Contents

RMBS

At a crossroads

Australian government intervention sought as RMBS funding runs out

The final mandates for the Australian Office of Financial Management's (AOFM) A$8bn RMBS investment programme have been awarded and, although a handful of deals are being prepared for real money investors, there is little hope of significant issuance without continued government intervention. Efforts to get the market restarted are therefore being stepped up in an attempt to re-attract domestic and - just as importantly - the international investors that bought so much Australian securitised paper in the past.

The Australian Securitisation Forum (AuSF) has put several options forward to the government. First is a continuation of the AOFM investment programme, both in duration and amount; second is to seek a government guarantee on the credit quality of RMBS to appease global investor preferences; third is an extension risk put option on RMBS to extinguish any fears about clean-up calls not being exercised; and lastly the AuSF is lobbying the government to allow the issuance of covered bonds, which are currently prohibited by the Australian Banking Act.

"So far we have not had any explicit answer from the government, although they have said they are 'minded to do something'," says Alex Sell, chief operating officer at the AuSF.

According to risk consultant Satyajit Das, Australia's securitisation market has become increasingly politicised. "The Australian government has indicated that it would like to exit guaranteeing bank funding as soon as possible, the AOFM funding for RMBS purchases is not sustainable in the long run and the central bank is not keen on covered bond legislation because of subordination of depositors," he says. "At the same time, should securitisation fail to restart, a return to balance-sheet funding means that banks' ability to finance their assets is more restricted than in the past, so lending may be constrained."

Sell explains that the AOFM's initial A$8bn investment was never intended to support the entire securitisation market; neither was it designed to solve the liquidity problem. "It was there in order to maintain competition through the smaller banks and non-bank lenders...then Lehman happened," he notes. "The objective of getting the government to support the securitisation market now is partially about competition, but it is also part of the broader credit puzzle - and without it key balance sheets are getting full, meaning that the financial system is getting constrained in terms of lending into all parts of the economy than need credit."

The AuSF is suggesting that the AOFM programme be extended and that it should include lo-doc RMBS. The association has not suggested a particular timeframe or amount to be invested, but it will recommend certain parameters.

"We're also asking the government to think about guaranteeing triple-A RMBS, even though no-one really thinks it would be invoked in practice," Sell adds. "For so long as other government guaranteed paper exists in the market, securitised issuance will struggle to get a look in."

He continues: "On the international front, we are hearing that there is palpable interest from international investors for Australian RMBS - from European accounts in particular. Apparently, one of the main obstacles for them not investing is the lack of a government guarantee on securitised bonds. We want that obstacle removed."

Although the issuance of covered bonds technically offends the Australian Banking Act because of the subordination of retail depositors to covered bondholders, the AuSF believes the economic argument for allowing them is overwhelming. "The senior unsecured issuance space is currently dominated by the big banks," says Sell. "If the large banks are able to issue covered bonds, they can fund themselves in a more diversified, cheaper way and in the process free up space for the small and medium-sized banks to occupy that space and expose themselves to a less volatile funding base."

Meanwhile, the ratings on existing Australian RMBS are performing well (see also separate News Round-up stories). Although Moody's has maintained a negative outlook for the collateral performances of Australian ABS, CMBS and RMBS over the next 12 to 18 months, the agency expects the implications on ratings to be limited.

Richard Lorenzo, Moody's vp/senior analyst confirms that no triple-A notes have been downgraded and that junior pieces in prime RMBS have only been downgraded due to Lenders Mortgage Insurance reasons, not performance reasons. "Even the non-conforming RMBS deals are doing well, with only upgrades and no downgrades," he says.

"If the AOFM funding goes away, there will be a dramatic decline in RMBS issuance," Lorenzo adds. "However, we do have a pipeline of other structured finance deals, like non-conforming and ABS that are being prepared for real-money investors. Although there has not been any ABS issuance so far this year, we expect issuance to reappear sooner rather than later."

According to Das, a couple of things need to fall into place in order for the Australian structured finance market to restart. "Confidence, even for vanilla investments, is in short supply both in Australia and on an international level. Investors will have to be convinced that a structured finance investment is not a hand grenade with the pin removed," he says.

He concludes: "Secondly, the rating agency process also needs to be resolved. Fundamentally, the investor will either have to believe in the ratings or have the capability of performing their own credit analysis. However, few investors have the resources and capabilities to do their own analysis."

AC

CLOs

Performance test

CLO managers find new ways to improve overcollateralisation ratios

Rising defaults mean that there is increasing danger of CLOs failing their performance tests. In the face of this, managers are looking to boost performance in new ways.

"Managers want to keep their deals going for as long as possible and so will reinvest in them for as long as possible," confirms Ratul Roy, head of structured credit strategy at Citi. "The 2006/2007 vintage transactions have relatively low financing costs and so managers are not necessarily in any hurry to retire senior liabilities."

KKR Financial Holdings last week cancelled the mezz liabilities of three of its CLOs (CLO 2005-1, 2005-2 and 2006-1) and retired the senior notes of another - CLO 2009-1 (see separate Job Swaps story). William Sonneborn, the company's ceo, says that addressing near-term liquidity and cashflow issues have been a priority for its new management team.

"The actions undertaken with respect to CLO 2005-1, CLO 2005-2 and CLO 2006-1 also provide the benefit of preserving the low-cost senior debt of these CLO transactions, which have an attractive weighted-average cost of funding of three-month Libor plus 27bp. In addition, these transactions, together with the deleveraging of CLO 2009-1 - our highest cost structured finance vehicle - greatly improve KFN's future liquidity profile," Sonneborn says.

Separately, the equity holders of the Egret Funding CLO I agreed to forgo part of their residual income stream to buy back the junior-most rated debt carrying a spread of 430bp. And finally, Blackstone injected additional equity into its Columbus Park and Riverside Park CLOs to increase their tranche cushions.

Though both deals were performing broadly in line with their peers, Columbus Park had been tripping its interest coverage tests, while Riverside Park was breaking its interest diversion test. Assuming that the equity injections were used to buy par loans at a price of 80 (such that there would be no discount purchase haircuts) and that the new loans would have a slightly higher coupon than the other assets in the pool, the breaches are understood to have been cured in both deals.

Managers owning equity have the most to gain from injecting equity cash into CLOs, as they are likely to be able to reinstate their sub-fees as well as the cashflows in their equity stake. However, Roy points out that issuing new equity is dilutive for existing equity holders, which means that non-manager equity holders will have to balance the dilution and any opportunity costs for the new investment versus the advantages of delaying any cash deferrals.

As a result of such a cash injection, the cash-on-cash return of the combined investment is higher than for the original equity - assumed to be bought at par - had there been no new cash. This is the reason why existing investors would consider adding to their investments at the right price. New investors in other deals may also consider buying an additional equity stake at low-dollar prices and seek to gain similar economics.

The prices that were paid for the Riverside Park and Columbus Park equity tranches (36.5 and 56 respectively) may appear to be somewhat high, but are more reasonable if the subordinated fees that would otherwise have been lost are included, as well as the wider spread and less leverage in these later structures. "If a much lower price was paid (such as the current market practice of equity being paid in most deals for just the next couple of cash payments) and yet the same amount of collateral addition was targeted, the degree of dilution would presumably have been unacceptable," Roy notes.

While injecting new equity and acquiring additional collateral are generally positive for the entire capital structure, retiring the mezz debt - as in the KKR case - is more beneficial for junior noteholders than senior noteholders. "Such an action effectively removes a test, which means that there are fewer tests to fail; triple-A noteholders tend to prefer there being more tests because they provide more opportunities for cash to be diverted to senior classes," says Roy.

These actions are easier to make when the manager has direct access to the equity or mezz debt. He adds: "Whether more managers are likely to follow similar courses of action depends on how aggressive they want to be in terms of pushing the boundaries of the documentation. If, for example, the documentation is silent about retiring mezz debt, it's easier to push the boundaries. But some other managers will likely prefer to keep triple-A noteholders happy and so will take a more conservative approach."

