Contents

CLOs

Downgrades loom

Moody's to cut most triple-A CLOs as improving metrics emerge

Moody's has revised its CLO rating outlook for senior tranches of CLOs and now expects that the majority of ratings on triple-A CLOs will be cut (see News Round-up). Although many in the industry suggest this is merely a confirmation of what was widely expected, the announcement comes at a time when fundamental improvements are being seen in the asset class.

"In the first four months of the year there was a significant deterioration in CLO portfolios, which was a continuation of the deterioration seen at the end of 2008," says Jian Hu, md of Moody's structured finance group in New York. "Although there have been signs of stabilisation in some key metrics in May and June, it is too early to say whether it will turn into a recovery in the sector. The revised outlook for senior tranches of CLOs is being implemented as a result of the impact CLO portfolios have already suffered."

Hu continues: "It is unlikely that the downgraded deals would be upgraded, should metrics continue to improve in the short term. Our rating assumptions for CLOs incorporate all phases of a credit cycle."

As for the likelihood of future CLOs attaining a triple-A rating from the rating agency, Thorsten Klotz, md at Moody's confirms that it would not be impossible. "A deal would have to reflect the credit enhancement or subordination levels required by our new criteria. Such a deal would look very different to CLO structures seen in the past," he says.

Some CLO managers said they did not have strong feelings about Moody's revised outlook for triple-A CLOs, noting that they anticipated the downgrades.

Peer Rosenberg, CLO manager at IKB, says it is not helpful for Moody's to downgrade all CLOs when investors want to be able to assess the good and bad CLO managers on the basis of their relative performance."All our cashflow forecasts show that even in severe downside scenarios (with reference to defaults, recovery rates and triple-C excess) - in a six tranche structure - Class A-C (and most parts of D) are fully repaid," he adds. "If Moody's ratings are a measure of probability of default and recovery, they got it wrong when downgrading the most senior tranches. That's problematic as actually, the CLO structures (e.g. straight forward cashflow CLOs) do work and the OC mechanisms kick in as intended - however, by downgrading the most senior notes, Moody's puts exactly those mechanisms in question."

One CLO investor indicates that there is, in general, the risk that new methodologies overshoot on the strict side with the potential to result in a drag on lending activity.

"Being lenient regarding ratings in the good times and harsh in bad times is too pro-cyclical," he says. "It creates regulatory risk and impacts any restarting of the securitisation market. Even if it makes sense to issue a CLO, any recovery will be slowed by having too harsh a regulatory environment."

Structured credit strategists at Citi, meanwhile, have described the current state of the CLO market as "cautiously optimistic". In their Global Structured Credit Strategy (published on 15 July), the strategists note that CLO collateral default rates are significantly lower than the overall loan universe default rate, negative rating migration is slowing, and the proportion of triple-C rated names in US CLO portfolios is diminishing.

"Slippage of names into the triple-C category remains at the forefront of investor worries, as market participants look closely at names such as Univision, Las Vegas Sands and MGM - large issuers teetering on the brink of single-B territory," says Eduard Trampolsky, vp of structured credit strategy at Citi. "However, with no significant additions and a few defaulted names leaving the triple-C basket, the proportion of triple-C rated names in US CLO portfolios has shrunk by an additional 0.2% to 12% - down 0.4% from its peak."

As of last week, there were 46 institutional loan issuer defaults year-to-date with an outstanding volume of over US$56bn, bringing the current CLO collateral default rate to 5.9%. "The number is significantly lower than the overall loan universe default rate of 9.3%; the reason being that many of the highly levered loans originated at the peak of credit frenzy - and many of which have defaulted by now - hardly made it into CLOs," Trampolsky adds.

European CLO transactions have not shown the improvement seen in their counterparts on the other side of the Atlantic, however. According to Trampolsky, the average WARF in European CLO transactions has jumped by 35 points to reach 2635, while the average interest diversion cushion has slipped 0.6% to -1.9% - bringing the difference between US and European transaction cushions to its lowest level since September.

"We do hope, however, that - barring unexpected events - the performance of European CLO transactions will stabilise in the upcoming months," Trampolsky concludes.

AC

CMBS

False start?

Muted start to legacy CMBS op as S&P refines methodology again

The uptake for the 16 July legacy CMBS TALF loan operation was muted, with just US$669m requested by investors. However, there is hope that activity in this area should now begin to pick up, especially as S&P has affirmed a number of deals that were previously on downgrade review and re-adjusted its CMBS rating methodology.

"I was surprised the TALF loan subscriptions for the legacy CMBS were so low - I would have expected them to have been four times that amount," says Adam Margolin, managing partner of Structured Finance Solutions. "However, the timeframe for issuers to get organised has been relatively short. Subscriptions will pick up in the next few months."

Craig Lieberman, md and co-head of commercial real estate at NewOak Capital, agrees that requests for loans should pick up in the coming months. "While investors' trepidation is understandable, given the magnitude of S&P's proposed downgrades and uncertainty around the logistics of the programme, especially the role of the collateral manager, I suspect more investors will begin requesting TALF loans for CMBS assets in the coming months," he says. "As these questions start to get answered, investors should grow more comfortable with TALF, which will increase its appeal."

Yesterday (21 July) S&P announced a refinement of the methodology it uses to assess the impact of losses and recoveries resulting from its triple-A rating scenario for US conduit/fusion CMBS. The rating agency says it received a number of inquiries from market constituents following the publications of its new methodology last month (SCI passim), which prompted it to clarify and refine its approach.

The rating agency will use these criteria for rating all US conduit/fusion CMBS transactions with super-senior classes, of which there are currently 336 deals with 1,436 certificates in this category. S&P says its testing of the methodology suggests that applying losses and defaults under its triple-A scenario will account more fully for the benefits of time tranching.

The application of these new criteria has resulted in upgrades to triple-A of seven benchmark super-senior tranches from three transactions that S&P recently downgraded. These include two Morgan Stanley Capital 1 Trust 2007 1Q16 deals, three Goldman Sachs Mortgage Security Trust 2007 GG10 deals and two Credit Suisse Commercial Mortgage Trust 2007 C3 deals.

Meanwhile, loan requests for new issue CMBS under the TALF programme have not yet seen any demand, despite rumours that deals - such as a US$600m deal from Developers Diversified Realty Corp - are in the works. According to Ron d'Vari, ceo of NewOak Capital, it will be some time before new issue TALF-eligible CMBS hit the market.

"Apart from uncertainty about which issues will be eligible, it takes time to cultivate a deal," says d'Vari. "Issuers will want to know if they are bringing out the right package for investors - therefore I expect a few trial runs. These will be easier to do with larger loans, so I expect single-borrower deals to go through first."

He notes that this is problematic in itself, though, as single-borrower deals have not been particularly popular in the past. "Extension risk and balloon risks also remain at the forefront: many of these deals will need to be refinanced in 2012 at the same time as a large number of other transactions. These are risks that the market is not necessarily prepared for."

For the time being, CMBS spreads remain on a tightening trend. Heavy trading continues, with US$4bn notional of bid lists circulating last week - more than 2.5 times the trailing six-month weekly average.

According to CMBS analysts at Barclays Capital, spreads are subject to policy-related dispersion, with TALF-eligible sectors outperforming non-TALF eligible. They estimate that 2007 vintage LCF dupers (predominantly TALF ineligible) tightened by 143bp on the week, while 2005 vintage LCF dupers (predominantly TALF eligible) tightened by 178bp. Non-TALF, but originally triple-A rated, bonds continue to benefit from potential PPIP demand.

"TALF has had a huge psychological effect in the process of driving the CMBS market toward equilibrium and recovery," concludes Margolin.

AC

Ratings

Revisiting ratings

Structured finance ratings still lack ability to describe cliff risks

The US SEC says it is continuing to strengthen its NRSRO oversight. But, as the latest methodology tweak is expected to cause another wave of downgrades (see separate News Analysis), it appears that the rating agencies themselves have yet to properly address their approach to structured finance ratings.

What is fundamentally lacking in ratings methodologies is the ability to describe cliff risks, according to Citi structured credit strategist Michael Hampden-Turner. "We need a measure based on expected loss that assesses the speed at which a triple-A note could potentially deteriorate and to what level. But this is difficult to implement," he explains.

He adds: "SROC goes part of the way, but we need more. It's helpful to be able to aggregate ratings risk across a portfolio, but the market should have additional information about the nature of the assets."

Douglas Long, evp business strategy at Principia, says information that provides guidelines about ratings behaviour over time is also key - although he concedes that indicators about overall sensitivity to ratings would also be helpful. "Further work around this issue needs to be done between the agencies, however."

David Matson, md at IKB Fund Management, notes that the market needs stability and consistency in terms of ratings approaches rather than wholesale change. "A process whereby it is possible to track downgrades over time rather than wholesale methodology changes is preferable," he says.

However, one source points out that the efforts the agencies have made so far to provide additional information about their structured finance ratings (SCI passim) has proved useful. Adding that the utility of rating agencies is in their provision of what are essentially global benchmarks, which helped facilitate the growth of capital markets.

"The reality is that only the largest investors can do credit work on a global scale," the source says. "If you undermine such global benchmarks, the danger is that investors will return to only investing domestically."

There is agreement in one area, at least - the issue of including liquidity measures in ratings. The source notes that liquidity is an issue of confidence, which isn't something that's measurable.

David Rosa, vp - senior analyst at Moody's, says that when the rating agency was exploring which additional ratings measures would be necessary to address structured finance risks, it soon realised that liquidity scores weren't feasible. "Rating agencies aren't the right entity to tackle liquidity risk," he explains.

"The market should address liquidity concerns through commoditisation, more transparent market pricing and reporting. But this is unlikely to happen for current deals because each deal has its own specific characteristics," Rosa adds.

Ian Linnell, md and head of Fitch's European structured finance group, points out that banking regulation doesn't provide for a specific liquidity capital charge precisely because liquidity is so difficult to measure.

Meanwhile, in a recent US House of Representatives testimony concerning SEC oversight, the Commission's chair Mary Schapiro confirmed that it is to establish a branch of examiners dedicated specifically to conducting examination oversight of the nationally recognised statistical rating organisations (NRSROs). The Commission is also exploring possible new regulations to increase NRSRO oversight, including limiting the potential for 'rating shopping' (SCI passim).

"One possible approach would be to require disclosure by issuers of all pre-ratings obtained from NRSROs prior to selecting a firm to conduct a rating, as well as requiring NRSROs to provide additional disclosures," she explained.

The SEC announced in February that it had taken a series of actions with the aim of enhancing the utility of NRSRO disclosures to investors, strengthening the integrity of the ratings process and more effectively addressing the potential for conflicts of interest inherent in the ratings process for structured finance products. Specifically, the Commission adopted several requirements designed to increase the transparency of rating methodologies, strengthen the disclosure of ratings performance, prohibit rating agencies from engaging in certain practices that create conflicts of interest, and enhance their recordkeeping and reporting obligations to assist the Commission in performing its regulatory and oversight functions.

In conjunction with the adoption of these new measures, the SEC proposed an additional amendment that would require NRSROs to disclose ratings history information for 100% of all issuer-paid credit ratings. Finally, an amendment was re-proposed that would prohibit an NRSRO from issuing a rating for a structured finance product paid for by the product's issuer, sponsor or underwriter unless the information about the product provided to the NRSRO is made available to other NRSROs.

Long agrees that one way rating agencies could move away from an incentive-based system would be to ensure that all other rating agencies have access to the same information that the chosen rating agency has - thus allowing independent third-party opinions.

