure of a CM might result in an orderly transfer of customer positions and related margin to another financial institution, according to the group.

"In the event customer positions and margin are not transferred, even if customer margin is adequately segregated, a potential challenge for a customer of an insolvent CM is the practical difficulty of obtaining the timely return to it of assets to which it is entitled as a matter of law, but which (as a matter of practice) may not be released to the customer in a timely manner," the report notes. "These concerns would be largely resolved if customer margin could be returned directly to a defaulting CM's customers and not to its insolvency representative, or if a legal regime could be instituted that would provide for a mechanism for the prompt return of customer margin (even if held in omnibus accounts). However, it is not possible to have a customer protection regime that ensures prompt return of customer margin while also providing for the holding of such margin in omnibus customer accounts."

If margin is held at or through an insolvent CM, the insolvency representative of the CM may not release the margin until all custodial claims have been processed and the entitlements of various claimants have been fully resolved. In addition, consideration would have to be given to how customer liabilities to the CM are satisfied prior to the return of margin to the customer. Even if margin is held away from the insolvent CM, absent a contractual relationship directly between customers of the CM and the central counterparty (CCP) or third-party custodian, the CCP/third-party custodian would almost certainly return the margin to the CM's insolvency representative, rather than directly to the customers.

The report notes that US CCPs and European CCPs have various mechanisms for the protection of customer positions and related margin, which differ in several key respects. As an initial matter, certain CCPs permit a variety of CM organisational types and jurisdictions, while others are more restricted. The range of permitted CM organisational types and jurisdictions - as well as where and in which manner customer margin is held - critically affects which laws may be applicable to customers seeking the return of their margin through the insolvent CM.

With respect to the segregation of margin, certain CCPs have pledge arrangements, while others have title transfer arrangements or title transfer combined with trust or security interest arrangements. In addition, certain CCPs provide for customer margin to be pledged (or repledged) to the CCP, while others allow only CM proprietary margin to be pledged to the CCP (with customer margin segregated - or not - at the CM). All but one of the CCPs provides for omnibus accounts, rather than accounts in a particular customer's name.

The group believes that proposals that are beyond the early development stage represent significant improvements over the current OTC CDS market in protecting customer margin and enhancing portability. "That being said, no proposal is perfect in its current form, especially given the imperfect or unclear state of relevant law. All of the proposals could benefit - to a greater or lesser degree, depending on the structure of the CCP's clearing solution and the laws applicable to the CCP and the CMs - from legislative or regulatory changes to enhance the customer protection analysis," it says.

The US Federal Reserve Bank of New York has welcomed the report's publication. "Segregation and portability are key elements in building robust central counterparties. We requested the analysis because market participants were not making enough progress to analyse and address these buy-side issues. This is a good first step and, as we move the OTC derivatives market to central clearing, we will work to strengthen the regulatory and legal environment for buy-side clearing," comments William Dudley, president of the New York Fed.

Supervisors are currently evaluating the specific issues raised by the analysis. Market participants are nonetheless expected to continue working with regulators and other authorities to strengthen the foundations for buy-side clearing as they work towards the goal of achieving buy-side access to CCPs by 15 December 2009.

Indeed, the working group says it believes that the report represents the commencement of a broader dialogue that will enable the buy-side and the sell-side to work together towards this commitment. "As our report demonstrates, ISDA and the industry remain committed to enhancing the processing of privately negotiated derivatives," comments Robert Pickel, ISDA executive director and ceo. "Going forward, ISDA welcomes comments from the supervisory community regarding the report and next steps in providing buy-side access to central counterparties."

ISDA adds that it continues to work closely with the Managed Funds Association (MFA) and SIFMA's Asset Management Group on outreach to buy-side participants.

CS

Indices

Positive trend continues for hedge fund index

Both gross and net monthly returns for May 2009 in the Palomar Structured Credit Hedge Fund (SC HF) Index continue the positive trend it has been exhibiting this year.

The latest figures for the index were published this week and show a gross return of 3.65% and a net return of 3.17% for the month of May (compared to readjusted returns of 1.96% and 1.65% respectively for April). Nevertheless, the gross and net indices still show negative - albeit improved - annualised returns since outset of -7.56% and -9.47%. For more Index data click here.

The objective of the Palomar SC HF Index is to produce an index that represents the risk and return of investable hedge fund investments in the structured credit area. It currently tracks 17 funds and represents over US$7.5bn of assets under management.

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

The Palomar SC HF Index is calculated by the Centre of Alternative Investments of the Zurich University of Applied Sciences and run by Palomar Capital Advisors. It is published exclusively by Structured Credit Investor.

Palomar Capital Advisors is a financial advisory firm specialising in structuring, managing and placing alternative investment products, specifically credit-related securities. It is an independent firm based in Zurich, Switzerland, owned and controlled by its investment professionals.

Investors

PPIP fund managers announced

The US Treasury Department, the Federal Reserve and the FDIC have announced further details about the legacy securities PPIP (SCI passim). Under this programme, the Treasury will invest up to US$30bn of equity and debt in PPIFs established with private sector fund managers and private investors for the purpose of purchasing legacy securities in the CMBS and non-agency RMBS sectors. To qualify for purchase, these securities must have been issued prior to 2009 and have originally been rated triple-A - or an equivalent rating by two or more nationally recognised statistical rating organisations - without ratings enhancement and must be secured directly by the actual mortgage loans, leases or other assets.

The Treasury has pre-qualified AllianceBernstein (and its sub-advisors Greenfield Partners and Rialto Capital Management); Angelo, Gordon & Co (and GE Capital Real Estate); BlackRock; Invesco; Marathon Asset Management; Oaktree Capital Management; RLJ Western Asset Management; The TCW Group; and Wellington Management Company to participate as fund managers in the initial round of the programme. Each fund manager will receive an equal allocation of capital from the Treasury.

These applications were evaluated according to established criteria, including: demonstrated capacity to raise at least US$500m of private capital; demonstrated experience investing in these assets, including through performance track records; a minimum of US$10bn (market value) of such assets under management; demonstrated operational capacity to manage the legacy securities PPIP funds in a manner consistent with treasury's stated investment objective, while also protecting taxpayers; and headquartered in the US. To ensure robust participation by both small and large firms, these criteria were evaluated on a holistic basis and failure to meet any one criterion did not necessarily disqualify an application.

These fund managers have also established meaningful partnership roles for small-, veteran-, minority- and women-owned businesses. Collectively, the nine pre-qualified PPIP fund managers have established 10 unique relationships with such businesses located in five different states, pursuant to the legacy securities PPIP.

According to ABS analysts at Barclays Capital, one of the big decisions that PPIP managers face is to decide to what extent they will use the leverage available through Treasury loans. They have primarily three options to choose from.

The first option involves no US Treasury debt, but borrowing from TALF or a third-party without any additional constraints. However, this would have no competitive advantage versus a third-party fund using TALF, the BarCap analysts note.

The second involves the full turn of leverage, which allows the PPIP to get 1:1 financing on its equity. However, no additional leverage can be used (including TALF).

The third involves a half turn of leverage, which allows the PPIP to borrow half of the equity amount. This option allows the PPIP to borrow further using TALF/third-party repo up to a 5:1 combined leverage ratio.

Although not as powerful as TALF, the analysts note that the PPIP will provide an avenue to leverage non-agency RMBS (and TALF-ineligible CMBS) and, as such, should be a marginal positive for fundamental valuations. "From a technical standpoint, US$30bn-US$40bn in incremental demand for non-agency/CMBS securities (if enough equity can be raised) should be a strong positive technical for next several months," they say. "For now, we maintain our neutral stance in both resi-credit and CMBS, but look to add selective long positions in areas PPIP is likely to benefit the most."

The first closing of a PPIF is anticipated in early August. Each pre-qualified fund manager will have up to 12 weeks to raise at least US$500m of capital from private investors for the PPIF.

The equity capital raised from private investors will be matched by the Treasury. Each fund manager will also invest a minimum of US$20m of firm capital into the PPIF. Upon raising this private capital, they can begin purchasing eligible assets.

SIFMA has welcomed the implementation of the securities portion of the PPIP. "Clearing troubled legacy assets off of banks' balance sheets is a positive step forward in our economic recovery," notes SIFMA president and ceo Tim Ryan. "Selling these assets should improve the financial strength and the value of banks, which should free up the banks' ability to lend to consumers and small and large businesses at more normalised levels. If the purchases are open and transparent, which the industry has advocated for, it will also establish reliable market clearing prices and allow investors to know the true shape of banks' balance sheets."

While the economy has shown recent signs of resilience, SIFMA continues to believe that the PPIP is an essential step to jumpstart the lending and securitisation necessary to achieve a healthy economy.

Meanwhile, the FDIC has announced that it will test the funding mechanism contemplated by the legacy loan PPIP scheme in a sale of receivership assets this summer. The FDIC expects to solicit bids for this sale of receivership assets in July. The FDIC says it remains committed to building a successful legacy loan programme for open banks and will be prepared to offer it in the future as needed to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy.

While utilisation of legacy asset programmes will depend on how actual economic and financial market conditions evolve, the programmes are capable of being quickly expanded if these conditions deteriorate, the Treasury notes. Thus, although the programmes will initially be modest in size, it is prepared to expand the amount of resources committed where necessary.

Lawyers at Paul Hastings conclude that the PPIP schemes appear to be the first cases where the establishment of 'bad banks' and the process by which they realise on the value of their distressed assets has been amalgamated into a single step - perhaps indicating an increased sense of urgency in seeking a final resolution to the problem of distressed assets.

CS

Investors

Firm to link RMBS investors seeking loan disclosure

A new company that will help investors recover money lost as a result of buying into pools of RMBS has been launched by the Barrent Group. The Barrent Bond Board & Reports will assist bondholders in identifying other investors to join with them to meet the minimum percentage requirements necessary to gain access to loan files.

"Bondholders have difficulty identifying other investors to join with them to meet the minimum percentage requirements necessary to gain access to loan files," says Richard Barrent, president and coo of the Barrent Group. "This has been a monumental stumbling block. Without access to the information contained in the loan files, it can be problematic for investors to identify flawed underwriting practices or fraud and to thereby exercise their recourse rights."

Typically, access to loan files requires a formal request by bondholders owning a minimum of 25% of the dollar value of an RMBS pool. Since many of the pools are comprised of several hundred million dollars of mortgages and have numerous bondholders, it is often necessary to identify and match up multiple bondholders of a single securitisation trust to gain file access.

The Barrent Group's Bond Board allows bondholders to register their investments in pools with disappointing performance on its website. Bondholders will remain anonymous until they provide written permission to the Barrent Group to share their identity with others. As further protection to assure anonymity, investors may choose to register their holdings in the name of a nominee.

After a bondholder registers its RMBS holdings, they will be advised when other bondholders have registered holdings in the same pool. That will facilitate the creation of bondholder alliances, for the purpose of gaining access to loan files.

The Barrent Group was founded in 2008 by Richard Barrent, a former executive with Wells Fargo Home Mortgage, and Richard Levitt, a retired vice chairman of Wells Fargo & Co.

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Investors

Investors bring suit against Highland

A group of institutional and individual investors has filed a lawsuit against Highland Capital Management and two of its hedge funds, alleging that the firm fraudulently misled them about the funds' financial state before it began to wind down and sell off assets starting last October. Investors claim that, as a result of Highland's misleading representations, their nearly US$50m total position will be worth a fraction of this amount once the funds' assets are liquidated.

The suit was brought in Texas state court by Boston-based LV Highland Credit Feeder Fund, along with several individuals and family foundations. The plaintiffs accuse Highland Capital's managers of misrepresenting the amount of redemptions from the two funds, which in turn induced the investors to maintain their positions and invest additional monies in the funds between 2007 and 2008. The lawsuit was filed by leading shareholder and corporate governance law firm Grant & Eisenhofer.

The two funds in dispute were heavily weighted in structured credit instruments, whose value plunged dramatically after the collapse of the subprime market.

Plaintiffs allege that the funds' February 2009 'Distribution Plan' to liquidate the assets of the two funds seeks to give "preferential treatment" to investors who sought to redeem their investments before 30 June 2008. Meanwhile, investors who either did not seek to redeem their interests or submitted redemption requests after that date would receive a disproportionately smaller percentage of the funds' liquidated value.

"The plaintiff investors suffered a double whammy at the hands of Highland Capital," says Grant & Eisenhofer partner Jay Eisenhofer. "First, they were induced into maintaining or increasing their positions in these funds, whose values took steady beatings during the height of the credit crunch last year. In response to direct and explicit inquiries, these investors were given fraudulent reassurances that other investors weren't withdrawing monies from the funds in significant amounts; but indeed this was happening."

He continues: "Second, the funds wilfully and without warning corralled these investors into an underclass of claimants of the liquidated assets that allows them to recover significantly less than those investors fortunate enough to withdraw their positions earlier. This kind of disparate treatment represents a total breach of investor trust."