Equity injections and debt cancellations typically require rating agency confirmation. But S&P placed the affected KKR deals on rating watch negative the day after the cancellation was announced.

Based on the information contained in the most recent trustee report and other relevant transaction documents, the agency says it understands that the note cancellations have resulted in an increase in the subordinate overcollateralisation ratios for the three transactions, which had previously been failing these tests but are now passing. This may result in excess spread being distributed to equity and subordinate noteholders rather than being used to pay down the balance of the senior notes, thereby reducing the credit enhancement available to support the senior notes, S&P adds.

The agency will review the impact of the note cancellations on these transactions to determine whether the ratings currently assigned to the notes remain consistent with the level of creditworthiness of each class.

Meanwhile, a recent case study on US CLOs conducted by structured credit analysts at JPMorgan confirms that managers have tried to maximise reinvestment in their deals, even amidst challenging conditions. The study aims to measure and assess how principal proceeds have been used by managers for the January to June 2009 period.

The findings indicate that cash is generally reinvested rather than used to amortise liabilities, even in cases where transactions are failing their OC tests. In many cases CLO managers have tended to hold on to defaults, rather than sell.

Additionally, they have generally traded up in credit quality to build par above discount haircuts. Typical average loan purchase prices were in the US$80-US$90 range, while typical average sale prices were in the US$70-US$85 range.

Finally, in transactions that are failing OC tests and amortising (representing about half of the sample), the primary source of cash for liability pay-down was from diverted interest proceeds and not principal proceeds.

CS

Clearing

CDS repository registration deadline met

The DTCC reports that 216,765 CDS contracts valued at approximately US$5.7trn in gross notional value were entered into its Trade Information Warehouse by market participants in the global OTC derivatives market. These trade submissions met in part industry commitments made to the Federal Reserve Bank of New York and other global regulators to have all CDS contracts registered into a global repository by 17 July.

Stewart Macbeth, DTCC md and general manager of the Trade Information Warehouse, says: "We are pleased to be able to verify and now report on CDS data based on what we've seen from firms' initial submission of contracts into our global registry to meet their 17 July deadline. There was a small percentage of CDS trades which were not previously held in the Warehouse because of the tailored nature of the contracts. In registering these CDS trade positions, the goal of trying to ensure that risk could be seen from a central vantage point at a central repository has now been achieved for the CDS market."

These contract submissions represent more customised contracts that are not confirmable on an electronic platform, such as the automated service provided by DTCC Deriv/SERV. Data registration was received using 30 different currencies from a customer base that spans 35 countries. The submission of these customised trades are for repository and reporting purposes only and do not confer a legal binding agreement in the Warehouse as do electronically confirmed trades that are maintained in the global repository.

As of 24 July, there were about 2.2 million electronically confirmed contracts with a gross notional value of about US$26.5trn registered in the Warehouse's repository. These new submission represents less than 10% of the total contracts and 17% of the total gross notional value of contracts registered.

Details on these customised contracts are generally expected to remain fairly static. DTCC will nevertheless publicly release statistical data on these contracts from time-to-time, though not necessarily as part of its weekly releases of data relating to more standardised contracts, particularly should significant changes in gross notional value or total contracts be determined. DTCC will provide global regulators with information on these contracts, also known as 'copper' records, as appropriate and upon request.

Separately, derivative risk management provider Reval has put itself forward as an alternative trade repository for OTC derivatives used by corporate end-users. The company's ceo and co-founder Jiro Okochi says: "Since its inception a decade ago, Reval has specialised in helping companies value and effectively account for derivative products used to hedge business risk. We are already, in fact, a trade repository for corporate end-users of OTC derivatives."

He continues: "With our ability to book, manage risk, value and account for derivatives across all asset classes, we have the technology and expertise today to help clients comply with whatever may become law and to help regulators obtain the reports they will require. Whether the idea of a trade repository takes the form of a sole repository or multiple repositories, Reval will certainly have a role to play in assisting its corporate clientele and the government."

According to Okochi, in order to support the objectives of the Obama administration's proposed reform agenda, a repository "should be able to book a multitude of standardised or customised transactions and be able to report on, among other things, open positions, fair values, total exposure by counterparty, notional volumes and any new margin or capital requirements".

JA

CMBS

GGP warns of possible substantive consolidation

The issue of substantive consolidation arose last week as a real possibility in General Growth Properties' (GGP) bankruptcy proceedings in New York federal bankruptcy court. GGP, the second largest US regional mall owner, filed the largest real estate bankruptcy case is US history last April and made the headlines when it included 166 of its special purpose entities (SPEs) in the Chapter 11 proceedings (SCI passim).

According to a comment in Moody's Weekly Credit Outlook, the issue of substantive consolidation arose at a routine hearing to extend the 'exclusive period', in which the debtor proposes its own reorganisation plan. The secured lenders to the SPEs argued that the issues at bar - how long a loan extension and what new market interest rate should attach - were easy, and that it shouldn't take more than three more months to figure out.

GGP responded that each SPE's situation cannot be extracted from the others. For instance, 'laddered' extensions may be needed - meaning that an individual SPE's mortgage extension must take into account what is happening with other SPE's mortgage extensions.

"Of course, application of such logic brings structured finance further away from pristine assumptions of asset isolation," note analysts at Moody's.

Moody's writes that in granting the six-month request, Judge Gropper gave clues of how next week (as promised) he may decide outstanding motions to throw out the bankruptcy cases of some SPEs. "The judge adopted GGP's argument that the 166 property filings are not merely simple, single asset real estate cases, each with its own equities to be administered in isolation. Rather, he ruled that each filing is just one point in a pointillist painting of SPEs that forms an integrated corporate-family bankruptcy portrait - for purposes of the extension motion, but perhaps for more weighty purposes as well," says the report.

The agency notes that the big surprise, however, was the colloquy between the lawyers for Metropolitan Life, GGP and the judge. A lawyer for Metropolitan Life Insurance Company said that GGP's papers "point toward an argument that either assumes or insinuates that some form of [substantive] consolidation was taking place". The judge tried to allay that concern, stating: "If that's in there, perhaps you can point that out.... I don't read anything in these papers about consolidating debtors."

Then the lawyer for GGP rose, saying that "Counsel for Met Life got up here and seemed very obsessed about substantive consolidation. You're right, Your Honor, it was not in our papers. We did, however, say we need to assess the inter-relationships of the debtors. Substantive consolidation is not a black or white thing."

"One of the things we're looking at," the GGP attorney continued, "is whether there are some sub-groups that should be appropriately substantively consolidated. We have not reached any conclusions on that at this point."

Moody's says it is hard to predict what GGP has in mind. "All along the secured lenders have argued that GGP's strategy hinted at de facto substantive consolidation. The next chapter of the GGP saga should unfold at the end of this week, when Judge Gropper likely will hand down one the most important and anticipated decisions in structured finance of the last few years."

AC

Distressed assets

FDIC distressed asset proposals move forward

The FDIC continues to progress its initiatives around alleviating the pressure of distressed assets on bank balance sheets. Last week the agency took the next step in the development of the PPIP Legacy Loans Programme (LLP) and announced initial details of its good bank/bad bank proposal.

The first test of the LLP funding mechanism commenced last week. In the transaction, the receivership transferred a portfolio of residential mortgage loans on a servicing-released basis to a limited liability company (LLC) in exchange for an ownership interest in the LLC.

The LLC will sell an equity interest to an accredited investor, who will be responsible for managing the portfolio of mortgage loans. Loan servicing must conform to either the Home Affordable Modification Programme (HAMP) guidelines or FDIC's loan modification programme.

Accredited investors will be offered an equity interest in the LLC under two different options. The first is on an all-cash basis, which is how the FDIC has recently sold receivership assets, with an equity split of 80% to FDIC and 20% to the accredited investor. The second option is a sale with leverage, under which the equity split will be 50% FDIC and 50% accredited investor.

The funding mechanism is financing offered by the receivership to the LLC using an amortising note that is guaranteed by the FDIC. Financing will be offered with leverage of either 4-to-1 or 6-to-1, depending upon certain elections made in the bid submitted by the private investor.