Marjorie Hogan, senior portfolio manager at Capstone Credit Advisors in New York, also suggests that the market would benefit from having more than just a couple of rating agencies. "We could encourage start-up ratings agencies to specialise in sectors where they have particular expertise. Investors might begin to demand that certain transactions be rated by the best agencies for those types of deals, as a prerequisite to buying."

She concludes: "A service that scored the ratings agencies on their performance would help investors in developing their guidelines going forward. Investors need to demand quality ratings and vote with their feet when they don't get them."

CS

Clearing

CDS CCPs scrutinised

The TABB Group has published new research regarding the clearing of CDS products in the US and Europe. The move comes as a working group established by the Committee on Payment and Settlement Systems (CPSS) and IOSCO's Technical Committee begins reviewing the application of the 2004 CPSS-IOSCO 'Recommendations for Central Counterparties' to clearing arrangements for OTC derivatives. The recommendations set out standards for risk management of a central counterparty.

The working group has been formed to discuss key issues that can arise when CCPs - including the new CDS CCPs - provide central clearing services for OTC derivatives. Where necessary, it will propose guidance on how CCPs may meet the standards set out by the recommendations and will identify any areas in which the recommendations might be strengthened or expanded to promote consistent interpretation, understanding and application of the recommendations.

The CPSS and IOSCO believe that the expansion of centralised clearing and settlement is a positive development because, if well designed, CCPs can reduce systemic risk in financial markets. However, applying the recommendations in practice can involve a significant degree of interpretation and judgment, the two organisations note.

The TABB Group report, entitled 'Global Credit Default Swap Clearing: Getting the Model Right', examines the mechanics of derivatives central clearing, as well as challenges of ownership, regulation, valuation, risk management and various CDS central clearing models proposed by major CCPs. It also pinpoints over 20 open issues requiring industry solutions.

Larry Tabb, founder and ceo of The TABB Group, says: "CDS clearing is more about managing risk, margin and workflow than transferring securities title and facilitating payment. The clearing of CDS is not all homogenous and has different complexity levels. Index-based CDS clearing is much more straightforward than clearing single name CDS or CDS tranche products. We believe the most significant CDS clearing challenges come from five major issues: product complexity, valuation, liquidity, interoperability and counterparty risk."

Robert Iati, partner, global head of consulting at TABB, adds: "One of the challenges with CDS clearing is simply the global nature of CDS. Most clearinghouses are local, as members, products and regulators typically are regulated nationally. For clearing of over-the-counter products to succeed, all of the participants must adopt standard contract language, structure, trade matching, affirmation and communication timeframes. But one of the primary challenges for effective global OTC trade clearance is the lack of consistent access to clearing corporations by potential participants, because scale and critical mass maximise the value of clearing."

TABB Group believes CCPs will be established in both the US and Europe for CDS contracts. "The larger question, though, revolves around what happens to the Euro-platform," continues Tabb. "Will there be one platform for Eurozone only and another for European non-Eurozone members? Will the platform be London-based, offered through players such as NYSE Euronext bClear or ICE Clear Europe, or will flow consolidate to a more continental platform such as Eurex?"

As part of his keynote address at a US Chamber of Commerce discussion entitled 'Modernising Derivatives Oversight: Developing Policy for the 21st Century', DTCC chairman and ceo Donald Donahue repeated his call for the establishment of a single trade repository for OTC derivatives contracts (SCI passim), claiming that it is essential to mitigating risk and enhancing transparency in the market. "DTCC strongly urges Congress and regulators to codify into law the continued operation of a central global repository for OTC credit derivatives," he said. "We believe that having all of this information residing in a single place is a crucial contribution to reducing risk and promoting market efficiency. When markets are in turmoil, it is critical that regulators have the ability to see the full details on the underlying trading positions of derivatives contracts from a central vantage point to quickly assess systemic risk across the financial system - and to bring greater transparency to the market. This snapshot of the market can only be provided by a single global repository."

DTCC operates the Trade Information Warehouse - a comprehensive repository and post-trade processing infrastructure for OTC credit derivatives. The Warehouse was also designed to be extended to other OTC derivative asset classes, the DTCC notes.

The corporation has publicly stated that it will support all efforts to create CCP services planned in the US and Europe, on a non-discriminatory basis. Donahue continued: "If we consider that globally there are about six CCPs planned to be launched either in Europe or in the US, we can recognise the potential for fragmentation of data about the market, if there's no central repository storing all the data in one place. If we recognise that these CCPs will only clear a portion of the market, the need for a central repository is further emphasised."

Indeed, Iati notes that the need for competition in the CDS clearing space is being driven by six factors: opportunity, jurisdictional squabbles, cost, multiple CDS products, risk mitigation and the fact that dealers do not want to put all of their eggs in one basket - at least at this time. He says: "CCP competition is possible, yet competition in the CDS clearing space is fraught with complexity, due to the heterogeneity of national, fiscal, legal and regulatory structures of the individual markets and the varied economic interests of market participants."

Tabb concludes: "This market needs both competition and flexibility in order to accommodate its diversity. If nothing else, should there ever be another issue the size of Lehman to unwind, it needs to be handled quickly and smoothly."

JA & CS

CLOs

CLO repacks to support senior bid?

Structured credit analysts at JPMorgan note that, while very few such repacks have occurred to their knowledge, there is potential for re-REMIC technology to be applied in the CLO sector (see last week's issue). They suggest that resecuritisations could help support the bid at the senior end of the CLO capital structure and act as a possible brake to capital-based selling pressures.

The analysts point out that when applying resecuritisation technology to CLO structures, a variety of factors should be considered, such as structural features as well as the current status of the transaction in terms of reinvestment periods and trading flexibility. "Additionally, consideration would need to be given as to whether the resecuritisation would occur inside or outside the transaction," they add. "Attempting to resecuritise under the confines of the CLO indenture itself poses a variety of issues, the largest being receipt of noteholder consent."

Resecuritising the CLO tranche outside of the vehicle (through an SPV, for example) may allow for more flexibility, as noteholder consent in general would not be required - though there could be increased cost considerations. An external resecuritisation could also allow for adjustments to coupon and rated notional, at the cost of required subordination.

But, according to JPMorgan, new ratings would depend on how much is truly affected by the retrenching. "We would think aspects such as only influencing cashflow timing might be relatively more easy/less cumbersome from a re-ratings point of view than, say, changing the structure wholesale."

In terms of pricing, some inferences can be made from CMBS re-REMICs, whose senior pieces are currently being offered in the 500bp-530bp range and the junior in the mid- to high-teen yields. "Given that CLO triple-As generically trade in the 600bp range, we think the senior piece could price considerably tighter than this - though we would be most comfortable taking the view that the junior piece could price in line or inside double-A yields, which implies low-teens," the analyst continue.

Finally, implications for EODs in resecuritised transactions have yet to be explored. The new junior bond is still part of the controlling class, but since it becomes second-priority, if a liquation were to occur the junior holder could still suffer principal impairment and likely favour acceleration.

CS

CMBS

CMBS rating linked to UK government credit risk

Provisional triple-A ratings have been assigned to the £370m Sceptre Funding 1 CMBS. Arranged by HSBC, this is a secured loan transaction backed by lease payments arising from a single-obligor commercial lease entered into by Land Securities with the current UK government tenant - the Secretary of State for Communities and Local Government (C&LG) - as lessee. The property is based in central London.

Moody's considers that the rating on the notes is directly linked to the credit risk of the UK government. The transaction is structured with the objective to achieve de-linkage from the credit risk of the borrower and to rely exclusively on the lease payments from the occupational lease.

The transaction structure relies on an 'issuer borrower loan agreement', whereby the issuer will apply the proceeds of the issuance of notes to grant a secured loan to the borrower, a Land Securities entity. The obligations of the borrower to the issuer will be secured over the beneficial interest of the borrower in the underlying occupational lease.

The beneficial interest in the rental income from the occupational lease is held by the property trustees on trust for the borrower. The property trustees guarantee the obligations of the borrower towards the issuer and, as a result, upon the occurrence of an event of default under the secured loan, the property trustees are obliged to repay the outstanding amount under the secured loan.

The property trustees will utilise the cashflows from the underlying occupational lease to repay the secured loan. The freehold interest in the property is held by Land Securities Reserve A Ltd and is not mortgaged or secured for this transaction.

AC

Investors

Counterparty risk falls amid positive earnings

Counterparty risk has fallen significantly in the last several weeks as investors gained confidence in the apparent strength of the major financials' earning power, with non-financial risk rising significantly relative to financials over the last month. Government discussions on the regulation of OTC derivatives also appear to have had some impact implicitly as centralised clearing efforts and moves towards improved transparency have given risk managers more confidence in their counterparties. Current risk, as measured by the Credit Derivatives Research (CDR) Counterparty Risk Index (CRI), stands at 149bp - well below its 195bp average since Q308.

Risk among the major financials has been relatively volatile over the last month, according to CDR, with investors' fears renewed in mid- to late-June pushing risk up to two-month highs before the last two weeks' pre-earnings seeing significant compression. "Net, counterparty risk is stabilising at around the 150bp level and it appears that any significant break above or below this level will be highly indicative of the next leg in credit risk in general," CDR's chief strategist Tim Backshall says.

He adds that while traditional credit and liquidity measures, such as TED spread, OIS-Libor and CP rates, have become increasingly intermediated by policymakers and therefore less and less important as indicators, the CRI remained a purer market indication of the risk inherent in the financial system - with its members representing the broad set of the most active OTC derivative counterparties (and therefore most likely to be considered systemically important).

The fourteen members of the CRI across Europe and the US range from BNP Paribas (the least risky at only 69bp) to Citigroup (the most risky at 367bp). The last month, since mid-June, has seen only a 5bp drop in risk - albeit with an inverted U-shaped pattern peaking at around 180bp on 23 June. US members have dramatically outperformed European members, with the former 6% less risky and the latter 3% more risky.

The average risk of US members of the CRI fell below 200bp for the first time in over two months, as financial earnings appear rosy at first glance, thanks to Goldman Sachs and JPMorgan. However, CDR suggests that transparency into Level 2 and 3 assets at Goldman and increasing NPLs at JPM provide some cause for concern.

The firm says its long-held view of European banks trading too tight relative to US banks - given the convergence in explicit government backstops, higher leverage and similar exposure profiles - continues to prove correct as the spread differential between the two compresses further. Dresdner (17% riskier), Deutsche (12% riskier) and UBS (11% riskier) have all shifted systemically into the 120bp-130bp range, while Citigroup and Bank of America saw risk drop by around 6%-7%.

"These regional differences sync somewhat with the relative sovereigns involved, as USA risk has been stable to modestly higher, while European majors saw risk rise as systemic risk is transferred from corporate to government balance sheets and back again in the eyes of market participants," Backshall notes.

CS

Secondary markets

Survey reveals views on fair value accounting

Valuation Research Corporation has completed a survey of financial professionals' views on fair value accounting (FVA). The survey finds that a majority of respondents believe that market turmoil and the collapse of active markets for many assets caused implementation issues in FVA.

According to the survey, 58% of respondents believe that market turmoil negates FVA's validity. Of those who believe FVA is flawed and potentially not valid during market turmoil, almost 34% suggest a temporary return to historical cost accounting as an alternative.

"Respondents to this survey came down hard on fair value accounting," says P. J. Patel, cfa and svp of Valuation Research Corporation. "While in less volatile times, fair value accounting has improved transparency, in unusual times like we've seen, FVA becomes more difficult to implement and understand."

Survey respondents note their uncertainty about the capability of publicly traded banks to reasonably estimate their own Level 3 financial assets. A full 44% believe the bank values were within an accuracy of 10% and another 40% think those values are as much as 30% off. Only 3% believe that bank reported values are within 3% of an accurate value, while another 12% say the accuracy is within 5%.