The complaint states that information about investor redemptions "was material to plaintiffs because redemptions in a significant amount could negatively impact the funds' liquidity and impair their ability to execute an optimal investment strategy".

Two divisions of JPMorgan were named as defendants - JP Morgan Investor Services and JPMorgan Hedge Fund Services (Bermuda). The complaint states that plaintiffs decided to hold their investment instead of redeeming before 30 June last year and also to invest more capital into the funds after that date in reliance upon false and inaccurate net asset value figures of the two funds that were created and distributed by JPMorgan.

The plaintiffs seek to recover a return of their full amount of the investments, or monetary damages resulting from the alleged fraudulent representations about the funds' redemption rates, which they contend delayed their redemption requests and prompted them to invest additional amounts in the failing Highland Funds. Alternatively, investors seek a declaratory judgment from the court that the contracts and law governing the funds require a pro rata distribution of the assets of the funds to all investors, as originally announced by the defendants.

"The Distribution Plan proposed by defendants is highly prejudicial to plaintiffs' interests," the plaintiffs argue in their complaint. It further states that the plan's effectuation "would violate the operative agreements and amount to a clear breach of defendants' fiduciary obligations to provide equal treatment among the stakeholders in the funds".

Eisenhofer adds: "The distribution plan was proposed without warning and is an obvious detriment to these good faith investors and contradicts Highland's promise to issue distributions of liquidation proceeds to investors on a pro rata basis. We will fight to see that does not occur."

CS

Regulation

Singapore minibond distributors banned

Upon the completion of its investigations into the sale and marketing of Lehman Brothers CLNs, the Monetary Authority of Singapore (MAS) has imposed bans on the sale of structured notes by 10 institutions for periods ranging from a minimum of six months to a minimum of two years.

MAS found that ABN AMRO Bank, Malayan Banking Berhad, Hong Leong Finance, CIMB-GK Securities, DMG & Partners Securities, Kim Eng Securities, OCBC Securities, Phillip Securities and UOB Kay Hian had policies, procedures and controls in place for the approval, sales and marketing of the Notes. However, the extent of the due diligence and level of internal controls differed among them.

As a result, there were various forms of non-compliance with MAS' notices and guidelines on the sale and marketing of investment products. Some of the specific failings included:

• risk ratings assigned by some financial institutions to some series of the notes that were inconsistent with risk warnings stated in the prospectus and pricing statement;
• insufficient steps taken by some financial institutions to ensure that all their financial advisory representatives were properly trained before marketing and selling the notes; and
• weaknesses in how some financial institutions ensured that their financial advisory representatives were properly equipped with accurate and complete information about the notes.

The Authority says it takes a serious view of all instances of non-compliance and, in deciding on the appropriate regulatory action, it considered the nature and impact of the failings, the steps taken by the financial institutions to rectify these and the extent to which they accepted responsibility and resolved investors' complaints. MAS has nevertheless issued formal directions to the 10 financial institutions to rectify all the weaknesses identified by the investigations and to review and strengthen all internal processes and procedures for the provision of financial advisory services across all investment products.

The financial institutions are also required to appoint an external person approved by MAS to review their action plan and report on its implementation, as well as appoint a member of the institution's senior management to oversee compliance with its direction. The financial institutions will not be able to distribute structured notes until the Authority is satisfied with the measures they have put in place.

MAS says it is concurrently looking into specific cases where individuals involved in the sale and marketing of the notes may have departed from the relevant regulatory standards. Inquiries are ongoing and any regulatory action taken against individuals will be published in due course.

The total issue size of the Lehman minibond notes programme was US$508m, of which US$373m was sold to about 7,800 retail investors through the 10 distributors.

CS

Raft of new hires for structured products team

Henderson Global Investors has made a number of appointments to its structured products team. Jim Irvine, head of structured products at the firm, continues to head up Henderson's four business areas, which include loans, CDOs, ABS and advisory, overseeing a team of 19 people.

Irvine says: "We have looked at how we can take advantage of available talent, reputation and experience at Henderson to reshape our structured products business in response to client demand and opportunity. Already we have repositioned ourselves to fill a variety of work-out roles within the structured products arena, most notably within an advisory role to the receivers of the Sigma SIV. We expect to play a similar role in the loans space and are working on consolidation opportunities. In addition, we successfully launched the European ABS Opportunity Fund on 1 July 2009 [see SCI issue 139]. We are confident that the quality, diversity and experience of the structured products team positions us well to further grow our business."

The lines of business reporting to Irvine include four positions. Colin Fleury will be responsible for ABS analysis and portfolio management, managing the European ABS opportunity fund and ABS subportfolios for other diversified fixed income strategies.

Reporting to him will be Jason Walker as ABS portfolio manager. Walker joins from Bank of Scotland Treasury in London, where he was a member of its ABS team and has 14 years' experience in ABS as a credit analyst and portfolio manager.

Alex Stockham will also report to Irvine and head up CDO management. In addition, Ganesh Rajendra will provide advisory and recovery business services to external clients.

Finally, David Milward will be responsible for loans analysis and portfolio management, managing loan subportfolios within other Henderson products and head the Henderson Secured Loans Fund. Reporting to Milward are three new staff acting as directors of loans.

Elissa Johnson joins Henderson from credit hedge fund Apollo Management International, where she was principal and made a significant contribution to the development of Apollo Investment Europe for the last two years. Johnson has previously worked for PIMCO Europe, Merrill Lynch, Citadel (Europe) and Morley Fund Management.

Nicholas Ware-Fredriksson joins the firm from Highland Capital Management Europe, where he was a senior portfolio analyst for the past four years and part of a team managing €2.5bn of European leveraged loans and high yield bonds. Prior to this, he worked at New Amsterdam Capital, Ahli United Bank and SEB Merchant Banking.

Finally, Stef Abelli will join on 20 July from BayernLB, where she was a director of acquisition and leveraged finance for over two years. Prior to this, she was a CIB expert at McKinsey in London. She has also worked in leveraged finance at GE Commercial Finance.

Each director of loans will specialise on specific industry sectors with the CDO team, taking on the administration and reporting of CLO structures.

Meanwhile, reporting to deputy head of fixed income - Mitesh Sheth - will be Dan Maynard, who joins as fixed income product specialist. He joins Henderson from Morgan Stanley and has 20 years' experience of fixed income sales in both London and New York. At Henderson his remit will be to support the international marketing effort for Henderson's fixed income product range, including the European ABS Opportunity Fund.

Sheth says: "We have attracted and hired the best individuals to help us best capture the significant opportunities available in the market today. With backgrounds in private equity, hedge funds, sell- and buy-side, strategy consulting and accountancy across the European marketplace, this team brings significant experience, diversity and complementary skills to Henderson's loans team and the wider credit business."

ABS

Recently-acquired broker names 29 new hires

A group of investors, led by Ben Carpenter, Ron Kripalani and Jay Levine, has purchased a controlling interest in CRT Capital Group (formerly Credit Research and Trading). This investor group also includes the existing management team of CRT, Chris Young and Michael Vaughn. Over the past four weeks, CRT's new management team has hired 29 top sales and trading professionals - including in the MBS and credit space - in anticipation of both a deepening of its existing platform and a significant expansion of product and service offerings to CRT's institutional client base, the firm says.

Kripalani, the new ceo of CRT, was the president and ceo of Countrywide Capital Markets from 2000-2008. Carpenter and Levine were co-ceos of Greenwich Capital from 2000-2007. The former is the new chairman of CRT and the latter is a strategic advisor to CRT, while continuing to serve in his position as ceo of Capmark Financial Group.

"Over the past two years, the credit crisis has weakened every major Wall Street firm beyond everyone's imagination and the ability for smaller firms to attract the industry's best producers and support personnel has never been better," comments Carpenter.

CRT's existing business platforms span the high yield, distressed, convertible and emerging market debt and equities asset classes. In addition to aggressively growing its existing credit and equities businesses, the firm plans to focus on the two product areas of expertise of the new management team members - mortgage- and asset-backed products and US treasuries.

Kripalani observes: "There is an historic opportunity in these markets to provide clients with value-added sales and trading advice and execution due to the enormous amount of mortgage- and asset-backed paper outstanding and the current market dislocations that are certain to continue for many years to come."

Among the new CRT hires is eight-person ABS/MBS sales and trading team. Bob Eick and Kevin Clare have been named co-heads of structured product sales, and were previously a manager in RBS/Greenwich Capital's asset-backed and mortgage groups and md, co-head of global sales at Countrywide Securities respectively.

Mike Scanlon, Jim Tennille, Mike Abamonte and Mark O'Donnell have been appointed senior mortgage salespeople. Scanlon was most recently an svp at Amherst Securities, responsible for mortgage sales. Tennille and Abamonte were most recently svps at Countrywide Securities, responsible for mortgage sales. O'Donnell was previously a senior mortgage salesperson at RBS/Greenwich Capital.

Meanwhile, Mark Rudnitzky has been named senior CMBS trader. As an svp at Countrywide Securities, he started and managed the CMBS secondary trading business. Joe Cesare, who previously ran Countrywide's mortgage pass-through desk, joins him as senior mortgage trader.

CRT has also made a number of hires across the corporate credit and emerging markets sectors. Robert Heffes, who was formerly head of high yield sales and trading at Wachovia, has been named head of credit trading.

He is joined by Glenn Hall and Kris Deodato as senior credit salesperson and senior credit trader respectively. Hall was previously md and Deodato was a financials trader at RBS/Greenwich Capital.

Additionally, Jay Cox becomes head of emerging market sales. He was most recently an EM senior trader at Citigroup.

On the research side, CRT has recruited John Paulsen and Anand Ogale from RBS/Greenwich Capital as senior research strategist and senior quantitative strategist respectively. Richard Guastello also joins the firm as senior desk analyst, focusing on merger and capital-structure arbitrage. He was most recently head trader at March Partners.

ABS

KfW outlines commitment to ABS

KfW pledged its commitment to the securitisation market at a press conference held in London on 13 July. Günther Bräunig, member of the managing board of KfW Bankengruppe, suggested that simply-structured securitisations - which banks use primarily as a means to refinance their core business and reduce their capital charge - will remain important in the future, particularly to ensure the credit supply for SMEs.

"They are an economically useful instrument, and for this reason we will continue to offer our securitisation platforms and our expertise in order to support the lending operations of banks for SMEs and for private housing construction," Bräunig said.

He added that the RMBS carried out with Postbank through KfW's securitisation platform (PROVIDE) in June was a "positive signal" (see SCI issue 143). A portfolio of German housing loans with a volume of roughly €1.5bn was securitised under the deal.

ABS

Securitisation lawyer joins MoFo

Morrison & Foerster has hired Jerry Marlatt to join the firm's capital markets group. Formerly with Clifford Chance, Marlatt focuses on structured capital markets transactions, including covered bonds, surplus notes and structuring specialised investment and operating vehicles, securities repackagings and public and private offerings of ABS, structured debt securities and commercial paper.

Keith Wetmore, chair of Morrison & Foerster, says: "What we do best, and the things for which we are best known as a firm, are of critical importance to our clients at this time. Our financial institutions work, financial services regulatory advice and capital markets activity focused on innovative products and offering methodologies are top of mind in this regard. We are pleased to welcome Jerry Marlatt as we continue to add to the firm's banking and finance focus."

Marlatt began his legal career at the US Securities and Exchange Commission.

Advisory

ABS research head recruited

PIMCO Advisory, a division of PIMCO, has hired Rod Dubitsky as evp and global structured finance specialist. Dubitsky joins PIMCO from Credit Suisse, where he was an md and head of ABS research.

Prior to his role at Credit Suisse, Dubitsky was a vp and senior analyst at Moody's, where he was responsible for analysing and assigning ratings to MBS. Previously, he was an agency MBS portfolio manager with BankAmerica.

Alternative assets

Coventry expands into Asia

Coventry has established Coventry Capital HK Ltd in Hong Kong and hired Charles Wong as md. Wong has an extensive background in structured finance and will play a key role in Coventry's growth in the Asian market. He joins Coventry after 13 years at JPMorgan, where he most recently served as md and head of structured investment derivatives marketing for Asia markets.

The move continues Coventry's global expansion and extends its industry-leading platform for accessing longevity-based assets to institutional investors throughout the Asia-Pacific region. The firm hopes to tap heightened investor interest in the US longevity market.

CDS

CIT under pressure

SME financing company CIT is struggling to avert bankruptcy, according to numerous reports. The company's stock price has dramatically declined and its CDS premia have risen on concerns the company will fail to solve its refinancing problems.

Just last month the company completed the first TALF-eligible small ticket equipment lease deal. CIT has so far not been able to win FDIC backing for its debt sales. Without outside support, the company will likely fail due to maturing credit lines in April next year. If it does fail, it is expected to have large repercussions in the structured finance market, particularly in the synthetic CDO space. S&P reports that 1,881 rated synthetic CDOs have exposure to CIT Group, and says it will continue to monitor the CDO transactions it rates and take rating actions, including credit watch placements, when appropriate.