If the bid incorporates the 6-to-1 leverage alternative, then performance of the underlying assets will be subject to certain performance thresholds including delinquency status, loss severities and principal repayments. If any one of the performance thresholds is triggered over the life of the note, then all of the principal cashflows that would have been distributed to the equity investors would be applied instead to the reduction of the note until the balance is zero. The performance thresholds will not apply if the bid is based on the lower leverage option.

The FDIC will be protected against losses on the note guarantee by the limits on the amount of leverage (both in terms of a maximum ratio and dollar amount), the mortgage loans collateralising the guarantee and the guarantee fee. The FDIC says it will analyse the results of this sale to see how the LLP can best further the removal of troubled assets from bank balance sheets and in turn spur lending to further support the credit needs of the economy.

Separately, two FDIC officials on 30 July made public statements regarding a plan to begin splitting off troubled assets from failed banks, as a way of enticing healthy banks to purchase the rest. According to lawyers at Schulte Roth & Zabel, if the FDIC believes that strategic buyers are unwilling to purchase a failed bank because of the distressed assets on the target's balance sheet, the agency will break the target into two pieces. The goal is to sell the charter, deposits and performing assets to another, healthier bank and the distressed assets to investment funds and other private capital sources - presumably with a loss-sharing or other similar arrangement serving as an incentive.

The FDIC is still determining how the process will work; for example, whether it will hold separate auctions for each half of a failed bank or whether it will expect strategic buyers to team up with private capital investors. However, the agency says it expects to release more details soon and to launch the programme "in the coming weeks".

AC & CS

Indices

Dramatic reduction seen in counterparty risk

Counterparty risk fell by over 25% in the last two weeks amidst a broader market rally. "With the S&P approaching 1000 and the CDX IG index reaching new tights, the CDR Counterparty Risk Index (CRI) now stands at 109.5bp, over 30% less risky than its one-year average but still well above its multi-year average of 80bp," says Dave Klein, manager of CDR Credit Indices. "While current levels are impressive, we note that before the credit crisis ramped up in the summer of 2007, the CRI routinely was valued below 15bp, a level we do not expect to see any time soon."

The CRI now matches its late-June 2008 levels. At that time, the CRI had come off a run up to over 200bp in mid-March and the early Lehman/FNM/FRE crises of July had yet to hit the market. According to Klein, comparing individual index member levels between now and June 2008 provides a clear contrast between financial 'winners and losers' of the credit crisis, as nine names now trade with less risk while the market judges five to be riskier.

"On the winning side, JPMorgan saw its CDS levels drop 40% and Credit Suisse is a close second. Merrill Lynch, due to its takeover by Bank of America, shed a third of its risk, while its parent ranks as the second biggest loser with BAC's spread widening by over 40%," he says. "Citigroup ranks as by far the worst performing name in the index, with its CDS spread 125% wider than last June. Despite all the Goldman Sachs bashing and tongue-in-cheek fears of world domination, GS's performance places the firm in the middle of the index pack, trading tighter than a year ago (and breaking below 100bp [on 29 July]) but not performing as well relative to peer Morgan Stanley (although Goldman trades well tighter than MS)."

CDR dares not venture a guess about where the CRI will be trading in a month's time. "The current market rally feels well overdone to us, but it felt that way a week ago as well," notes Klein. "Each sign that the economy is stabilising seems is met with market euphoria. A month ago, the CRI was valued in the 170bp range. In such a volatile market, we would not be surprised to see the CRI at either 80bp or 150bp in a couple of weeks."

AC

Regulation

SFO to probe structured finance

Structured finance products are to be included in the scope of investigations led by the UK's Serious Fraud Office (SFO), as it steps up its efforts to become more proactive. The mis-selling of CDOs is one area likely to come under further scrutiny.

An SFO spokesperson confirms that the move stems from the department's desire to begin initiating more cases itself. "Historically, we've often relied on referrals from the UK FSA, for example. We've taken on 14 cases since September 2008 and six of these have come from our own sources."

This process involves the SFO gathering its own intelligence about certain risk areas, including looking for potential 'red flags'. "To use the hedge fund industry as an example, data indicates certain commonalities among failed hedge funds; for instance, their management board is located in the Cayman Islands and a small [as opposed to one of the 'big four'] accountancy firm oversees their operations," the spokesperson explains.

Another potential red flag could be an organisation's involvement with CDO or credit derivative products. The SFO would then investigate how valuations were arrived at or how the products were bundled together and sold. The spokesperson says that the department is aware that the valuation angle could stem from management incompetence or over-enthusiasm about values.

"We're not investigating individual transactions, but rather potential issues inherent within certain business models and industries. The ABS/CDOs and credit derivatives markets are areas of special interest to us," he adds.

As part of this process, the SFO is keen for more whistleblowers - for example, investors that have suspicions about potential mis-selling - to come forward. Such actions enhance the department's knowledge of an industry and help to get cases to court as quickly as possible, with the best chance of prosecution and recovering money for victims, the spokesperson notes.

CS

Secondary markets

Accessing dark pools

Robert Barsky, coo and a founder, and David Audley, founder responsible for strategic planning at Beacon Capital Markets, answer SCI's questions

Q: How and when did Beacon Capital Markets become involved in the structured credit market?
RB: Beacon was set up in 2004 to promote liquidity in less liquid markets by providing an open trading platform - called the Trade Discovery Platform - to all participants on an anonymous and equal basis. The platform is an electronic engine that matches buyers and sellers of ABS, CMBS and RMBS throughout the transaction lifecycle, including clearing and settlement.

Q: What is your strategy?
RB: We began trading agency RMBS on the platform in April 2008, but our customers urged us to expand into other asset classes - non-agency RMBS, CMBS and ABS - which we launched on 10 July (see SCI issue 142). The aim is to access dark pools/hidden liquidity in the market, including by enabling traders to receive alerts when incoming buy orders match their inventory. We estimate that buy-side institutions hold more than 99% of all the inventory in these asset classes.

The platform has the capability to do auctions, but much of the trading is done via bid list technology that advertises what's available to participants and potential buyers can then negotiate a price. Another common way of executing a transaction is if something is advertised, or posted on the platform. Alternatively, buyers can stipulate what they'd like to buy through describing the ideal characteristics that they'd like to see in a security in order to elicit a response from any potential holders.

Q: Which market constituent is your main client base?
RB: So far we have engaged 52 large institutional and dealer participants on the agency side of the market and 56 on the non-agency side. Daily, there are several billion dollars worth of securities advertised on the platform from our participants.

Beacon acts as executing broker for all non-agency MBS, ABS and CMBS trades, while Broadcort - a provider of clearing and settlement services and a division of Merrill Lynch - will clear and settle the trades. Daiwa Securities is the central counterparty for agency securities, of which there is around 1.2m listed on the platform.

Market participants can locate and trade non-agency MBS and ABS using search methods specifically fine-tuned for these securities. Trade details are automatically captured, creating an electronic audit trail.

Q: How do you differentiate yourself from your competitors?
RB: Our customers are receptive to our trading model and, in this environment, have found it an excellent way to conduct price discovery. One advantage of anonymity is that customers can trade significant positions without the other side of the trade knowing who they are.

But it also allows for opportunistic trading and the ability to find specific securities to service a customer quickly and efficiently. We're essentially adding automation to the marketplace and providing the opportunity to figure out a fair price for high quality assets.

Q: Which challenges/opportunities does the current financial environment bring to your business and how do you intend to manage them?
RB: We think this is an important time to release trading in non-agency securities as the Obama administration advances its PPIP programme using a funding mechanism like the successful TALF programme. Holders of legacy bonds will want to make those available to the new sources of investment coming to market, explicitly to own those bonds.

We're currently establishing direct links to the order management systems that hold customer inventory information, so that traders can receive alerts when someone is interested in buying or selling a security they own. It will also give them the opportunity to answer/negotiate on an anonymous basis.