Respondents believe the accuracy of hedge fund and private equity valuations of Level 3 assets, determined by the funds themselves, were even further off the mark. 36% believe that hedge fund and private equity values are only within an accuracy of 10%, while 49% think these values are as much as 30% off.

Patel adds: "The survey found there is some uncertainty in the ability of banks, private equity firms and hedge funds to accurately report the value of their own Level 3 assets."

Respondents were split when asked if mark-to-market accounting should be suspended for the purposes of bank regulatory capital, with 50% believing it should be and 50% believing it should not be. When asked if external auditors had caused them to revise their projections, 30% agreed. Of those who had to revise projections, 9.6% needed to change purchase allocation projections (under FAS 141), 19.3% needed to revise goodwill impairment projections (FAS 142) and 14.5% had to revise fair value estimates (FAS 157).

Survey participants also opined on who provides the best valuation of Level 3 assets. 61% think the owner/purchaser working together with an external valuation firm provided the best valuation. Only 19% of respondents believe the owner/purchaser working on their own was best, while another 19% reckon that an external valuation firm working on its own was best.

The survey was completed in May by financial professionals from public accounting, investment banking, private equity, hedge fund, law, real estate, consulting, valuation and fund administration firms.

JA

Risk advisory group names md

Moelis & Company has recruited Yadin Rozov as an md in its risk advisory group. Rozov, who will be based in New York, has nearly a decade of fixed income trading, structuring and risk management experience.

Ken Moelis, ceo of Moelis & Company, says: "We are committed to helping clients establish outstanding risk management and assessment practices, which are critical now more than ever. Yadin's extensive fixed income and risk management experience makes him an ideal addition to the advisory platform."

Rozov was most recently an md and the Americas head of the repositioning group at UBS Investment Bank. In this role, he was responsible for the implementation of the strategic exiting of legacy businesses and risk positions across the bank, including complex structured and securitised products with underlying credit, real estate and consumer obligations.

Prior to the repositioning group, Rozov was global co-head of the structured products group at UBS. Before UBS, he was a credit derivatives trader at Citigroup Global Markets.

Chris Ryan, md of Moelis & Company, adds: "Yadin Rozov is a highly talented and innovative risk manager. Moelis & Company's clients will benefit greatly from Yadin's skills and experience as they manage complex transactions and portfolios. We are very pleased to welcome him to the risk advisory group."

ABS

Aladdin details sales and trading hires

Aladdin Capital has expanded its sales and trading division with the appointment of eight new hires. The division, which currently comprises ten professionals, is led by Michael Gibbons, who joined Aladdin in March 2009, having previously headed up distressed trading at BNP Paribas.

Mark Atmore joins the firm with more than 19 years of experience from Bear Stearns and Nomura. He is a senior hire responsible for managing senior relationships in Europe, Ireland and the UK.

Brian Robertson has been appointed head of European trading and syndicate. He has 18 years of experience, which includes head of syndicate at Bank of America. Prior to his appointment at Aladdin, Robertson was a credit trader at Lehman Brothers for eight years.

As previously announced in SCI (see SCI issue 143), Alan Packman has joined the ABS trading team at Aladdin. He has 16 years of experience, including head of ABS trading at Dresdner Kleinwort and ABS, portfolio and proprietary trading at Lloyds TSB.

Mounir Guessous joins as head of sales for France. Previously, Guessous was head of France and Benelux sales at Nomura. He also served as a director at Bear Stearns.

Robert Ekblom will cover sales for Scandinavia and Switzerland. He started his career at Merrill Lynch as a member of the structured credit sales team, where he later became the head of both debt market sales and Scandinavia at the bank.

Lori Aljian covers the UK and Ireland. Before joining Aladdin, Aljian was head of structured solutions at UBS. Prior to her time at UBS, she was vp of structured credit solutions at Wachovia Bank.

Mark Wegbrans has responsibility for the Benelux region. Wegbrans was previously at Merrill Lynch, where he was head of Benelux structured solutions, and at Lehman Brothers, where he was head of Benelux fixed income.

Finally, Eoin Daly has joined Aladdin on the sales desk from Bear Stearns and Mitsubishi UFJ. Denny Miyazaki-Ross also joins Aladdin's trading desk from BGC Partners.

An additional pipeline of hires is pending, the firm says.

ABS

Prop trader joins bespoke investment manager

Bespoke investment manager Glendevon King has hired a new portfolio manager. Nicola Marinelli has joined the firm from Monte dei Paschi di Siena, where he was a proprietary trader on the credit desk, trading ABS, CDOs and CDS.

Prior to Monte dei Paschi di Siena, Marinelli was a fixed income portfolio manager at RAS Asset Management (now Allianz Global Investor) in Milan, where he was responsible for three euro-denominated fixed income funds. He began his career at Credit Suisse Private Banking, also in Milan.

ABS

Jefferies names group head

Jefferies & Company has hired Mark Plansky as an md and head of its ABS and MBS group in Boston. Plansky will focus on serving Jefferies' ABS and MBS clients in Boston and the Northeast of the US. He joins the firm from Barclays, where he worked for eight years and was most recently an md focused on MBS sales.

In a joint statement, Johan Eveland and William Jennings, co-heads of global ABS and MBS at Jefferies, comment: "We are very pleased to announce that Mark Plansky has joined Jefferies. His experience, knowledge and strong relationships will significantly enhance our mortgage- and asset-backed capabilities in Boston, as well as continue the group's geographic expansion. We continue to extend Jefferies' dedicated MBS/ABS/CMBS platform to bring additional levels of service to our existing and new institutional clients."

Plansky will lead the firm's team in Boston that also includes James McLaughlin and Jeffrey Farkas, two veteran salespeople who have been focused on the sales and trading of ABS and MBS securities for Jefferies in Boston.

Before Barclays, Plansky was an md at Lehman Brothers, where he was a top producer in MBS sales. Previously, he was with Paine Webber, and started his career at First Albany.

ABS

GE hires EMEA securitisation head

GE Capital has named James Fenner as the new head of capital markets for EMEA. Based in London, he will be responsible for all strategic lease and loan syndication activities and will oversee securitisation and alternative funding strategies, in partnership with GE's Treasury function, for GE Capital businesses in the region. The position reports to GE Capital EMEA president and ceo Richard Laxer.

Laxer explains: "As one of the largest lenders to the SME sector in EMEA and the largest factoring provider globally, GE Capital is already working extensively with governments and customers in the major European economies to support key sectors and businesses."

He adds: "James brings a wealth of experience to the capital markets role that will help us provide more creative solutions to customers and generate new sources of funding that we can pass onto businesses."

Fenner was previously head of leveraged loan capital markets with Merrill Lynch, a position he held since 2005. Prior to that, he was in a variety of roles with Deutsche Bank from 1986, ending as md of loan capital markets responsible for project finance, telecoms and leveraged finance.

ABS

Manager replacement for ABS CDOs

Aventine Hill Capital is set to replace Terwin Money Management as asset manager on the Cascade Funding CDO I, Glacier Funding CDO II and Glacier Funding CDO III transactions. Aventine Hill is an affiliate of FSI Capital, a Securities Exchange Commission-registered investment advisor with approximately US$10bn of assets under management as of 30 June 2009. Through its ABS platform, FSI manages or sub-manages 26 replacement structured finance CDOs.

Cascade closed on 26 July 2004 and exited its substitution period in July 2006. As of the May 2009 trustee report, the portfolio comprised 37.6% SF CDOs, 31.7% subprime RMBS and 30.6% prime RMBS.

Glacier II closed on 12 October 2004 and exited its substitution period in February 2007. As of the May 2009 trustee report, the Glacier II portfolio comprises 49.9% prime RMBS, including home equity loan securitisations, 26.7% subprime RMBS, 16.2% CMBS, 3.6% SF CDOs and 3.6% other ABS.

Glacier III closed on 29 July 2005 and exited its substitution period in November 2007. As of the May 2009 trustee report, the Glacier III portfolio comprised 31.7% prime RMBS, 25.6% subprime RMBS, 21.1% home equity loan securitisations, 13.5% CMBS, 5.7% SF CDOs and 2.4% other ABS.

With the end of the substitution period, the asset manager does maintain the ability to sell defaulted, credit risk and credit-improved securities and the proceeds of any such sale would be distributed as principal proceeds on the subsequent distribution date, in accordance with the transactions' priority of payments.

Fitch has determined Aventine's capabilities to be consistent with the current ratings assigned to the transactions in question.

ABS

Permacap considers mezzanine investments

As of the end of June 2009, the GAV of Volta Finance was €56.2m against €56.1m at the end of May 2009, leaving the value at €1.86 per share unchanged. The June mark-to-market variations of the permacap's asset classes have been: +0.3% for ABS investments, +3.2% for CDO investments and +12.4% for corporate credit investments.

In June, the company bought two mezzanine debt tranches of European CDOs: €2m of the Serie II tranche of the Leveraged Finance Capital II CLO issued in August 2003 and managed by BNP Paribas, as well as €1.5m of nominal of the Serie III of Adagio III CLO issued in July 2006 and managed by AXA IM.

The company says that opportunities could be seized in the current market environment in several structured credit sectors. Mezzanine tranches of CLOs and of European ABS or senior tranches of corporate credit portfolio could be considered as the main area for such investments, it adds. These investments will be realised depending on the pace at which market opportunities can be seized.

Advisory

Managers selected to amortise Bayern portfolios

Cairn Financial Products and Federated Investors have been selected by Bayerische Landesbank (Bayern LB) as investment advisors for its multi-billion-dollar portfolios of euro- and US dollar-denominated ABS, CMBS and RMBS securities respectively. The two firms will assist in the unwinding of the portfolios over a multi-year period, with a focus on realising appropriate values through a combination of constant surveillance and sales of portfolio securities when appropriate. The move follows the Landesbank's decision to re-focus its attention on its core activities and the creation of its new restructuring division.

"Bayern LB has significantly reduced its portfolio of asset-backed securities over the last two years. In order to continue and possibly accelerate this portfolio amortisation in a capital-efficient way, we will draw on [Cairn and Federated's] experience and advice," confirms Ralph Schmidt, chief risk officer of Bayern LB.

Cairn director David Littlewood says: "This is a tremendously interesting and exciting opportunity for Cairn and one which will clearly demonstrate the full range of our skills and services. We are delighted to have been selected as BayernLB's partner on such a prestigious and key mandate for the bank."

"Federated has demonstrated its ability to manage a variety of bond products and portfolios over decades. With the tremendous changes in the bond market over the last two years, clients are increasingly looking to Federated to help them realise appropriate value from their portfolios of asset-backed securities and structured products. We are honoured to be selected to work with Bayern LB in this area," adds Gordon Ceresino, vice chairman of Federated.

Alternative assets

TD Ameritrade settles ARS charge

The US SEC has settled charges against TD Ameritrade for making inaccurate statements when selling auction rate securities (ARS) to customers. The settlement reached with the online brokerage firm will provide its customers with the opportunity to sell back to TD Ameritrade any ARS that they bought prior to the collapse of the ARS market in February 2008.

According to the SEC's administrative order, TD Ameritrade's registered representatives told customers that ARS were an alternative to certificates of deposit and money market accounts. Among other things, the firm's representatives did not tell customers about the complexity and risks of ARS, including their dependence on successful auctions for liquidity, the order claims.

TD Ameritrade's ARS customers include individual investors, small businesses, small non-profit organisations, charities and religious organisations. "TD Ameritrade improperly marketed ARS to retail customers as short-term investments without telling them about the special risks of the ARS market," adds Donald Hoerl, regional director of the SEC's Denver regional office. "This settlement provides hundreds of millions of dollars to thousands of TD Ameritrade customers who hold ARS that are now illiquid."

