Contents

RMBS

Lessons learnt?

Signs of life in primary US RMBS market

The long-dormant US RMBS primary market is seeing flickers of life, with a handful of deals being prepared. The new prime and subprime deals appear to have taken heed of rating agency and investor requirements, and are conservatively structured with better credit quality and underwriting standards. Investor appetite is expected to exist for the transactions, should they launch, with first-to-market issuers likely to have the advantage.

"I believe there would be demand for new-issue RMBS," says one US-based RMBS investor. "There is a roll to be played by the private sector to fund new agency and non-agency RMBS, although we'll have to see big changes in the underwriting standards and the integrity of the structures of the deals."

He adds: "That current gap in the market (i.e. investment capital for new RMBS) needs to be filled and it will happen - slowly but surely. Issuers will find a way to structure new deals that fills investors and rating agency requirements. I also believe that early entrants to the scene will have some advantage - particularly with pricing."

DBRS says it has received a series of requests to evaluate new US RMBS structures over the past few weeks. Out of the 12 requests recently submitted to the rating agency, there is an equal split of prime and subprime pools, along with a liquidating trust and a FHA/VA proposal.

Seasoning on the prime and subprime pools range from one month to eight years, with an average seasoning of two to three years. Collateral backing these transactions have all been positively selected. Delinquent loans and second liens are generally removed, and some pools contain only fixed rate mortgages.

"The more recent or the highly seasoned pools are considerably better in credit quality and underwriting standards," note analysts at DBRS. "They also have substantially lower current loan-to-value (LTV) ratios generally in the 50% to 60% range, while the pools originated in 2005-2007 all have current LTVs well exceeding 100% due to significant home price declines."

The agency has already assigned ratings to Citigroup Mortgage Loan Trust Inc (CMLTI) 2009-A. The transaction contains extremely prime collateral, according to DBRS. The loans are on average 73 months seasoned first-lien, 15-year fixed-rate mortgages secured by one- to four-family residential properties.

As of the cut-off date (1 June 2009), the loans had a weighted-average mortgage rate of 4.89% and a FICO score of 751. The average original and amortising LTVs are 54.3% and 36.0% respectively, based on the original appraised values.

Meanwhile, the US$30bn-US$40bn of capital provided by PPIP's launch is resulting in a robust secondary market for legacy RMBS. Spreads across the asset class are subject to tightening, with option ARM and fixed rate deals subject to the most tightening.

"PPIP technicals mean that we can likely move another 10%-20% higher in subprime RMBS prices," agree securitisation strategists at JPMorgan.

The RMBS investor remains cautious over the PPIP-induced rally, however. "The entry price is very important. As the price for the assets escalates up, there is less margin for error," he concludes.

AC

Trading

Seasonal protection

Credit portfolio managers prepare for likely market 'events'

After a strong second quarter, credit portfolio managers now face a summer period when market depth is likely to decrease even further than it has already. At the same time, the summer and early autumn months typically experience a higher-than-average instance of market 'events'. Some investors are consequently considering putting on seasonal protection trades.

Summer liquidity cuts both ways in terms of market events, according to Adam Cordery, head of European/UK credit strategies at Schroders. "At a time of low liquidity, a negative event means that corporate bond prices will gap down, but if there is no negative event at a time of low liquidity prices can easily gap higher," he explains. "The market is already seeing that happen this summer: liquidity is declining, but corporate bonds are performing really well."

The kind of market events that could potentially occur during the summer/early autumn include: nationalisation of the Irish banking system; a risk flare in currency-mismatched Eastern European sovereigns; further collapses of over-leveraged, liquidity constrained financial institutions; and choppy macro-economic data fallout from the rise of national and municipal government deficits. But a number of mitigants, all with asymmetric risk pay-offs, can be incorporated in portfolios to provide seasonal protection against adverse market events.

One is to sink premiums into an out-of-the-money payer option on a credit index, which - if it subsequently widens - will move the position into-the-money. "But an investor has to consider how much premium they expect to give up to achieve this, as well as the probability of a negative event happening. The trade is asymmetric to the extent that the fixed cost of the option is justified by the pay-off in the event of a negative tail event. The downside is that, if there is no tail event, the premium is gone," notes Cordery.

Another seasonal protection trade is via a short CDS basket of financial and sovereign names. A number of banks have experienced strong spread tightening year to date, with subordinated CDS now trading inside of 200bp-300bp.

Schroders believes that this is an expensive level for banks that remain extremely overleveraged, both versus their own historical standards and other banks. The authorities are faced with managing down this leverage - a difficult task, given that assets on bank balance sheets are far from stable.

Negative basis trades can also be tactically employed to provide seasonal protection. Derivative instruments tend to underperform cash instruments when risk rises sharply. By buying bonds and hedging their default risk with CDS, credit portfolios can earn a positive premium while also benefiting from the sharper likely move between derivatives and cash bonds in the event of a risk flare.

However, the big issue at present for most credit portfolio managers is when to re-risk. Many investors are sitting on cash or government bonds, which are yielding very little, and the question for them is when to start buying riskier assets.

"Some investors are holding off because they expect more volatility to hit the market and to provide them with buying opportunities, but if lots of people are doing that the market may not get a whole lot of volatility," Cordery adds. "For a major sell-off to occur, the market would need to see some major new bad news."

He says that the key for investors is to think about where they expect prices to be in a year's time. If they expect prices to be materially higher, it makes sense to enter the market today. On the other hand, if investors see value today but are too nervous about near-term volatility to pull the trigger, Cordery suggests they could follow a 'dollar-cost averaging' strategy, investing each month or quarter a fixed fraction of the money they have to put to work.

CS

ABS

Alternative routes

Dysfunctional ARS market continues to hamper origination

A dysfunctional auction rate securities (ARS) market continues to hamper, among other asset classes, US student loan origination. While it seems clear that issuers will have to leverage alternative sources of funding for these deals going forward, the ARS sector is expected to be increasingly dominated by refinancing activity.

The continued failure of the ARS market for student loans is putting pressure on student loan origination, according to Brian Weber, senior associate at Houlihan Smith & Co. However, the fact that spreads on student loan ABS have fallen recently (from approximately 450bp over Libor at end-December to 180bp over) is positive for ARS issuers in terms of the ability to refinance.

"If spreads fall to around the 100bp level, it would make it more economical for issuers to refinance/remarket many securities," Weber explains. "Historically, spreads averaged 10bp over and the auctions began failing when spreads rose above 150bp. Some auctions are still likely to fail, but people will eventually begin to realise that they're paying more than they perhaps need to."

Student loan ARS are typically considered to be the best quality ARS, due to high collateral ratios and/or FFELP guarantees, and have historically accounted for 40%-50% of total issuance in the sector. A few issuers have tried to support their deals by increasing transparency around the assets and/or providing liquidity facilities, but cost of funds is a problem.

"If an issuer has cash, they can earn more by originating new loans, so there's no incentive to go to the auction market. Investor comfort around student loan ARS has increased recently and increased liquidity has restored bids in the sector, but nobody's accepting the bids because holders feel that the haircut remains too big for securities that are essentially money-good," adds Weber.

One ABS trader notes that there is significant policymaker pressure to restart the student loan ABS markets. He indicates that one potential method of doing so is through relaxing underwriting standards to facilitate origination - though he suggests that investors would likely only buy these securities if they have FFELP guarantees. Connecticut Higher Supplemental Loan Authority is the latest issuer to come to the market, with a US$30m private student loan deal.

The US SEC sought to establish a transparency framework for municipal ARS and variable rate demand obligations (VRDO) in January, although no such formal move has been made for the student loan sector. The new framework involved implementing an electronic system that would collect and disseminate ARS and VRDO information; provide free public access to information disseminated from the Short-term Obligation Rate Transparency (SHORT) system through the Municipal Securities Rulemaking Board's Electronic Municipal Market Access (EMMA) system; and amend Rule G-34 on CUSIP numbers and new issue requirements to require dealers to report interest rate and descriptive information to the SHORT system about ARS and VRDO following an ARS auction or VRDO interest rate reset.

While the ARS market is unlikely to return for new originations, Weber expects it to be used for refinancing going forward. "ARS refinancing will be a trend for 2010. Alternatively, issuers could tap the market via variable rate demand notes or straight ABS bonds."

CS

ABS

Private-label issuers outperform in credit cards

Against the backdrop of weaker consumer credit performance and the evolution of credit enhancement in credit card trusts (SCI passim), ABS analysts at Wells Fargo Securities have tiered the major credit card ABS issuers that they track by their excess spread and charge-off rates. The larger general purpose credit card issuers (CHAIT, COMET, CCCIT), as well as DCENT and AMXCA, all fall within a relatively tight range.

The exception is the BACCT trust, which has been reporting increasingly high charge-off rates over the past three months. In addition, the WMMNT trust outperforms all others due to the removal of legacy subprime receivables from the pool.

"Private-label credit card ABS issuers tend to outperform under this analysis," notes Glenn Schultz, md and head of ABS and mortgage research at Wells Fargo. "In the past few months, they reported lower charge-off rates and higher excess spread than their general purpose counterparts. They generally are also required to have more credit enhancement than bank card issuers. As a result, the wider credit spreads usually associated with private-label credit card ABS would indicate better relative value."

However, he points out that not all risks are captured in such an analysis. Larger commercial banks and financial institutions may have deeper resources to support their ABS trusts, for example.

Furthermore, many have already received substantial government support to stabilise the financial system. "It does not seem likely that retailers would receive the same kind of support, in our opinion. Thus, the servicing risk is still probably higher in private-label credit card ABS relative to bank card issuers, despite lower charge-offs and higher excess spread. Nevertheless, we still view non-benchmark credit card issuers as presenting good relative value opportunities for ABS investors," explains John McElravey, director, ABS & MBS research at Wells Fargo.

The actions taken by issuers to bolster their credit card ABS deals include adding new classes of subordinated debt and utilising the principal receivables discount option, while servicers have added or removed receivables to influence credit metrics.

Among the major credit card issuers, Capital One remains the only one that has made no major changes to its credit enhancement or to discount receivables. In fact, until recently, its credit enhancement was higher than many other master trusts and its credit performance was better than the industry average.

Nevertheless, Moody's downgraded on 1 July the COMET Class C and D bonds from Baa2 to Ba1 and Ba2 to B1 respectively. The agency cited increasing charge-off rates and a decline in the principal payment rate as the primary reasons for the action. Furthermore, Moody's indicates that the spread account used as credit enhancement for Class C notes would not provide adequate credit protection to maintain the ratings.

Indicative spreads for three-year triple-A credit card floaters are currently at 145bp over Libor for CHAIT paper, while CCCIT paper is 5bp wider, BAACT and AMXCA 20bp, COMET 50bp and DCENT 80bp wider than CHAIT. BACCT triple-A paper last week widened by 10bp-20bp when Moody's placed all classes of the trust on review for possible downgrade.

The action affects approximately US$64.4bn of securities, backed by a US$93bn revolving pool of unsecured consumer bank credit card receivables. According to Moody's, the review is primarily driven by a pronounced acceleration of the trust's charge-off rate in recent months. Specifically, the gross charge-off rate has jumped by almost 50% in the past three months, up from 9.6% in March to 14.1% in June.

Also being reviewed is the trust's recently-implemented discounting mechanism, which is working as anticipated to increase yield and excess spread, but is set to expire in September 2009. While it is expected that Bank of America will extend the discounting beyond September, it is under no obligation to do so. If discounting is discontinued, the yield would begin to fall over a period of several months by up to approximately five percentage points and make early amortisation more likely, according to ABS analysts at JPMorgan.

Moody's review will primarily focus on the bank's ability to address and mitigate the risk of further deterioration in trust performance, as well as any indication of its intent to extend discounting beyond September 2009.

CS

Clearing

Euro CDS CCP, buy-side solution launched

Eurex Clearing has partnered with Calypso Technology to support its new clearing service, Eurex Credit Clear, for OTC CDS. The central counterparty solution was operational on 27 July and is expected to start clearing on 30 July 2009. The move follows ICE's announcement of a solution that provides segregation of customer funds and positions in CDS clearing designed to enable buy-side participation (SCI passim).