According to credit strategists at BNP Paribas, CIT has US$80bn in assets and US$39bn in debt: "A bankruptcy will have some impact on the market," they say.

CDS

High yield group adds senior trader

Robert Leone has been hired as md and senior high yield trader for Jeffries & Company, a subsidiary of Jeffries Group. Leone will be initially responsible for trading high yield bonds in the gaming, healthcare, utility, home builder and building products sectors. He joins Jefferies from Deutsche Bank, where he worked for more than four years and was most recently an md within the firm's high yield bond and CDS trading group.

Before joining Deutsche Bank, Leone worked at Merrill Lynch, where he spent nine years and was most recently a director in the firm's high yield trading group. He began his career at JPMorgan.

Robert Harteveldt, chairman of fixed income at Jefferies, says: "The addition of Robert Leone, with his extensive experience and deep relationships, further enhances the scope of Jefferies' high yield capabilities for our institutional clients. We continue to extend Jefferies' dedicated high yield offering and bring additional levels of service to our existing and new institutional clients."

Jefferies has added more than 20 professionals to the firm's high yield group over the last year, which includes sales, trading and research. This further extends the firm's presence in the leveraged loan, high yield and distressed markets.

CDS

CypressTree acquisition completed

Primus Asset Management, a wholly owned subsidiary Primus Guaranty, has completed its acquisition of CypressTree Investment Management. CypressTree will operate as a wholly owned subsidiary of Primus Asset Management, which now has over US$25bn in assets under management in structured credit vehicles. This includes the US$21bn notional credit default swaps portfolio of CDPC Primus Financial Products, as well as eight CLOs with US$3.2bn in assets and three CSOs totalling US$800m.

Founded in 1995, CypressTree manages leveraged loans and high yield bonds in investment products, including CLOs, CSOs, off-shore funds and separately managed accounts. Its assets under management total approximately US$2.4bn.

CLOs

New CLO servicing mandate for Avoca

The noteholders of Clio European CLO have voted to appoint Avoca Capital Holdings as replacement portfolio servicer for the transaction. Lehman Brothers International (Europe) was the previous portfolio servicer. The deal is currently in receivership, with Deloitte acting as receivers.

CLOs

Law firm hires three

Mayer Brown has hired three finance partners to its London office in order to strengthen the key areas of leveraged finance and asset-based lending.

Leveraged finance lawyers Lee Cullinane and Nicola Marley are joining the firm from Clifford Chance and Linklaters respectively. In addition, asset-based lending practitioner Graham Wedlake is joining from Taylor Wessing. Mayer Brown says that they will enhance its finance practice's capability to provide clients with the resource and experience to cover the whole capital structure.

Mayer Brown's senior partner in London, Sean Connolly, comments: "This is a further commitment to develop a leading City finance practice, complementing the skills and resource provided in the US, Europe and Asia. These hires are the first of a raft of measures to help us achieve this objective and they build on the significant successes the finance practice has achieved in recent years. We look forward to the arrival of Lee, Graham and Nicola."

Cullinane has over 20 years' experience in the London market for leveraged finance. His focus over the past three years has been on leveraged finance, investment grade and margin stock loans and most recently on the restructuring side of such deals.

Wedlake is an English qualified banking lawyer with over 25 years of experience in the profession. He is a specialist asset-based lending (ABL) practitioner, although his career has also covered public-to-privates, acquisition finance, syndicated lending and project financings.

Nicola Marley has broad experience in finance, having advised on a number of market-leading leveraged financings, particularly in the retail and luxury goods sectors, cross-over credit financings, investment grade financings and project finance transactions. Most recently she has been advising lenders, private equity sponsors and companies on the cross-border restructuring of high profile leveraged financings.

Chairman of Mayer Brown, Bert Krueger, adds: "I am delighted to welcome these outstanding lawyers to our firm - a sign of our determination to strategically invest in core practice areas and offices globally. They will each help to strengthen our position as one of the world's leading law firms."

CMBS

CMBS advisory JV launched

Real estate investment banking firm George Smith Partners (GSP) and law firm Manatt, Phelps & Phillips have joined forces to offer a full-service platform to advise and assist CMBS borrowers in restructuring their debt. The new initiative will be led by Gary Tenzer, co-founding principal and senior director, and David Rifkind, principal and md at GSP.

Tenzer says: "This new partnership with Manatt is a proactive effort on behalf of both firms to meet a fundamental need in the commercial real estate industry. In 2009 alone, the wall of maturity on more than US$15bn in securitised loans with major international investment banks is rapidly approaching, with no apparent refinancing opportunities; in 2010 and 2011 the maturities grow to US$45bn and US$65bn respectively. By combining the real estate finance knowledge and experience of GSP with Manatt's securitisation and workout expertise, we are offering a unique interdisciplinary approach to providing complete workout solutions for borrowers facing CMBS defaults."

Both Manatt and GSP offer teams of CMBS industry veterans to help borrowers work successfully with both master servicers and special servicers who administer their loans.

Adam Salis, partner at Manatt, says: "Through this joint initiative we are uniquely positioned to offer clients a full service team that has strong property underwriting skills, extensive knowledge of the securitisation process and real-world experience with assisting borrowers in restructuring their CMBS debt. As more borrowers are faced with the need to restructure their debt, we believe this advisory group will become the go-to resource to develop and implement achievable workouts. The key will be to craft a workout which addresses the challenges of the underlying property, the economic motivations of the players and the contractual limits on the servicer's discretion. Manatt and GSP have combined to create a best-in-class platform with all of the right tools to create that optimal workout strategy for the client."

The GSP/Manatt platform will meet a growing need in the commercial real estate industry. Combining both legal and financial knowledge, the advisory group will assist borrowers in navigating securitised commercial real estate loans, the two firms note.

CMBS

New md for CMBS team

Lisa Pendergast has joined Jefferies & Company's fixed income division as an md in the MBS/ABS/CMBS group. She will be responsible for strategy and risk for CMBS, and strategy for other structured commercial and multifamily real estate products. Pendergast has more than 20 years of industry experience and was most recently an md in the fixed income strategies group at RBS Greenwich Capital, where she worked for eight years.

In a joint statement, mds in charge of mortgage trading business at the firm Johan Eveland and William Jennings comment: "Lisa Pendergast is a significant addition to our well-established team. Guided by years of valuable experience, her strategic insights and market knowledge will meaningfully enhance our client offering in the CMBS and related markets. With continued uncertainty in the mortgage markets, we see a tremendous opportunity for Jefferies to continue to add value for our clients."

Pendergast will provide analysis and commentary on commercial real estate credit fundamentals and relative value within the CMBS and structured product markets. She joins the firm's CMBS and multifamily trading desk with traders for these products, including GNMA project loans.

Pendergast says: "I'm excited to join the thriving MBS/ABS/CMBS team at Jefferies, where I see opportunity to continue the strong growth of the firm's fixed income platform."

She is the president-elect of the Commercial Mortgage Securities Association (CMSA).

CMBS

US$500m to be deployed for commercial real estate

Investment management company, The Pembrook Group, is seeking to deploy up to US$500m over the next 24 months for commercial real estate debt opportunities, within primary, gateway and urban markets, and other infill locations with high barriers to entry.

Stuart Boesky, founder and ceo of Pembrook, says: "The ongoing credit market dislocation has created compelling opportunities for lenders. I believe that Pembrook can capture extraordinary value for our investors, while maintaining stringent underwriting and core investment parameters."

Pembrook originates and acquires commercial real estate debt in the form of first mortgages, participating first mortgage loans, B-notes and mezzanine loans in major markets across the US. Target asset classes are multifamily, retail and multi-tenant office, medical office and warehouse/distribution properties with well-diversified tenancy. The firm also participates in the distressed debt markets and will venture with developers buying back their own debt or third-party debt.

Boesky adds: "The prolonged credit crisis is putting intense pressure on owners of fundamentally sound commercial real estate, as they deal with problematic capital structures resulting from tighter credit standards and falling real estate values. We foresee tremendous opportunities for those investors who are patient and well capitalised."

Pembrook, founded in March of 2007, currently has approximately US$260m of assets under management.

Distressed assets

Mortgage opportunity fund closed

Fir Tree has announced the final closing of Fir Tree Mortgage Opportunity Fund (MOF), a limited term opportunity fund that totals approximately US$400m in capital and commitments. The firm plans to deploy the capital broadly across the mortgage opportunity set, which includes senior, high quality mortgage securities, structured products and other areas that are related to the fallout in the US mortgage market.

Fir Tree launched MOF in July 2008 to provide dedicated exposure to opportunities resulting from the collapse of the housing and related structured products markets. Terms of the fund allow Fir Tree to call capital from limited partner commitments as the managers identify investment opportunities. In addition, limited partners have agreed to a multi-year lock-up of their capital to allow Fir Tree to execute its investment strategy through the current credit market cycle.

"As patient investors, we wanted to structure the Mortgage Opportunity Fund so that we could properly optimise our LP's capital in 2009," says Andrew Fredman, managing partner of Fir Tree. "Our decision to maintain a cautious approach in 2008 allowed us to take full advantage of the opportunities unfolding in 2009."

Clinton Biondo, md at the firm, adds: "Our differentiated and diversified investment strategy has allowed our fund to establish scalable positions across the spectrum of RMBS assets. Time will be our friend as market fundamentals return in the medium to long term and we capture full value from a carefully-managed portfolio."

With the closing of MOF, Fir Tree now manages over US$4bn. Since its founding in 1994, the firm has pursued an opportunistic and value-oriented approach by investing in both equity and credit markets.

"In what is regarded as the most difficult market environment in decades, we are pleased with MOF's initial performance and are extraordinarily grateful for the support of many of our long-standing limited partners and a select group of new institutional partners. We look forward to building upon MOF's early success and delivering attractive long-term risk adjusted returns," notes Jim Walker, managing partner at Fir Tree.

Distressed assets

Broker expands distressed credit group

BTIG is set to continue the expansion of its fixed income group through the addition of both sales and analyst expertise.

Joe Labriola has joined the company as a fixed income analyst on the high grade desk. He comes from Barclays Capital, where he was in the principal strategies group with responsibilities for credit research, trading and risk management in the financial institutions, insurance and real estate sectors. Prior to Barclays, Labriola was with Sigma Capital, where he was responsible for credit research, covering financial institutions, insurance and real estate across the capital structure.

Steve Cohen joins as fixed income analyst on the high yield/distressed desk. Previously, he was an md in high yield research at Citigroup, where he worked for 16 years.

John Walsh and Michael Kirsch have also joined BTIG's high yield/high yield distressed sales team. Walsh has more than 25 years' experience on both the buy- and sell-side, and joins the firm from Bank of America, where he was an md and senior high yield trader for the healthcare, industrials, services and restaurant sectors. Prior to BofA, Walsh was head of the Fleet Securities high yield trading desk at Citicorp.

Kirsch comes to BTIG after 10 years at Morgan Stanley in leveraged credit. At Morgan Stanley he helped start the distressed desk, which morphed into high yield and later all leverage credit. Prior to that he traded risk arbitrage for a hedge fund in Conneticut and practiced law in New York City.

Jon Bass, co-head of global fixed income at BTIG, says: "We are excited to welcome Joe, Steve, John and Michael to our fixed income team at BTIG. The expertise, knowledge and relationships of these proven professionals will further enhance our quickly growing group."

John Purcell, co-head of global fixed income at the firm, adds: "We are fortunate to have attracted some of the highest quality talent on the Street over the last six months. The continued expansion of our team underscores our commitment to provide clients with the highest quality, best-in-class sales, trading and desk analyst capabilities."

Emerging Markets

SF partner to head Appleby in Bahrain

Appleby has opened a representative office, as part of the corporate administration arm of the Appleby Group, in the Kingdom of Bahrain. The office, operating under the name of Appleby (Middle East), will cover the whole Middle East region.

Jeanne Bartlett will be the md of the new office. She is Appleby's global leader for Islamic and structured finance, and a partner in the firm's legal practice in the Cayman Islands.

Bartlett says: "This is a significant opportunity for us to expand our offering to Middle East markets, where we already have extensive experience of Islamic and structured finance (conventional and Shariah), and investment funds."

The Bahrain office will offer Middle East clients convenient access to Bermuda, the British Virgin Islands, the Cayman Islands, Jersey, Mauritius, Isle of Man and Seychelles structures.

Last month Appleby announced the opening of a new office in the Seychelles and its pending merger with Isle of Man law firm Dickinson Cruickshank in October. On completion of the merger, the firm will have 73 partners and over 800 staff, making it the world's largest offshore law firm by partner numbers.

Peter Bubenzer, Appleby's global group managing partner, adds: "Our driving strategy is to be the leading provider of legal, fiduciary and administration services in the offshore world, and this includes being where our clients are located and providing the widest choice of offshore options. By opening in Bahrain, our Middle East clients will have immediate access to our services across a significant range of offshore options. This ease of access to such a variety of products and jurisdictions is unsurpassed by any other offshore firm."