The announcement follows finalised ARS settlements with Bank of America, Citi, Deutsche Bank, RBC Capital, UBS and Wachovia (SCI passim). The SEC's Division of Enforcement previously announced a settlement in principle with Merrill Lynch.

"TD Ameritrade is the latest in a series of landmark ARS settlements that bring unprecedented relief to tens of thousands of investors," comments Robert Khuzami, director of the SEC's Division of Enforcement. "ARS customers of numerous firms can get back all of the money they invested in auction rate securities as more than US$50bn in liquidity is being made available to them through these historic settlements."

The SEC's order finds that TD Ameritrade wilfully violated Section 17(a)(2) of the Securities Act of 1933. The Commission censured the firm, ordered it to cease and desist from future violations, and reserved the right to seek a financial penalty against the firm.

Without admitting or denying the SEC's allegations, TD Ameritrade has consented to the SEC's order and agreed to: purchase eligible ARS from individuals, charities and those small businesses and institutions with assets at TD Ameritrade of US$10m or less; compensate eligible customers who sold their ARS below par by paying the difference between par and the sale price of the ARS, plus reasonable interest; reimburse excess interest costs to eligible ARS customers who took out loans from TD Ameritrade after 13 February 2008; and at the customer's election, participate in a special arbitration process with eligible customers who claim additional damages.

CDO

US manager to take on seven CDOs

Alcentra NY is expected to become replacement collateral manager on seven CDOs. The CDOs under consideration are: Archstone I, Archstone Synthetic CDO II SPC, Prospero CLO I, Prospero CLO II, Veritas CLO I and Veritas CLO II. Collateral management responsibilities were previously performed by Rabobank International.

Alcentra NY is also tipped to replace BNY Capital Markets as collateral manager on OWS CLO 1.

S&P has issued preliminary rating confirmation on the deals.

CDO

CDO collateral advisor replaced

Stone Tower Debt Advisors has replaced Bear Stearns Asset Management (BSAM) as collateral advisor on the Stone Tower CDO II deal, under the management agreement dated 12 October 2005 between the issuer, Stone Tower Debt Advisors as collateral manager and BSAM as collateral advisor. BSAM was terminated for cause as collateral advisor and Stone Tower Debt Advisors' succession has been approved by the issuer at the direction of a majority of the controlling class. Stone Tower Debt Advisors has executed an instrument of assumption, whereby it agrees to assume all of the responsibilities, duties and obligations of the collateral advisor under the management agreement and the applicable terms of the indenture.

The parent of Stone Tower Debt Advisors, Stone Tower Capital, is an asset management and advisory firm founded in 2001 that currently has approximately US$41.4bn of assets under management. Stone Tower has a team of 18 investment professionals in its corporate credit group and employs 11 managers and analysts in its structured credit group. They are supported by 14 professionals providing operations, legal and compliance assistance.

Stone Tower considers itself to have a particular advantage in analysing the credit quality of speculative grade leveraged investments, according to Moody's, and currently manages 13 CLOs with assets totalling US$7.1bn. Moody's has determined that the ratings currently assigned to Stone Tower CDO II will not, at this time, be reduced or withdrawn solely as a result of the appointment.

Distressed assets

LBIE claims resolution progresses

The joint administrators of Lehman Brothers International (Europe) last week made an application to the High Court in London with respect to a Scheme of Arrangement designed to provide procedures to be used by LBIE for the purpose of returning 'trust property' held by LBIE to certain of its customers. Among the primary purposes of the scheme is the desire to avoid the need for a case-by-case resolution of the claims made by LBIE's creditors, according to lawyers at Schulte Roth & Zabel.

The administrators hope to begin the return of assets in the first quarter of 2010. An initial hearing on the scheme is currently scheduled to take place at the end of July. The administrators anticipate that a series of creditors' meetings will be held in October, to be followed by an approval vote (which requires a 75% majority). An opt-out provision is envisaged that would enable opt-outs to become unsecured LBIE creditors, whose claims will be dealt with outside the scheme.

The scheme's objectives include: setting a bar date beyond which most claims can no longer be made against LBIE (31 December 2009 has been proposed); establishing a mechanism to determine and value creditors' claims (a pro forma claim form allowing for uniformity of claims will be prepared and assets are to be valued at sale price, mid-market price or fair market value); establishing reserves; predicting costs for the management and distribution of assets held in trust by LBIE; effecting distributions to LBIE's creditors (as trust property becomes available for distribution, it will be allocated to LBIE's creditors in proportion to their asset claims); and setting an end date for the scheme (which is expected to be five years after its effective date). The scheme contains a dispute resolution procedure with referrals to a valuation expert, an independent adjudicator or the court.

Investors

IDB launches new prime brokerage business

Cantor Fitzgerald has hired Noel Kimmel as senior md to head its new prime brokerage business. Kimmel joins Cantor from JPMorgan, where he served as North American head of sales & marketing for the fixed income prime brokerage division.

Shawn Matthews, ceo of Cantor Fitzgerald, says: "Our customers have been asking us to develop a prime services business to help meet their needs. The mid-market in particular has been underserved by the largest banks."

He adds: "Noel will focus on creating our equity and fixed income prime brokerage offering. His talent, experience and breadth of relationships in the marketplace, combined with Cantor's financial strength, are an ideal combination as we expand the solutions, services and support we offer across fixed income and equities sales and trading, investment banking as well as prime brokerage."

While at JPMorgan, Kimmel's responsibilities encompassed fixed income securities prime brokerage, credit and interest rate derivatives intermediation, and foreign exchange and commodities prime brokerage. Prior to this, he was a senior md at Bear Stearns, where he was responsible for sales and relationships in the fixed income prime brokerage business, and served as a member of the senior relationship management group, prime brokerage operating committee and the firm's global hedge fund relationship management effort.

Investors

Investment group expands management

Fortress Investment Group has made several changes in management responsibilities.

Daniel Mudd, currently a member of the Fortress board of directors, will become the firm's ceo, effective as of 11 August 2009. As ceo, Mudd will be responsible for Fortress's day-to-day operations and will be charged with developing the firm's global growth strategy, continuing to develop best-in-class policies and infrastructure, and developing and retaining the firm's talent. He will also retain his seat on the board.

Peter Briger and Wesley Edens will become co-chairmen of the Fortress board of directors. Each of the Fortress principals will continue to lead their respective investment businesses and serve on the board of directors. The principals of the firm will continue to own approximately 70% of Fortress.

Edens says: "These are truly unprecedented investment markets that play directly into Fortress's strengths and expertise. We are energised by the investment opportunities we see emerging over the next several years. However, we recognise that these dynamic markets require the firm's principals to be single-mindedly focused on investments, both existing and new opportunities that will create value for our investors. The expansion of the team with a ceo of Dan's caliber and skill-set really rounds out the partnership."

He adds: "We have known Dan since 1997 when he was at GE, and have had worked closely with him as a valued member of our board. Dan is a seasoned investment professional with deep operational and leadership skills and we are excited to have him join our firm."

Mudd says: "I have known the principals for a long time, have worked with them as a partner and a Board member, and I have great respect for what they have done to build Fortress thus far. I look forward to helping the team manage and grow this institution."

Mudd is an executive with leadership experience across a range of financial services businesses. Most recently, he served as president and ceo of Fannie Mae.

Monolines

Monoline restructures, won't write new business

Syncora Guarantee says it has completed all of the steps of its comprehensive restructuring. On 15 July the company closed all the transactions with its counterparties to the CDS and financial guarantee policies involved, and accepted the tender offer for 55 classes of RMBS it insured on behalf of the BCP Voyager Master Funds SPC (SCI passim). The monoline expects that the successful remediation of its policyholders' surplus deficit will allow it to return to compliance with the New York State Insurance Department's (NYID) minimum policyholders' surplus requirement of US$65m.

The restructuring will effectively relieve Syncora of approximately US$6bn in losses and loss reserves. As a result, the monoline believes it will remediate its policyholders' surplus deficit by in the range of US$3.9bn and US$4.1bn.

Mike Esposito, chairman of Syncora's board of directors, says: "We are pleased to announce this very significant and unprecedented restructuring in the financial guarantee industry. We expect that the successful completion of all the various transactions will restore Syncora Guarantee to positive policyholders' surplus."

Acting ceo Susan Comparato adds: "This result would not have been possible without the hard work and dedication of the company's employees and its advisors. Thank you also to the NYID for their ongoing oversight of the restructuring process, which was essential in helping the company achieve its goals. BSG Markets and Deutsche Bank Securities, as dealer managers for the RMBS tender offer, should be commended for their efforts."

Following the closing of the 2009 MTA, Syncora Guarantee's financial counterparties received 23,736,349 common shares of Syncora. 6,332,700 of its common shares that were previously held in trust for the benefit of Syncora Guarantee were cancelled.

As of 15 July 2009, Syncora had 59,339,343 total common shares outstanding, with its counterparties holding approximately 40% of the aggregate equity ownership. In addition, the counterparties received surplus notes of an aggregate amount of US$625m issued by Syncora Guarantee.

The monoline confirms that it is not currently writing new insurance business and will not resume writing new insurance business.

Ratings

S&P completes ratings reform

S&P says it has identified and undertaken four core reforms to restore investor confidence in its ratings.

First, the agency has further strengthened standards to prevent conflicts of interest. In order to create clear separation between analysts who analyse securities and employees who negotiate issuer fees, S&P has established a new rotational system for its analysts.

Furthermore, if an analyst leaves to work for an issuer, S&P has mandated 'look-back' reviews to ensure the integrity of the prior ratings. To further increase independence from issuers, the agency is exploring proposals for tying compensation to the performance of ratings over time.

Second, S&P says it has increased the transparency of its ratings process by publishing 'what if' scenario analyses and sharing the risk factors that it considers when analysing securities. Third, the agency has taken steps to improve its performance in the structured finance segment. This involved revising criteria to incorporate a measure of stability into investment grade ratings and publishing economic stress scenarios to be used as benchmarks for enhancing consistency and comparability of ratings across sectors and over time.

Finally, S&P says it supports the calls for more accountability for rating agency performance to investors and regulators, beyond the market scrutiny ratings and criteria receive on an ongoing basis. Under newly proposed legislation, the SEC would have the explicit authority to impose stiff punishments against firms that fail to meet regulations for disclosing conflicts of interest and ratings methodologies, similar to new rules in the EU.

As countries continue adopting new regulations, the agency says it will continue working closely with policymakers to produce rules that are consistent around the globe. "Ultimately, we envision a future when investors share the same safeguards wherever they put their money and when ratings agencies share a level playing field wherever they operate," it concludes.

RMBS

New REIT to benefit from proprietary loan mods

PennyMac is readying an IPO on NYSE of its newly formed REIT, PennyMac Mortgage Investment Trust, which will invest primarily in residential mortgage loans and mortgage-related assets. A substantial portion of these assets is likely to be distressed and acquired at discounts to their unpaid principal balances. PNMAC Capital Management, as the REIT's external manager, will then seek to maximise the value of these mortgage loans through proprietary loan modification programmes, special servicing and other initiatives focused on keeping borrowers in their homes, the firm says.

The IPO is expected to comprise 20 million common shares at a price of US$20 per share. In a separate private placement, 5% of the common shares issued in the underwritten offering will be sold to a number of the firm's executive officers, an affiliate of BlackRock, Highfields Capital Investments and Private National Mortgage Acceptance Company.

Structuring/Primary market

Commutation agreement takes effect

Radian Group has entered into a commutation and release agreement with Ambac, effective as of 1 July 2009. This agreement will enable the commutation of US$9.8bn of Radian Asset's reinsurance portfolio assumed from Ambac.