In order to enhance the user experience on the platform even further, we've formed a multi-year strategic alliance with outsourcing solutions provider Broadridge Financial Solutions. Broadridge currently handles on average over US$3trn in notional value of US fixed income securities transactions daily.

By utilising Broadridge's industry-leading impactSM (for non-agency MBS, ABS and CMBS) and MBS Expert (for agency MBS) products, clients will be able to search through the largest universe of less-liquid fixed income securities, find the other side of the trade for instruments that meet specific investment criteria and transact on liquidity that otherwise would not be publicly advertised in current trading channels. This connectivity is scheduled to go into production over the next few weeks.

Otherwise, the Bloomberg Trade Order Management System can be used to connect to the platform.

Q: What major developments do you need/expect from the market in the future?
DA: The new issue ABS market in the US has improved considerably due to the support of TALF and the bonds are typically better credit quality because of the improved rating agency criteria. For example, indicative spreads have tightened from 500bp over swaps in February to around 100bp over. But the situation for legacy assets is lagging considerably behind that of new issues - albeit the US Federal Reserve appears to be mindful of this, given its indications that it might extend the TALF programme past year-end for legacy CMBS.

CS

ABS

Managers join forces to focus on ABS

Harbourmaster Capital Management is set to establish a new business with Mirja Wenski, the former ZAIS Group Investment Advisors md. The new business will provide advice and asset management services to institutional clients, and will be solely focused on portfolios of ABS.

Alan Kerr and Mark Moffat, co-heads of Harbourmaster, comment: "We are excited by the huge potential that we see for this partnership. Mirja brings a great depth of experience of the global ABS markets and has a superb track record in buy-side portfolio management. Mirja's skills and knowledge will be extremely complementary to Harbourmaster's considerable corporate credit expertise."

Wenski comments: "I am delighted to be joining forces with Harbourmaster. We have a shared view that there is more appetite than ever in today's investor community for high quality, impartial investment advice - both on existing ABS exposures and on the unique opportunities presented by the current state of the markets. I firmly believe that our combined experience, resources and credentials mean that we can service this demand effectively and successfully."

ABS

ABS and flow credit changes made

The Royal Bank of Scotland has made changes within its ABS and flow credit sales teams. Jonathan Peberdy has moved to flow credit sales from ABS syndication and was replaced in that department by Tim Michael. Peberdy has worked at the fixed income and ABS syndication desk for eight years.

Michael will now report to Mark Dodd, co-head of EMEA syndicate.

Advisory

Australian advisory/fund manager minted

A new Australian advisory and funds management firm has launched. Moss Capital was founded by chairman Bill Moss and ceo Glenn Willis to specialise in debt and equity financing, and corporate and real estate advisory.

Previously, Moss spent 23 years as a senior executive and executive director with Macquarie Group. He founded, grew and led Macquarie Real Estate Group to a point where it managed over A$23bn worth of investments around the world.

Willis co-founded Grange Securities, which after 12 years of growth was acquired by Lehman Brothers in 2007. Following the acquisition, he was appointed country head and md of Lehman Brothers Australia, overseeing the integration of the two businesses and the operation of Lehman Brothers' investment banking business in the country. In 2008 Willis was appointed vice chairman of Lehman Brothers Australia.

CDO

Cairn wins CDO mandate

Cairn Financial Products has replaced Duke Funding Management as collateral manager on the Duke Funding High Grade III transaction. Under the agreement, Cairn has agreed to waive a certain portion of the fees that would otherwise have been payable to it under the terms of the original collateral management agreement. An amended and restated collateral management agreement has also been put in place.

The original collateral management agreement permitted termination of the original collateral manager where certain overcollateralisation ratios had failed for over 180 consecutive days and, as in this case, over two-thirds of the holders of the Class A notes (other than the Class A-1B-2 notes) directed such termination. In addition, because the trustee issued a notice of event of default in December 2008, which a majority of the transaction's controlling class has stated is continuing, that majority was entitled to appoint the replacement collateral manager.

Cairn has 44 employees operating in London and over US$41bn of assets under management and long-term advice. It is the portfolio manager for US$3.6bn of ABS CDO, CMBS/CRE CDO, TRUPS and CLO transactions across the US and Europe, in addition to managing CMBS, US RMBS and other ABS transactions. Because the reinvestment period has ended for the Duke Funding deal, Cairn will be managing the transaction to enhance overall recovery proceeds.

Moody's says that the appointment of the replacement collateral manager and the execution of the waiver and replacement collateral management agreement do not result at this time in a downgrade or withdrawal of the current ratings it assigned to the transaction.

CDO

CRE CDO manager replaced

CWCapital Investments (CWCI) is being tipped as a potential replacement CDO asset manager for RFC CDO 2007-1, a US$1bn revolving CRE CDO that closed on 2 April 2007. As of the May 2009 trustee report, the transaction was substantially invested in commercial mortgage whole loans/A-notes (accounting for 54.1%), CMBS (21.2%), CRE B-notes (12.5%), CRE mezzanine loans (11.7%) and CRE CDOs (0.5%).

The deal has a five-year reinvestment period, ending April 2012, during which principal proceeds may be used to invest in substitute collateral. As of May 2009, the CDO was failing two par value tests due to haircuts associated with four defaulted assets (8.5%).

CWCI currently manages five CRE CDOs and re-REMIC transactions totalling US$6bn issued since May 2005. CWCI is a subsidiary of CW Financial Services, a real estate finance and investment management company with 11 offices and approximately 300 employees across the US.

CWFinancial is an indirect, majority-owned subsidiary of the Caisse de Depot et Placement du Quebec (CDP) and acts as the US manager for Otera Capital, CDP's global commercial real estate platform. It is also a commercial mortgage servicer through its CWCapital Asset Management and CWCapital servicing platforms.

On 16 July, Fitch was notified of a proposed amendment to the RFC CDO 2007-1 collateral management agreement in which the CDO asset management responsibilities for the transaction would be transferred to CWCI from Realty Finance Corporation (RFC). It says the transfer will not impact RFC CDO 2007-1's ratings.

CDO

New manager to take on distressed CRE/SF CDOs

Ventras Capital Advisors is set to become the replacement CDO asset manager for eight commercial real estate and diversified structured finance CDOs currently affiliated with Capmark Investments - Blue Bell Funding, the Crest G-Star 2001-1 and 2001-2 deals, and the G-Star 2002-1, 2002-2, 2003-3, 2004-4 and 2005-5 transactions. Ventras is a newly-formed investment management firm focused on distressed opportunities within the commercial and residential real estate sectors.

The firm is co-owned and operated by the former CDO management team of Capmark and co-owned and capitalised by private equity firm MBH Enterprises. The principals and employees of Ventras include the management team that oversaw ongoing management of the CDOs.

All of the CDOs to be managed by Ventras were issued between 2001 and 2005. The portfolios generally consist of CMBS, RMBS and ABS.

Five of the eight CDOs are considered to be commercial real estate CDOs, with each having at least 45% of their collateral in CMBS or other commercial real estate-related collateral. The remaining CDOs are considered to be diversified structured finance CDOs, with collateral predominantly consisting of subprime RMBS and RMBS assets. Other assets include CMBS and ABS.

Four of these transactions have experienced at least one overcollateralisation test failure or an event of default. No classes of the CDOs are currently on rating watch negative.

For all transactions, the asset manager may no longer purchase new collateral, as the substitution period has ended or the deal has been static since issuance. For some CDOs, Ventras does maintain the ability to sell defaulted, credit risk and credit improved securities, and the proceeds of any such sale would be distributed as principal proceeds on the subsequent distribution date.

CDO

Credit trading trio hired

Maxim Group has expanded its fixed income platform with the appointment of three senior-level executives. Marc Steinberg joins the New York-based firm as an md in CDO trading, Sheila McGillicuddy joins as an md in leveraged finance sales and trading, and Michael Kinnear joins as a director in credit trading. These appointments are part of an ongoing expansion of Maxim Group's fixed income capital markets business, which has included the recruitment of multiple senior-level executives in the fixed income space with expertise in corporate debt, mortgage securities and ABS.