The initial product scope of Eurex Credit Clear covers a European CDS product suite of the iTraxx benchmark indices and 17 single name iTraxx index constituents from the utility sector. In a next step, further European single names will be added to provide full coverage of the iTraxx benchmark index constituents.

Eurex Clearing will act as the central counterparty by becoming counterparty to every transaction, netting gross market risk and margining open positions to mitigate counterparty risk. The clearer says its new OTC derivatives clearing service improves market stability on a global scale - enhancing transparency and regulatory reporting, as well as reducing systemic risk for the financial market as a whole.

Thomas Book, member of the Eurex Executive Board responsible for clearing, explains: "We are always looking for innovative ways to expand our central clearing offering and leverage our risk expertise with powerful technology solutions. We are confident that together with the Calypso application we will offer a sound, reliable and flexible engine to deliver central clearing initially for credit derivatives and subsequently also for further OTC traded asset classes."

According to Eurex, the major advantages of Eurex Credit Clear are: comprehensive product scope covering index and single name CDS; full STP integration into DTCC Deriv/SERV Trade Warehouse; state-of-the-art risk management solution specifically designed for CDS; and customer governance concerning product and service scope for CDS, as well as economic participation. Technical readiness for OTC CDS clearing was accomplished as planned by the end of Q109 and the solution is currently providing production simulation for 20 market participants.

The US SEC on 23 July approved a conditional exemption that allows both Eurex Clearing and ICE Clear Europe to operate as a central counterparty for clearing CDS. The new clearing services are also accessible for UK market participants after the FSA's regulatory approval on 24 July.

Backloading of legacy CDS positions onto both platforms are expected to begin immediately. The global gross volume for these derivatives is €3.4trn and the weekly notional volume of new CDS trades in the running series of iTraxx Europe Main is about €40bn. UniCredit strategists expect that a large share of this market will be cleared within a few months' time.

The implementation of the Calypso-based solution was completed in less than four months, leveraging Eurex Clearing capabilities as well as Calypso Professional Services and Calypso Fast-Track, a market standard solution aimed for controlling the costs, risks and timelines associated with implementing new trading and risk applications. Eurex Clearing completed full implementation in March 2009 and is running the service simulation with more than 20 potential clearing members. Market launch will take place by 31 July 2009, to support the implementation of the industry self-commitment given by nine major market participants to the European Commission to use a European CCP for European CDS products.

Eurex says the risk management solution is specifically tailored to the requirements of OTC CDS clearing, based on the Calypso ERS Risk module - an approach that accounts for the specific risk characteristics of individual CDS index and CDS products. It applies sophisticated, market-proven risk analytics (an incremental risk check service) to determine whether a trade should be accepted for central clearing. The clearer plans to expand the risk management services to additional asset classes over time according to market demand.

Book adds: "With the fast implementation of the Calypso application, we have been able to respond quickly to market and regulatory demands to provide a central clearing service for OTC derivatives. The Calypso-based solution provides us with additional advanced risk management capabilities supporting our state-of-the-art risk margining methodology, as well as market standard pricing models; not just for credit but covering all asset classes."

Charles Marston, ceo of Calypso Technology, says: "Eurex Clearing is our first client to deploy the Calypso software system to support the launch of an exchange service. We're very excited to be working with Eurex Clearing on this groundbreaking new development for the derivatives market. We remain at the forefront of innovation for the derivatives market and are partnering with leading market participants to help usher in a new era in derivatives trading."

Meanwhile, ICE's buy-side CDS clearing solution is expected to be introduced in October 2009, subject to regulatory approval. The solution offers a roadmap for the industry's transition to clearing based on participants' specific risk management needs, allowing firms to retain trading relationships and a range of competitive execution models, the clearer says. It is designed to provide segregation of customer funds and positions, as well as enhanced position and margin portability.

The expanded legal framework protects customer positions and collateral in the event that a clearing member defaults on its obligations to the clearing house. These customer protections, together with ICE's rigorous CDS risk model, should provide increased security for buy-side market participants.

The buy-side solution also addresses systemic risk by supporting both new trades and the existing backlog of outstanding OTC CDS contracts at the DTCC Trade Information Warehouse (TIW). ICE's offering accelerates time-to-market by utilising existing market infrastructure and incorporating existing ISDA agreements - eliminating the need for lengthy renegotiation - and supports existing connectivity to all dealers, more than 400 buy-side firms and the TIW through its ICE Link platform. The segregated funds structure was developed through in-depth consultation with buy-side and sell-side market participants and regulators.

Over the coming weeks, ICE will continue to consult with regulators and actively test connectivity with buy-side firms in preparation for the October introduction.

CS

Indices

ABX outperforms on home price data

Structured finance analysts at JPMorgan suggest that the Markit ABX index is "biased to more upside price moves and relative outperformance in the near term". They note that recent strong growth in the FHFA home price index caused risky assets to rally strongly last week, with ABX a top performer on a relative basis. The index returned an annualised positive month-on-month growth of 10.8%.

Speculation is intensifying about whether the US housing market has reached a bottom. Ron D'Vari, ceo of NewOak Capital, suggests that inventory levels will be a good indicator.

He says: "Once we get inside 10 months' level of inventory based on a realistic sustainable sales rate, we should see home prices to stabilise. Unemployment rate will bottom out ahead of that as companies cut to the bare bone."

Remittance reports for the July distribution date show that a number of ABX sub-indices are benefiting from improved voluntary prepayments and moderating loss severities. Liquidation speeds, however, increased across indices over the prior month.

The latest figures indicate that, after remaining largely unchanged from May to June, default rates rose across indices in July. CDRs are currently 22.4, 25.2, 21.1 and 20.1 for the 06-1 through 07-2 indices respectively; an absolute change of 58bp, 138bp, 155bp and 68bp from last month.

Aggregate 60+ day delinquencies grew faster versus last month for the 07 series, but at a more moderated pace for the 06 series. Aggregate 60+ day delinquencies climbed by 13bp, 48bp, 86bp and 87bp for 06-1 through 07-2 indices respectively, compared with changes of 22bp, 57bp, 77bp and 84bp last month.

"Given the two extra business days and favourable seasonality in June versus May, we would have expected voluntary prepayments to increase this month," ABS analysts at Barclays Capital note. "This materialised with sharp increases in the 06-1 and 07-2 series."

The MLMI 2007-MLN1 and MLMI 2005-AR1 transactions saw large negative curtailments last month, which biased voluntary prepayments downward in May. Excluding these two deals, the difference between June and July's figures narrows by about 30bp, the BarCap analysts add.

Meanwhile, the JPMorgan analysts indicate that the ferocity of anticipation around PPIP has outweighed any market concern about loan modifications. "Given the overall strength of the rally in risky assets [last] week, there is little reason to think that will change in the immediate future as we head into actual implementation of PPIP asset purchases," they say. "But as prices move higher, particularly with the speed seen this week, risk/reward obviously shifts away from ABX. We are not recommending a short, just paring back risk positions."

However, with respect to cash subprime RMBS, the implication is that bond selection and price paid is becoming increasingly important. Consequently, the analysts believe that at some point modifications will return as a risk factor that needs to be considered.

The US Treasury reported on 16 July that a total of 325,000 trial loan modifications have been offered under the Home Affordable Modification Programme (HAMP) so far. However, analysts at Moody's note that in general HAMP has not gained traction.

"Given the infancy of the programme, the vast majority of approved HAMP modifications are still in the initial three-month trial period," they explain. "In the coming months, we expect to see the volume of modifications rolling into a 'closed' status increase substantially."

Moody's believes servicers that implement best practices will be more successful in processing and closing large volumes of modifications than those that do not, with RMBS transactions serviced by these 'best practice' servicers to see a more significant reduction in ultimate losses on their mortgage pools. Ultimately, the agency expects a 10%-15% reduction in ultimate losses on mortgage pools due to the government affordability programmes.

CS

Indices

Protection sellers warned over iTraxx levels

Markit iTraxx Europe protection sellers should not accept spreads lower than about 80bp, if they believe default rates could match the peak levels that Baa credits experienced since 1970, according to credit strategists at BNP Paribas. The call comes as the market approaches these levels on the Main index on the back of better-than-expected earnings and signs of recovery in the US labour and property markets.

The peak five-year cumulative default rate for Baa rated credits has been 5.76%, according to Moody's. Assuming a recovery of 30%, this means that investors should require at least 84bp in order to break even, the strategists note. This spread does not include any other compensation for risk - such as market risk - and investors should therefore require more.

However, the BNPP strategists detail two noteworthy observations. First, the average rating for the iTraxx Europe index is between A and Baa, and peak default rates for A rated companies have been a much lower 2.56%. Second, given the high levels of refinancing in investment grade credit so far this year, it is possible that the upcoming default cycle will be relatively benign compared to earlier expectations - resulting in default rates below the peaks seen since 1970.

"As such, we would not be surprised if the iTraxx dipped below 80bp over the coming months - but investors willing to accept such a low level of compensation should be aware that it would not take a depression for them to fail breaking even," the strategists warn.

CS

Real Estate

REIT restructures financing, management agreement

Arbor Realty Trust has completed a restructuring of its financing facilities, totalling US$374m, with Wachovia Bank and has agreed in principle to amend its management agreement with Arbor Commercial Mortgage as manager.

The restructured indebtedness comprises two term loan facilities with an aggregate outstanding balance of US$332m and a working capital facility with an outstanding balance of US$42m. The maturity dates of the facilities were extended for three years, with approximately US$8m in reductions due every six months beginning in December 2009.

In addition, margin call provisions relating to the collateral value of the underlying assets have been eliminated, as long as the term loan reductions are met, with the exception of limited margin call capability related to foreclosed or REO assets. The financial covenants have also been reduced to include a minimum quarterly liquidity of US$7.5m in cash and cash equivalents, a minimum quarterly GAAP net worth of US$150m and the ratio of total liabilities to tangible net worth shall not exceed 4.5 to 1 quarterly.

The working capital facility requires quarterly amortisation of up to US$3m per quarter, US$1m per CDO, providing that both the CDO is cash flowing to the company and that the company has a minimum quarterly liquidity level of US$27.5m.

Arbor Realty's ceo and chairman, Ivan Kaufman, is required to remain an officer or director of the company for the term of the facilities.

Other than the Wachovia facilities, in Q209 the company also extended two of its financing facilities with an outstanding balance of approximately US$15m for one year, with one-year extension options, and also retired its only other remaining short-term financing facility which had a balance of approximately US$37m.

Kaufman comments: "We are very pleased with our success in restructuring our debt with Wachovia, as well as all of our other short-term debt facilities. This, combined with our ability to restructure our trust preferred securities, has put us in a position where all of our non-CDO debt has been modified and/or extended for the long term."

Meanwhile, the firm has agreed to replace the existing base management fee structure - which is calculated as a percentage of its equity - with an arrangement whereby Arbor will reimburse the manager for its actual costs incurred in managing the company's business based on the parties' agreement in advance on an annual budget, with subsequent quarterly true-ups to actual costs. This change will be adopted retroactively from 1 January 2009 and the firm estimates the 2009 base management fee will be in the range of US$8m to US$9m.

Concurrent with this change, all future origination fees on investments will be retained by the firm, as opposed to the manager earning up to the first 1% of all originations fees in the existing agreement. In addition, Arbor will make a US$3m payment to the manager in consideration of expenses incurred in 2008 in managing the company's business and certain other services.

The percentage hurdle for the incentive fee will be applied on a per share basis to the greater of US$10 and the average gross proceeds per share, whereas the existing management agreement provides for such a percentage hurdle to be applied only to the average gross proceeds per share. In addition, only 60% of any loan loss and other reserve recoveries will be eligible to be included in the incentive fee calculation, which will be spread over a three-year period, whereas the existing management agreement does not limit the inclusion of such recoveries in the incentive fee calculation.