Radian ceo S. Ibrahim says: "A key component of our capital plan is to provide capital support and cash infusions over time to our core mortgage insurance business. We continue to utilise Radian Asset as an important source of capital support for Radian Guaranty, our principal mortgage insurance subsidiary, and - by reducing our overall financial guaranty risk through this commutation - we have increased our ability to access that capital."

The commutation agreement provides, among other things, for Radian Asset to make a US$100m settlement payment to Ambac, including a refund of unearned premium reserves and payment of statutory loss reserves. The commutation, which represents 99.7% of the insured portfolio, previously assumed from Ambac, decreases Radian Asset's total insured portfolio by 10%, including a decrease of 42% in Radian Asset's exposure to MBS.

The statutory surplus of Radian Asset (and Radian Guaranty) will be positively impacted in Q309 by approximately US$40m as a result of the Ambac commutation.

Trading

Boutique preps credit funds

Ambix Capital is preparing three fixed income strategies to be managed by Marco Sticchi. Sticchi will establish and manage a long-short credit fund, a long-only credit fund and an absolute return multi-asset fund, co-managed with Pier Alberto Furno.

Previously, Sticchi was the portfolio manager of the Whitebeam Credit Fund, which he launched in 2007 after joining the firm in January that year. Before joining Whitebeam, he worked at Morgan Stanley for 10 years as the senior high yield bond trader in London.

Furno comments: "We are delighted to announce Marco's appointment. We are seeing exciting opportunities in the global fixed income markets at the moment. Being able to hire someone with Marco's experience, combined with the current market conditions make this an extremely exciting opportunity. We will be working hard with Marco to develop these products and get them to market quickly and efficiently."

Trading

FI head hired, interest in manager acquired

Morgan Stanley has hired Jack DiMaio as global head of interest rate, credit and currency trading. He will report to Michael Petrick, global head of sales and trading.

The firm also announced that it will take a minority stake in DiMaio Ahmad Capital. Nasser Ahmad will become the sole managing partner of D/A Capital, and DiMaio will continue his relationship with the firm as a member of its advisory board. D/A Capital is an investment management firm specialising in credit products.

DiMaio has more than 20 years' experience in the bond and credit markets, and previously served as the head of fixed income for North America at Credit Suisse, as well as the head of alternative investments at Credit Suisse Asset Management. He will also join Morgan Stanley's management committee.

Walid Chammah, co-president of Morgan Stanley, says: "Jack DiMaio is a well regarded bond trader with a proven track record of building talented and profitable fixed income teams. We believe Jack is ideally suited to help us drive improved performance in our fixed income business as we look to leverage the strong talent and build upon the platform we have in place.''

Petrick adds: "It's not often that one has the opportunity to hire someone of Jack DiMaio's calibre, and we are pleased that he is bringing his vast experience to bear in the leadership of our fixed income sales and trading business. Jack's fixed income expertise and leadership skills will be particularly valuable as we look to continue building out Morgan Stanley's client flow businesses and seize attractive market opportunities in the months ahead."

In addition to DiMaio, Morgan Stanley has hired md Al Chinappi and six other sales and two trading professionals in emerging market credit.

Trading

Securities firm adds two traders

Southwest Securities has added two traders to its taxable fixed income trading desk. Derek Rose has joined the firm's Chicago office as an svp of ABS and CMBS trading, and Steve Palmer has joined its New York office as svp of mortgage trading.

Rose served most recently as ABS/CMBS trader and director of securitisation syndicate at RBC Capital Markets in New York. He also managed ABS trading at ABN Amro, Sutro and Nesbitt Burns. He will work with vps/traders John Kemnitzer and Beth Stobbs to expand Southwest Securities' ABS/CMBS trading and distribution capabilities.

Palmer, who most recently was an executive director with JPMorgan trading non-agency fixed rate securities and unsecuritised residential loans, worked at Chemical Securities, Smith Barney, HSBC Securities and FTN Financial prior to joining Southwest Securities. He will work with Jeff Bohnsack, svp and trader, and Suraj Jagannathan, trading assistant, to expand the firm's mortgage trading effort.

"Derek and Steve are the type of experienced professionals we are adding to our trading staff to support additional sales volume," says Dan Leland, Southwest Securities evp and head of fixed income.

He adds: "We have been active participants in the taxable fixed income market for many years and we are finding there are opportunities now to grow because of the experienced talent available."

ABS

South African structured finance downgraded

Moody's has downgraded all Aaa and Aa1 rated notes of outstanding South African ABS, RMBS, CMBS and repackaged securities to Aa2. 75 tranches were downgraded and 28 transactions were affected by the action.

The downgrades are a result of Moody's downgrading the country ceilings for South African local currency bonds and deposits to Aa2 from Aaa, aligning the global scale structured finance ratings with the revised ceiling. The agency says that the downgrade of the country ceilings was to better align South Africa with countries at similar stages of economic development and institutional strength, according to its sovereign bond rating methodology.

The country ceiling for local currency bonds is typically the highest rating for an issuer domiciled within a given country. This ceiling generally caps the ratings of specific securities and/or issuers within the country.

Moody's notes that none of these global scale rating actions for structured finance transactions is prompted by performance concerns of the underlying collateral portfolios. It emphasises that local currency country ceilings do not often change, as they address the general country-level risk.

ABS

Indian ABS performance data published

Performance data for each of the 21 Fitch-rated Indian ABS transactions currently under surveillance has been released by the agency.

Dipesh Patel, senior director in Fitch's structured finance team, says: "As we had anticipated in our outlook report released in February 2009, the performance of most ABS asset classes has deteriorated in recent months. However, the ratings outlook for the majority of Indian ABS transactions continues to remain stable due to available credit enhancement cover in the range of 4x-6x and high levels of amortisation."

In commercial vehicle (CV) loans, Fitch has observed deterioration in collection efficiency levels since July 2008. Jatin Nanaware, associate director of Fitch, explains: "The drop in collections for heavy and medium commercial vehicles loans has been more pronounced than the drop for light commercial vehicles and tractors. This reflects that sub-categories of CV perform differently in periods of economic stress, depending on the end-use of the CV."

In auto loans, the agency observed a strong correlation between delinquency levels and the year in which the loans were originated. Loans originating prior to 2006 have 180+ days past due (DPD) rates ranging from 0.6%-0.9% of original principal outstanding. In contrast, loans originating post-2006 have a much higher 180+ DPD rates, ranging from 3.5%-4.1%.

Associate director of Fitch, Deep Mukherjee, says: "It is likely that the performance of loans originated post-2006 has not only been affected by changes in the underwriting standards to meet high growth targets, but also by changes in recovery practices since November 2007, following adverse publicity over the engagement of recovery agents."

In unsecured personal loans, Fitch has observed high 180+ DPD delinquency rates in the range of 6%-6.5% of original principal outstanding. Personal loans are often disbursed for a wide variety of purposes, making them particularly vulnerable to the economic slowdown.

Alternative assets

Export finance deal prepped

Fitch has assigned ExFin Capital's forthcoming issue of US$1.306bn Class A notes an expected rating of triple-A with a stable outlook. ExFin Capital is a true sale securitisation vehicle set up to fund export finance structures originated by ABN AMRO Bank or The Royal Bank of Scotland.

The loan claims to be securitised are guaranteed by three European export credit agencies (ECAs) representing the sovereigns of France, Germany and the UK respectively. All three sovereigns are rated triple-A with a stable outlook.

The rating on the notes is predominantly based on the credit support from the guarantees and is directly linked to the sovereign ratings. If one of the three sovereigns is downgraded, the Class A notes would be downgraded accordingly.

This will be the first issuance out of the programme to finance 80 loans against five borrowers (four airlines and one operating aircraft leasing company). The portfolio amounts to a current balance of US$1.5bn.

The notes will amortise from closing, applying the collections in strict sequential order. The unrated Class B notes are designed to protect the issuer mainly from interest rate risk and any delays in compensation payments due from the ECAs.

Fitch believes the credit risk of the portfolio's payments to be equal with the respective sovereigns' obligations. As such, the agency solely focused on the guarantee support and did not take the credit quality of the loan obligors into account. Apart from the credit risk, the transaction is, however, exposed to shortfalls on the interest payments on the rated notes due to the high margin on the Class A notes, interest rate volatility and payment delay risks.

The weighted average margin on the loan portfolio amounts to 7bp, which compared to a margin of 100bp on the Class A notes creates a negative coverage from the outset, according to the rating agency. The structure foresees that principal collections will be used to make up any shortfall between interest collections and obligations on the rated notes.

The credit enhancement provided by the Class B notes is also designed to cover the transaction's exposure against interest volatility and basis risk. Interest on the loans and the notes are both linked to USD Libor; however, the re-set dates differ. Additionally, about 34% of the portfolio is referenced to three-month USD Libor, while the notes are linked to six-month USD Libor.

Fitch tested the cashflow structure using several stress tests on interest rate movements and mismatches. In addition, it took into account that the guarantors will compensate the issuer for loan payment losses only with a certain time delay. Based on these tests, Fitch concludes that the available credit enhancement of 12% is sufficient to support an expected triple-A rating of the Class A notes.

CDO

Synthetic CDO notes repurchased

The issuer of ARLO VI, a European synthetic CDO, has repurchased all outstanding notes of the class B-5D tranche, amounting to €10m. The notes have therefore been cancelled. The deal was arranged by Barclays Capital in 2006, with DWS Finanz Service acting as portfolio advisor.

CDO

Minimal CIT ratings impact on IG CSOs

A credit event by CIT Group would have a minimal impact on investment grade ratings of synthetic CDOs, according to Fitch. Despite being referenced in over half (53%) of its rated synthetic CDOs, recently-completed sensitivity analysis shows that many tranches rated triple-C and below are likely to default and suffer losses, while investment grade tranches can absorb a potential loss and maintain their current ratings. Tranches currently rated in the triple-B and double-B rating categories face downgrade risk resulting from diminished credit enhancement from potential CIT losses, adds Fitch.

CDO

Loan mods unlikely to impact CDO's liabilities

Two recent loan modifications to collateral assets from ARMSS 2004-1 are not expected to adversely impact Fitch's ratings of the CDO liabilities. The agency's view of loss expectation for one loan has not been affected, while the other's has slightly improved.

Arbor Realty Collateral Management, the asset manager, notified Fitch of its intention to modify the loan terms of two B-notes (a US$7.5m senior B-note and a US$15.2m junior B-note) secured by Grand Reserve at Park Isle and a US$21m A-note secured by the Lembi Portfolio, which are underlying the CDO. While these loan modifications are not expected to negatively affect the ratings of the transaction at this time, it should be noted that the transaction remains on rating watch negative.

Fitch expects Arbor to continue to provide periodic updates regarding the performance of these assets as well as all others in the portfolio, and will take further action if deemed necessary. The CDO is expected to be fully reviewed within the next three months.

Grand Reserve at Park Isle is a Fitch loan of concern. The current modification maintains the 4% interest rate for an additional 12 months to allow further time to lease up the vacant units. The interest rate will revert to 7.25% in May 2010.

Also, a US$500,000 shortfall reserve was established with additional debt proceeds that are subordinate to the CDO interests. A US$6m participation of the A-note, which is held by an Arbor affiliate, was also made subordinate to the CDO interests.

Based on the highly leveraged position of these B-notes, Fitch previously viewed the loan interests to have limited recovery prospects in the case of default. The extension has not changed its prior loss expectation.

The Lembi Portfolio loan is another Fitch loan of concern secured by a portfolio of San Francisco multifamily properties. In this case, the loan modification extends the loan term by an additional four years, replaces the sponsor with a better-capitalised entity, converts two subordinate participations into equity, and increases the interest rate spread while removing the interest rate floor. Funds were also transferred from the renovation reserve to the debt service reserve, providing for interest shortfall coverage of another one to two years.