Appleby had previously planned to open in Dubai, but has now chosen to open its first Middle East office in Bahrain instead. However, the Group says it will continue to look at further options in the region.

Listed products

Permacap reports

Carador has announced that, as at the close of business on 30 June 2009, its unaudited net asset values per share were €0.4205 (a decline of -1.37%) and US$0.5419 (-1.49%). This month's calculations include an estimated €214,505.46 of net cashflow interest received in the month (to be allocated between capital and income), which equates to €0.0016 or US$0.0023 per share.

RMBS

Legal action taken against Countrywide

MBIA has commenced an action in the Superior Court of California against Countrywide, several of its senior officers and the underwriters of certain RMBS insured by the monoline. The complaint alleges state securities law violations and seeks damages for fraudulent, material representations and omissions in Countrywide's offering of documents that have resulted in substantial damages to MBIA.

On 8 July 2009, in a separate suit filed by MBIA against Countrywide, the New York State Supreme Court ruled that MBIA's fraud claims against Countrywide will be allowed to proceed.

Trading

New md named for CMO/MBS trading

A new md and head of agency CMO and MBS trading has been appointed by Oppenheimer & Co, a unit of Oppenheimer Holdings. Ed Tappan will fill this position and report to senior md at the firm Robert Lowenthal.

Tappan will manage the trading of agency CMOs and MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae.

Lowenthal says: "Ed's experience and expertise with institutional customers and high net-worth accounts will have an immediate impact on our business. Ed's contribution will help grow our mortgage-backed sales and trading business."

Tappan joins Oppenheimer from Citigroup Smith Barney, where he was director and manager of the middle market government agency CMOs and MBS trading desk. Prior to that, he worked at Tucker Anthony and Gruntal & Co. In each of these positions, he maintained proprietary positions and traded agency CMOs and MBS with middle market and high net-worth accounts.

Trading

Conduit adds in sales

Structured finance specialist Conduit Capital Markets has appointed Paul Blake as head of fixed income sales. He was previously head of institutional bond sales, Europe and Asia, at CIBC World Markets in London.

Paul Morgan, chief executive of Conduit Capital Markets, comments: "Paul has developed a leading position in the market and we are very pleased to have secured someone of his knowledge and capability. He has demonstrated a consistent ability to drive revenue growth in very competitive environments and he will play a significant role in the development of our business. We very much look forward to working with him."

Blake began his career in fixed income in 1982 with Wood Gundy, where he rose to the position of vp in charge of fixed income. In 1989 he joined CIBC World Markets as executive director, became head of institutional and retail sales eight years later and was appointed head of institutional bond sales in 1999.

ABS

TALF-eligible subprime auto ABS deal debuts

Americredit Corp has priced the first TALF-eligible subprime auto ABS through lead managers Credit Suisse and Deutsche Bank Securities. Co-managers on the deal are Barclays Capital, JPMorgan, RBS and Wells Fargo Securities.

The US$725m offering, AmeriCredit Automobile Receivables Trust 2009-1, comprises five classes of rated notes. The US$236m A-1+/Prime-1 (S&P/Moody's) 0.25-year Class A1 notes priced at 0.8375%, the US$166m triple-A 0.91-year Class A-2s at 2.26%, the US$164.56m triple-A 1.95-year Class A-3s at 3.04%, the US$66.2m AA/Aa2 2.89-year Class Bs at 9.79% and the US$92.24m A/A2 3.33-year Class Cs at 14.55%. The triple-A notes were reportedly 11 times oversubscribed.

The weighted average coupon on the notes to be paid by AmeriCredit is 7.5%. The transaction will have initial credit enhancement of 28.10%, consisting of a 2% cash deposit and 26.10% overcollateralisation. Total required enhancement level will build to 38% of the then-outstanding receivable pool balance, which includes the initial 2% cash deposit.

ABS

'Too early' for green shoots in Euro ABS

Fitch says it is too early to identify 'green shoots' of recovery in European structured finance performance, despite signs that the global economy is stabilising. The agency expects headline economic growth to become evident during the last two quarters of 2009, but that the nature of the recovery will be weak and remain significantly below long-term growth trends.

"Unemployment is the most significant negative factor weighing on existing European structured finance assets," says Ian Linnell, head of structured finance for EMEA at Fitch. "With the unemployment rate across the euro area set to continue rising in 2010 and remain close to those highs in 2011, Fitch anticipates downward pressure on structured finance assets to remain in place until late 2010 or 2011. However, the pace and intensity of downgrades are likely to slow, reflecting the impact of previous negative rating activity as well as the economy stabilising and the start of an anaemic recovery."

"Drastic cuts in interest rates have taken the pressure off consumers regarding the affordability of their substantial debt burden in the short term," addsPhilip Walsh, md in the European structured finance group at Fitch. "This has supported some arrears performance stabilisation in RMBS and consumer securitisation transactions; however, the effect of rising unemployment is expected to eventually outweigh this and render this stabilisation a temporary respite."

In its latest quarterly EMEA structured finance outlook report, the agency notes that interest rate easing has also helped to stabilise UK house prices. UK house price indices suggest value declines are bottoming out and house prices may have even started to rise after a peak-to-trough decline of 19% to date.

However, the weak recovery and rising unemployment mean house prices are likely to resume their downward trajectory. An overall 30% peak-to-trough house price decline remains Fitch's central expectation in its UK RMBS ratings.

Elsewhere in Europe, house price indices may lag the true extent of value decline and therefore overstate the recoveries that can be achieved on enforcement. As arrears and enforcements rise, loss severities are also therefore expected to rise.

ABS

UK Banking Act unlikely to impact Euro ABS

Moody's has confirmed that the UK Banking Act 2009 does not negatively affect the ratings of structured finance transactions or covered bonds. The assessment relates to the 'stabilisation options' under the Act, which enable the UK authorities to exercise various transfer powers in respect of failing banks. These powers are wide-ranging and can potentially be used in a way that negatively affects financial markets.

Moody's considers it is very unlikely that the UK authorities will choose to exercise the transfer powers to the detriment of structured finance transactions or covered bonds. This is based on the fact that when exercising their transfer powers, the UK authorities must have regard to certain objectives specified in the Act, including the protection and enhancement of financial stability. Moody's understands that any negative impact on structured finance or covered bond markets will be taken into account when applying this objective.

Equally, at around the same time the Act came into force, a Safeguards Order was made that limits how the transfer powers can be used in relation to "capital market arrangements". While this order does not provide full protection for structured finance transactions, it clearly indicates a political will that they should not be negatively affected, according to Moody's. This is further supported by a recent amendment to the Safeguards Order.

CDO

CRE CDO delinquency index increase to continue

The June 2009 Fitch CREL CDO delinquency index has increased to 8.2% from 7.9%. While this appears slight, it has been tempered by managers trading out credit-impaired loans over the past two months (0.9%).

However, these trades have been primarily at discounts to par. While the trades mute delinquency increases, the losses from selling assets at a discount lead to less available credit enhancement to the notes.

Fitch expects the US CREL CDO delinquency index (CREL DI) to continue increasing. Senior director at the agency Karen Trebach explains: "A leading indicator of future delinquencies is the 30 days or less past due bucket, which has exceeded 2% for the last two months, with a high in June of 2.8%. While these loans are not included in the index, nearly half of all new delinquencies over the past six months were previously 30 days or less late."

In the June reporting period, 15 loans were added to the CREL DI, while 10 assets were removed - including seven that were traded out at prices ranging from 49.6% to 100% of par. The average June recoveries for removed assets were 63.1%. While higher than the prior two months' average recoveries of 25.5% and 46.6%, Fitch considers it too early to conclude a positive trend.

Loans traded out at discounts result in realised losses to the CDO collateral. Fitch takes into account all such losses in its evaluation of the credit enhancement available for each CDO tranche.

For the second straight month, assets that are 30 days or less past due have exceeded 2%, with the June level at 2.8%. While these loans are not included in the CREL DI, they can be a leading indicator. Over the past six months nearly half of all new delinquencies where previously in the 30 days or less late bucket; as such Fitch expects a further rise in the CREL DI.

Asset managers extended 26 loans in the June reporting period, including some for periods as short as one month. Short-term extensions are typically used to allow time to negotiate longer-term extensions or pursue third-party refinancing, which in most cases Fitch expects will be unobtainable. The agency considers the merits of all extensions in its analysis of each transaction.

Fitch currently rates 35 CREL CDOs, 27 of which had delinquent assets in the June reporting period. Individual CDO delinquency rates ranged from 0% to approximately 35% of the CDO par balance. All CREL CDOs with delinquent assets have either recently had classes downgraded or currently have classes on rating watch negative, with full transaction reviews to be conducted in the next few months.

CDO

TruPS CDOs rating pressure continues

Recessionary pressures continue to weigh on US financial institutions, which in turn will continue to compound rating pressure on US TruPS CDOs, according to Fitch. With 22 defaults and 109 deferrals (totalling US$3.7bn) observed during H109 compared to 14 defaults and 56 deferrals for all of last year, the outlook is bleak given current economic conditions, it says.

"As bank failures continue, available credit enhancement to support the rated CDO liabilities will further erode," says Elizabeth Nugent, a senior director in Fitch's US structured credit group. "The pace of defaults and deferrals will be a primary catalyst in dictating potential future rating actions on TruPS CDOs."

Taking the outlook for increased defaults and deferrals into account, Fitch is applying a more conservative view of how lower quality financial institutions will perform as part of its US TruPs CDO rating review criteria. The criteria refinements are emblematic of the agency's continued negative rating outlook for both US banks and property/casualty insurers, it says.

If the observed trend of collateral underperformance continues at its current pace, further rating actions on Fitch-rated US TruPS CDOs may be warranted. In the interim, the agency will continue to closely monitor developments in the market as it relates to the performance of TruPS CDOs.

CDS

Six Flags settled, Bradbi determined

Six Flags CDS and LCDS were settled on 9 July at 14 (with 11 dealers participating in the auction) and 96.125 (with 10 dealers participating).

Meanwhile, ISDA's EMEA Credit Derivatives Determinations Committee has resolved that a failure to pay credit event occurred in respect of Bradford & Bingley. The Committee also voted to hold auctions for both the senior and subordinated debt of Bradford & Bingley.

Whether a succession event has occurred on CIBA Holdings, following its acquisition by BASF, is currently being debated.

CDS

Euro CDS market remains more liquid than the Americas

Fitch Solutions says the European CDS market remains more liquid than the Americas market, closing on 10 July with a CDS liquidity score of 9.88 versus 10.08 for the Americas.

Thomas Aubrey, md of Fitch Solutions, London, says: "In times of market uncertainty there is a flight to quality in terms of liquidity, with liquid names becoming more liquid and less liquid names becoming more illiquid. During recent weeks there have been more entities towards the mid-range, with liquidity scores between 7 to 10, becoming more liquid in Europe than in the Americas. Furthermore, the Americas market has a far longer tail of illiquid assets which have remained illiquid."

This trend explains why, even though the top-ten most liquid names in the Americas region are more liquid than the top-ten European names, Europe remains more liquid on aggregate than the Americas.

In general, the liquidity of a credit derivative asset increases when it is showing signs of financial stress in combination with a significant amount of debt outstanding and/or changes in its capital structure, including new issuance. The liquidity scores of assets have historically traded between four at the most liquid end through to 29 at the least liquid end. Entities also tend to be more liquid when there is agreement about present value but disagreement about future value, due to heightened uncertainty surrounding the entity.

CLOs

Economic perspective of US CLO managers highlighted

S&P has published the first in a series of articles highlighting the economic perspectives of US CLO managers regarding projected leveraged loan defaults and recoveries. The feedback was gained from 134 CLO managers through a comprehensive questionnaire at the end of Q109.

Some of the key perspectives revealed by the managers that participated in the questionnaire include: 45.3% of them believe leveraged loan defaults will peak in the first half of 2010, while 29.9% believe leveraged loan defaults will peak in the fourth quarter of 2009. Additionally, the feedback shows that there was no noticeable projected default bias based on manager type, ownership structure or aggregate assets under management.

The projected anticipated mean recovery range for senior secured leveraged loan recoveries was found to be 51%-70%, based on the response from the 120 managers that answered this question. The projected mean recovery range from the 19 managers who indicated that they had experienced more than 15 senior secured workouts in 2008 reflected a broader projected senior secured recovery range of 44%-75%. The projected mean recovery range for second-lien leveraged loan recoveries is 20%-41%, based on the response from the 85 managers that answered this question.

Finally, the projected mean recovery range from the 15 managers who indicated that they had experienced more than 15 second-lien workouts in 2008 reflected a broader projected second-lien recovery range of 16%-52%.

CLOs

Geldilux given structural tweaks

Structural amendments including an increase of credit enhancement and the adjustment of eligibility criteria will be made to SME CLO Geldilux-TS-2008 in order to address concerns raised by S&P and Moody's earlier this year, according to securitisation analysts at UniCredit. The rating agencies will take any amendments made to Geldilux-TS-2008 into consideration for their rating assessment and are expected to publish their review results for this transaction in due course.