Steinberg will be responsible for trading and selling CDOs. Prior to joining Maxim Group, he was with Dinosaur Securities, where he was responsible for building out the firm's structured credit business. Previously, Steinberg was the head of the alternative funding business unit of Lehman Brothers in London, where he executed and traded Lehman Brothers' first European CRE CDO. Prior to Lehman Brothers, Steinberg spent six years at Morgan Stanley, where he was responsible for expanding the firms synthetic CDO business.

Prior to joining Maxim Group McGillicuddy was a vp, bank loan capital markets at Goldman Sachs, where she was head of investment grade loan capital markets and created the high grade syndicate loan business. Previously, McGillicuddy was a director in loan execution and portfolio management at Merrill Lynch, where she structured loans for syndication in the primary market.

Kinnear will be responsible for middle market and customer flow trading of high grade and crossover telecom, media, technology (TMT) as well as customer flow trading for the bank and finance corporate bond sectors. Prior to joining Maxim Group, Kinnear was at Jefferies & Company, where he traded various investment grade corporate bond sectors across multiple electronic platforms. Previously, Kinnear was a credit derivatives trading analyst at Barclays Capital.

CDO

Redemption offer for CDO-linked investments

Singapore-based Great Eastern is making a one-time redemption offer to its GreatLink Choice (GLC) policyholders. The offer will be open for acceptance from 3 to 28 August 2009 and involves the cancellation of the GLC units in return for a sum equal to the original purchase price of US$1.00 per unit, less the total annual payouts received to date.

GLC is a series of investment-linked insurance products with the underlying investments in CDO instruments. Insurance coverage is provided over the duration of the investment. Both the annual payouts and principal repayment on maturity are not guaranteed.

At inception, the GLC products were rated AA/AA- by S&P, based on the terms of the instruments and that each fund has a built-in loss protection level allowing for as many as 16 to 23 credit events (depending on the individual fund) before the annual payouts and maturity benefits would be affected. In addition, each fund is made up of reference entities diversified across various industries and geographical regions; and no single reference entity in any GLC fund accounts for greater than 1.5% of the fund's overall exposure.

Since inception, annual payouts have been made under the GLC products as projected. However, because of the global financial crisis, the market values of these products are at steep discounts to par due to several credit events effectively eroding the loss protection cushion. Great Eastern understands that these steep discounts have given rise to concerns among GLC policyholders.

Group ceo of Great Eastern, Ng Keng Hooi, says: "We are comfortable with these products as they were designed with built-in loss protection levels and diversification amongst at least 115 reference entities, spread across various industries and geographical regions. However, the global financial crisis has created much uncertainty for many investors all over the world. Market sentiments have been severely impacted and many financial instruments have been badly affected by the crisis."

He continues: "To address GLC policyholders' concerns in these extraordinary times, we have taken a decision to make this one-time offer, as a gesture of goodwill, to redeem these products. Our offer is voluntary and is made without any admission of liability."

The offer applies to GLC products only. Other than GLC products, Great Eastern says it did not sell any other similar structured products to its policyholders.

CDO

Lehman CLN judgement obtained

Perpetual Trustee Company, acting in its capacity as trustee for retail investors in Australia, New Zealand and Papua New Guinea, has obtained a judgement in the English High Court to the effect that certain provisions which allow for the subordination of the rights or beneficial entitlements of Lehman Brothers Special Financing (LBSF) on its bankruptcy or default are valid and effectual under English law. Perpetual was represented by English lawyers from Sidley Austin working together with lawyers from the Australian firm of Henry Davis York.

The action, called 'Perpetual Trustee Company Limited v BNY Corporate Trustee Services Limited and Lehman Brothers Special Financing Inc.' (together with a similar case called 'Belmont Park Investments Pty Limited and Others v BNY Corporate Trustee Services Limited and Lehman Brothers Special Financing Inc.'), has been closely monitored by market participants given its potentially far-reaching significance to similar synthetic CDO and other derivative transactions in which parties have deliberately selected English law to govern their dealings (SCI passim). The proceedings were brought by Perpetual as the holder of certain CLNs issued as part of the Dante CDO programme sponsored by LBSF and its affiliates against BNY Corporate Trustee Services. LBSF obtained an order under which it was joined as party to the proceedings.

The court considered a variety of issues, including the issue of whether BNY should be prevented from applying noteholder priority in relation to the distribution of the proceeds of the collateral over which it was directed to enforce security, following an acceleration of the notes held by Perpetual. The documents (which were governed by English law) provided for a reversal of the priority of payments to allow Perpetual (as holder of the notes) to be paid ahead of LBSF (as swap counterparty) if there was an event of default in relation to LBSF under the swap agreement. An EOD under the swap agreement occurred as a result of the Chapter 11 bankruptcy filing of LBSF in the US.

While BNY adopted a neutral stance on the substantive issues, LBSF maintained that certain provisions of the US Bankruptcy Code (the 'ipso facto' rule) and, in the alternative provisions of English law, operated to prevent the reversal of the priority of payments.

The decision confirms that provisions in contracts governed by English law that subordinate the rights or beneficial entitlements of the swap counterparty on an insolvency or other default will not generally be prohibited by English law, Sidley Austin notes. "The efficacy of provisions such as these is widely perceived to be an important assumption in the assignment by credit rating agencies of credit ratings to credit-linked notes and other instruments. The validity of provisions such as these as a matter of US law has yet to be determined by the US courts and is presently the subject of litigation in the US," the firm concludes.

CDPCs

CDPC begins portfolio restructuring

Primus Financial Products, a subsidiary of Primus Guaranty, has entered into a transaction to terminate certain credit default swaps with a bank counterparty, with a total notional principal of US$1.2bn (aggregate notional of US$40m). These CDS were written primarily on a financial guaranty insurance reference entity. Primus has paid a termination fee of US$15m to the counterparty to terminate these swaps.

In addition, Primus has assigned the remaining CDS that it had sold to the counterparty to its newly formed, wholly owned subsidiary, having paid an assignment fee of approximately US$36m to the subsidiary. The subsidiary's exposure to the CDS contracts with the counterparty is limited to this US$36m, plus future premiums.

Thomas Jasper, ceo of Primus Guaranty, says: "A key business priority for Primus in 2009 is actively managing our credit protection portfolio to improve its performance in amortisation. The transaction we are announcing today is an important step in that direction."

CDS

Derivatives partner appointed

International law firm Jones Day has hired Joel Telpner as a partner in its banking & finance practice based in New York. Telpner comes to Jones Day from Mayer Brown, where he was a specialty capital markets attorney focused on representing financial institutions, derivative dealers, investment banks, private investment funds and end users in designing, structuring and negotiating complex structured finance and derivative transactions.

Mark Sisitsky, co-chair of Jones Day's banking & finance practice, says: "We are very pleased to welcome Joel as a partner in our New York office. Joel's extensive experience in structured finance and derivatives will be of great benefit to our clients."

Telpner adds: "Meeting the needs of clients in this changing economy requires a unique law firm, with the deepest bench of knowledge, experience, business savvy and geographic reach. No other firm is as well positioned as Jones Day to do this."

Telpner's broad range of experience includes advising clients on financial products and transactions, including total return and CDS, synthetic products, credit and equity-linked products, hedge fund-linked products, structured and leveraged finance transactions, CDOs/CLOs and other securitisation products. He provides strategic advice to clients on restructuring, repackaging, risk management and regulatory concerns in connection with the current credit crisis.

CDS

Law firm adds two in structured finance

International law firm Nixon Peabody has expanded its global finance practice with the addition of two partners, Keith Krasney and Peter Morreale, to lead the firm's securitisation and structured finance team. Krasney and Morreale will join the firm's New York City office and Washington, DC office respectively.

Mats Carlston, leader of the firm's global finance practice, says: "Keith and Peter are two top legal practitioners in the securitisation and structured finance field. Their arrival will greatly complement the financing capabilities we offer to our clients as Keith and Peter will work closely with our real estate, private equity, investment fund, REIT and public finance practices, as well as continuing to service their existing clients and broaden their client base."