The amended management agreement will allow the company to consider, from time to time, the payment of additional incentive fees to the manager for accomplishing certain specified corporate objectives. The agreement will modify and simplify the provisions related to the termination of the agreement and any related fees payable in such instances, with a termination fee of US$10m, rather than a multiple of base and incentive fees as currently exists.

The agreement will remain in effect until 31 December 2010 and will be renewed automatically for successive one-year terms thereafter.

A special committee of the company's board of directors, consisting solely of independent directors, acted on behalf of the company with regards to the agreement. JMP Securities served as financial advisor to the special committee and Skadden, Arps, Slate, Meagher & Flom served as its special counsel.

Kaufman concludes: "We are very pleased to have reached an agreement with our manager to amend our management contract. We believe the new management agreement more properly reflects the change in the market and the company's current activities in this environment."

JA

Alternative assets

An alternative universe

Edward Torres, president Baldwin & Lyons Capital Markets, argues that the last 12 months have showcased the diversification benefits of insurance-linked securities

Given the challenges facing investment managers today, it is not surprising that many are casting a wider net in search of attractive yields and less volatility. One option, which has received a lot of attention recently, is insurance-linked securities (ILS).

While much has been written about the diversification benefits of this emerging asset class, the last 12 months seem to have finally validated this hypothesis; during the recent market turmoil, ILS consistently delivered attractive/positive returns. Although structural defects in a few bonds exposed these securities to the financial meltdown, the asset class as a whole performed well and remained un-correlated to the wider market.

Background
For those unfamiliar with ILS, they are structured investment products that allow insurers to transfer the risks associated with catastrophes, such as hurricanes and earthquakes to investors; essentially operating as a substitute for reinsurance. The return earned by the investor is a function of the consideration, or premium, the insurer is willing to pay for this 'risk capital'. They come in a variety of forms, most notably catastrophe bonds, catastrophe swaps, industry loss warranties (ILWs) and sidecars.

While intrigued by both the theory and recent performance, many investors continue to associate ILS with 'betting on the weather'. The most common retort to the benefits outlined above has been: "Sure, these have performed well. There hasn't been a large hurricane recently; once that happens you get wiped out, right?"

The reality is that there are a variety of strategies available to ILS portfolio managers, some of which are riskier than others. A common theme across these strategies is that performance is based on the occurrence of fortuitous events.

While this is difficult for many non-insurance professionals to quantify, the insurance industry has a variety of tools available for this purpose. Equipped with these tools, a portfolio manager can select and modify the level of risk they are willing to assume.

High risk/high reward
The most aggressive strategies capitalise on the rapid change in value that can occur while a catastrophe is taking place; this is known as 'live cat' trading. Although trading on US hurricane exposed catastrophe bonds typically slows down during the hurricane season (1 June through to 31 October), there are investors willing to buy these bonds at steep discounts, even as a hurricane is approaching land. These investors may also sell ILWs - derivatives that pay a stated amount if the industry loss produced by the event exceeds a certain threshold.

There is a lot of uncertainty associated with the ultimate magnitude of loss, even within a few hours of landfall. Given this uncertainty, live cat traders must employ sophisticated forecasting models and get paid substantial premiums for assuming the risk.

Low risk/low reward
As with any asset class, the availability of an index provides investors with a benchmark for the market. Swiss Re has produced an index of catastrophe bonds since 2001 - the Swiss Re Cat Bond Total Return Index (Bloomberg Ticker: SRCATTRR:IND). The index tracks the total rate of return for all outstanding US dollar-denominated cat bonds.

Some ILS portfolio managers attempt to mimic the performance of this index and participate across the full range of catastrophe bonds available. With an average rating of double-B and average annual yield since 2001 of 7.5%, the Swiss Re index has outperformed most other high yield strategies since 2001 (see chart below). Portfolio managers attempting to match the index generally limit their participation to catastrophe bonds that have been rated by a rating agency, avoiding ILWs and sidecars.

Managed risk/return
Finally, some portfolio managers employ proprietary models in an effort to optimise the risk-adjusted return across multiple zones and perils. This strategy is premised on an assumption that there are discernable differences between highly similar securities and that the optimal portfolio does not necessarily match the index.

These funds resemble professional reinsurers in their techniques and in their perception of risk. They employ modellers and actuaries, as well as capital market professionals. Recent advances in catastrophe modelling technology, increased availability of data and a consistent sponsor base has established a firm foundation for the asset class.

Measuring the risk
There are a variety of tools available to measure the efficacy of a particular ILS strategy. Most investors utilise ILS to shift the efficient frontier of risk/return in their investment portfolio.

One should be able to measure the 'risk' associated with a portfolio inclusive and exclusive of a potential investment in ILS. Risk is typically defined as the volatility of an investment.

Measurements can include beta, value-at-risk, the Sharpe Ratio or the Omega Function. While each of these measurements has its merits, the ones most applicable to ILS deal with extreme 'tail' events, such as the Sharpe Ratio and the Omega Function.

The exhibit below compares the standard deviation of ILS to equities and high yield bonds.

Conclusion
It is important to recognise that each of the different strategies listed above populates a distinct point on a risk spectrum. In all cases, they allow investors to access an alternative universe of securities with unique characteristics to add to their portfolios.

The correlation between equities and corporate bonds and ILS is demonstrably low. This is particularly relevant to investors interested in attaining the benefits of diversification without giving up yield.

ILS investment strategies lend themselves to a high degree of transparency. An ILS portfolio manager should therefore be able to articulate the strategy employed and place it on the above continuum.

ABCP

Enforcement notices issued in ABCP investigation

Current and former officers of Coventree have received enforcement notices from the Ontario Securities Commission (OSC), following the Commission's investigation into the Canadian ABCP market. Dean Tai, Geoff Cornish, David Allan and Bridget Child were the recipients of the notices, which identify the disclosure issues that have been the subject of the OSC's investigation and indicate that the Commission is contemplating commencing proceedings in relation to those issues.

Following the OSC's acknowledgment in early 2008 that an investigation into the Canadian ABCP market was under way, Commission staff inquired into Coventree's participation in the Canadian ABCP market. The disclosure issues include the sufficiency of the disclosure in the prospectus relating to Coventree's initial public offering that was completed in November 2006, the company's disclosure of its US subprime exposure to customers and dealers during 2007, and the company's compliance with its continuous disclosure obligations prior to 13 August 2007. Coventree cooperated with OSC staff throughout the investigation.

The enforcement notices afford Coventree and the individuals an opportunity to make representations before a decision is taken by the OSC to commence proceedings. The firm is reviewing the notices and will respond to them after it has considered its position.

ABS

Law firm adds partner in London

Morgan Lewis has hired Christopher Harrison as a partner in its business and finance practice, resident in London. Harrison brings nearly 20 years of experience as an English law banking lawyer at several international law firms in London. His arrival follows a recent expansion of the corporate practice across the firm's US offices, with the addition of a finance and restructuring team in Boston and a corporate and tax team in Chicago.

"Chris's arrival reflects our commitment to the strategic expansion of the firm, not only in the US but internationally as well," notes Morgan Lewis chair Francis Milone. "At a time when clients increasingly need comprehensive advice on complex international transactions, Chris's experience further strengthens our finance capabilities."

Harrison has experience in acting for financial institutions, sponsors and corporations on complex domestic and cross-border finance transactions under English law. He has advised on a broad range of finance matters, including acquisition finance, debt restructurings, asset-based lending and project financings.

David Pollak, leader of Morgan Lewis' business and finance practice, says: "Paired with our existing private equity, M&A and tax capacity, Chris will help build and develop our finance practice and expand the range of services for Morgan Lewis clients in London and internationally."

Advisory

CDO head recruited

Dominic Powell has joined Synergy Global Capital - the hedge fund founded in 2007 by Stefano Ghersi, Syd Hanna and Sean Flanagan - as a consultant. Powell was previously global head of the CDO business at JPMorgan Asset Management - a position he held since 2006.

Prior to his role at JPMorgan, he spent 16 years at Henderson Global Investors, where as head of investment solutions he established one of the first structured products platforms in Europe, encompassing a wide range of asset classes including derivatives, high yield bonds, leveraged loans and commercial property. He was previously head of credit for Henderson's predecessor, AMP Asset Management, where he helped establish a segregated fixed income platform.

Advisory

Advisory firm to manage defaulted CDO

Annaly Capital Management's wholly-owned subsidiary Fixed Income Discount Advisory Company (FIDAC) has been appointed as collateral manager to Citation High Grade ABS CDO I, following the transaction's event of default due to downgrades. Citation was issued in January 2007, backed by US$1.1bn original face amount of RMBS.

Wellington Denahan-Norris, Annaly's vice chairman, cio and coo, says: "Ratings-driven EODs, a defining characteristic of today's structured finance market, present senior bondholders with many possible courses of action to maximise their outcome. I'm pleased that our structured products group, led by Choudhary Yarlagadda, is able to provide a range of services in this capacity, including restructuring, portfolio management and liquidation."

Annaly's FIDAC subsidiary is an auction agent for liquidations of CDOs and other portfolios. It was appointed to help restructure Citation to maximise value for the bondholders and to perform asset management services on an ongoing basis.

CDO

CDO jurisdictional issues come into play

UK courts are next week set to decide on jurisdictional issues relating to the Dante CDO. Following Lehman's default, Australian asset manager Perpetual Investments asked the UK courts to enforce the provisions of the contract (SCI passim), but the attorneys for Lehman responded by requesting that the case be moved to the US.

The dispute involves the validity of the priority of payments in the Dante transaction. The waterfall provides for an early termination payment to appear in two different places: above the payment to noteholders in the case that an SPV has experienced an event of default or has been affected by a termination event; or at the bottom of the waterfall in cases where the counterparty has actually defaulted.

The UK courts are likely uphold the provisions of the documents. However, certain provisions of US bankruptcy law preclude forfeiture, modification or termination of the debtor's interest in property because of a commencement of a case under the US Bankruptcy Code.

Lehman's lawyers argue that subordination of the early termination payment effectively amounts to forfeiture of those amounts. This is one of the arguments that Lehman has made in litigation currently pending in the US bankruptcy court for the Southern District of New York in the case of another deal, Ballyrock ABS CDO 2007-1.

Regardless of the outcome of these lawsuits, investors so far have not been able to receive the liquidation proceeds of the assets in a timely manner following the default of the counterparty, according to analysts at Moody's. "If the court is to reject provisions of the documents as written, it will also put in question many aspects of structured finance deals, including ultimate recovery," they note. "If Lehman is successful in its arguments, losses to investors will be much greater than anticipated and will not only be linked to the credit risk of the portfolio, but also to the mark-to-market risk of the swap, which is very difficult to measure."

CDO

Wealth manager hires in structured credit

The international arm of RBC Wealth Management, part of Royal Bank of Canada, has recruited Wasim Afzal to the position of manager in structured notes and fixed income, advisory. Afzal will be responsible for developing RBC Wealth Management's structured notes offering for its high net-worth (HNW) and ultra HNW clients.

Afzal has more than twelve years' experience in the industry. He previously worked for RBC Capital Markets, the corporate and investment banking arm of RBC, and before that was at Lehman Brothers and Deutsche Bank. His specialisms include structured credit products, structured rates and fund derivatives.

Phil Cutts, head of advisory, RBC Wealth Management, British Isles and head of the joint venture between RBC Capital Markets and RBC Wealth Management, comments: "In this low interest rate environment, we are finding that one of the main preoccupations of HNW clients is how to generate yield and we are talking to our clients about investing in structured products to realise this goal. Wasim's role is to find our clients the best structures, solutions and pricing from a wide range of providers. This highlights RBC Wealth Management's open architecture model, which enables us to deliver our clients competitive and innovative solutions."

CDS

Monoline hit by continuing CDS losses

Ambac expects to report that estimated statutory impairment losses on credit derivatives increased by approximately US$1.6bn in Q209 to around US$4.9bn. Additionally, the firm expects to report statutory loss and loss expenses incurred amounting to approximately US$800m for the quarter ended 30 June 2009.