The rating agencies put the notes of Geldilux 2008 on watch negative/review for potential downgrade in March. Moody's review was triggered by the new SME CLO rating criteria/methodology, while S&P put the notes on credit watch negative due to refinancing risk and reassessed gross default assumptions.

CLOs

Trustee seeks to divert collateral account payments

State Street Bank and Trust Company, as trustee on the Cheyne CLO Investments I transaction, has notified investors that on the latest payment date the aggregate amount standing to the credit of the interest collection account and principal collection account was insufficient to meet the obligations of the issuer. The trustee and issuer are consequently considering whether the balance, or part thereof, of the collateral account may be applied to meet any shortfalls in these payments.

Pending clarification on this matter, State Street has instructed the portfolio administrator to suspend any payments from the collateral account and to instruct the account bank to segregate amounts in the collateral account, including any interest accrued, until further notice.

This follows an event of default, which occurred on 31 March 2009. However, no party has yet to instruct the trustee to issue an enforcement notice for the CLO.

CMBS

CMBS Class As downgraded to Baa1

The Class A notes of Windermere XII have been downgraded to Baa1 from Aaa by Moody's. The rating action follows Moody's updated surveillance approach for EMEA CMBS, as well as recent transaction developments.

The Lehman-originated transaction is backed by the landmark Coeur Defense office building, located in the centre of Paris' central business district of La Defense. The whole loan is non-amortising until its maturity date in July 2012 and there have been no partial prepayments since closing.

The downgrade of the Class A notes follows a reassessment of the whole loan's credit risk, which includes Moody's expectation for future property value movements in La Defense and the property's tenancy composition over the medium term. As the whole loan is already in default, the rating assessment has focused principally on the value of the property and expected property cashflows over time. Given the higher leverage based on current and expected property values, the agency expects that the whole loan and also the securitised senior loan will crystallise a very large amount of losses over the term of the transaction.

On 15 September, 2008 Moody's placed the notes' ratings on review for possible downgrade, due to the transaction's exposure to Lehman Brothers (Europe) as hedging provider. Due to the insolvency of the hedge provider, a new hedging instrument was required under the terms of the loan documentation and the borrower had a 30-day grace period in which to find such a replacement.

This grace period passed and the borrower was in the process of negotiating a grace period extension on 3 November 2008, when it filed for voluntary bankruptcy and protection from its creditors - thereby triggering a loan event of default. Shortly thereafter, the loan was transferred into special servicing.

The Paris courts opened the voluntary bankruptcy proceedings of the borrower, which included a Procedure de Sauvegarde - a reorganisation proceeding - whereby all debts and assets under control of the borrower were temporarily frozen. The amounts accruing to the rental account for the property were escrowed into a separate account solely under the control of the court, instead of being paid into the issuer's accounts. Therefore, the issuer has not been receiving any funds with which to pay loan interest since that date and instead had to draw down on its available resources in order to meet the interest payments under the notes.

First, the issuer drew on the cash reserves that were available to it, but when depleted, the issuer started to draw on the liquidity facility. The liquidity facility at closing was sized at €182.28m.

It amortises over time, in line with the outstanding note amount, and it also can reduce owing to appraisal reductions. Moody's understands that the court-imposed moratorium is due to end in October 2009, whereupon the agency expects that the rental amounts accrued will be released to the issuer and that the issuer will be thereafter entitled to receive all contracted cashflows as before.

As the property is revalued semi-annually and its value has declined from € 2.13bn at closing to €1.24bn as per 30 March 2009, the loan is currently in breach of its LTV covenant.

Moody's is aware that under the voluntary bankruptcy proceedings, the goal of the court will be to aim to maximise recoveries to the creditors. This could include a loan restructuring or debt forgiveness, and such amendments are almost without limitation.

The experienced property value declines have already resulted in a significant erosion of the property value cushion available to the Class A noteholders. Moody's expects this cushion to erode even further.

Based on the updated March 2009 valuation, the Class A note-to-value (NTV) is 62.7%. Based on Moody's expected trough value in 2010, it anticipates a Class A NTV of approximately 76%, which will in the agency's opinion only slightly recover thereafter.

Moody's currently considers that a restructuring of the loan is the most likely outcome of the reorganisation proceeding affecting the borrower.

CMBS

White paper on REMIC reform issued

Commercial Mortgage Securities Association (CMSA) has issued a white paper that outlines its opposition to sweeping REMIC regulatory proposals specifically aimed at loan modifications, which require the restructuring of contracts for commercial real estate loans. REMICs are statutorily created trusts and are the principle vehicle for the securitisation of CMBS.

For the past several years, CMSA says it has actively sought additional servicer flexibility within the REMIC rules to allow collateral improvements and substitutions that provide performing borrowers more flexibility while at the same time enhancing the protection of asset value for investors. However, the Association opposes very recent reform proposals that seek to dramatically expand the circumstances constituting reasonably foreseeable default, which allow the terms of the commercial real estate loans to be modified. These proposals would allow distress determinations to be made well in advance of the widely accepted current servicing standard and without a clear set of principles to govern servicers' decisions to modify the loans, it says.

CMSA opposes these loan contract modification proposals because they create uncertainty for bondholders because servicers believe the current standard for reasonably foreseeable default is sufficient. The CMSA paper states: "Reliance solely on borrower representations of market conditions to justify a loan modification is inconsistent with the servicing standard, which obligates the servicer to act prudently and in the best interests of the certificate holders."

Patrick Sargent, president of the CMSA, says: "Some of these overly broad proposals, if adopted, would have a significantly negative effect on CMBS investors because any new laws that authorise servicers to prematurely modify the terms of mortgage contracts already in place can change the construct and dynamics of investor cashflows and liquidity."

CMBS

CMBS tap issued

ABSA has launched a tap issuance of South African CMBS Vukile Series 1, which first closed in November 2005. The proceeds of the initial issuance were used to acquire two loans, one with a five-year term maturing in November 2010 and one with a seven-year term maturing in November 2012, advanced to the borrower.

For this tap issuance, the issuer acquired a new 2.8-year loan which is cross-collateralised and cross-defaulted with the existing loans. The tap issuance of ZAR150m is attributed to an increase in the value of the existing properties.

CMBS

Increased risk profile, downgrades for Japanese CMBS

Japanese CMBS continues to see an unprecedented increase in underlying loan defaults - with defaults on maturing loans and loans becoming due in Fitch-rated CMBS reaching 53% in the six months to 30 June 2009. The loan default rate reflects the limited availability of finance for real estate, given current market conditions, the agency notes.

This is compounded by uncertainty on commercial property values and a gloomy economic outlook for Japan. Consequently, Fitch has placed all tranches of Japanese CMBS that contain bullet maturity loans on rating watch negative (RWN) to reflect the increased risk profile of the sector.

The agency expects the extremely challenging refinancing environment to continue in the near-to-medium term and expects the overall default rate to continue to rise as a result. In response to the extremely stressed state of the Japanese commercial property loan market, for the purpose of its ratings analysis, it is now assuming the default of all loans maturing in the next 12 months and the possible need for forced liquidation of real estate securities at distressed prices.

During H109, Fitch witnessed a default rate on underlying securitised commercial property loans becoming due (including a number of event-driven term defaults) of 53% by number and 63% by value. 16 of 30 loans maturing in the six months to 30 June 2009 were not paid when due, and Y58.6bn of Y92.3bn in loans that matured during that period did not pay when due.

Ben McCarthy, Fitch's head of Asia Pacific structured finance, says: "The default rate for loans maturing during 2009 has reached an unprecedented high. It reflects the current lack of finance available in the Japanese commercial property sector, driven by the disappearance of several large commercial property lenders from the market, as well as the inherent uncertainty for remaining lenders with regard to valuations in the sector. This is also against a grim economic backdrop, with Fitch forecasting a decline of 6.9% in Japanese GDP for 2009 - more than any other major developed nation."

He adds: "The RWN status applied to all Japanese CMBS transactions containing bullet maturity loans reflects all of these factors. The potential outcome could be the downgrade of some or all tranches of the majority of transactions. However, the quantum of any downgrade action will be dependent on transaction-specific factors."

Masaaki Kudo, head of Japanese structured finance at the agency, notes: "The default rate on underlying loans in Fitch-rated large loan CMBS was 3.7% by number (1.6% by value) in December 2008 and has now risen substantially to over 11.6% by number (5.6% by value) in just six months, as a result of the majority of loans coming due defaulting as a result of the lack of refinance options. The lack of finance and the resultant forced disposition of assets are weighing heavily on the real estate market. Fitch expects this factor to have a fundamental impact on the outstanding ratings of Japanese CMBS."

To date, only one defaulted loan whose balance was around Y0.9bn has concluded its recovery process. This loan was resolved relatively quickly without incurring any loss; however, loans with material risk of loss will generally take more time to be resolved, as special servicers are likely to act with more caution to pursue maximum recovery. Fitch is currently reassessing the values of each of the underlying properties in its Japanese CMBS portfolio, and plans to reflect the result of these analyses in rating actions.

In addition, transactions that are relatively close to their legal final maturity date could face the risk of maturity defaults on even the most highly-rated CMBS, should defaulted loans take longer to work out than provided for in transaction structures. Fitch expects ultimate recoveries on senior ranking notes in such cases to be excellent; however, transactions in such circumstances could potentially be downgraded by several rating categories - even at the top of the capital structure - if Fitch considers there to be materially increased risk of default with respect to the likelihood of timely repayment of principal by legal final maturity.

Emerging Markets

Unique criteria for Indian ABS

Fitch has published a report detailing its analytical approach to rating Indian ABS transactions backed by vehicle financing loans, equipment loans and consumer loans originated by Indian banks and non-banking finance companies (NBFCs).

Dipesh Patel, senior director in Fitch's structured finance team, says: "The qualitative and quantitative factors covered in the report are consistent with Fitch's global criteria for ABS transactions and also address the unique features of Indian ABS structures and asset classes."

Although the vast majority of the 65 Fitch-rated Indian ABS transactions have been rated only on the national scale, the report addresses issues relevant for both national scale ratings and international local currency ratings. The report also provides a comprehensive analysis of four specific factors that Fitch focuses on as a part of its rating and surveillance process: review of the transaction documentation and legal structure; analysis of the underlying assets; cashflow modelling; and assessment of the counterparty risks.

Samiran Talukder, associate director in Fitch's structured finance team, adds: "The originator and servicer's capabilities, as well the impact of the economic environment on the asset class outlook, have a significant effect on the transaction's future performance. These factors therefore form a key part of Fitch's analysis."

The criteria report explains how the agency establishes its base-case assumptions for three key performance variables - defaults, recoveries and prepayments - as well as how stress scenarios are applied for different rating levels. Associate director at the agency Deep Mukherjee notes: "As part of an empirical data study, Fitch's stress multiples were benchmarked against historical volatility of non-performing assets observed in publicly-rated ABS transactions and in the Indian financial system as a whole."

Indices

Home price improvement continues for third month

May's LoanPerformance home price index showed a sharp improvement for the third straight month. National home prices rose in May by 5.23% (annualised, unadjusted), the first increase since July 2006, according to ABS analysts at JPMorgan. However, on a crude seasonally-adjusted basis (one-month annualised), figures for May dropped by -2.53%, April by -7.40% and March by -10.18%.

Nonetheless, the analysts note that the improved picture suggests that foreclosure moratoria might be yielding some benefits.

Year-over-year price declines (12-month HPA) are at -14.38% in May, compared to -15.72% in April and -16.71% in March. "While we are still far away from flat territory, this is a major improvement from the -18% to -19% area during the second half of last year," the JPMorgan analysts point out. "The other main home price indices, FHFA and Case-Shiller, have also seen stabilisation in the rate of decline over the past few months."

The JPMorgan HPI model suggests that at the national level there is a V-shaped recovery ahead in home price appreciation. The model projects that the market is near the bottom in year-on-year HPA for the Case-Shiller index, and that price declines will turn and move slowly to flat and positive territory over the next two years.

Investors

TARP warrant buybacks trending to fair value

A new study by Pluris Valuation Advisors, a provider of market-based valuations of illiquid securities, finds that bank buybacks of TARP warrants from the US Treasury have been increasingly trending towards fair value.

"Some media and industry experts have claimed that banks are underpaying for their warrants," Pluris president Espen Robak says. "That was true at first. However, our study shows that recent repurchases have been in line with accurate valuations of the warrants."

The study, which was developed to provide guidance for future TARP warrant sales, compiles data from all 265 public banks that received funds from the TARP facility. Funds were awarded by the US Treasury in exchange for warrants and shares of preferred stock. To exit TARP, banks must repurchase their warrants.

"If banks underpay, taxpayers lose out," Robak adds. "If they overpay, banks and their shareholders lose out. As such, the success of TARP depends on fair valuations."