He adds: "They will position us well to become a leading provider of legal services in this area as our economy recovers. Their experience in distressed financial assets and innovative structures is invaluable in this economic climate."

Krasney and Morreale join Nixon Peabody from McKee Nelson, where they were both partners. Their practice involves securitisations, structured finance, sales, purchases and financings of financial assets, and sales, divestitures and purchases of interests in financial institutions. Their clients include investment banks, commercial banks, hedge funds and private equity firms, and historically have also included other forms of financial institutions and investors.

Morreale says: "One of the key elements of our economic recovery will be a healthy and robust securitisation and structured finance market. That market will look different than it has in the past, but it will utilise many of the structures that have been developed and refined over the years."

Krasney adds: "The market landscape is shifting to reflect the lessons of the last two years and the new regulatory framework. This current credit market environment presents an extraordinary opportunity for our clients. We're excited to leverage our experience with a diversified team of attorneys across practice groups at Nixon Peabody."

Clearing

Clearer names CDS director

Suzanne Hubble has joined ICE Clear Europe as director, CDS development. She is responsible for the strategic development of ICE Clear Europe's European CDS clearing business. Prior to joining ICE, she spent over ten years at JPMorgan, where she was most recently responsible for e-commerce and strategic initiatives for the European credit trading business.

ICE Clear Europe, which also provides clearing services for ICE's futures and OTC energy markets, has established a separate risk pool for clearing CDS, including guaranty fund and margin accounts, as well as a dedicated risk management system and governance structure (see last week's issue). Initial CDS clearing members at ICE Clear Europe include Bank of America, Barclays, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley and UBS.

Each clearing member has made a significant contribution to establish the European CDS guaranty fund. The guaranty fund will continue to scale in conjunction with the transfer of CDS positions to ICE Clear Europe.

In addition to member contributions, ICE has contributed US$10m towards the guaranty fund, in addition to its US$10m contribution to the ICE Trust guaranty fund to date. ICE remains committed to a guaranty fund contribution of US$100m over a two-year period, which will be split evenly between its US and European CDS clearing houses.

CLO Managers

Rabobank confirms CLO business handover

Rabobank has assigned the management of four CLOs (Prospero CLO I, Prospero CLO II, Veritas CLO I and Veritas CLO II) and two synthetic CDOs (Archstone I and Archstone Synthetic CDO II) to Alcentra NY, part of BNY Mellon Asset Management. As part of the assignment, Rabobank transferred its collateral management rights and obligations to Alcentra.

Three members of the Rabobank team - portfolio manager and team head Ron Grobeck, Randy Watkins and Daymian Campbell - moved from Rabobank to Alcentra's New York team to continue their active work on management of the funds. As previously reported in SCI, Alcentra NY is also tipped to replace BNY Capital Markets as collateral manager on OWS CLO 1 (see issue 146).

CLOs

Manager retires debt of four CLOs

KKR Financial Holdings has taken certain actions regarding four of its CLO transactions that the company's management believes will have a positive impact on KFN's liquidity outlook.

In response to both the strong improvements in the credit market and increases in loan prices during the second quarter of 2009, KFN sold certain of its investments financed in CLO 2009-1 in order to generate proceeds to repay the entire amount of senior notes outstanding, which totalled approximately US$561m as of 31 March 2009. The company focused such sales on assets that had the highest prices relative to par.

Prior to the retirement of the senior debt, an affiliate of the company held a 20% interest in the subordinated notes issued by CLO 2009-1. As part of the deleveraging of the transaction, the subordinated notes in CLO 2009-1 held by KFN's affiliate were retired in exchange for a 20% interest in each of CLO 2009-1's assets that remained following the deleveraging.

The company now holds the residual assets of CLO 2009-1, which consists of approximately US$317m par amount of corporate debt investments with an estimated fair market value of US$242m and approximately US$15m of cash and receivables. KFN believes that these assets currently generate approximately US$11m of annualised cash interest income for the company that would have otherwise been used to amortise and pay interest on the senior notes issued by CLO 2009-1, which had a coupon of 425bp over Libor.

The company surrendered for cancellation, without consideration, approximately US$298m in aggregate principal amount of mezzanine and junior notes previously issued to it by the issuers of CLO 2005-1, CLO 2005-2 and CLO 2006-1. The surrendered notes were promptly cancelled upon receipt by the trustee of each transaction and the related debt was extinguished by the issuers. KFN believes that this transaction brings the overcollateralisation (OC) tests for these three CLOs into compliance, enabling the mezzanine and subordinated noteholders - including the company - to resume receiving cashflows from these transactions during the period when the OC tests are maintained.

In accordance with US GAAP, KFN consolidates its CLOs subsidiaries and therefore does not expect this transaction to have an impact on its consolidated financial statements. Similarly, as CLO 2005-1, CLO 2005-2 and CLO 2006-1 are treated as disregarded entities for tax purposes, this transaction is not expected to have any tax implications for the company or its shareholders.

KFN expects to announce earnings for the quarter of between US$0.11 and US$0.19 per diluted common share. The company does not expect to make any cash distributions to shareholders for the quarter. At 30 June 2009, KFN had unrestricted cash of approximately US$114m.

Investors

Investment for ex-hedge fund execs' new venture

FRM Capital Advisors (FCA), a division of Financial Risk Management (FRM), and WestSpring Advisors have formed a strategic relationship - part of which involves FCA making a significant investment in WestSpring's first fund.

WestSpring is a New York-based credit-focused asset manager that will seek to exploit market inefficiencies through a combined fundamental and quantitative approach to credit analysis and evaluation of technical imbalances. The firm was formed in May 2009 by Ralph Nacey and Eric Phillipps, who have worked together since 2002, most recently as cio and portfolio manager/lead trader respectively at long-short credit-focused hedge fund Brigadier Capital Management.

Clive Peggram, ceo of FCA, says: "WestSpring offers a transparent investment strategy and the team has an excellent track record of delivering returns and properly managing risks. They are among a select group of managers that have a deep understanding of the inefficiencies surrounding asset-backed security and credit valuations, and we expect this knowledge to allow the WestSpring team to continue to deliver impressive returns. We are confident in their ability to build a high quality alternative investment business and we believe this strategic relationship is a great opportunity for our investors."

Nacey, managing principal of WestSpring, adds: "When planning the launch of our business it was important for us to partner with the right team and institution. As part of the FRM Group, FCA provides the ideal combination of institutional depth and infrastructure along with a talented investment team that understands and supports our investment approach."

Following the signing of the strategic relationship WestSpring is expected to launch its first fund in September 2009. The move represents FCA's second strategic investment announced within the last month: on 16 July 2009 the firm announced a strategic investment in JD Capital's volatility trading strategy.

FRM is a global fund of hedge funds group managing approximately US$9bn worldwide for institutional and other sophisticated investors. FCA makes strategic investments in emerging alternative investment managers.

Before Brigadier, Nacey worked for Merrill Lynch, where he formed the North American derivative structuring desk and headed a structured finance long/short proprietary trading effort. Phillipps also worked at Merrill Lynch as lead structurer and trader of credit derivatives. Prior to joining Merrill Lynch, both men worked at Credit Suisse First Boston.

Operations

PIMCO gets TALF monitoring role

The New York Fed has named PIMCO as a collateral monitor for the TALF programme. The Fed clarifies that while Trepp will focus solely on CMBS, PIMCO will perform a broader role that encompasses the entire TALF portfolio, including both mortgage-backed and non-mortgage-backed ABS. The collateral monitors will not establish policies or make decisions for the New York Fed, including decisions whether to reject a CMBS as collateral for a TALF loan or exclude loans from mortgage pools.

RMBS

Firm seeks downgraded MBS for re-REMIC treatment

The Geary Companies has launched CEMP - a new firm that takes existing, recently-downgraded MBS from multiple sources, adds credit enhancement in the form of zero-coupon Treasuries, and then pools them together to create a new triple-A security. CEMP then sells the new re-REMIC back into the marketplace. The first re-REMIC from the firm was CEMP 09-1, which was comprised of 28 different MBS from six different sources that totaled US$203m original face, with US$164m current face.