The increase in impairment losses, which relate to Ambac's insured portfolio of ABS CDOs, was driven by rising forward Libor rates. The statutory loss and loss expenses relate primarily to deterioration in the monoline's second-lien and Alt-A RMBS financial guarantee portfolios.

The increase in the estimated impairment losses in Q2 is net of the impact of a settlement that reduced a significant portion of exposure under an ABS CDO transaction that closed in July and a commutation of all of the exposure under a different ABS CDO transaction that is expected to close by the end of July. The two transactions, with an aggregate of approximately US$2.8bn net notional outstanding at 31 March 2009, are expected to be settled with counterparties for a total cash payment of approximately US$750m.

On 31 March Ambac reported statutory capital and surplus of US$372.8m and contingency reserves of US$1.95bn. The firm has requested the approval of the Office of the Commissioner of Insurance (OCI) of the State of Wisconsin to release a substantial portion of its contingency reserves, although there can be no assurance that the OCI will approve such release. The amount of contingency reserves released, if any, will increase the monoline's statutory capital and surplus by the same amount.

On 31 March Ambac also reported total claims-paying resources of approximately US$11.9bn. Total claims-paying resources will be reduced by commutation and settlement payments related to the ABS CDO portfolio, including the two transactions closed this month, and claims paid related to the direct financial guarantee portfolio since 31 March.

Ambac also announced that, in order to preserve cash at Ambac Financial Group, it will discontinue paying the semi-annual interest on its directly-issued subordinated capital securities (DISCs) beginning 1 August 2009. Additionally, to preserve cash and surplus at the firm, it will discontinue paying the monthly dividend on Ambac's outstanding auction market preferred shares beginning 1 August 2009.

Clearing

UK clearer names ceo

CME Group has named Andrew Lamb ceo for CME Clearing Europe, subject to the approval of CME Group's application to the UK Financial Services Authority to become a UK Recognised Clearing House (RCH). In this newly-created position, Lamb will act as a special advisor to CME Group during the RCH approval process and will be responsible for the development of strategic initiatives, risk management policies and day-to-day operations for CME Clearing Europe.

CME Clearing Europe will be based in London and is designed to serve as a central counterparty clearer for OTC derivatives, including CDS, guaranteeing the performance of every trade it clears and therefore substantially mitigating counterparty credit risk for its customers.

Craig Donohue, CME Group ceo, says: "Based on growing demand for centrally cleared solutions in global financial markets, our efforts to launch CME Clearing Europe are intended to provide greater efficiencies to our European customer base during local market hours. The EMEA region has been a significant source of growth for our business and volume during non-US trading hours has grown to more than 14% of CME Group volume overall. As part of our global growth strategy, CME Clearing Europe will help to extend the safety and security of central counterparty clearing to our European clients, both through the initial offering of CDS clearing and additional locally relevant products we plan to offer in the future."

Prior to joining CME Group, Lamb spent more than 30 years improving financial markets infrastructure, having served as head of risk and deputy ceo at London Clearing House from 1993 to 2003, and as ceo and director of LCH.Clearnet in London from 2004 to 2006. He also served for 15 years at the Bank of England - including four years as senior advisor, derivatives and commodity markets. He most recently worked as an independent consultant for private and public companies on clearing, risk management and settlement, including among his customers the Futures Industry Association (FIA), the Futures and Options Association (FOA) and various US and European investment funds.

CLO Managers

US CDO manager to be replaced

The collateral manager of Acacia CDO 6 - Redwood Asset Management - is to be replaced, according to a regulatory news filing. Acacia 6 is a US CDO that closed in November 2004. The deal is composed of 82.2% RMBS primarily from the 2004 vintage, 12.1% CDOs and 5.7% CMBS, according to Fitch. Several tranches of the deal were downgraded earlier this year.

CMBS

Asset manager debuts PPIP offering

BlackRock has filed the prospectus for its PPIP offering, BlackRock Legacy Securities Public-Private Trust, with the US SEC. The filing confirms that the Trust's investment objective is to generate attractive returns for shareholders through long-term opportunistic investments in legacy assets eligible for purchase under the PPIP.

The fund will borrow money from the US Treasury for investment and portfolio management purposes in an amount up to 33.3% of the value of its total assets immediately after giving effect to the borrowing. It may also borrow up to 5% of its total assets as a temporary measure for making distributions to shareholders in order to maintain its favourable tax status as a regulated investment company. The Trust will not borrow money for investment purposes.

The Trust's investment advisor is BlackRock Advisors, while its sub-advisor is BlackRock Financial Management. The PPIF's general partner is BlackRock.

The PPIF will invest substantially all of its total assets in CMBS and non-agency RMBS issued prior to 2009 that were originally rated triple-A or equivalent by two or more rating agencies. The assets must have no ratings enhancement and must be secured directly by the actual mortgage loans, leases or other assets underlying the bonds.

CMBS

Director hired to head CMBS strategy

The Davis Companies has hired Emily Cooper as director of acquisitions and fixed income investments. She will be responsible for overseeing the company's investment strategy and acquisition of CMBS, as well as sourcing other fixed income, debt and property acquisition opportunities for the firm.

Jonathan Davis, founder and ceo of the Davis Companies, says: "We're delighted to have Emily join us in building out the company's capacity to capitalise on the very interesting market opportunities that exist in publicly traded real estate-backed fixed income securities."

The Davis Companies is a privately held owner, developer and manager of commercial real estate.

Prior to joining Davis, Cooper was svp and structured credit specialist at Putnam Investments in Boston. At Putnam, she was responsible for managing the firm's US$5bn CMBS portfolio since 2004. Prior to her position at Putnam, she headed the CMBS surveillance group at LNR Property Corporation in Miami, Florida.

CMBS

CMBS/WBS trader appointed

Kale Brown has moved over to a trading role at Barclays Capital in London. Brown, who will trade CMBS and WBS floating rate notes, has been working on the trading desk as a desk analyst for the past year. He reports to Stuart Calnan, RMBS trader at Barclays Capital.

Before his role on the trading desk, Brown was a corporate securitisation research analyst at the bank. He previously worked at Fitch as associate director in global infrastructure and project finance.

Investors

Investment manager hires three

Structured Investment Management (SIM) has made three new appointments.

Mark Graham has been named evp in structured finance. Prior to joining SIM, he headed corporate solutions and hybrid capital for the Americas at Barclays Capital, where he assisted corporations in using capital markets products in innovative ways to solve their corporate financing challenges.

Before Barclays Capital, Graham spent 15 years with Citigroup, where he was an md responsible for investor new products and headed the hybrid capital effort for insurance companies and corporates. His role running investor new products included responsibility for Citigroup's repackaging vehicles for both retail and institutional investors. These vehicles used the full range of equity and fixed income products to create investments tailored to particular needs of investors.

Prior to this, Graham was responsible for corporate structured bonds and completed several transactions that were recognised as 'deals of the year' by the industry.

"Mark's addition reflects our ongoing commitment to building our structuring strength on our platform," comments Ramesh Menon, SIM's president and founder. "We are fortunate to add a person of Mark's experience and skill - he has been at the forefront of structuring quality products for both institutional and retail investors for many years."

The firm's additional new recruits are Ed Chandler and Leona Qi. Chandler joins SIM as svp for platform distribution. During his 15 years in the financial services industry he has specialised in a broad range of investments, from traditional to alternative and private equity.

Most recently Chandler held the position of vp for managed products distribution at Ameriprise Financial. Prior to Ameriprise, Chandler was vp at Boston Capital, where he was instrumental in raising the company's profile in the independent broker-dealer community.

Qi has also joined SIM as svp, for global sales and distribution, institutional and dealer sales. She has over five years' experience in the investment banking industry, specialising in structured products. Her previous experience includes distributing structured products across asset classes to domestic and international private banks and broker-dealers at BNP Paribas and Nomura Securities.

Investors

Prime brokerage group offers FI services

BTIG has expanded its prime brokerage group to offer fixed income services, including trading and portfolio financing. The expansion into fixed income is in conjunction with the launch of BTIG's global fixed income group in February, which focuses on sales and trading of credit products across the full credit spectrum from investment grade to distressed debt. BTIG prime brokerage previously covered equity and equity options, and made the move to fixed income to better meet the needs of its hedge fund clients in today's market.

"As our clients became more interested in fixed income products, we saw a huge need and opportunity to expand our services," says Justin Press, md and co-head of prime brokerage at BTIG. "We have created a one-of-a-kind fixed income offering that will bridge the gap for hedge fund managers who have traditionally been operating in equities only."

BTIG's global fixed income group has added more than 50 professionals since its launch earlier this year.

Investors

Investment manager hires for high yield fund

Hotchkis and Wiley Capital Management has hired Mark Hudoff to co-manage its high yield bond strategy, including the Hotchkis and Wiley High Yield Fund, with Ray Kennedy.

George Davis, ceo of Hotchkis and Wiley, says: "All of us at Hotchkis and Wiley are excited that Mark has joined Ray Kennedy to further strengthen our high yield bond team. Mark brings with him extensive experience and what we feel is an outstanding record. He and Ray form a formidable nucleus for this important new part of our business."

Prior to joining Hotchkis and Wiley, Hudoff was an evp, portfolio manager and head of global high yield investments at PIMCO. He started at PIMCO as a credit analyst for the high yield team and moved to Europe in 2000 to build and manage the firm's European credit business, including the management of PIMCO's European high yield strategies.

Upon returning to the US in 2004, Hudoff founded and developed PIMCO's global high yield practice, while also managing US high yield portfolios. He has over 20 years of fixed income investing experience.

Ratings

Morgan Keegan charged over ARS

The SEC has charged Tennessee-based broker-dealer Morgan Keegan & Company for misleading thousands of investors about the liquidity risks associated with auction rate securities (ARS), and the agency is seeking a court order requiring Morgan Keegan to repurchase the illiquid ARS from its customers.

The SEC alleges that Morgan Keegan misrepresented to customers that ARS were safe, highly liquid investments that were comparable to money market funds. The firm sold approximately US$925m of the instruments to its customers between 1 November 2007 and 20 March 2008, but failed to inform them about increased liquidity risks for ARS even after the firm decided to stop supporting the ARS market in February 2008.

"Morgan Keegan was clearly aware that the ARS market was deteriorating, but it went so far as to actually accelerate its ARS sales even after other firms' ARS auctions began to fail," says Robert Khuzami, director of the SEC's Division of Enforcement. "As we've done in our enforcement actions against other firms, the SEC is firmly committed to restoring liquidity to Morgan Keegan customers who purchased ARS."

The SEC's complaint, filed in US District Court for the Northern District of Georgia, alleges that Morgan Keegan ignored indications that the risk of auction failures had materially increased amid investor concerns about the creditworthiness of ARS insurers, auction failures in certain segments of the ARS market, increased clearing rates for auctions managed by Morgan Keegan and other broker-dealers, and higher than normal ARS inventories at Morgan Keegan. The Commission is seeking an injunction against the firm for violations of the antifraud provisions of the federal securities laws, as well as disgorgement, financial penalties and other equitable relief for investors.

Meanwhile, in a separate case, Charles Schwab has announced that it will not accede to the demands of the New York State Attorney General to buy out its clients' ARS at par and would defend itself in court, should legal proceedings against it be commenced. The firm says that its role with regard to ARS was different from that of the major broker-dealers and denies any improper sales or marketing of these securities. Analysts at Moody's note that while the outcome of any potential legal proceedings cannot be predicted, there is at least the possibility that Schwab could be compelled to buy the ARS, which might exacerbate any potential negative impact on its reputation.

Real Estate

ARMOUR REIT to focus on agency RMBS

Enterprise Acquisition Corp, a public investment vehicle, and ARMOUR Residential REIT have signed an agreement and plan of merger pursuant to which Enterprise will merge with a wholly-owned subsidiary of ARMOUR. ARMOUR intends to invest, on a leveraged basis, primarily in adjustable-rate, hybrid adjustable-rate and fixed rate agency RMBS.

ARMOUR will be externally managed and advised by ARMOUR Residential Management. The transaction is expected to be completed early in Q409, pending approval by Enterprise's stockholders and warrant holders and subject to certain closing conditions.