Additionally, Arbor was appointed special servicer for the loan, allowing for more immediate control over the asset. These modifications are expected to delay or prevent a potential loan default, Fitch says.

CDO

EODs for SF CDOs

Moody's has withdrawn its ratings on 426 classes of notes issued by 60 SF CDOs. The tranches affected 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, and in one case to terminate the transaction.

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.

CDS

Lear prices settled, another determination pending

Final prices for Lear Corp CDS and LCDS were settled at 38.5 (with 12 dealers participating) and 66 (nine dealers participating) respectively in yesterday's (21 July) auction.

Separately, UBS has requested that ISDA's determinations committee determine whether a failure to pay has occurred in connection with Kellwood Co after it failed to make a required principal payment on its 7 7/8% notes.

CLOs

Moody's to downgrade majority of triple-A CLOs

Moody's has revised its rating outlook for senior tranches of CLOs and now expects that the majority of ratings on triple-A tranches will be cut (see also separate News Analysis).

"Due to significant credit deterioration in CLOs' underlying portfolios in the first half of this year in combination with revised assumptions, [Moody's] now expects that a majority of senior notes in CLOs, including a majority of Aaa tranches, are likely to be downgraded," the rating agency says. "For the Aaa rated tranches that may be downgraded in the coming months, Moody's expects that they will mostly fall into the Aa category, with the actual magnitude of downgrade to vary from deal to deal."

During Q209, Moody's downgraded 510 CLO tranches of 93 transactions, totalling approximately US$33bn. Approximately 74% of the 180 triple-A rated tranches that were reviewed during this period were downgraded, and the average magnitude of the downgrades was approximately 3.6 notches (i.e. between Aa3 and A1 on average).

Of the 510 downgraded tranches, 481 were from 89 US CLO transactions totalling approximately US$31bn, with the remainder having been originated in Europe. Downgrade actions affected 132 tranches (approximately 26%) that were previously rated triple-A. Combined with rating actions taken in the first quarter, to date Moody's has downgraded 2,307 tranches (roughly 48% of a total of 4,762 tranches) totaling approximately US$82bn globally in 2009.

The agency notes that during the first half of this year, CLO portfolios experienced significant deterioration in portfolio performance, although in May and June there were signs of stabilisation in key performance metrics. In particular, the average portfolio WARF (weighted average rating factor) increased by about 200 points from 2720 to 2918 in the first quarter, before it declined slightly in June. The proportion of triple-C rated assets in CLO portfolios on average rose from around 9% in January to 12.6% in April and then declined to 11.9% in June.

At the same time, defaults increased steadily from 3% in January to 6.3% in June, whereas OC levels showed some stabilisation in May and June after suffering a significant drop from January to April. The stabilisation in OC levels was partially a result of the improvement in loan prices and the slow-down in the pace of corporate downgrades into the triple-C category.

This performance deterioration coincided with global corporate credit deterioration, which has been one of the worst in several decades. According to Moody's June Default Report, the trailing 12-month default rate in the universe of Moody's-rated US loans rose to 8.2% in June from 5% in the first quarter and 2.1% a year ago.

CLOs

Euro CLO gets documentation revamp

A number of amendments have been made to Neptuno CLO II, a European cashflow CLO. Among the modifications are changes to eligible assets, an increase in the size of the triple-C bucket and a lower threshold for the discount obligation definition.

According to information from the investment manager, Caja de Ahorros y Monte de Piedad de Madrid, on June 23 the noteholders agreed to the amendments requested by the issuer, investment manager, trustee and other transaction parties. The specific changes to the deal include amendments to the eligibility criteria to allow the collateral manager to purchase unsecured senior loans and investment grade bonds.

In addition, changes to the portfolio profile tests include the increase in the manager's ability to purchase unsecured senior loans, mezzanine obligations, second-lien loans and high yield bonds (increase of the combined bucket to a maximum of 25% from a maximum of 15%). A combined bucket for mezzanine obligations, second-lien loans and high yield bonds has been added with a maximum of 15%. This limit was not documented at closing.

The senior secured loans bucket has also decreased to a minimum of 75% from a minimum of 85%, while the triple-C securities bucket has been raised to a maximum of 7.5% compared with 5.0% at closing.

Finally, an amended discount obligation definition lowered the threshold for an asset to qualify as discounted, compared with the threshold at closing. This threshold level is specific to each type of underlying asset. In addition, a set of conditions need to be satisfied for a limited number of discounted assets to be carried at their par value to calculate the coverage tests.

According to S&P, these amendments have not had an adverse effect on the ratings in the transaction.

CMBS

Tentative start to legacy CMBS operation

The New York Fed has announced that US$669m in legacy CMBS TALF loans were requested for the 16 July facility (see also separate News Analysis). Issuers did not request any loans for newly-issued CMBS. The fixed three-year loan rate is set at 3.0275%, and at 3.8735% for the fixed five-year loan.

CMBS

Uncertainty remains for Epic CMBS

31 of the 120 assets in the Epic Industrious portfolio were sold late last week at an average gross yield of 12.4%. The auction, arranged by King Sturge, attracted significant interest and each offered property had several bidders.

According to S&P, the total sale price of the assets is about half their open market value at closing. If all the remaining properties are sold at this discount, principal losses (disregarding swap breakage fees and costs) would result in material losses for the Class B notes, the rating agency says. S&P expects the total principal shortfall for the properties sold to be approximately £21.4m, before costs.

There are a variety of factors that will likely influence the sale process for the remaining assets, according to S&P. First, Ernst & Young, the borrowers' administrative receivers, may decide to sell the remaining 89 assets as one portfolio, which could trigger a larger discount.

Second, in line with current market experience, smaller assets attracted more interest than the larger assets at the auction, and many of the properties that remain in the transaction are larger than those sold last week. Third, the sooner the properties are sold, the higher the swap breakage fees will be and the greater the loss will be borne by the noteholders.

Based on these uncertainties, securitisation analysts at Barclays Capital expect that the Class A notes will suffer a material ultimate loss of between 10%-20%. "S&P's statement that disregarding the swap breakage fees and costs, if the remaining properties are sold at this discount, principal losses would result in material losses for the Class B notes is not that useful, in our opinion, especially as disregarding swap breakage and costs is unrealistic," the BarCap analysts note. "After taking down the rating on the Class A to triple-B minus from triple-A on 3 July, we feel that given the remaining uncertainties with the rest of the portfolio, an investment grade rating (triple-B minus) for the Class A is too optimistic."

CMBS

Euro commercial loan defaults increase

The number of defaulted loans in European CMBS transactions continued to increase in Q209, according to a Fitch quarterly update. The latest defaults were predominantly triggered by reductions in rental income caused by tenant defaults and increased vacancy rates.

Even though the majority of Fitch-rated CMBS loans are performing in line with their terms and conditions, due to relatively stable incomes and long leases, the number of tenant defaults and subsequent loan events of default is rising. In the last quarter, eight loan defaults were triggered by tenant defaults, for example.

Fitch estimates that 45 loans are currently in default across non-granular European CMBS transactions rated by the agency, 51% of which have been driven by movements in collateral income. These figures only reflect cases where an event of default has occurred, therefore exclude loans where a default has been avoided through additional cash injections, waived or not yet called.

Properties left vacant following tenant defaults and lease expiries are increasingly exposed to reported falls in rental values. The pace of rental value declines has increased in many markets, exacerbating falls in capital value for assets that currently, or will soon, have exposure to the occupational market.

Gioia Dominedo, director in Fitch's European CMBS team, explains: "The consequences of falling rental values are twofold: they have the potential not only to further depress capital values, but to also trigger loan defaults due to income deterioration. As the revaluation of European portfolios and testing of LTV covenants remain infrequent, the main causes for loan defaults are on the income side, especially in continental European jurisdictions where income profiles tend to be weaker than in the UK."

"As in previous downturns, stress in occupational markets is being registered after other signs of recession," continues Dominedo. "So, even as yields eventually stabilise, property values may continue to fall in line with expectations of future rental receipts."

In addition to covenant breaches or outright payment default, two conduit loans failed to make their bullet repayments in Q209. Mario Schmidt, associate director of Fitch's European CMBS team, says: "While several small-ticket loans have defaulted at their scheduled maturities in the past twelve months, most of these have since been repaid in full. Fitch is now starting to see the first wave of larger loans, generally from more recent vintages and with higher LTVs, reaching maturity and failing to repay. The agency expects this to become an increasing occurrence going forward."

In Q209, Fitch affirmed 183 European CMBS tranches, downgraded 136 and upgraded three. A total 473 tranches have a stable outlook, 361 have a negative outlook and 49 are on rating watch negative. A further 56 publicly-rated European CMBS tranches (accounting for approximately 6% of all Fitch-rated European CMBS tranches) are currently rated triple-C or below; tranches at this level of distress are not assigned a rating outlook or watch.

Documentation

Loan data repository to launch

Further to its partnership with the American Securitization Forum (see last week's issue), S&P fixed income risk management services (FIRMS) is to create a new loan numbering system and a central loan data repository to provide investors with a means to understanding the risk, collateral and credit of an individual loan that has been securitised or may be repackaged for the secondary market.

The unique loan identifier and mortgage loan repository are central to the efforts by the ASF Project RESTART initiative to help rebuild investor confidence in mortgage- and asset-backed securities and restore capital flows to the securitisation markets. The loan ID linked to the CUSIP and ISIN number of the security will help investors track the loan throughout its lifespan and provide a chain of accountability between loan originators and investors, FIRMS says.

David Goldstein, md of FIRMS, says: "It is our mission at FIRMS to give investors a multi-dimensional perspective on risk and we see this partnership with ASF as a critical turning point toward greater transparency into the individual loans that make up the mortgage- and asset-backed securities markets."

He adds: "By leveraging our strengths in managing some of the world's most well regarded reference databases, along with our deep insights into the credit markets, we look forward to playing a central role in restoring investor confidence in the securitised loan market."

Tom Deutsch, deputy executive director of the ASF, explains: "This partnership with FIRMS allows the market to develop better infrastructure necessary to develop commonly accepted and widely used standards for transparency, due diligence and risk retention. The creation of unique loan-level identifiers is an enormous step forward in the process of creating more transparent information on underlying collateral in securitisations."

The loan ID and its accompanying industry mortgage loan database will enable investors to perform ongoing analysis of the underlying collateral and portfolio, as well as to monitor loans when they change servicers. In addition, the ID creates standardisation in connecting and reporting monthly performance data of a loan, along with valued data from third-party providers like credit bureaus.

FIRM notes that the loan ID is not intended to replace the servicers' primary loan key, but rather to be a consistent piece of data that would not change on a loan as it is moved between entities after the loan has been securitised.

Investors

Investor taskforce urges reform

A report issued by the Investors' Working Group (IWG) states that bold reforms are necessary to restore investor confidence in US financial markets. The IWG is a blue-ribbon panel of experts chaired by two former SEC chairs, William Donaldson and Arthur Levitt. The group, sponsored by the CFA Institute Centre for Financial Market Integrity and the Council of Institutional Investors, has advocated a series of immediate fixes for the financial regulatory system and careful consideration of long-term solutions.

In 'Report on Financial Regulatory Reform: The Investor's Perspective', the IWG urges policymakers to adopt reforms that make the US financial regulatory system more comprehensive, effective and in tune with the needs of investors. This collaborative effort offers an investor-centric perspective and notes that financial institutions and players are regularly the primary beneficiary of US regulation, at the expense of investors, the IWG says. The report also cautions that some changes will take time, thoughtful analysis and political will.