"The rating agencies broad swipe downgrades of private label mortgage-backed securities seemingly driven by regulatory agencies has forced selling and created a buyer's market," says Keith Geary, chairman, president and ceo of the Geary Companies. "For someone who focuses on the mortgage market, it was very simple to see the opportunity to create CEMP. In any line of business, it is a simple fact that poorly planned actions always result in 'unintended consequences.' In this case, more than 600 banks across the US and thousands of money-fund managers were negatively affected and became forced sellers."

RMBS

Mortgage REIT IPO downsized

PennyMac Mortgage Investment Trust, a newly-formed mortgage REIT, has announced the pricing of the initial public offering of 16 million common shares at US$20 per share. The IPO was initially expected to comprise 20 million shares (see SCI issue 146).

PennyMac has granted the underwriters a 30-day option to purchase up to an additional 15% of the common shares sold in the underwritten offering to cover overallotments, if any. At the same time, the REIT intends to complete a private placement of 5% of the common shares sold in the underwritten offering at the same US$20 per share.

PennyMac intends to use the net proceeds from the offerings to purchase residential mortgage loans and RMBS, a substantial portion of which may be distressed.

RMBS

Mortgage risk analytics team developed

Strategic Analytics has launched an internal division dedicated to providing proven and significant solutions in mortgage risk analytics. The Mortgage Risk Analytics group will be led by director Dale Cline, an industry veteran with more than twenty years of mortgage experience.

In addition, Strategic Analytics has introduced two innovative products that it believes are critical to the stable growth and viability of the US retail lending industry. First, its Mortgage Risk Model offers retail lenders access to a comprehensive mortgage loan-level database and forecasting technology.

Strategic Analytics describes the model as being "efficient, intuitive and transparent, providing unmatched accuracy within the field of mortgage analytics". The offering incorporates significant measures of origination quality, maturation effects and environmental factors into analytical tests that traditional roll-rate modelling methodologies cannot effectively capture.

Second, the firm's MBS/ABS Securities Forecasting Service provides lenders with cashflow, CPR, CDR and loss severity projections, enabling them to price and trade mortgage assets with greater efficiency, it says.

ABCP

BoE support may ease ABCP liquidity pressures

The expansion of the Bank of England's (BoE) support mechanisms to incorporate ABCP may ease liquidity pressures on ABCP conduit sponsors, according to Fitch. The Secured Commercial Paper Facility (SCPF) could also prompt renewed activity in the European ABCP sector that has been severely affected by the global financial crisis, the agency says. However, stringent eligibility criteria, coupled with a pricing structure that may limit the attractiveness of the scheme, means that the SCPF is unlikely to prove a panacea for the European ABCP market.

Emma-Jane Fulcher, director in Fitch's European structured finance ABCP group, says: "Prior to the introduction of the SCPF, the only external means European conduits had to provide ongoing client funding and generate liquidity was to tap the facilities created by the US government. This essentially kept many programmes, with US dollar issuing ability, going. Alternatively, sponsoring banks have been either forced to bring assets back onto their balance sheet or pay down outstanding ABCP via internal liquidity facilities - neither of which is likely to be an optimal strategy for a programme sponsor."

While the take-up of the BoE's scheme remains to be seen, at the minimum its existence may provide sponsoring banks with another source of otherwise limited liquidity. It may also be a catalyst to stability and investor confidence in ABCP, and the agency anticipates an element of new ABCP programme creation to ensue with the specific aim of accessing the SCPF.

The SCPF, which came into force on 3 August, is largely aimed at shoring up the availability of short-term credit to market participants active in the UK, including corporate borrowers and particularly SMEs that conduits generally fund. The facility brings the UK somewhat in line with the US Federal Reserve that launched the ABCP Money Market Mutual Fund Liquidity Facility (AMLF) and the Commercial Paper Funding Facility (CPFF) special support programmes in 2008.

Fitch expects that many ABCP conduits within its rating universe will meet the eligibility criteria set down by the UK central bank, as most already fall into the higher short-term rating categories of either F1+ or F1 and many of the pure multi-seller programmes already consist of portfolios of short-term receivables from SMEs, for which the scheme is chiefly targeted.

Under the facility, the maximum weighted average life of the programme's assets cannot exceed nine months (with no underlying asset to have an expected final maturity of more than 18 months) and sterling-denominated paper only is acceptable. This latter condition may be a disincentive for some existing European programmes due to the current ease of issuance in the US ABCP market and favourable foreign exchange rates.

Fitch does not expect the SCPF to impact adversely on its outstanding ABCP ratings, but will monitor its usage and take appropriate rating action as necessary.

ABS

Surveillance recommendations made for EMEA ABS

Moody's has published its recommendations for further improving investor and servicer reports in EMEA markets in a report entitled 'Investor/Servicer Reports: Important Considerations for Moody's Surveillance of EMEA ABS and RMBS Transactions'. The agency believes that the quantity and the quality of information disclosed at issuance, and throughout the lifetime of a securitisation transaction, will be key factors for restoring confidence in the RMBS and ABS markets.

Moody's says that performance information of both collateral and transaction is essential in a normal economic environment, but becomes even more vital during times of economic strain, such as the current economic crisis. The lack of this information typically leads the agency to take conservative assumptions and could potentially imply ratings being withdrawn.

In Moody's view, an issuer's ability to meet these information needs without delay will help to maintain transparency and will ultimately support the restoration of investor confidence. To illustrate this point, the rating agency has focused on the reporting practices of the Spanish ABS/RMBS market, which is one of the oldest markets in Europe.

For the primary rating analysis, Spanish originators invite Moody's to perform an operational review and typically provide a solid set of data, such as loan-by-loan collateral characteristics and static vintage default/recovery historical data. There are two points in this process that Moody's believes could be improved: information for the transaction analysis and operational reviews.

Collateral performance data covering a full economic cycle is rarely available in the Spanish market. In order to make the most accurate assumptions on default and recovery rates, Moody's encourages originators to complement existing information by adding internal rating/scores and the corresponding migration matrices, dynamic delinquency and prepayment data and loss given default information.

Equally, in Spain it is unusual for Moody's to receive presentation material and summarised procedures documentation. The agency says it would expect to receive such material upfront for each meeting to review it beforehand and discuss more efficiently with management and the relevant business units origination, underwriting, servicing, collection and enforcement processes.

With regards to surveillance, Spanish issuers and management companies (Gestoras) have adopted European market principles that establish a standard of consistency, transparency and comparability for investors. However, the definitions and quality of the data in investor reports varies between the Gestoras.

Moody's suggests that additional information is included in investor reports, including:

• Defaults/artificial-write-offs: For granular portfolios, the aggregate amount of defaulted loans and number of new periodic defaults should be reported. For less granular portfolios, a list of all defaulted loans would improve the transparency regarding the nature of the defaults. With respect to artificial write-offs, investor reports should distinguish whether write-offs relate to i) the loan being declared as defaulted by the servicer as part of it general servicing policies and practices; or ii) the loan having accumulated a certain number of missed payments (typically for more than six to 18 months).

• Losses and recoveries: Losses are not usually disclosed in investor reports. Moody's gives credit to recoveries in its analysis. Therefore, it is important to disclose the final loss severity net of the recoveries. For instance, Gestoras should report losses net of the proceeds received from the sale of an underlying property. Moody's expects detailed data to determine loss severity such as total recoveries (including partial recoveries, refinancing, liquidation of the collateral) and recoveries associated with the liquidation of the collateral (number of properties sold, average loss severity, time to recovery).

• Property acquisition: Originators and funds may end up owning a property if one of the following scenarios occurs: i) a foreclosure process has been concluded and no auction bid was received for the property; or ii) "daciones en pago" (payment in kind). Investor reports should disclose whether the originator or the fund has acquired the property. This information would help to assess the risk associated with property acquisition, such as increased costs for the fund due to, for instance, property acquisition tax and maintenance costs.