Pluris used data from arm's-length transactions in illiquid warrants from the secondary market to value the warrants of all 265 banks, including the 11 banks that have bought out their TARP warrants to date. This data yields significantly better results than theoretical models alone, the firm says.

According to Robak: "The Black-Scholes model was never designed for non-tradable instruments like warrants. It's a helpful input, but on its own it falls short as an analytical technique."

Comparing its own market-based warrant valuations with what the 11 banks paid to repurchase them, Pluris found that Old National Bancorp (ONB) - the first bank to repurchase its warrants - underpaid significantly, but that pricing has progressively been approaching fair value. ONB paid US$1.48 per warrant (US$1.2m in total), but Pluris valued them at US$3.15 per warrant, meaning that by Pluris' estimates ONB underpaid by 53%.

Iberiabank Corporation (IBKC), the second bank to buy out of TARP, paid US$8.66 per warrant (US$1.2m in total), compared with Pluris' valuation of US$10.19 - an underpayment of 15%, according to the firm.

Since then, amounts paid have been within 12.8% of the valuation price in all cases, with three banks paying more than the price calculated by Pluris. FirstMerit Corporation (FMER), the third bank to buy out of TARP, paid US$5.28 per warrant (US$5,025,000 total), while Pluris valued the warrants at US$4.68 each (a 12.8% difference). Berkshire Hills Bancorp (BHLB) paid US$4.60 per warrant, compared with a valuation of US$4.09 (an overpayment of 12.5%). HF Financial Corp (HFFC), the most recent bank to repurchase warrants, paid US$2.15 (US$650,000 total), compared with a valuation of US$2.11 (an overpayment of 1.9%).

Warrants are similar to call options in that they can be exercised to create new shares of stock. However, warrants are illiquid and, as a result, are worth less than liquid options. How much they are discounted by depends on the volatility of the underlying shares, the size of the block, time to expiration, the size of the issuer and the 'moneyness' of the warrant.

Investors

Q209 asset-backed new issuance plummets

Asset-backed new issuance accounted for US$100.6bn of all issues in Q209, a drop of 54.1% (US$118.7bn) on Q208 figures, according to Xtrakter data. The overall size of the international capital market rose by 10.3% (US$1.3trn) over the same period to a total value of US$14.1trn.

Kevin Milne, chief executive of Xtrakter, says: "It is not unexpected that the appetite for asset-backed new issues has declined; this does not rule out all, as the amount of Pfandbriefe new issues this year has virtually doubled from US$27bn in Q1 to US$51bn in Q2 - highlighting a continuing demand for regulated covered issues in the market."

Once again the euro was the preferred currency of issue, capturing 51.6% (US$525.8bn) of market share; the US dollar was selected for 36% (US$367.4bn); and sterling was chosen for 6.6% (US$67.7bn) of total fixed income new issuance in Q209.

The top issuers in Q209 were: Freddie Mac (accounting for US$42.8bn), Société de Financement de l'Economie Française (US$33.3bn), European Investment Bank (US$26.1bn), Lloyds TSB (US$24.7bn), Fannie Mae (US$23.9bn) and KFW (US$22.9bn).

Ratings

Monoline-insured ratings approach revised

Moody's has modified the rating methodology it applies to structured finance securities insured by financial guarantors. Starting on 1 September 2009, the agency says it will withdraw the ratings on those structured finance securities insured by guarantors that have financial strength ratings below Baa3 if either Moody's is unable to determine an underlying rating on the security, or the issuer has requested that the guaranty constitute the sole credit consideration.

If the underlying rating cannot be determined or if the issuer has requested that the guaranty constitutes the sole credit consideration - and providing the guarantor's financial strength rating is Baa3 or higher - Moody's rating on a structured finance security shall continue to be equal to the guarantor's financial strength rating. Otherwise, Moody's will withdraw the rating.

At this time, Moody's is not changing the rating methodology it applies for non-structured finance securities wrapped by financial guarantors.

Ratings

MV CLO assumptions changed, ratings on review

Changes in the modelling assumptions for market value CLOs are being implemented by Moody's. The changes follow the agency's request for comments published in April 2009 and the receipt of comments from market participants.

In light of these updates, Moody's has placed its ratings of MV CLOs on review for possible downgrade. This action impacts 33 tranches from 17 MV CLO transactions totalling approximately US$10.5bn. It is anticipated that the new assumptions will lead to significant downgrades of many outstanding tranches, particularly for subordinate classes.

The changes include more conservative parameter estimates for market volatility and illiquidity, following the extreme turbulence of the 2008-2009 period. These revised assumptions imply less leverage for given collateral pools, transaction structures and target liability ratings.

Though the collateral pools are mostly comprised of corporate loans, they may also include corporate bonds. For this reason Moody's has also updated parameter estimates for both corporate loan and bond collateral.

Moody's has ratings outstanding on 30 MV CDOs, consisting of both US dollar-denominated and euro-denominated transactions. The ratings address a total of nearly US$19bn and over €650m in securities.

Reflecting market responses, Moody's has modified two of the proposals contained in its April 2009 request for comment. First, it will not apply an absolute cap on its MV CLO liability ratings. Previously, the agency had proposed a cap of Aa1 to reflect the potential for a temporary market shutdown during the liquidation of an MV CLO's collateral.

Instead, Moody's md Eun Choi says: "The evidence shows that even during the height of debt market turmoil in late 2008, secondary trading of corporate loans and bonds continued, albeit at depressed prices." Moody's will, however, apply highly stressed volatility and liquidity parameter estimates when considering Aaa liability ratings, resulting in very low advance rates for such tranches.

For Aaa target ratings, the agency will explicitly consider scenarios in which senior controlling noteholders opt for gradual liquidation. In doing so, Moody's will apply its MV CLO model to a period of several months with lower assumed volatilities and liquidity haircuts than are assumed for short-run analysis. However, since cumulative price volatility is far greater over the long run, the additional analysis may imply lower advance rates than those based on short-term modelling.

Second, Moody's modelling assumptions will give consideration to the maintenance of collateral cushions in excess of those implied by the advance rates. Most MV CLO collateral managers have maintained such cushions, even during the recent period of market stress. However, because MV CLO managers are not contractually obligated to maintain such cushions, Moody's will give only partial credit in its modelling.

Regardless of the target rating for a liability tranche, the agency will also apply stressed historical simulation as a check against its advance rates. To the extent the expected losses for each tranche are higher than appropriate for the tranche rating target within this historical simulation, Moody's will lower the advance rates until the expected loss criteria are satisfied.

Ratings

SF CDOs downgraded on EODs

Moody's has downgraded to single-C the rating of 56 tranches contained within 41 US structured finance CDOs. The tranches affected by these actions are from CDOs that have experienced an event of default and in each case the trustee has been directed to liquidate the collateral as a post-event-of-default remedy.

Moody's has been notified by the respective trustee in each of these cases that a final distribution of liquidation proceeds has taken place (except for retention of a small amount of residual funds in certain cases). The rating actions consequently reflect the final liquidation distribution and changes in severity of loss associated with the downgraded tranches.

Ratings

Continued Asia downgrades due to CMBS

Downgrades of Fitch-rated Asia Pacific structured finance tranches were up almost ten-fold in 2008, while upgrades during the year were a third of those seen in 2007. The agency explains that the deterioration in Japanese CMBS contributed to a large portion of downgrades in the region in 2008, a trend likely to continue throughout 2009.

As a result, the CMBS sector's stellar record for investment grade tranches either maintaining their ratings or being upgraded was tarnished, with nearly 4% of tranches in this sector being downgraded during 2008, compared to less than 0.5% during 1998-2008. Non-conforming RMBS from Australia and New Zealand also experienced downgrades, as the countries' deteriorating economies led to higher than expected losses in this sub-sector. As a result, Asia Pacific RMBS lost its 100% long-term record of all ratings being either affirmed or upgraded.

Alison Ho, director and head of Asia Pacific performance analytics at Fitch, says: "The outlook for CMBS ratings throughout the rest of 2009 in Japan and Australia is negative. Recovery of the full underlying loan amounts in Japan is under pressure due to the challenging commercial real estate market, in terms of availability of finance and property values."

RMBS was the most stable asset class during 2008, with over 98% of tranches either maintaining or improving their ratings. Synthetic investment grade corporate CDOs with assets located predominantly within the region experienced eight downgrades.

Mobius, the troubled Australian ABS transaction, was the only Asia Pacific deal in this sector to experience downgrades in 2008. Several CDO tranches, plus three tranches from Mobius, were downgraded to D in H109, the first defaults in this region to date.

The 2008 study did not include CDOs where assets are not predominantly located within Asia Pacific and RMBS tranches whose ratings are dependent on the ratings of lenders' mortgage insurance providers.

Ratings

EMEA SF outlooks remain negative

The sector outlook for almost all RMBS, CMBS and ABS structured finance asset classes in EMEA remains negative, according to Moody's in a new special report. The rating agency's expectation is that further quarters of GDP contraction and rises in unemployment lie ahead in all the countries covered in this study, and that asset performance will continue to react to macroeconomic trends with a delay.

Nitesh Shah, a Moody's economist and author of the report, says: "Moody's sector performance outlooks for RMBS, ABS and CMBS in the EMEA region remain unchanged from our previous update in January 2009. The only asset class without a negative outlook is Turkish diversified payment rights, which has a stable outlook."

Moody's believes it is too soon to change the negative performance outlooks on most segments and cautions that, in the event of a slow recovery, asset performance trends could still prove disappointing - even amid a steady pick-up in macroeconomic conditions. Shah explains: "The rating implications of the negative performance outlooks vary depending on the structural features of transactions and headroom within existing rating assumptions. The diverse nature of individual transactions means that broad generalisations of rating implications are difficult to make."

However, Moody's report provides some commentary on cases where the rating agency believes the negative performance pressure is likely to translate into negative rating pressure.

Since its previous update, the negative performance outlooks in certain sectors have been reflected in actual rating downgrades on certain transactions. Although some downgrades had been prompted by a change in Moody's methodology, the downward pressure on the ratings in question ultimately reflected a deterioration in performance combined with an improved mechanism to capture the deterioration.

Those sectors that have already undergone formal reviews are not necessarily exempt from experiencing further rating changes, Moody's notes.

Ratings

European SROC figures reported

S&P has taken credit watch actions on 141 European synthetic CDO tranches, following its month-end SROC figures. Specifically, 136 tranches were placed on watch negative; four tranches were affirmed and removed from watch negative; and one tranche was removed from watch negative and placed on watch positive.

Of the 136 tranches placed on watch negative, 28 refer to US RMBS and US CDOs that are exposed to US RMBS, which have experienced recent negative rating actions. 108 have experienced corporate downgrades in their portfolios.

Regulation

Final enhancements to Basel 2 released ...

The Basel Committee on Banking Supervision has approved a final package of measures to strengthen the 1996 rules governing trading book capital and to enhance the three pillars of the Basel 2 framework. The Committee says that the programme aims to introduce new standards to promote the build-up of capital buffers that can be drawn down in periods of stress, strengthen the quality of bank capital and introduce a leverage ratio as a backstop to Basel 2.

The Committee is also taking measures to mitigate any excess cyclicality of the minimum capital requirement and to promote a more forward-looking approach to provisioning. It will issue a consultative proposal on this broader programme by the first quarter of 2010.

The new trading book rules, which take effect at the end of 2010, introduce higher capital requirements to capture the credit risk of complex trading activities. They also include a stressed value-at-risk (VaR) requirement, which the Committee believes will help dampen the cyclicality of the minimum regulatory capital framework.

In terms of securitisation, the Committee is strengthening the treatment for certain transactions in Pillar 1 (minimum capital requirements) by introducing higher risk weights for resecuritisation exposures (ABS CDOs) to better reflect the risk inherent in these products, as well as raising the credit conversion factor for short-term liquidity facilities to off-balance sheet conduits. It is also requiring that banks conduct more rigorous credit analyses of externally rated securitisation exposures.

In addition, supplemental guidance under Pillar 2 (the supervisory review process) of Basel 2 has been released. This addresses the flaws in risk management practices revealed by the crisis, the Committee says. It raises the standards for: firm-wide governance and risk management; capturing the risk of off-balance sheet exposures and securitisation activities; managing risk concentrations; and providing incentives for banks to better manage risk and returns over the long term.

The supplemental guidance also incorporates the 'FSF Principles for Sound Compensation Practices', issued by the Financial Stability Board in April 2009. The Committee, through its standards implementation group, will begin work immediately on the practical implementation of these principles.

Finally, the new package includes enhancements to the Basel 2 framework's third pillar (market discipline) to strengthen disclosure requirements for securitisations, off-balance sheet exposures and trading activities. These additional disclosure requirements will help reduce market uncertainties about the strength of banks' balance sheets related to capital market activities, according to the Committee.