The IWG's proposals for reform call for the strengthening and reinvigorating of existing federal agencies responsible for policing financial institutions and markets, as well as protecting investors and consumers. They also call for all standardised (and standardisable) OTC derivative contracts to be moved to regulated exchanges.

In addition, investors need better tools to hold directors accountable, so they will be motivated to challenge executives who pursue risky strategies. Finally, the creation of an independent systemic risk oversight board unaffiliated with existing regulators is necessary to gather information and make recommendations to function regulators.

"Too often politics and special interests get in the way of doing what's right for investors," says Levitt, who chaired the SEC from 1993 to 2001. "The IWG's inclusive, pragmatic and balanced approach to understanding other proposals and what investors truly need has resulted in a series of actionable recommendations, with a longer-term view toward more comprehensive regulatory structure, stronger oversight and better-governed companies."

"The task before policymakers is challenging, but it presents an opportunity to create a more stable, transparent and adaptable US financial market," says Donaldson, who chaired the SEC from 2003 to 2005. "The IWG strongly seeks more investor protections and a system of checks-and-balances for managing systemic risk. We look forward to advising members of Congress and the Obama Administration on what steps are needed to ensure regulation serves the needs of investors, consumers and the broader financial system."

Investors

Britannia closes tender offer

Britannia Building Society has released the results of its tender offer for the Class A2 tranches of its Leek 17, 18 and 19 programmes. The lender bought back the full £100m worth of notes, with prices ranging between 80.5%-78.5% for Leek 17, 78.5%-76.5% for Leek 18 and 77%-71% for Leek 19.

Ratings

Holmes affirmed on restructuring

Fitch has affirmed notes from the Holmes Master Trust programme following its restructuring. The notes are backed by mortgage loans originated by Abbey National.

Pursuant to the restructuring, a second funding company and a further master issuer have been established - Holmes Funding 2 (Funding 2) and Holmes Master Issuer 2 (HMI 2) respectively.

HMI 2 has assumed the obligations of the Holmes Master Issuer 2007-3 notes, 2008-1 notes and 2008-2 notes. The ultimate position of investors following the completion of these arrangements is the same as previously when HMI 2 had issued the 2007-3 notes, 2008-1 notes and 2008-2 notes.

Following the restructuring, credit enhancement for the Class A notes of Holmes Funding totals 8.59%, which is provided by the subordination of the Class B (2.13%), Class M (1.24%) and the Class C notes (2.37%), as well as a reserve account of 2.85%. Credit enhancement for the Class A notes of Funding 2 totals 10.75%, which is provided by the subordination of the Class B (3.27%), Class M (0.86%), Class C (2.49%) and the Class D notes (0.66%), as well as a reserve account of 3.47%. This compares to the credit enhancement levels at the closing of the Holmes 2008-2 issuance on 19 December 2008, when the reserve fund totalled 1.83%.

Fitch has affirmed the ratings of the outstanding notes from each of the nine outstanding issuances under the Holmes master trust programme. Each class of notes in these transactions has a stable outlook. In order to affirm the ratings, the agency carried out a full loan-by-loan default analysis - based on an updated pool cut - and a full cashflow analysis.

Ratings

Asia Pacific tranches default, downgraded

Fitch downgraded 101 tranches (including public, private, international and national ratings) during Q209 in the Asia-Pacific region, while seven were upgraded. Additionally, 139 tranches were affirmed, accounting for nearly 11% of all outstanding tranches rated by the agency in the region.

Alison Ho, director and head of performance analytics in the agency's Asia Pacific structured finance team, says: "CDOs accounted for the majority of downgrades this quarter as the first Asia-Pacific tranches defaulted, as tranche credit enhancements were permanently eroded following final settlements on several high profile investment grade corporate credit events triggered in previous quarters. Tranche defaults, as a result of the final settlements, led to the downgrades of eight corporate CDO tranches to D during the quarter."

Ho adds: "Three tranches from the troubled Mobius ELR-01 transaction were also downgraded to D during the quarter, although this was due to circumstances specific to this transaction and is not indicative of wider credit issues in Australian ABS."

There were a total of 58 CDO downgrades, 12 ratings on which were simultaneously withdrawn, following tranche defaults and subsequent note cancellations by issuers. Two Indian corporate entities were also downgraded in Q209, resulting in the downgrades of 24 series from 20 single loan sell-down transactions. In Japan, seven ABS tranches were downgraded as a result of similar rating actions on life insurers, to which the ratings are linked.

All of the tranches whose ratings were placed on rating watch negative (RWN) in the second quarter are from Japanese CMBS transactions, predominantly as a result of Fitch's review of transactions exposed to liquidation-type loans. In July 2009, a further 130 tranches from 31 large loan Japanese CMBS transactions were placed on RWN, as defaults on maturing loans and loans becoming due in Fitch-rated CMBS reached 53% in H109. This reflects the limited availability of finance for real estate, given current market conditions, compounded by the uncertainty on commercial property values and the gloomy economic outlook for Japan.

At the end of June 2009, 157 tranches in Asia Pacific had negative outlooks, an increase from 107 at the end of Q109. Australian RMBS accounted for the majority of these - mainly as a result of outlooks on the lenders mortgage insurers - with Japanese CMBS and Indian single loan sell-down transactions also having a sizeable number of negative outlooks.

But seven tranches from two well-seasoned Australian small balance CMBS transactions were upgraded, as asset performance has been good and credit enhancement built up, following the redemption of senior notes.

RMBS

Alt-A/subprime RMBS downgraded

S&P has lowered its ratings to D on 864 classes of mortgage pass-through certificates from 797 US RMBS transactions from various issuers. The agency removed 90 of the lowered ratings from 85 of the downgraded transactions from credit watch with negative implications.

In addition, 434 ratings from 60 of the affected transactions were placed on watch with negative implications. The ratings on 673 additional classes from 85 of these transactions remain on watch with negative implications.

Approximately 88.08% of the defaults affected Alt-A or subprime collateral. The 864 classes that defaulted consisted of 451 classes from Alt-A transactions (52.20% of all defaults), 310 from subprime transactions (35.88% of all defaults), 61 from prime jumbo transactions, 18 from closed-end second-lien transactions, 10 from re-performing transactions, seven from outside-the-guidelines transactions, two from document-deficient transactions, two from risk-transfer deals, one from a HELOC transaction, one from an RMBS "other" transaction and one from a re-REMIC transaction.

The downgrades reflect S&P's assessment of principal write-downs on the affected classes during recent remittance periods. The watch placements reflect the fact that the affected classes are within a group that includes a class that defaulted from a single-B minus rating or higher. The agency lowered approximately 85.53% of the ratings on the 864 defaulted classes from the triple-C or double-C rating categories, and it lowered approximately 95.61% of the ratings from a speculative grade category.

S&P expects to resolve the watch placements affecting these transactions after it completes its reviews of the underlying credit enhancement. The agency will continue to monitor its ratings on securities that experience principal write-downs and adjust the ratings as appropriate.

RMBS

New mortgage servicing platform launched

Exact Mortgage Experts has launched its Intelligent Mortgage Servicing platform. The platform uses predictive credit analysis to facilitate proactive mortgage account administration and collection strategies, delivering improved performance for lenders and borrowers. Exact clients can access 100% up-to-date management information on the performance of their book at any time.

Alan Cleary, md of Exact Mortgage Experts, says: "In the past servicing has been seen as a dull, process-driven series of cogs - send out a letter, send out another letter, send out a third letter. That attitude has to change... a badly managed mortgage book has the power to bring an organisation to its knees - we've already seen it happen."

Proactive credit analysis starts from day one, according to the firm, ensuring that optimum collection strategies are selected for each individual borrower. As mortgage arrears rates rocket, managing the collections process efficiently is swiftly becoming the main concern for lenders.

Exact's Intelligent Mortgage Servicing is a new approach to mortgage servicing - effectively Exact can monitor the credit performance of existing customers to identify changes in behaviour and provide updated risk assessment. This knowledge means Exact can apply an intelligent and appropriate collections strategy to loans, satisfying both TCF requirements and making the most efficient use of a lender's servicing budget, it says.

"A one-size-fits-all approach to borrowers in arrears just isn't good enough anymore," concludes Cleary. "The third-party servicing sector is long overdue for a shake-out - people have got complacent in their attitudes to servicing and there's no place in this market for lenders who don't treat their customers fairly."

SIVs

SIV ratings withdrawn

Moody's has withdrawn its ratings assigned to the Euro and US MTN and CP programmes of Tango Finance, a SIV managed by Rabobank International. As of 9 July 2009, Tango had repaid all debt securities issued under its senior debt programmes in full. The vehicle has indicated that it will not seek to issue any further debt securities under its senior debt programmes.

Technology

Growth in online brokerages examined

Online brokerages and the option of self-service are set to continue growing, according to a new report from Celent. In the report, the consulting firm finds that while poor markets and a declining number of advisors push more and more investors towards a self-service environment, many online brokerages are creating and enhancing strong value propositions.

Improvements in online platforms in terms of capabilities and trading sophistication, coupled with the growing presence of derivatives (including credit derivatives), equities and foreign exchange in the online brokerage world, are contributing to the sector's growth.

The report also highlights the role of 'Generation Y', or those born between 1980 and 1995, in the growth of online brokerages. It finds that this age group is comfortable with online delivery channels and is more likely than older generations to research, apply for and access financial products online. They tend to be more self-directed in their investment strategies than other investors and with relatively few investable assets, which is a segment that is underserved by full-service brokerage firms.

In addition, Generation Y is very comfortable using and benefiting from social networking sites, according to the research. To capture these customers, online brokerages are introducing new features, including social networking, aimed at this segment.

"Online brokerages continue to develop at the speed of the internet. Business models are quickly changing to reflect the different value propositions that individual client segments find most appealing," says Isabel Schauerte, Celent analyst and co-author of the report.

She adds: "New technologies are leap-frogging outdated systems and those firms that are willing to invest and adapt, both in terms of technology and a strong client experience, will be future online brokerage winners."

Investors

Much-awaited PPIP finally announced

Barclays Capital securitisation analysts Sandeep Bordia, Jasraj Vaidya, Glenn Boyd, Aaron Bryson and Sandipan Deb present their initial thoughts on the PPIP's valuation implications

The PPIP programme for securities was finally announced after months of anticipation. In this publication, we summarise our preliminary understanding of programme structure and cashflow waterfall mechanics, and present our initial thoughts on valuation implications.

Although not as powerful as TALF, this does 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 the next several months. For now, we maintain our neutral stance in both resi-credit and CMBS, but look to add selective long positions in areas that PPIP is likely to benefit the most.

Introduction
At the outset, we point out that there are several unanswered questions. They range from the interpretation of the cumulative net interest income cap to uncertainty as to the eventual TALF eligibility of any RMBS, or currently ineligible CMBS assets. In addition, some PPIP documents have yet to be released (e.g. Schedule A). However, the existing documents provide many details about the nature of the partnership and the financing structure.

The Treasury expects the nine chosen funds to complete fund raising and close the first round "as soon as practicable", but no sooner than 4 August 2009. The Treasury earlier estimated that the process would take about 12 weeks. The general partners (GP) of the fund can also have two additional closings for the fund no later than six months from the first closing date.

Investment term
The partnership will dissolve eight years from the closing date and can be extended for two consecutive one-year terms at the discretion of the GP. The partnership can fund capital commitments to make new investments during the first three years after closing, which is called the 'Investment Period'. The investment period can be terminated at any time after the first-year anniversary by the US Treasury.