"There is an especially compelling opportunity to invest in agency residential mortgage-backed securities because of their long-term attractive return profile. This transaction is a great way to give our investors the opportunity to invest at just above book value when many similar mortgage REITs are valued at substantial premiums to book value," says Daniel Staton, president and ceo of Enterprise, who will become non-executive chairman of ARMOUR upon completion of the transaction.

Staton adds: "We are excited to partner with Jeffrey Zimmer and Scott Ulm, co-ceos of ARMOUR. Jeff and Scott have a strong background of profitably investing in residential mortgage-backed agency securities and generating significant returns for their investors. We believe that after this transaction, ARMOUR will be well positioned to generate attractive risk-adjusted returns for our shareholders."

RMBS

Broker-dealer adds in RMBS sales

Amherst Securities Group has appointed Charlie Ulmer as an MBS salesperson. Ulmer, who joins the RMBS broker-dealer after spending the last 15 years at RBS Greenwich Capital, is based in the company's Greenwich, Connecticut office.

"We are very pleased to have added Charlie to our expanding MBS sales team," says Sean Dobson, ceo of Amherst Securities Group. "Charlie's tremendous knowledge of the MBS market and his extensive client relationships will enhance the services we provide to our customers. In particular, his experience with hedge funds and other alternative investment funds will be a great addition to our growing suite of offerings."

Ulmer adds: "I am very excited to be joining one of the most respected companies in the MBS space. Over the past few years in particular, Amherst has developed a strong reputation for the high quality advice it offers and its ability to analyse complex data to help clients make the best possible decisions. That is particularly true in the alternative investment space, which is increasingly seeking the type of sophisticated advice and analytics that Amherst can provide."

Ulmer began his career in MBS with RBS Greenwich Capital in October of 1993, where he worked in operations, and joined the MBS sales desk in late 1994. He has worked with a variety of accounts over the past 15 years, more recently focused on the hedge fund community.

RMBS

REIT unveils investment strategy

Invesco Mortgage Capital says it has almost completed the deployment of capital that it raised in its IPO earlier this month. As of 17 July, the company had acquired an aggregate portfolio of US$829.4m, comprised of US$711.9m in agency RMBS, US$67.8m in non-agency RMBS and US$49.7m in CMBS. The company also has entered into repurchase agreements totalling US$630.6m, secured by US$669.7m in agency RMBS, and has applied for US$41.2m in financing under TALF secured by US$49.7m in CMBS.

"Our strategy was to place approximately half of our equity in non-agency RMBS that provide an attractive return while working to mitigate downside risk," says Richard King, the REIT's ceo. "In addition, we acquired agency RMBS that we expect will provide returns similar to our non-agency RMBS when financed with repurchase agreements, and CMBS to be financed under TALF. We also continue to explore opportunities provided under the Public-Private Investment Programme that would be managed by Invesco Institutional Inc."

RMBS

Partnership to assist Freddie Mac initiative

As part of its support for President Obama's Making Home Affordable programme, Freddie Mac has joined forces with Home Retention Services to help several regional servicers process thousands of additional applications for Home Affordable Modifications. Home Retention Services, a wholly owned subsidiary of Stewart Lender Services, will assess the eligibility of delinquent borrowers with Freddie Mac-owned mortgages for Home Affordable Modifications or other potential workouts and process borrower financial information for the servicers' review and approval.

Ingrid Beckles, svp of default asset management at Freddie Mac, says: "By using Home Retention Services' staff and resources we can ease some of the pressures on our servicers' staff while helping more borrowers pursue a mortgage workout."

She adds: "Today's announcement builds on Freddie Mac's strategy to improve the borrower experience when seeking a mortgage workout and our commitment to the Making Home Affordable programme's success."

Under the agreement, potentially eligible borrowers identified by a participating Freddie Mac servicer will receive a letter from the GSE asking them to call Home Retention Services using a proprietary toll-free number. The letters will be specially formatted and include unique borrower PIN numbers to protect borrowers from counterfeits produced by fraud artists.

Home Retention Services will work with the borrower, assess their eligibility for a Home Affordable Modification, complete the documentation and income gathering processes, and advise the borrower of their proposed modified payment. The firm will then forward the completed package to the servicer for final approval.

The borrower's Home Affordable Modification trial period begins once the servicer approves the modification and receives the borrower's check for the new monthly mortgage amount. Home Retention Services will also advise borrowers of other Freddie Mac workout options if they don't qualify for Making Home Affordable.

While the new initiative will supplement the capacity of participating servicers to process loan modifications, Beckles emphasises that "borrowers should continue to call their servicers first to determine the best solution for their situation".

Jason Nadeau, president and ceo of Stewart Lender Services, says: "We are pleased to be working with Freddie Mac and their servicers to bring additional capacity to the Making Home Affordable programme process. Home Retention Services specialises in supplementing servicers' efforts to preserve home ownership for their borrowers."

Using Home Retention Services to relieve servicers of several preliminary workout processing steps builds on earlier Freddie Mac borrower outreach initiatives. The GSE has used the consumer credit counselling services of Atlanta and San Francisco to contact low- and moderate-income borrowers at high risk of default since 2005 and selected Ocwen Financial Corporation to target borrowers with delinquent high-risk mortgages in 2009.

Technology

Mortgage data JV launched

Strategic Analytics' mortgage risk software is now fuelled by BlackBox Logic, a repository of loan-level mortgage data and cashflow analysis. The new partnership will provide Strategic Analytics with data and performance updates for more than 7200 RMBS representing more than 92% of all US mortgage loans. BlackBox's BLIS service transforms data from bond trustees and securities issuers into usable business information through its proprietary process of normalising and cleansing.

Strategic Analytics says its expanded mortgage database enables clients to access massive data sets in order to produce high-level analysis of loan-level segments, including metropolitan area, asset types and loan types, with a greater degree of accuracy. The long-term perspective of the software combined with this expanded database enables industry-leading forecasting, stress-testing and volatility analysis, the firm adds.

Technology

OAS analytics partnership announced

Calypso Technology has integrated BondOAS, a market standard in callable bond analytics from Andrew Kalotay Associates. The partnership expands the automated functionality of the cross-asset, front- to back-office Calypso platform and allows the firm to value fixed rate, step-up coupon and amortising bonds with embedded calls and puts.

Calypso's integration of BondOAS will allow these market standard analytics to be used in all Calypso features, including pricing, P&L analysis, risk measurement and management. BondOAS produces price given option-adjusted spreads (OAS), along with risk measures, such as effective duration, convexity and DV01 that are instrumental in comparative valuations and hedging.

Pieter Hamman, vp of business development at Calypso Technology, says: "In the current turbulent markets where speed and transparency are key, bond traders and risk managers need a reliable cross-asset platform for trading, powered by well-tested, widely accepted models. We are excited to have partnered with Andrew Kalotay to provide seamless access to market standard analytics."

Technology

Risk management company adds three directors

FinAnalytica has appointed three new members to its sales teams in London and New York. This follows additional board level hires in May of this year.

Marcus Rasche joins FinAnalytica's London team as director of sales for Northern Europe. He brings over 16 years of experience to the firm, having worked in Europe for many of the major global players in the financial sector, including various roles at Siemens and Dow Jones Markets.

Bill Quadrini and Henry Lamour have both been appointed director of sales for the Americas, based in New York. For the past three years, Quadrini was director of the client solutions group with Moody's KMV/Moody's Analytics. After various positions at Reis, Bridger Commercial Funding and Swiss Capital Partners, he brings over 20 years' expertise to the firm.

Lamour moves to FinAnalytica from Cadis Software, where he was vp of sales, marketing and business development. Prior to this, he held numerous sales positions at Merrill Lynch, Cantor Fitzgerald Securities and SS&C Technologies, in addition to his work with multi-billion dollar hedge funds, fund of funds and prime brokers at Pertrac Financial Solutions. Lamour will leverage 18 years' industry experience at FinAnalytica.

Rasche, Quandrini and Lamour will report directly into Dave Merrill, FinAnalytica's ceo.

Merrill comments: "We are well positioned in the marketplace to meet the rapidly changing attitudes and critical requirements for risk management solutions among existing and prospective clients. We are confident that these additions will be an asset to our customers as the business continues to grow and we look to expand our client base around the globe."

Trading

Cohen hires Sussman for European expansion

Cohen & Co has announced the expansion of its European capital markets business with the hiring of Sheldon Sussman as president of its European operations. Sussman will be responsible for building on Cohen's existing European platform, with responsibility for sales and trading, investment banking and advisory. He will be based in Cohen's London office.

Sussman joins Cohen from Rabobank International where he was senior evp, head of its global financial markets business and a member of the board of Rabobank International. Prior to Rabobank, Sussman was svp at Deutsche Bank, where he set up its North American credit derivatives operation. Previously, he was among the founding members of Lehman Brothers derivative products team and ran its global emerging market derivative and municipal derivative units.

Trading

Institutional credit sales team expands

BNP Paribas has grown its institutional credit sales (ICS) team, co-headed by Philippe Guyot and Joe Lovrics. The bank says the new hires demonstrate its commitment to continue to grow both its flow and credit solution businesses.

Andrew Sultana has joined the bank from Nomura to cover flow credit clients in Italy and Greece, reporting to Andrea Fabbri, head of ICS Italy. Alessandra Bock has joined the high yield sales team, reporting to Remi Derieux. She was previously at Citi.

Sally Golden joins the ICS UK team covering real money investors on flow credit products. She reports to Nick Tudball, head of UK credit sales. Golden most recently worked at Societe Generale in London.

Johanna Claesson will join the ICS Nordic team from Royal Bank of Scotland to work alongside Claus Buch Andersen.

Another recent hire is Marion Schlicker, who joined ICS Germany in May, reporting to Martin Rudolph, head of credit sales Germany. Also reporting to Rudolph is Alexander Pietrowiak, who joins from LBBW to focus on strategic regulatory capital and accounting business.

ABS

South African store card ABS prepped

S&P has assigned preliminary credit ratings to the first issuance of notes from OntheCards Investments II, under its asset-backed floating-rate notes programme. The notes are backed by collateral generated from store cards issued by Edcon in South Africa.

Edcon's scoring and underwriting methodology is in line with a developed credit card market, such as the one in the UK, S&P notes. The receivables are generated by accounts opened before January 2006, which means that payment history of obligors is established.

The issuer will issue notes of one- and three-years' scheduled maturity. Each maturity set will comprise Class A and B notes and a sub-loan. The notes will revolve until their scheduled maturity date, when they will be refinanced or else enter a controlled amortisation period.

ABS

Credit card delinquent accounts acquired

Egg Banking has exercised a call option to acquire a number of delinquent accounts from the Pillar Trust. The purchased covered 8,500 accounts, with a total balance of £38m, which were removed from the trust and will artificially boost the payment rate for July. The Pillar trust had the highest arrears (13.69% in June) of all the UK credit card ABS collateral pools last month.

ABS

ABS CDO issuance remains muted

Since July 2008, S&P has lowered its ratings on 107 tranches of cash or hybrid ABS CDOs and 121 synthetic tranches of synthetic ABS CDOs, according to a recent report. ABS CDO issuance for the year to date remains muted, with issuance driven primarily by the willingness of arrangers to use central banks' repo facilities.

Over this period, S&P has assigned ratings to eight ABS CDOs, compared with 13 transactions rated in the same period the previous year. During the rest of 2009, the agency expects to see fewer transactions structured to use central banks' repo facilities, as the European Central Bank has tightened its eligibility criteria. The transaction pipeline mainly comprises retranchings of existing transactions.

CDO

New asset manager rating criteria released

Fitch has published criteria for assigning ratings to credit-oriented asset managers. The criteria will take into consideration the changing dynamics of the credit asset management industry and lessons learned from recent credit market dislocations.

In order to capture the distinctive features of credit asset managers, Fitch has developed specific criteria within its asset manager rating framework. The new 'M' ratings provide investors with an independent assessment of a manager's capacity and vulnerability to operational and investment management failures along five distinct dimensions of operational risk, the agency says.