Banks and supervisors are expected to begin implementing the Pillar 2 guidance immediately. The new Pillar 1 capital requirements and Pillar 3 disclosures should be implemented no later than 31 December 2010. The Committee also agreed to keep in place the Basel 1 capital floors beyond the end of 2009.

Regulation

...while EU proposes further CRD revisions

The European Commission has put forward a further revision of EU rules on capital requirements for banks that is designed to tighten up the way in which banks assess the risks connected with their trading book; impose higher capital requirements for resecuritisations; increase market confidence through stronger disclosure requirements for securitisation exposures; and require banks to have sound remuneration practices that do not encourage or reward excessive risk-taking. Under the new rules, banks will be restricted in their investments in highly complex resecuritisations if they cannot demonstrate that they have fully understood the risks involved, while national supervisory authorities will review banks' remuneration policies and have the power to impose sanctions if the policies do not meet the new requirements.

The proposal amends the existing Capital Requirements Directives and represents part of the EU's response to the financial crisis. It now passes to the European Parliament and the Council of Ministers for consideration.

Commission President José Manuel Barroso says: "These proposals address risks linked to two major causes of the current crisis: securitisation and remuneration. We are acting ambitiously to prevent lightning striking twice. The proposals aim to ensure that banks hold enough capital to reflect the true risks they are taking. In particular, banks will have to offset risks associated with highly complex resecuritisation products and deal with perverse incentives created by pay and bonus schemes."

He adds: "We will legally oblige banks and investment firms to have remuneration policies consistent with effective risk management. Supervisors will be given the powers to take measures, including increased capital requirements, to address any failures. I am calling on Member States and the European Parliament to back these proposals and on other jurisdictions to act on similar lines, in line with the common commitments made at the G20."

Among other things, the proposal seeks to change the way that banks assess the risks connected with their trading books to ensure that they fully reflect the potential losses from adverse market movements in the kind of stressed conditions that have been experienced recently.

Regulation

'Small bang' protocol launched

ISDA has launched its 'small bang' protocol and restructuring supplement, which allows for the incorporation of auction settlement terms following a restructuring credit event into standard CDS documentation (SCI passim). The adherence period for the protocol will run until 24 July. The market practice changes set out by the protocol will take effect on 27 July.

Robert Pickel, ISDA executive director and ceo, says: "The small bang protocol is an additional step towards achieving increased standardisation, transparency and liquidity in the industry and facilitating central clearing of CDS. The ability to hold an auction for any credit event that may occur is a critically important piece of the continuing enhancement of the CDS business."

The small bang protocol for the existing trade population, together with the restructuring supplement for trades going forward, is the latest in the ongoing series of documentation and market practice changes to the trading convention for CDS. Other market practice changes, which took effect on 22 June, include the adoption of fixed coupons payable up-front for European trades and a move from monthly to quarterly roll dates in emerging market CDS transactions.

Regulation

IASB releases draft financial instrument proposals

The IASB has published for public comment an exposure draft of proposals to improve financial instrument accounting. The proposals, which the Board believes will significantly reduce complexity and make it easier for investors to understand financial statements, address how financial instruments are classified and measured.

The proposals also attempt to answer concerns raised by certain parties during the financial crisis (for example, eliminating the different impairment approaches for available-for-sale assets and assets measured using amortised cost). The IASB plans to finalise the classification and measurement proposals in time for non-mandatory application in 2009 year-end financial statements. 

The proposals respond directly to and are consistent with the recommendations and timetable set out by the G20 leaders and other international bodies. In order to be responsive to calls for improved accounting, the IASB decided to split the comprehensive project into three phases (the other phases address the impairment methodology and hedge accounting). The IASB plans to complete the replacement of IAS 39 during 2010, although mandatory application will not be before January 2012.

Initial interpretations of the proposal suggest that an instrument that provides a predictable cashflow can be held at book value, but if the instrument has a volatile cashflow, then it should be marked-to-market. The implication is that by focusing on cashflows, anything with a fixed coupon means that cash bonds and cash ABS should be able to be marked at par.

David Tweedie, chairman of the IASB, comments: "The financial crisis has demonstrated that investors need to be given a better understanding of information presented in the financial statements about financial instruments held or issued by a company. Making it easier for investors to understand financial statements is an essential ingredient to the recovery of investor confidence."

He adds: "The proposals today are an important first step in this process. They also respond directly to concerns raised about the accounting for financial instruments. In finalising these proposals we will continue to work jointly with the US standard-setter, the Financial Accounting Standards Board, to achieve a common and improved accounting standard on financial instruments."

Regulation

RFC on model reps and warranties

The American Securitization Forum (ASF) has issued a request for comment (RFC) on its new Model RMBS Representations and Warranties, designed to enhance the alignment of incentives of mortgage originators with those of investors in mortgage loans. The ASF also released the final ASF RMBS Disclosure and Reporting Packages, which will significantly increase the transparency of RMBS to investors and credit rating agencies, it says. Together, they represent the next phase of ASF Project RESTART, an industry-developed initiative begun in February 2008 to help rebuild investor confidence in MBS and ABS, and to restore capital flows to the securitisation markets.

Representations and warranties are used to allocate the risk of defective mortgage loans among mortgage originators, issuers of securities and investors who purchase them. A defective mortgage loan can be 'returned' to the issuer through a repurchase out of a securitisation trust. Many market participants, including investors and rating agencies, believe that the representations and warranties in previous transactions and their related repurchase provisions have not effectively aligned incentives of originators and investors to produce the highest quality loans.

The ASF has sought to address risk retention techniques in future securitisation transactions by enhancing and standardising the representations and warranties, as well as developing stronger repurchase obligation provisions that allow investors to enforce buybacks of defective mortgages. The RFC includes a new provision covering fraud by any party to the mortgage loan origination (originators, borrowers, appraisers), which was not previously a universal representation. They also cover the qualifications and independence of the person performing a property appraisal and due diligence tests for verification of income, employment and assets on loans with less than full documentation.

The final ASF RMBS Disclosure and Reporting Package standardises and expands existing issuer disclosure to investors and credit rating agencies, particularly on mortgage loan-level information. It will enable investors to more easily compare loans and transactions across all issuers and perform necessary and sufficient loan-level analysis to evaluate RMBS transactions on the basis of the features and performance of the underlying mortgage loans, the Association notes. The same loan-level detail will aid credit rating agency evaluations by enhancing the quality, consistency and comparability of information relating to securitised assets upon which the agencies make qualitative judgments of the likelihood that investors will receive promised payments of principal and interest in accordance with the terms of the securities.

As part of its RMBS Disclosure and Reporting Packages, ASF also announced that it is partnering with Standard & Poor's Fixed Income Risk Management Services (FIRMS), an analytics unit separate from S&P's ratings business, to implement an industry-wide unique mortgage loan identification system and mortgage loan database. By assigning an identification number to each loan at origination, investors, credit rating agencies and other market participants will be able to track the performance of each loan throughout its life.

The loan identification would include information about the loan, such as asset type, country code and origination date, while ensuring compliance with federal privacy laws. The mortgage loan database will provide a comprehensive repository for critical mortgage loan data for investors, credit rating agencies and regulators.

Comments on the ASF Model RMBS Representations and Warranties are due by 4 September 2009.

Regulation

UK outlines financial reform plans

The UK government has released its White Paper on reforming financial markets, in which it sets out a number of core issues that it plans to respond to. The report endorses the key findings of the Turner Review; in particular, the recommendations in respect of capital and liquidity reforms.

The government says it aims to strengthen the UK's regulatory institutional framework, so that it is better equipped to deal with all firms and, in particular, globally interconnected markets and firms. Second, it will deal with high impact firms that may be seen as being 'too big to fail', through improved market discipline and through improved supervisory focus on such firms.

Third, it plans to identify and manage systemic risk as it arises across different financial markets and over time. Finally, the government says it will work closely with international partners to deliver the global action required to respond to the lessons of the financial crisis.

The UK FSA has welcomed the government's intention to legislate to give it a statutory objective in respect of financial stability, as well as new powers to act in pursuit of this objective. These include new powers in the areas of enforcement and information gathering, and an explicit statutory duty to promote sound international regulation and supervision. The White Paper recognises the role the FSA is playing in reaching global agreement on how to pursue these issues, the Authority says, working in international fora.

RMBS

US Alt-A loss projections revealed

S&P has provided its revised projected losses for US RMBS transactions backed by Alt-A collateral issued in 2005, 2006 and 2007. These loss projections are for the underlying collateral of the transactions.

The weighted average projected loss for the 2005 vintage transactions is approximately 10% of the original pool balance, with 80% of the loss projections ranging from 3.18% to 16.72%. The weighted average projected loss for the 2006 transactions is approximately 22.5%, with 80% of the loss projections ranging from 9.42% to 31.93%. Finally, the weighted average projected loss for the 2007 transactions is approximately 27%, with 80% of the loss projections ranging from 12.03% to 41.99%.

S&P incorporates each transaction's current delinquency (including 60- and 90-plus-day delinquencies), default and loss trends into its projections. Specifically, the impact on credit enhancement of potential losses from the loans 60- and 90-plus-days delinquent, coupled with the losses projected from the default curve is weighed.

The findings are based on the assumption that the loans currently classified as real estate owned (REO) will be liquidated over the next eight months and that loans in foreclosure will be liquidated over the next 15 months. Lifetime projected losses are estimated by adding these losses to the actual losses that the transactions have experienced to date.

RMBS

RMBS originator review criteria updated

New review criteria for European RMBS originators have been announced by Fitch. As part of the process, targeted loan file reviews will be conducted by the agency to determine whether a loan was originated and underwritten within the originator's stated guidelines.

Associate director of Fitch's European structured finance operational risk group Mark Wilder says: "The continued aim of the process is to provide increased information to the market regarding originators, their products and how effectively they address and mitigate operational risk. The focus on originators has increased following the impact of the global credit crunch and subsequent recession, and this process continues to provide detailed insights into originator practices across Europe."

The review process, which was originally launched in February 2007, continues to be implemented across Europe, with the UK and Ireland currently in operation. The focus on RMBS in other jurisdictions, following the turmoil in credit markets, underlines the importance of a detailed originator review, and the process provides investors with enhanced transparency on how mortgage collateral backing transactions is being originated. Fitch's ability to expand the process to other jurisdictions depends on the degree of cooperation and disclosure accepted by originators.

There are inherent risks in all aspects of origination across Europe, according to Fitch, primarily regarding the inconsistent application of policies and guidelines, inadequate quality control, fraud and unsophisticated credit scoring systems. These risks can be compounded when lenders are not directly involved in the origination process through the reliance on broker and third-party originators. However, an originator's retail operations, particularly when decentralised - as is typical in Italy, Spain and countries with developing mortgage markets - face many of the same issues.

RMBS

Irish RMBS delinquencies on the rise

S&P has published a report on Irish RMBS, focusing on the performance of the underlying mortgage loan portfolios. The agency notes that delinquencies in the sector have risen. However, despite this, the number of repossessions reported to date has been relatively low and losses are currently negligible.

There are currently 15 Irish RMBS transactions outstanding, of which two are classified as non-conforming and the rest as prime. Total issuance outstanding is around €37bn-equivalent.

Average Irish prime RMBS delinquencies have increased to 3.9% from 2.1% in March 2008; and 90+ day delinquencies have more than doubled to 1.5%. Delinquencies for the two Irish non-conforming RMBS transactions rose to over 25% for the first time in April 2009. Despite these rising delinquencies, there have been few repossessions so far and cumulative net losses are therefore currently negligible.

This could be due to a number of factors; the legal system, for example, is generally considered to be 'borrower-friendly'. Furthermore, the introduction of schemes such as the Code of Conduct on Mortgage Arrears, which prevents lenders from entering court proceedings until at least six months after arrears first arise (or 12 months in some cases), could also be lengthening the time from first arrears to repossession in this sector.

As in other European countries, prepayment rates are falling, partly due to more constrained credit availability. Two non-conforming transactions have been affected the most, with prepayment rates falling to less than 10% from a peak of almost 50%.

Since the beginning of 2009, S&P has lowered the ratings on the subordinated notes in Lansdowne Mortgage Securities 1 and 2, and lowered and placed on watch negative the ratings in Celtic Residential Irish Mortgage Securitisation 12 and 13.

Distressed assets

European 'bad banks': issues and challenges

Conor Downey, Alberto Del Din, Hergen Haas and David Lacaze, lawyers in Paul Hastings' European finance, regulatory and real estate practices, discuss the issues that arise in the creation of 'bad bank' structures in Europe

Building on a variety of historic models, particularly the FDIC and the Resolution Trust Corporation (RTC) in the US and the Securum and Retriva asset management companies in Sweden, Europe has seen a surge of interest over recent months in the use of so-called 'bad banks' as a possible solution to the difficulties currently faced by the banking sector. Specifically, Germany has resolved a bill for enabling a rescue fund called SoFFin to guarantee bonds backed by distressed asset-backed securities in return for a fee based on expected losses and a loss sharing mechanism, Ireland is planning to introduce legislation next month to establish its National Asset Management Agency (NAMA) which will take over troubled loans from Irish banks and in Switzerland UBS's 'bad bank' is already managing over €60bn of assets.