Eligible securities
Eligible assets include CMBS and non-agency RMBS securities issued prior to 2009. These securities are required to have been rated triple-A by at least two rating agencies and be backed by loans and leases and not other securities. This would keep re-REMICs outside the universe of eligible securities. We estimate that about US$1.381trn of non-agency RMBS and US$216bn of CMBS securities in notional terms satisfy the above criteria (see below figure).

For short-term temporary investments, the partnerships are required to invest the money in cash, US government securities or money market funds that invest in US government securities.

Restrictions on hedging
The partnership's investment objective is to generate returns through opportunistic long-term investments. Thus, the partnership is not allowed to take any negative credit exposure.

To this effect, no credit hedging of any sort is permissible. Only the use of interest rate derivates to hedge the mismatch between invested assets and funding is allowed.

The GP or its affiliates are also restricted from investing in any similar fund targeting the eligible assets without permission from the US Treasury other than in certain circumstances. GPs are also restricted from trading with any affiliates or other GPs managing PPIPs.

How does PPIP distribute its cashflow?
To understand the potential price effect of PPIP on legacy securities, we first need to understand the cashflow waterfall, especially from the standpoint of the equity. There are two levels of the cashflow distribution in the PPIP structure (ignoring TALF debt, if any).

First, the cash needs to be allocated between the UST debt (full or half turn) and the partnership (see below figure). Second, the partnership cashflows are divided between the partners in the PPIP and to the warrant holder.

EOD drives cashflow allocation to equity
The distribution of cashflows between the PPIP and the UST debt follows different waterfalls depending on whether the PPIP structure is in an event of default. The conditions determining whether the PPIP is in an event of default are described below:

• Non-payment of loan at maturity.
• Breach of representation and warranties made to the UST for the debt.
• Violation of any of the covenants of the debt, except for the asset coverage test (ACR) and the leverage ratio test.
• Bankruptcy of either the partnership or of the financing subsidiary or the general partner (asset manager).
• Cross-default on debt of the borrower or of the financing subsidiary. This is an important consideration for asset managers when they are trying to decide the amount of leverage they want in PPIP. Our interpretation of this language is that default on the TALF borrowing (or a put back) would be considered as an event of default on the PPIP. This means that even if the TALF option to put the bond back to the Fed was exercised, the PPIP structure would be in default and would trigger a deleveraging as well as an increase in the funding cost. If our interpretation is correct, then the TALF put back option would be nearly worthless for the PPIP, making TALF borrowing less attractive for the PPIP than for a non-PPIP investor who uses TALF.

Waterfall (no event of default)
If no event of default is in place, cashflows to the PPIP are allocated in the following order of priority:

1) Pay administrative expenses.
2) Pay on interest rate hedges, other than to terminate.
3) Pay interest to the UST debt and any other non-principal payments.
4) Top-up the required interest reserve amount. This is set at expected interest payable in steps 2 and 3 over the next three months.
5) If the asset coverage test fails, then pay principal on UST debt till the test cures. Asset coverage test is defined as MV (Assets + Equity in Financing Subsidiaries)/Debt Outstanding. The test passes if the ratio is above 2.25 for half turn and above 1.5 for full turn of leverage.
6) Termination payments on interest rate hedges attributable to counterparty default.
7) During the investment period, the general partner (asset manager) has the option to do one of the following or do nothing:
a. invest in temporary assets (cash or equivalents).
b. invest in eligible assets with or without additional leverage.
c. prepay some proportion of the loan from the UST.
8) After January 2010, PPIP can make interest payments on the equity. These cumulative payments cannot be more that the minimum of 8%, cumulative net interest income for the borrower in the last calendar year in any calendar year. This, however, can only be done so long as the asset coverage ratio after paying the interest is higher than 300% on half turn and 200% on full turn.
9) Pay down the debt principal in the following schedule. So in the first three years, the debt and partnership (equity) are paid pro-rata to the original contribution. After Year 3, the debt is deleveraged at a faster pace than the first three years. After Year 5, all excess cashflows are used to pay down principal on debt. This has important price implications for securities that expect to get most cashflows in first few years versus ones that are locked out for a few years.
10) Any additional cashflows after paying the debt in step 9 (pro-rata share for the equity) is paid to the partnership or are used for prepayments if the general partner chooses.

Waterfall (event of default)
1) Pay administrative expenses.
2) Pay on interest rate hedges, other than to terminate.
3) Pay interest, principal and other non-principal payments to the Treasury debt.
4) Termination payments on interest rate hedges attributable to counterparty default.
5) Paid to partners. This is the net return from the investment and it gets paid to the partners as follows.
a. pay pro-rata to all partners until 100% of the original contribution is paid out.
b. after that, pay 100-warrant percent of the cashflows to partners and the rest to the warrant holder.

To summarise, any excess cashflows after paying coupon to the debt and equity are applied pro-rata for the first few years if the structure is not in default. However, in an event of default, the deal starts to deleverage sooner, with all cashflow going exclusively to pay down the debt.

Asset coverage test
One of the significant covenants on the UST debt is to maintain a minimum ACR.

Market value of total assets
of the partnership net of any
third party or TALF Debt

Asset Coverage Ratio = -------------------------------------------------------------------------

Principal amount
of treasury debt

The asset coverage ratio has a threefold effect on the PPIP:

1) If the ACR falls below 2.25 for half turn and 1.5 for full turn, then the PPIP's cashflows are diverted to pay down debt until the ACR reaches these thresholds.
2) No further borrowing is allowed if ACR is below 2.25 for half turn and 1.5 for full turn.
3) The partnership gets paid carry from the returns only if after paying the carry the ACR is above 3 for half turn and above 2 for full turn.

To calculate the ACR, market value is determined in a multi-step process. The recent bid-side price from an independent pricing service is most preferable, followed by bids from multiple independent broker-dealers and finally a fair value model-based approach. If no actual bid is found within 180 days, then the asset is marked to 0.

Because the ACR is calculated based on market prices, this adds a component of mark-to-market volatility to the risk for the PPIP's cashflows and makes it less attractive compared with a TALF-like structure. Although this can be significant, we note that the ACR is calculated at the portfolio level, so prices will need to decline in a secular fashion by about 25% from their initial levels for the PPIP to fail this test.

How many turns?
One of the big decisions that PPIP managers face is to decide to what extent they will use the leverage available through Treasury loan to the PPIP. They have primarily three options to choose from (described in the figure below):

• No UST debt: Can borrow from TALF or third-party without any additional constraints. However, this would have no competitive advantage versus a third-party fund using TALF.
• Full turn of leverage: This option allows the PPIP to get 1:1 financing on its equity. However, no additional leverage can be used (including TALF).
• Half turn of leverage: This option 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 5:1combined leverage ratio.

Half turn least attractive
Although the half turn option might seem attractive at first glance owing to the higher maximum possible leverage, the TALF leverage with the half turn option comes with several catches. One of the main factors that make TALF borrowing attractive is the non-recourse nature of the funding and the option it provides to be able to put the bond back to the Fed and walk away from the loan. It seems that a TALF put-back will not be considered an EOD and thus might make half turn a little more interesting.

There are two additional reasons why half turn may not be as attractive to asset managers. First, funding cost for half turn is higher. In event of accessing any leverage outside PPIP, the funding rate on Treasury loan would be 100bp higher than the other source because PPIP debt would be junior to the new debt.

Second, TALF currently is available only until end of 2009 and may provide a narrow time frame for the PPIPs to use. There is some likelihood that TALF could be extended beyond the end of the year, but it would be vital for managers to know about this before they can make an informed decision on whether to use half or full turn of leverage.

Finally, the option available for full turn to be converted to half turn is available for only a very small additional warrant fee. This means that if either TALF or other third-party funding prospects improve at some future time, the PPIP can switch from the full to the half turn option and use the additional leverage.

PPIP implications on pricing
There are two primary ways in which the PPIP should affect the markets.

Demand/supply
The plan should result in US$30bn-US$40bn in additional demand for legacy RMBS and CMBS combined (nothing else is eligible for now). Although a far cry from the initial US$300bn-US$400bn for securities, it is still a very meaningful number in terms of new demand.

We estimate the typical traded volume in non-agencies and CMBS combined to be about US$2bn per week in market value. This implies about 15-20 weeks of supply at current levels and should serve as a strong demand technical. Granted that raising US$10bn in private capital may not be easy and trading volumes could also go up meaningfully, but this should still be a positive demand supply technical.

Fundamental valuation
The primary way PPIP has an impact on valuations is by providing 10-year non-recourse leverage (1:2 or 1:1). In some sense, it is similar to TALF funding, but with clear differences.

Understanding these differences will help explain some of the PPIP implications on the valuation front. The figure below summarises the key differences between the two, along several dimensions:

• For securities that are eligible for both the programmes, the relative attractiveness will primarily depend on the price of the security. A higher priced security will have a smaller haircut in TALF and vice versa. As such, TALF financing should be more attractive for higher priced securities. To the extent investors can double dip by taking advantage of both, it will be even more attractive.
• There are likely to be several lower priced triple-As that will either be ineligible for TALF (mezzanine bonds) or will have very large haircuts as percent of price. In these cases, PPIP should provide a new avenue for leverage and benefit pricing. Some of the securities that benefit would be lower priced option ARM and hybrid super-seniors, mezzanine triple-A bonds and penultimate/LCF subprime triple-As.
• There should be some indirect positive effect on ineligible securities as well, as demand drives yields lower on eligible securities.

© 2009 Barclays Capital. All rights reserved. This Research Note is an extract from 'Much awaited PPIP finally announced', first published by Barclays Capital Securitised Products Research on 10 July 2009.

Trading

Trading ideas: green shoots

Dave Klein, senior research analyst at Credit Derivatives Research, looks at an equity outperform trade on Monsanto Company

Since mid-February, Monsanto's CDS level tracked closely to expected fair value. Recently, this relationship broke down as the company's CDS hovered around 60bp and fair value continued to drop.

This leads us to believe that Monsanto's credit will outperform the broader market in the medium term. When looking at the company's capital structure, the best place to take advantage of this improvement is by taking a beta-hedged long equity position.

Our CSA model provides a short-term view on the relative value of a company's CDS compared to its equity and implied vol. Longer term, we believe the two securities will revert back to their classic inverted relationship (CDS widens/equity drops, CDS tightens/equity improves). That is, credit and equity improve and deteriorate together over the medium to long term.

The figure below charts market and fair value equity levels for Monsanto. Additionally, we forecast an equity time series by combining our CSA and directional credit fair values.

Our CSA model points to equity trading too cheap and CDS trading too tight. Our directional credit model points to medium-term improvement in Monsanto's CDS levels based on its margins, free cashflow, interest coverage and leverage. Earlier this year, our directional credit model became moderately bullish on Monsanto and, more recently, our fair value CDS level pushed even tighter as the company's CDS traded flat.

The figure below charts Monsanto's five-year CDS against its equity. The red line indicates the fair value curve for five-year CDS given equity price. The blue squares indicate historical market levels.

The green circle shows the current market level and the red square indicates our expected levels in three months. The yellow circle shows the current fair value levels when implied vol is also considered. Given that current market levels are below the red line, we expect a shares rising and CDS widening to bring Monsanto back to fair.

Our model-implied three-month target for Monsanto shares is US$112. Since we are recommending going long against a short SPY hedge, we would not place a specific stop on the trade. We will look to exit when one of two events occurs.

First, we will exit if Monsanto reverts to fair value, eliminating further profit potential. Second, if Monsanto continues trading too cheap over the next four months, then we must assume that the company is trading under a new CDS/equity/vol relationship and the trade will be re-evaluated for potential exit. Overall, we view this as a short- to medium-term trade.

Position
Buy 10,000 shares Monsanto Company at US$75.67.
Sell 7,900 shares SPDR Trust Series 1 at US$94.24.

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).