Manuel Arrive, senior director in Fitch's fund and asset manager rating group, notes: "Assessing the operational platform of a credit asset manager can be extremely valuable for investors, at a time of increasing allocations of assets to credit funds managed by institutions that are in the process of launching, restructuring or rebuilding their credit platforms."

M ratings for credit asset managers supersede existing CDO asset manager (CAM) ratings, as the analysis extends beyond CDOs to all types of credit-oriented investment vehicles (e.g. funds and segregated mandates). The rating's broadened scope is also a recognition of long-term structured credit market trends, with CDO asset managers transitioning to fund management and broadening their credit platform while building on their existing core expertise in a given credit sub-asset class. All existing CAM ratings will be converted into M ratings in the near future.

Once the conversion is completed, all Fitch-rated asset managers - namely traditional asset managers, fund of hedge fund managers, real estate asset managers and CDO asset managers - will be rated on a scale from M1 to M5, with M1 indicating the highest rating. According to the rating agency, such a unified scale emphasises the common general framework and creates greater consistency and comparability across the range of rated asset managers and underlying investment approaches.

CDO

Upward rating pressure for Japanese SME CDOs

Moody's says that Japan's SME CDO sector will increasingly experience upward rating pressure, even if it shows more or less the same default rate as in fiscal year 2008. This is according to a report entitled 'Monitoring of Japan's SME CDO and Rating Outlook'.

Government initiatives to support SME financing in the country have recently been effective in curbing the rise in corporate bankruptcies, but the business environment for SMEs remains severe and the sector's default rate migration will require close attention, the agency notes. Accordingly, Moody's expects default rates in the underlying pools to be higher than initially expected.

Moody's also notes that some SME CDOs have been downgraded, but at this point further downgrades are unlikely for most transactions. If the SME CDO sector shows more or less the average default rate observed in fiscal year 2008, then amortising CDOs will increasingly experience upward rating pressure, driven by rises in subordination ratios along with the amortisation of underlying assets.

CDS

Not all CDS players signed up to 'small bang'

The ISDA Small Bang Protocol (SCI passim) became effective yesterday. According to the Association, 2107 counterparties adhered to the protocol, a slightly higher number than the 2023 parties that initially signed up for the Big Bang Protocol in April. Credit strategists at UniCredit suggest, however, that not all players in the CDS market have signed up to the protocol.

"In our view, adherence to the protocol is a necessary prerequisite in order to comply with future regulatory requirements for CDS," they note.

CDS

CDS liquidity divergence signals market concern

Fitch Solutions says the divergence in CDS liquidity between the financial sectors in European and Americas now illustrates greater market concerns about the prospects for European financials.

Thomas Aubrey, md of Fitch Solutions in London, says: "In the last three months, the divergence in financial sector CDS liquidity between Europe and the Americas is striking, suggesting that the eventual global economic recovery is unlikely to be synchronised across regions. In contrast, while some major US financial institutions still remain in the media spotlight, the sustained drop-off in financial sector liquidity is an encouraging sign that the effects of the financial crisis could be easing in the Americas."

As of 27 July, Fitch's European financial CDS liquidity index closed at 10.18 versus 10.43 for the Americas. Overall, General Electric Capital, Macy's and TelMex are the most liquid corporate names in the Americas, while Rhodia, OJSC Gazprom and Continental display the greatest liquidity in Europe.

CDS

NCOIL to review CDS proposals in November

The National Conference of Insurance Legislators (NCOIL) is continuing its controversial efforts to ban 'naked' CDS and regulate certain other CDS contracts that it describes as 'covered'. The group on 22 July provided key US House and Senate Committee Chairs with a letter highlighting its development of draft 'Credit Default Insurance Model Legislation', - a year-long process grounded in what some sources say is the mistaken belief that certain CDS are insurance.

The letter explains that the proposed model act, which is scheduled for final NCOIL review in November, would regulate certain "covered" CDS - those that maintain a material interest in an underlying asset - as a new form of insurance, known as credit default insurance (CDI), and would prohibit "naked" CDS, or swaps in which a party has no material interest in the underlying asset.

The proposed NCOIL model would mandate licensing of credit default insurers and impose solvency standards, such as minimum capital and surplus, as well as contingency, loss and unearned premium reserve requirements on such insurers. It would also require strict limitations on permissible credit default insurance - restricting writing of the product to purchasers with a material interest in the asset. Additionally, single and aggregate risks limits would be set, as well as minimum policy and rate standards.

The NCOIL legislators write in the letter: "The definition of CDI, the explanation of permissible CDI and other regulatory requirements included in our draft model bill mirror financial requirements imposed on a similar credit default instrument - financial guaranty insurance. Instead of reinventing the wheel, NCOIL Task Force [on CDS regulation] members based the model bill on New York State Article 69 - the 1989 law governing financial guaranty insurance - and drew into its scope the CDS that most resembles insurance."

CDS

Credit event but no auction for Kellwood

ISDA's determinations committee has determined that a failure to pay credit event has occurred on Kellwood Co, but there will be no auction to settle the price.

Separately, the auction for senior and subordinated Bradford & Bingley CDS has been scheduled for 30 July.

CLOs

Revised SME CLO criteria released

Fitch has published its revised criteria for rating CLOs of granular pools of smaller corporate loans (SME CLOs). This follows the exposure draft published in April 2009 and subsequent consultation period with market participants.

"This criteria release represents the final stage in Fitch's structured credit criteria update," says Jeremy Carter, senior director of Fitch's structured credit team. "In April 2008 we published the updated corporate CDOs criteria and since then we have completed project finance CDOs, structured finance CDOs, synthetic CDOs and the leveraged loan CLOs criteria updates."

Glenn Moore, director of Fitch's structured credit team, says: "The criteria reflect Fitch's credit view that on average European SMEs demonstrate a 90+ day delinquency default rate consistent with the single-B rating category. The loss-given default will be determined using Fitch's recovery framework that will apply market value decline assumptions for secured loans and apply a recovery rate table for unsecured loans."

Fitch has placed all 87 of the SME CLOs it rates under analysis while the criteria are implemented. The agency has contacted each originating bank and requested updated performance and portfolio information. Where such information is not provided or is insufficient, Fitch will make worst case assumptions - based on the transaction reports - in its analysis.

The agency intends to complete its initial analysis of the 87 SME transactions by mid-August 2009 and will either affirm the ratings or place them on rating watch negative (RWN). In resolving the rating watch actions, Fitch will apply its most up-to-date criteria to the transactions to determine the level of credit protection offered by each rated note.

Fitch is set to release an updated version of the portfolio credit model during the week commencing 27 July 2009, which will incorporate rating criteria for European granular corporate balance sheet securitisations.

CMBS

External guarantees to attract Euro ABS investors

Sceptre Funding, a £360.25m single-tranche CMBS backed by lease payments on a Land Securities-owned office (see last week's issue) was said to be three times over-subscribed when it priced last week. The deal is a fully amortising sale-and-lease back transaction credit-linked to the UK government. A price of 145bp over Gilts was achieved for a WAL of 11.2 years.

According to securitisation analysts at UniCredit, the deal is providing some direction in terms of current CMBS pricing, although it is not directly comparable with a classic CMBS issue. "Quite interesting is the fact that all recently placed securitisation transactions have been linked to the credit risks of guarantors or the originator itself," they note. "Before this latest public placement, Tesco Property Finance 1 (credit linked to Tesco) as well as Ceami (guaranteed by the Spanish government) were placed publicly, for example. We expect future issuance activity to include guarantee features and third-party credit risk until ABS will have recovered in a way to allow stand-alone issuance."

The UniCredit analysts add: "For now, either some kind of external impulse or external guarantees are needed to lure investors back into structured finance lending. Nevertheless, the Sceptre Funding deal is another example that issuance is possible. It could also be a guide for any long awaited UK RMBS deal that may be structured, e.g. including UK government liquidity guarantees."

CMBS

Realpoint publishes analysis for ratings-volatile CMBS

Realpoint is making publicly available its subscription-based ratings and analysis for three CMBS transactions that have recently been subject to ratings volatility. The three deals are: Morgan Stanley Capital I Trust 2007-IQ16, GS Mortgage Securities Trust 2007-GG10 and Credit Suisse Commercial Mortgage Trust 2007-C3. These deals have been subject to downgrades and subsequent upgrades from S&P (see last week's issue).

The rating agency says it has long identified issues with certain collateral properties of each of the three deals, but does not expect any potential losses to impact the senior triple-A bonds of any of them.

Realpoint currently has an 'underperform' outlook on the Class F notes, which carry a rating of single-A, and below on Morgan Stanley Capital I Trust 2007-IQ16. Classes senior to the F class have a 'perform' outlook.

Realpoint is forecasting US$32.8m of losses from the eight loans, with a balance of US$149.5m that are in special servicing. It has 35 loans with a balance of US$470m (18 % of pool) on the Realpoint watch list.

On GS Mortgage Securities Trust 2007-GG10, the agency has an 'underperform' outlook on Class AJ, which is rated single-A minus, and below. Classes senior to the AJ class have a 'perform' outlook.

It is projecting that the 13 loans in special servicing will result in US$196.7m of losses. It has 54 loans with a balance of US$3.5bn (47 % of pool) on the Realpoint watch list.

On the Credit Suisse Commercial Mortgage Trust 2007-C3 transaction, Realpoint has an 'underperform' outlook on class AJ, which is rated double-A and below. Classes senior to the AJ class have a 'perform' outlook.

The agency is forecasting US$78.71m of losses from 19 of 20 loans (US$275.2m in balance) that are in special servicing. It has 72 loans with a balance of US$938.3m (35.1% of the pool) on the Realpoint watch list.

CMBS

Accepted/rejected TALF legacy CMBS revealed

The New York Fed has published a list on its website of the legacy CMBS that were accepted as collateral for the 16 July TALF operation, or rejected on the basis of either the explicit requirements of the scheme's terms and conditions or the Fed's risk assessment. Some 35 CUSIPs were accepted as eligible collateral, while only one CUSIP was rejected.

CMBS

Update released on CMBS rating refinements

S&P has released an update on the criteria document outlining refinements it has made to its methodology for assessing the impact of losses and recoveries on US conduit/fusion CMBS (see also last week's issue). Of the 3,382 conduit/fusion classes that were negatively affected by the initial announcement on 26 June 2009, up to 74 classes may be affected by the 21 July refinement, the agency says.

In particular, the refinement focused on the assumptions used related to the timing and application of losses and recoveries resulting from S&P's triple-A rating scenario described in the 26 June criteria publication. The refinement does not alter any other aspect of the CMBS rating criteria, methodology or assumptions, however; in fact, the aggregate loss levels produced by the triple-A stress scenario remain the same.

S&P explains that within conduit/fusion CMBS structures, the performance of classes can vary, sometimes significantly, depending on the specific assumptions used. Based on further analysis and market feedback, the agency believes that the modification better reflects what may occur during a severe economic downturn. The modification will also more fully account for the structural nuances of time tranching within the senior classes of CMBS transactions.

The modification also has the potential to affect the ratings on some super-senior classes in recent-vintage deals that incorporate the concept of a crossover date, which is the point in time when the allocation of principal distributions to the super-senior classes change to pro rata from sequential. This date occurs when losses reach a certain level in the transaction.

Changes in the timing of defaults and losses can have a significant impact on the payment profile of senior securities, many of which receive principal sequentially prior to the crossover date. Further differentiating the timing of losses, even by a few months, can result in the same security potentially experiencing a full payoff or substantial loss.

The implementation of these changes resulted in the reversal of seven downgrades across three transactions that occurred last week. S&P does not anticipate any other ratings reversals as a result of this modification.

However, the modification could have a beneficial impact on shorter weighted-average life triple-A ratings (less than 10 years), some of which may be affirmed.

Indices

Index reveals drop in sovereign risk

Credit Derivatives Research (CDR) has published the latest figures for its Government Risk Index (GRI), an index of the CDS of seven sovereign names selected on the basis of volume of outstanding debt and CDS liquidity.