'Bad banks' defined
Although the details vary from scheme to scheme, 'bad banks' tend to have the following common features:

• the establishment of one or more vehicles (a 'bad bank') to acquire distressed assets from banks wishing to avail of the scheme (participating banks);
• a process in which participating banks are required to identify and publicly disclose their distressed or defaulted loan assets and other investments (the distressed assets);
• the sale of the distressed assets by the participating banks to a bad bank at a price (the transfer price), which represents a discount to par or face value but which will be somewhat greater than their real value;
• a transparent post-transfer procedure to establish the actual open market value (real value) of the distressed assets via independent experts;
• government assistance (state support) to the bad bank to raise funds to pay the transfer price, taking a wide variety of forms, including equity injections, loan facilities, guarantees, state insurance and asset swaps, often government bonds for distressed assets;
• payment of compensation to the relevant government by the participating banks for the provision of state support (typically in the form of an annual fee based on the difference between the transfer price and the real value of the distressed assets transferred to the bad bank by such participating banks);
• a loss sharing arrangement between the bad bank and the participating banks (which may include their shareholders) in respect of losses ultimately realised on the distressed assets normally requiring the participating bank to take at least some level of first loss;
• asset management (including restructuring and enforcement) of the distressed assets by the bad bank, the participating banks and/or third-party asset managers; and
• innovative disposal strategies for the distressed assets by the bad bank, including arrangements such as joint ventures with private investors.

Objectives of bad bank schemes
The overriding objective of bad bank schemes is to safeguard financial stability and support the supply of credit. The requirement for participating banks to disclose the value of their distressed assets is designed to establish benchmarks to help the market for such assets to re-open and to overcome the effects of rumour and speculation as to the effect of distressed assets on the solvency and creditworthiness of participating banks.

It should be noted that unlike their US counterparts, most European banks do not undertake mark-to-market accounting and so do not suffer the detrimental effect of the same during periods of market illiquidity. As such, the objective of the FDIC in the US of stopping the downward spiral caused by losses of investor confidence and the impetus to sell assets in fire sales due to the effect of mark-to-market accounting is generally not a motivating factor in European bad bank schemes. In most bad bank schemes, the relevant government takes some element of risk on the performance of the distressed assets, although generally such losses can be recovered from the equity of the participating banks (to the extent the same has any value).

These schemes can also allow participating banks to defer recognising at least some of the losses on their defaulted assets until the value of such assets can be more objectively established. This feature of bad bank schemes is particularly important in the current market where a lack of liquidity has made real values difficult to verify, which has encouraged some banks to defer revaluing their assets, which in turn has produced speculation as to the strength of such banks.

The role of the EU
EU law plays an important role in determining the scope of activities of Bad Banks. In particular:

1. EU state aid rules prescribe the way in which EU Member States can support the businesses of their participating banks;
2. European competition law will seek to ensure that bad bank schemes do not distort competition in relevant markets (particular emphasis will be put on competitive advantages and disadvantages arising between participating banks and other banks which do not use the bad bank scheme in the relevant market); and
3. From a monetary policy perspective (particularly with regard to Eurozone Member States), the EU will be concerned to ensure that the costs to individual Member States of operating a bad bank scheme do not affect the financial stability of that Member State.

The role of the ECB
A number of the European bad bank schemes announced to date will operate in conjunction with the repurchase facility made available through the ECB (the ECB repo facility) for certain high grade securities, including government debt, certain triple-A rated ABS and certain covered bonds. In Germany, the SoFFin scheme will involve SPVs holding distressed assets issuing securities with the benefit of SoFFin guarantees, which will be eligible for 100% funding under the ECB repo facility. NAMA in Ireland plans to purchase distressed assets from participating banks by issuing them with Irish government bonds, which the participating banks can then repo with the ECB.

At the time of writing, the ECB is effectively the only active investor in significant parts of the European debt capital markets. Market participants (including the ECB itself) are concerned as to the sustainability of this position and so it remains to be seen for how long the ECB will continue to 'backstop' European bad bank schemes in this way.

Issues in establishing bad bank structures
At this stage, the current crop of European bad banks are either in the process of being established or have just commenced operations. As such, the way in which they will operate in practice remains to be seen. However, it seems clear at this stage that every bad bank will face a number of issues and challenges in their acquisition and management of distressed assets, not least because of the complexity of modern financing transactions and the cross-border nature of many transactions.

Set out below are a number of points that parties involved with bad banks may wish to consider.

1. Determining real value
One of the most important and problematic activities undertaken by a bad bank is the establishment of the actual real value of its distressed assets. By definition this real value cannot be the prevailing price at the time of determination (either on the basis of a willing seller and buyer or in a fire sale scenario). The concept has to somehow capture the expected cashflow that will actually be received from each distressed asset on a present value basis, so funds received far into the future are discounted appropriately.

In Germany, the SoFFin scheme will establish this real value through expert independent valuers chosen by and owing direct duties to SoFFin valuing the distressed assets in accordance with specific provisions set out in the statute establishing the scheme. The scheme further provides that valuations are to be made in accordance with generally accepted valuation models and that future cashflows are to be discounted.

This would seem to follow to at least an extent the model established in the US by the RTC, where a 'derived investment value' was established for each distressed asset on the basis of clearly defined assumptions, so as to enable third parties to easily make direct comparisons between pools of distressed assets for investment and other purposes.

Whatever approach is taken to this, the real value ascribed to any distressed asset will affect both the loss realised on the same by the participating bank transferring the same to the bad bank and the recoveries ultimately realised by the bad bank on such distressed asset through disposal or otherwise. As such, a number of interested parties have much to lose or gain through this and so any process for establishing real value which is not totally transparent, independent, reliable and consistent (among participating banks, as well as between European countries) can be expected to give rise to disputes.

2. Extent of risk transfer
Every bad bank will take (subject to its arrangements with its participating banks) some level of credit risk and liquidity risk on the distressed assets it acquires. However, the distressed assets will also carry a range of other risks, including legal risk, structural risk and fraud risk.

The secondary markets for certain asset classes addresses these risks by requiring sellers to represent and warrant as to a range of matters concerning the origination, underwriting, ownership and operation of the assets in question and provide indemnities or repurchase obligations as remedies for breach. In the context of a bad bank, it is difficult to see how participating banks could be required to give such representations and warranties without compromising the objectives of the bad bank scheme.

On the other hand, there may be sensitivities as to public funds being exposed to such risks. Ultimately, this issue would seem to be capable of resolution only through understanding what (if any) assumptions a bad bank may be making as to the nature and quality of the distressed assets it acquires and perhaps modifying the pricing or loss sharing arrangements accordingly.

3. Effect of loss sharing
Different bad bank schemes contemplate a variety of mechanisms to recoup higher than anticipated losses on distressed assets (being recoveries significantly below the real value of the distressed assets as established post-transfer of such assets to the bad bank in question). In Ireland, indications are that this will be achieved through a levy on participating banks, while Germany's SoFFin will hold a preferential claim on amounts available for distribution by the participating banks, the assets of which gave rise to such losses.

Regardless of the mechanism chosen, governments establishing bad bank schemes will need to balance the need to protect public funds against any detrimental effect that loss sharing measures may have on future efforts by participating banks to re-capitalise themselves by raising funds from third-party equity investors.

4. Ancillary rights
Many types of distressed assets will carry with them a range of ancillary contracts, reports and opinions which were relied upon by the participating banks in originating and managing such distressed assets. These will include legal opinions, valuation reports and contracts with property managers.

Unless the participating banks took steps to allow for parties to whom they might transfer the distressed assets to be able to rely on these, successor parties - such as the bad banks - may not be able to enforce any rights or claim any resulting losses from the parties to or providers of these contracts or reports. Furthermore, some of these reports and contracts may be subject to confidentiality provisions, which prevent the participating banks from even providing copies to the bad banks.

Trust mechanisms created by the participating banks over their rights under these contracts and reports can provide some assistance in jurisdictions where such arrangements are effective.

5. Accounting treatment
In some jurisdictions, generally accepted accounting principles (GAAP) may require participating banks to create provisions in their annual accounts for compensation payments to or loss sharing arrangements with bad banks. Such provisioning requirements would undo much of the beneficial effect of the transfer of distressed assets by participating banks to a bad bank. There may, however, be legislative solutions to this or it may be possible to agree concessionary treatment for transfers of distressed assets to bad banks with the accounting bodies.

6. Asset management
Having accepted distressed assets from participating banks, the principal responsibility of a bad bank is to realise the greatest possible recovery on such distressed assets. The instinctive position is for the bad bank itself to take responsibility for this.

However, bad banks will usually have limited resources and staff available for such purpose. Accordingly, the question arises as to who is most appropriate to service the distressed assets. The obvious choice is the relevant participating bank, which will already be familiar with the distressed assets and who, as banks, will presumably have substantial asset work-out teams.

Furthermore, as the participating banks will hold usually a first loss position in the distressed assets under a bad bank scheme, they will have a substantial interest in maximising recoveries from the distressed assets. However, such an arrangement gives rise to two distinct problems.

First, the participating bank's wider banking relationships with the borrowers under particular distressed assets may conflict with the objective of the bad bank to maximise recoveries on the distressed assets. This issue has been recognised in the ECB's guidelines for bad banks where the ECB emphasises the necessity to "ensure clear and functional organisational separation between the [participating banks and their distressed assets], notably as to their staff, management and clientele", so as to prevent possible conflicts of interest.

Second, where the ultimate strategy of a bad bank is to fully or partially dispose of distressed assets to third-party investors such as private equity funds, these investors will typically want to take over asset management themselves. Possible solutions to this will include outsourcing the asset management function to third parties.

The securitisation industry has given rise to a number of dedicated independent asset managers, some of whom specialise in dealing with distressed assets, particularly special servicers for commercial mortgage loans. An alternative may be to put in place arrangements (possibly with the originating participating banks) allowing for related parties to manage the distressed assets on an interim basis, but providing a mechanism for replacement of the asset manager on disposal.

Whoever is given responsibility for asset management, it will be important to structure an appropriate agreement between the bad bank and the asset manager. Among other things, this should contain an agreed standard to be observed by the manager and a remuneration structure which incentivises the manager to produce the greatest recoveries and controls, so that the bad bank and the relevant participating bank are able to participate in the most important decisions made by the manager.

Conclusion
Bad banks are clearly an important tool for governments wishing to support their banks. Bad bank schemes offer significant advantages over other types of state support, particularly as such schemes can create the transparency that is vital to restoring confidence to institutions and markets. However, it is also clear that careful thought will be needed to ensure that bad banks are established with the structures that will enable them to overcome the many obstacles they will face and fulfil the expectations of interested parties.

© 2009 Paul Hastings. This Research Note is an extract from 'Issues and challenges in establishing "bad banks" in Europe', first published by Paul Hastings on 7 July 2009.

Trading

Trading ideas: falling to pieces

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright short trade on The New York Times Company

New York Times recently surveyed internet users to find out if they would pay between US$30 and US$60 a year for online access. With advertising revenues falling and not showing any signs of stabilisation, we find the company grasping for any sort of additional revenue to be rather distressing for its credit valuation.

The equity market is also signaling bad things to come for the company. Ahead of its second-quarter earnings announcement this month, we recommend buying credit protection on NYT.

Considerable downward pressure remains on New York Time's revenue generation power and there are not many signs of it lifting. As the below exhibit demonstrates, advertising sales - the vast majority of its total revenue - dropped severely in recent quarters.

The company reports second-quarter results on 23 July and we expect the nosedive to continue. The looming issue regarding the newspaper business is whether or not it will ever come back.

Dave Novosel, Gimme Credit's media expert, noted last week in a report on New York Times that the "primary problems in the newspaper sector are secular as opposed to cyclical. As such, we do not foresee a significant improvement in profitability if and when the economy begins growing again."

We encourage clients to read Dave's full report. His analysis is in line with our quantitative view that New York Time's credit is poised to underperform.

New York Time's equity price and implied volatility both strongly signal potential credit deterioration. High yield debt is highly correlated to moves in a company's equity price as their positioning in the capital structure is similar.

New York Time's stock is now below US$5/share, giving the company a market cap of only US$670m. This is after trading well above US$40/share just four years ago.

Its three-month implied volatility is 85%, which is the highest amongst its peers (see below exhibit). The equity market is clearly signaling that the company will have trouble producing consistent earnings in the new economy.

We see a 'fair spread' of 1000bp for New York Times based upon our quantitative credit model, due to its equity-implied factors, change in leverage and margins factors. Throughout 2008 and up until May, its market and expected spreads traded closely in line with one another; however, our view abruptly changed when the company's equity lagged behind the rest of the market (see below exhibit). We expect a substantial sell-off in its credit spread of roughly 400bp.

Position
Buy US$10m notional New York Times 5 Year CDS at 585bp.

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).