Dave Klein, manager of CDR credit indices, says: "Sovereign risk dropped across all of the majors this month after showing weakness two weeks ago. Through [22 July], the CDR Government Risk Index is down 4.2bp (-8%) to 50bp from 54.3bp at the beginning of the month."

He adds: "The GRI is approaching its lows of early May, but remains higher even as the broader credit market matches its recent best levels. We expect the corporate credit rally to continue to drive sovereign risk lower in the near term."

Spain and the UK were the strongest performers this month, according to CDR data, both seeing their credit risk drop by over 10%. All index members now trade below their one-year average CDS levels.

"The majors still trade above their year-ago levels (some significantly so), even as in the corporate market some strong companies rallied through that barrier," Klein continues. "With the broader credit and equity markets responding positively to earnings season, it appears the majors have moved past their late-winter risk crisis. Of course, the fragility and volatility of current markets could easily send sovereign risk soaring, as we saw earlier in the month."

Ratings

Derivatives use concentrated among US financials

The use of derivatives among US companies is widespread, although an overwhelming majority of the exposure is concentrated among financial institutions, according to a Fitch review of first-quarter financial statements. The Q109 financial reports marked the first time that comprehensive derivatives disclosure was mandated for all US companies.

Olu Sonola, director of Fitch Ratings, explains: "The new derivative disclosures are a welcome addition for analysts and investors, and they bring much needed transparency to financial reporting. The disclosures reveal plenty, but careful analysis and additional scrutiny must be applied."

Fitch reviewed Q109 filings of 100 companies from a range of industries representing nearly US$6.4trn in aggregate outstanding debt and a total notional amount of derivative positions in excess of US$296trn. The agency sought to: ascertain the degree to which new disclosure practices provide insight into how entities are using derivatives and for what purpose; determine the effect of derivatives on the financial statements of reviewed entities; and compare disclosures across companies and industries to see if entities have achieved transparency, consistency and comparability in disclosures related to derivatives.

Fitch's analysis found that approximately 80% of the derivative assets and liabilities carried on the balance sheet of the companies reviewed were concentrated in five financial services firms: JPMorgan Chase, Bank of America, Goldman Sachs, Citigroup and Morgan Stanley. Approximately 58% of the companies reviewed disclosed the presence of credit risk-related contingent features in their derivative positions. These contingent features generally require a company to post collateral or settle any outstanding derivative liability in the event of a downgrade of the company's credit rating.

However, use of both credit and equity derivatives as a proportion of total derivatives was found to be limited, with the primary concentration being among financial institutions. Non-financial companies appear to use derivatives only for hedging specific risks.

Ratings

Survey reveals improved outlook for US credit markets

The outlook for both the US economy and the credit markets has much improved, according to a recent survey conducted by Fitch in conjunction with the Fixed Income Forum. At mid-year 2009, the survey of senior fixed income professionals reveals a still-gloomy but far less negative view of economic conditions and, in some pockets of the credit markets, optimism for a rebound in fundamentals over the coming year.

The new survey, completed in June, is entitled 'Sentiment lifts among senior US fixed income investors - credit outlook on the mend' and offers a fresh perspective on the extent to which market anxiety has lifted from the depths of early 2009, Fitch notes. For example, the share of respondents placing the global recession's severity at very deep fell across all regions, especially with respect to the US and emerging markets. At least 23% of respondents now believe that the recession in the US will be mild going forwards (up from 2% in January), while 43% hold such a view for emerging markets (up from 8% in January).

Importantly, opinions in certain investment areas showed the most positive views in several years. Roughly two-thirds of respondents, for example, believe that fundamental credit conditions will improve in the investment grade corporate sector in the coming year, double the January share. Opinions were similarly more robust across specific industries - especially with respect to the financial sector.

Investor responses also offered insight into near-term corporate strategy, with most believing that debt reduction and maintaining a cash cushion will continue to be priorities. Additionally, while in the January survey there was a split view on the issue of inflation or deflation as the greater risk going forward, the new survey shows that 71% of respondents placed inflation as the bigger threat. In the June survey, investors were more concerned about government intervention than event risks, such as the collapse of another financial institution.

Initiated in 2005, the bi-annual Fitch Ratings/Fixed Income Forum Survey provides insight into the opinions of professional money managers regarding the state of the US credit markets. Responses were received from 131 senior investment personnel on their views of the economy, fundamental credit conditions across asset sectors and products, corporate strategies and other relevant topics.

Ratings

Ambac junked

S&P has lowered its counterparty credit, financial strength and financial enhancement ratings on Ambac to double-C from triple-B and removed them from credit watch, where they were placed on 24 June 2009 with negative implications. The outlook is developing.

At the same time, S&P lowered its counterparty credit rating on Ambac Financial to double-C from double-B and removed it from watch negative. The outlook is negative. In addition, the agency lowered its ratings on the monoline's preferred stock and Ambac Financial's directly issued subordinated capital securities to single-C from single-B in light of the announced deferral of dividends (see separate Job Swaps story).

This rating action reflects S&P's view of the significant deterioration in Ambac's insured portfolio of non-prime RMBS and related CDOs, which has required the company to strengthen reserves to account for higher projected claims. The additional reserves will have a significant negative effect on operating results, which S&P believes will likely cause surplus to decline to below regulator-required minimums.

The monoline's policyholders' surplus was US$372m as of 31 March 2009. However, Ambac has announced that it expects to increase ABS CDO impairments by US$1.6bn for the quarter and loss reserves by approximately US$800m. These actions could lead to negative policyholders' surplus as of 30 June 2009.

The developing outlook on Ambac reflects the possibility that the rating could be revised to 'R' if there is regulatory intervention because of Ambac's expected weakened capital position. Alternatively, if the release of contingency reserves to bolster surplus is approved, the rating could be raised - but in such circumstances the rating would not be expected to rise higher than the triple-C category.

The negative outlook on Ambac Financial reflects S&P's view of the monoline's dependence on the dividending capabilities of Ambac to support its debt-service obligations. The rating would be lowered if Ambac is not able to provide sufficient cash to allow Ambac Financial to service its debt.

Ratings

Rating agency legislation sent to Congress

The Obama administration has sent legislation to Congress designed to remove conflicts of interest between rating agencies and issuers of the bonds that they rate (see last week's issue). The proposal bans rating agencies from offering consulting services to these firms and requires them to disclose fees and other potential conflicts. Issuers, in turn, would be forced to disclose the preliminary ratings they seek.

Ratings

CDPC downgraded

S&P has lowered its issuer credit, senior subordinated and subordinated note ratings on Athilon. S&P's outlook on the CDPC remains negative. The rating actions reflect the agency's projected increase of Athilon's CDS payout on two senior tranches of an ABS CDO based on the updated RMBS lifetime loss assumptions, as well as the further credit deterioration in Athilon's corporate CDS portfolio.

Athilon's issuer credit rating has been downgraded to single-A/negative outlook from double-A/negative outlook, the senior subordinated note issues downgraded to double-B from triple-B and the subordinated note issues downgraded to triple-C from single-B.

Ratings

Global SF rating action remains negative

Fitch says that negative rating action continued to be prevalent for global structured finance in Q209 as recovery from the economic downturn remains elusive. US and EMEA non-mortgage ABS continue to demonstrate a higher level of rating stability and are expected to remain resistant to downgrades, however, particularly at the triple-A level.

The US continued to experience falls in commercial property values. Adam Fox, senior director of US CMBS at Fitch, says: "Peak-to-trough property value declines will average 35% for all property types."

Delinquencies in Fitch-rated CMBS transactions increased by 67% in Q209 to 2.55bp. Delinquent hotel and office properties backing CMBS grew by 100% during the quarter and retail delinquencies grew by 60% to now represent nearly US$4bn.

US CMBS saw a slight reprieve in downgrade activity, with negative rating actions declining by 30% from the prior quarter. However, Fitch expects to resolve the rating watch negative status on US$18bn US CMBS originated in 2006-2008 later this quarter.

Loans in these vintages were originated at peak market conditions and under weaker underwriting standards. These vintages represent 57% of Fitch-rated US CMBS and 56% of current delinquencies.

During Q209, the performance of US credit card ABS continued to deteriorate, with increasing charge-offs and compressing excess spread compared to the prior quarter. However, the ratings on many trusts remained stable as issuers have taken various actions to increase credit enhancement (CE) and utilised the discount option (SCI passim).

Fitch continues to expect current ratings of senior tranches to remain stable, given the available CE and structural protection afforded investors. The outlook for subordinate tranches becomes increasingly negative, however, particularly given recent delinquency and personal bankruptcy filing trends.

Meanwhile, continued deterioration in portfolio performance of US prime and subprime RMBS during the first half of 2009 led the agency to increase its loss estimates for these sectors, resulting in negative rating actions for prime RMBS in March and April and subprime RMBS in June and July. The negative rating actions for both RMBS sectors were concentrated within the 2005 -2007 vintages.

In June 2009 Fitch revised its subprime RMBS base-case average loss estimates as a percentage of remaining pool balances for 2005, 2006 and 2007 vintage transactions to 45%, 59% and 55% respectively. Revised loss estimates for prime RMBS were published in March.

Downgrades also continued to dominate in CDOs, particularly sectors impacted by systemic economic risks, including exposure to residential and commercial real estate, continuing corporate issuers' defaults and lower recoveries on all types of collateral. The sectors with the biggest number of negative actions in Q209 were trust preferred securities, investment grade corporate, diversified structured finance and commercial real estate loans. The average severity of downgrades in these sectors was seven notches, with the triple-A tranches downgraded on average by five notches.

With regards to the EMEA markets, Andy Brewer, senior director of EMEA structured finance performance analytics at Fitch, comments: "Year to date, EMEA structured finance downgrades are now at the level reached for the whole of the 2008. However, significant repayments in ABS and RMBS sectors resulted in a small number of upgrades too during the quarter."

For the second quarter running, CMBS led other sectors in the number of negative rating actions. This was predominantly triggered by declining UK commercial property values.

RMBS continued to see a high number of downgrades, with Spain again leading the way, followed by the UK. This was predominantly driven by delinquencies in recent vintage transactions.

Rising charge-offs, delinquencies and reduced excess spread in UK credit card transactions led to tranches from two issuers being downgraded and the revision of outlook on one triple-A tranche to negative from stable.

The downgrades in EMEA CDOs primarily impacted synthetic CDOs comprised of corporate credits. The downgrades were driven by corporate defaults compounded by lower than expected recoveries.

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

The CDO sector also dominated Asia Pacific structured finance rating actions during the second quarter. The first-ever defaults in the region were recorded as CE was eroded permanently following final settlements on several high profile investment grade corporate credit events.

CDO downgrades and tranche impairments in Q209 remained concentrated in the synthetic corporate CDO sector, driven by high yield corporate defaults coupled with low recovery prospects, as well as significant portfolio deterioration with an increase in assets rated triple-C or below. The majority of these transactions cannot withstand further defaults of reference assets or have CE levels much lower than the proportion of triple-C (or below) assets. Nine tranches have defaulted, with ratings being downgraded and withdrawn simultaneously following the termination of the transactions.

Separately, seven junior classes of Japanese CMBS were downgraded during the period, driven by underlying loan defaults or slower-than-expected progress in defaulted loan workouts. Fitch placed 130 tranches of large loan, bullet maturity Japanese CMBS on RWN in July 2009, due to the limited availability of refinancing in the sector, compounded by uncertainty on commercial property values and a challenging economic outlook.

Prime RMBS in Australia continued to show stable delinquency performances, with lenders mortgage insurance claims remaining low. Senior notes have continued to pay down steadily, providing increased CE to the remaining senior notes. This has also been the case for CMBS transactions in the country, with upgrades made to seven classes during the quarter.

Finally, Latin American structured finance ratings have been performing as expected, reflecting the strength of the future flow asset class and the stable political and economic climate of the region. However, the Mexican RMBS market has seen a large increase in delinquencies. While some of these increases can be attributed to specific events for particular portfolios, much of this relates to the economic pressures impacting the country.

Ratings

Spanish SME deal performance continues to decline

S&P has seen the performance of Spanish securitisations backed by loans to SMEs that it rates continue to decline in line with the ongoing deterioration in the Spanish economy, according to a recently published report. According to Bank of Spain statistics, the number of non-performing loans granted by Spanish financial entities had increased to 4.4% by April 2009, almost quadruple the level at the start of 2008 and the highest point for 13 years.

"At the same time, Spanish SME transactions that we rate reported their highest delinquency rates across all arrears buckets," says S&P surveillance credit analyst Michela Bariletti. "As of April, the weighted-average of 90-365 day delinquent loans represented 2.29% of the outstanding collateral balance of the transactions we rate, up from 0.30% in January 2008."

S&P remains concerned about the continued property market contraction and its knock-on effect on Spanish SME transactions because, on average, they have more than 30% exposure to the real estate and construction sectors. In general, transactions with a higher exposure to these sectors are reporting higher levels of delinquent loans as a percentage of their outstanding balance.

Surveillance credit analyst Chiara Sardelli adds: "However, we believe that shrinking levels of consumption may lead to a decline in demand not just for real estate and construction, but for a wider range of industries, potentially reducing the borrowers' business and their ability to repay their debts."

The report also discusses the effect on ratings of counterparty risk in some Spanish SME transactions and recent rating actions that have been taken in this sector.

Regulation

Basel LCDE results revealed

Results from the 2008 Loss Data Collection Exercise (LDCE) have been published. The study was conducted for the Basel Committee on Banking Supervision by the Operational Risk Subgroup of its Standards Implementation Group.

This is the first international LDCE to collect information on all four data elements that are used in the advanced measurement approach (AMA) for operational risk under the Basel 2 framework - internal loss data, external loss data, scenario analysis and business environment and internal control factors (BEICFs).

The results are covered in two papers. The first, 'Results from the 2008 Loss Data Collection Exercise for operational risk', focuses on internal loss data and scenario analysis, as well as on operational risk capital. The second paper, 'Observed range of practice in key elements of Advanced Measurement Approaches (AMA)', covers external loss data and BEICFs, as well as the observed range of practice in banks employing the AMA for operational risk.

The results provide an opportunity to assess operational risk data and practices across regions, in order to promote consistency in implementation of the Basel 2 Accord. The findings also present an opportunity for banking institutions to compare their operational risk management frameworks with those of other institutions and to identify potential areas for improvement, the Committee says.

The findings reveal that overall banks have made considerable progress in the collection and use of internal loss data since the previous international LDCE, conducted in 2002. In addition, the frequency of internal losses of €20,000 or more varies significantly across regions when the data are scaled by various exposure indicators. However, despite the regional variation in loss frequency noted, there is some consistency in the severity distribution of operational losses across regions.

Most banks' scenario data extends the tail of the loss distribution beyond the point at which they have experienced internal losses. At many banks, the number of large scenarios greater than €10m is approximately 20 times larger than the number of internal losses that are greater than this amount.

Although the number of large scenarios significantly exceeds the number of large internal losses, the frequency of large losses implied by scenarios and internal data are broadly consistent among AMA banks. AMA banks have a higher frequency of internal losses greater than €100,000 than non-AMA banks, even when the data are scaled by exposure indicators. Some of this difference may be explained by the fact that AMA banks generally are larger, more complex institutions, with more mature processes for collecting loss data.

However, operational risk capital for non-AMA banks is higher than for AMA banks, regardless of the exposure indicator used for scaling. For the typical AMA bank, the ratio of operational risk capital to gross income at 10.8% is significantly below the alpha for the basic indicator approach (BIA) (which is 15%) and also below the range of betas for the standardised approach (SA) (which is between 12% and 18%). Also, the amount of capital relative to the frequency of large losses is generally higher at non-AMA banks than at AMA banks.

The observed range of practice (ROP) paper updates a 2006 report of the same name. In framing the discussion of observed practice in the measurement and management of operational risk, the update identifies both emerging effective practices as well as practices that are inconsistent with supervisory expectations.

In addition, the report highlights supervisory issues encountered in the supervisory reviews of operational risk, whether related to governance, data or modelling. Finally, the report provides a resource for both banks and national supervisors to use in their respective implementation processes, and ongoing development and monitoring of AMA frameworks.

The Basel 2 framework envisions that, over time, the operational risk discipline will mature and converge towards a narrower band of effective risk management and risk measurement practices. Understanding the current range of observed operational risk management and measurement practices, both within and across geographic regions, contributes significantly to the efforts to establish consistent supervisory expectations, the Committee says.

Through the analysis of existing practices, it is better able to promote the maturation of operational risk practices and support supervisors in developing more consistent regulatory expectations. The ROP paper therefore provides supervisors with an opportunity to engage individual banks in discussions of their operational risk management and measurement practices relative to their peers in domestic and international markets.

Regulation

AIMA warns against EC directive

The Alternative Investment Management Association (AIMA) has warned that the European Commission's draft directive on alternative investment fund managers would impact fund managers and investors around the world if enacted into European law. The Association argues that the directive creates potentially major difficulties for non-EU funds and/or non-EU managers in accessing the EU market.

Under the proposed new rules, marketing of funds by managers will only be allowed with a special marketing passport that the directive creates. However, the directive also delays the introduction of the passport by three years and imposes significant obstacles (such as demonstrating regulatory and tax equivalence) to obtaining it.

AIMA suggests that the directive makes it so difficult and costly for non-EU funds and managers to access the EU market that it is protectionist in effect, if not in intent. This will have major consequences for non-EU funds and managers (particularly in North America and Asia-Pacific), who will face a major loss of business in the EU, the Association says. Investors will likely face loss of choice, increased costs and diminished returns.

Andrew Baker, ceo of AIMA, says: "Funds and managers outside the EU face being locked out of the EU market with extremely worrying consequences. Global industry centres, such as the US, Canada, Switzerland, Hong Kong, Singapore, Japan, Australia and South Africa, will all be affected by this. This is not just an internal EU matter."

Baker continues: "This will also have a very significant impact on investors. EU investors, in particular, face a situation where they can use only EU asset managers of EU domiciled funds investing assets under an EU custodian. And international investors with EU funds or managers will find that their costs will go up and their returns will go down because of the restrictions and compliance costs the directive imposes."

He concludes: "We believe that the provisions of the draft directive with protectionist consequences will not only hit the industry worldwide, but weaken the competitiveness of the EU in investment management and make the EU a less attractive destination for international investment. Naturally, we hope that it can be revised to avoid this."

Regulation

Leaders call for far-reaching regulatory reforms

The IIF has published a new report called 'Restoring Confidence, Creating Resilience: An Industry Perspective on the Future of International Financial Regulation and the Search for Stability'.

"We are publishing this report because we recognise that the industry and the public sector have to build a system that can weather storms, yet still provide the credit that the global economy depends upon," says Josef Ackermann, chairman of the IIF's board of directors and chairman of the management board and group executive committee at Deutsche Bank. "We are operating in a globally interconnected world where we need to strengthen the system's capacity to minimise the risks and to maximise the benefits of the interconnected global marketplace."

The report - reflecting the views of the industry's leaders - emphasises the shared responsibility between the industry and public sectors for strengthening the global financial system. It stresses that financial regulatory reforms must better align incentives for sound risk management, improve transparency and enhance resilience over the business cycle. It noted the overarching need to build a strong international financial system where regulation should work with the market, with investors and creditors to bring market discipline to bear and be framed with the costs and benefits of regulatory measures in mind.

"We recognise that far reaching regulatory and industry reforms are necessary to guard against systemic vulnerabilities. A return to 'business as usual' is not an option for us," adds Ackermann. "We need to establish a more resilient and stable international financial system, which stimulates and encourages innovation and foster competition to provide cost effective services to customers. We believe that international coordination among regulators and supervisors is essential. For our part, financial services firms are committed to strengthening our own practices and to working with the official sector in the design of necessary structural and regulatory changes to minimise the risk in the future of the kind of crisis that we are still wrestling with."

RMBS

RMBS valuation benchmarking study unveiled

S&P's Fixed Income Risk Management Services (FIRMS) has launched its quarterly valuation benchmarking study for RMBS. The study is designed to develop clear valuation benchmarks based on the input of buy-side and sell-side participants in the sector.

Market participants are invited via the survey to provide their views on default rates, delinquencies, prepayment rates, loss severity and recovery lag assumptions in the US. The study also tracks investor expectations on key variables, such as house price movements, which are used to value US prime and non-conforming RMBS.

Catherine Barratt, director of Valuation Scenario Services (a unit of FIRMS) at S&P, says: "Our research has consistently shown that investor assumptions for future default rates, prepayment rates and the like are the most critical component to determining the value of a mortgage-backed portfolio. By instituting a quarterly benchmarking study, we're effectively creating an investor consensus for RMBS valuation, which we believe will go a long way toward building transparency in the mortgage-backed security market."

With an estimated US$1.7trn in structured mortgage assets still held in investor portfolios, data relating to the assumptions that investors are using to value those assets fulfils a critical need in the current market. The data provided by the quarterly benchmarking study will serve as a valuable reference point for investors, FIRMS notes.

Results summarising marketplace consensus for third-quarter RMBS valuation assumptions will be published in October 2009.

RMBS

Revised subprime RMBS loss projections announced

S&P has provided its revised loss projections for US RMBS transactions backed by subprime collateral issued in 2005, 2006 and 2007. These loss projections are for the collateral underlying these transactions.

The weighted average projected loss for the 2005 vintage transactions is approximately 14% of the original pool balance. The 2005 loss projections range from 2.98% to 35.94%.

The weighted average projected loss for 2006 transactions is approximately 32%, with loss projections ranging from 4.71% to 59.34%. Finally, the weighted average projected loss for the 2007 transactions is approximately 40%, with loss projections ranging from 5.12% to 66.70%.

RMBS

Australian RMBS ratings to remain stable

Moody's says that despite the recent trend of increased delinquencies, Australian RMBS ratings are safe from downgrades for now. The rating agency notes that rating downgrades for Australian prime and non-conforming RMBS are unlikely, as collateral in both sectors are performing within expectations.

"Moreover, despite a long-term trend of increased delinquencies, their ratings are anticipated to remain stable in the absence of mortgage insurer downgrades, while some upgrades should occur as subordination levels increase due to the typically sequential pay structures employed in Australia," says Arthur Karabatsos, a Moody's vp and senior analyst.

He continues: "The Australian RMBS market is dominated by prime loans that represent 98% of the current outstanding as of March 2009 and loans originated by investment grade banks. Loans to credit-impaired borrowers account for only 0.6% of the RMBS market."

Trading

Trading ideas: rising tide

Dave Klein, senior research analyst at Credit Derivatives Research, looks at an equity outperform trade on Procter & Gamble Co

We revisit Procter & Gamble from an equity perspective. In May, we recommended selling CDS protection on the company partly due to its strong equity-implied rankings. The name still looks good to us from a credit perspective and, given its recent equity underperformance, we believe its equity is a good bet too. We recommend buying stock in Procter & Gamble with a beta hedge.

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 below exhibit charts market and fair value equity levels for PG. 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 PG's CDS levels based on its margins, leverage, free cashflow and interest coverage.

We note that PG scores especially high in its equity-implied market factors (part of the motivation for our earlier long credit trade recommendation). We removed these factors from our analysis to avoid the circular reasoning of equity implies improved credit, which implies improved equity.

The exhibit below charts Procter & Gamble'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.

In both the short term (yellow square) and medium term (red square), we expect PG's equity to improve. Continued credit improvement should yield outsized gains in equity.

Our model-implied three-month target for PG shares is US$79. 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 PG reverts to fair value, eliminating further profit potential. Second, if PG continues trading too cheap over the next six months, then we must assume that the company is trading under a new CDS/equity/vol relationship and the trade will be reevaluated for potential exit. Overall, we view this as a short- to medium-term trade.

Position
Buy 10,000 shares Procter & Gamble Co at US$55.48.
Sell 3,900 shares SPDR Trust Series 1 at US$97.42.

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).