• Standardisation of waterfall information: Investors need to distinguish between the available distribution amounts, the amount of prepaid principal, gross excess spread as well as the issuer and swap costs. Additionally, the reporting of principal deficiency ledgers is key in underperforming transactions as it shows the asset-liability mismatch when a reserve fund is fully depleted.

• Explanation of triggers: Disclosure of trigger values is key in transactions where triggers are determined at a different point in time to the reporting date.

• Details on the security of the loans: It is common in Spanish transactions that SME loans, for example, benefit from a mortgage over a property or land. It is important to keep investors and rating agencies updated on the quality of the underlying loan security over time.

• Portfolio amortisation profile: Information on the portfolio expected amortisation is not widely available. A 0% constant prepayment rate (CPR) and a 0% default probability rate (DPR) profile would be key to determine the weighted-average life under their respective assumptions of the portfolio and of the notes issued by the fund.

ABS

Australian ABS rating methodology published

Moody's says in two new reports on the Australian ABS market that the sector should pick up in 2009 after a slow start to the year.

Ilya Serov, a Moody's vp, senior analyst and author of the report, says: "Despite the global financial crisis, we are continuing to see healthy levels of activity in the Australian ABS sector. In fact, 2008 saw the second highest levels of issuance on record."

"Although to date this year has been quiet, we view this as a temporary lull and expect a return to healthier volumes in the near future," adds Serov.

The reports are part of a series of publications summarising Moody's approach to rating Australian ABS. The first report explains the agency's updated approach to Australian ABS, while the second covers its data and information guidelines for the sector. Moody's says that together they should provide the investor community with a full outline of its methodology from deal inception to surveillance, focusing on traditional Australian ABS structures, including securitisations of auto loans and equipment leases.

In particular, the reports focus on the expected loss methodology Moody's uses in its analysis of ABS; historical data analysis, including analysis of transactions' past default, recovery and delinquency performance, as well as the limitations of quantitative analysis, and techniques used by Moody's to better reflect the credit quality of rated securities through the economic cycle. In addition, the report will offer guidelines relating to the data used by the rating agency in its analysis, including both quantitative performance data and qualitative information obtained by Moody's in its operations reviews.

ABS

New functionality, additional models for ABSXchange

ABSXchange is set to introduce new functionality next month, whereby users can add additional collateral lines to represent the underlying collateral more accurately. It says it is also investigating options to add loan-level data to many European RMBS transactions to improve the accuracy of cashflow model projections.

The firm has recently updated the way collateral is represented in UK prime RMBS master trust cashflow models. The collateral representative line is now classified as interest-only instead of repayment, as these transactions report total repayment rates instead of prepayment rates. An interest-only representative line will allow users to more easily simulate the current prepayment performance of the deals when performing cashflow analytics, ABSXchange says.

During August, the firm will release additional cashflow models for Arkle Master Issuer, Fosse Master Issuer and Pendeford Master Issuer. Its library of European master trust cashflow models already includes: Aire Valley Trust, Gracechurch Mortgage Funding, Granite Mortgages, Lothian Mortgages, Mound Financing Master Trust, Permanent Financing and Beluga Master Issuer B.V. Master Trust.

Advisory

Manager due diligence good practices published

IOSCO's Technical Committee has published a final report - entitled 'IOSCO Good Practices in relation to Investment Managers' Due Diligence When Investing in Structured Finance Instruments' - which contains guidelines aimed at assisting both investment management industry participants and regulatory bodies in assessing the quality of their due diligence procedures regarding investments in structured finance instruments (SFI) by collective investment schemes (CIS) offered to retail investors.

The Investment Manager Due Diligence Practices were developed in cooperation with industry representatives following the recommendation made in the 'Report of the Task Force on the Subprime Crisis', published in May 2008, that the Technical Committee's Standing Committee on Investment Management (TCSC5) conduct work, and develop good practices, on investment managers' due diligence processes and procedures when investing in SFI on behalf of CIS offered to retail investors.

The Investment Manager Due Diligence Practices are based on five key messages:

• Investing in a SFI is different from investing in a more traditional instrument. The risks are different and call for a tailored due diligence process;
• If you do not understand a SFI, do not buy it;
• Due diligence is and must remain a value-added process. It is not and must never become a plain box-ticking process;
• Due diligence is generally a three-step, iterative process, which is structured around the understanding of the underlying assets of the SFI, of its structure and of how it fits into the CIS mandate; and
• Due diligence is not a static process. It is an on-going process, which starts at the time the initial investment in the SFI is contemplated and ends when the SFI matures or is divested.

The practices are broken down into the three stages that should be included in the due diligence process and also address the question of the use of third parties in the due diligence process, including credit rating agencies. The three stages are:

1. Analysing the underlying assets of the SFI
Investment managers should assess the availability, reliability and relevance of information available both on the market and on the underlying assets.
2. Analysing the structure of the SFI
The analysis of the structure of the SFI should be conducted both in 'normal' and in 'stress' scenarios. The asset manager should understand how cashflows will be allocated to the different tranches of the SFI.
3. How does the SFI fit into the CIS mandate?
The investment manager should check that investing in the SFI on behalf of the CIS is consistent with the disclosures, mandate and internal operations of the CIS.

Finally, the investment manager should understand the methodology, parameters and basis on which the opinion of a third party was produced. They should have adequate means and expertise to challenge the methodology and parameters.

CDS

BIS assesses financial sector rescue programmes

BIS has published a paper entitled 'An assessment of financial sector rescue programmes', which provides an overview of the government support measures introduced between September 2008 and June 2009 and an account of their effects on banks and on the functioning of credit and financial markets. The report first provides an overview of the programmes, comparing their characteristics, magnitudes and participation rates across countries. It then considers the effects of the programmes on banks' risk and valuation, looking at the behaviour of CDS premia and stock prices.

The paper then proceeds to analyse the issuance of government guaranteed bonds by banks, examining their impact on banks' funding and highlighting undesired effects and distortions. Finally, it briefly reviews the recent evolution of bank lending to the private sector. BIS says it draws certain policy implications, in particular as regards the way of mitigating the distortions implied by such programmes and the need for an exit strategy.

Government interventions are divided into three main categories: capital injections to strengthen banks' capital base; explicit guarantees on liabilities to help banks retain access to wholesale funding; and purchases or guarantees of impaired legacy assets to help reduce banks' exposure to large losses. Among other factors, the correlation between country-specific indices of bank CDS premia and the announcement of governments' commitment to support the banking sector is analysed. How the actual deployment of government resources affected the CDS premia of individual institutions is then analysed, together with the main events that affected CDS premia since Lehman Brothers' bankruptcy and cross-country differences in the reactions to these events.

CDS

Final auction results in for Bradbi

Final results for the Bradford & Bingley CDS auction were announced on 30 July. Senior CDS were settled at 94.625, while subordinated CDS were settled at five.

Separately, ISDA's determinations committee has dismissed a request from Legal & General Investment Management concerning a bankruptcy credit event with respect to Bradford & Bingley upon its nationalisation last year.

Clearing

Euro CDS clearing services begin

Eurex Credit Clear and ICE Clear Europe began operations in the European CDS market last week (see also last week's issue). Eurex successfully cleared its first transaction on 30 July, while ICE says it cleared €5.9bn in European CDS indexes in its first week of operation.

EU Internal Market and Services Commissioner Charlie McCreevy comments: "I am pleased that the extraordinary efforts by the industry and service providers have made it possible that two European CCPs are starting to clear these products now, with a third [LCH.Clearnet] aiming to launch its service by the end of the year. The existence and the use of more than one CCP is essential for the proper development of a safe and competitive environment."

Thomas Book, member of the Eurex executive board and responsible for clearing, says: "I am very pleased that our first credit clearing members used our new clearing solution for CDS at the earliest opportunity. Eurex Credit Clear has successfully completed its first production cycle and effectively delivers OTC clearing for CDS for the first time in Europe."

Eurex Credit Clear so far is the only CCP in Europe that offers both index and single name CDS. The new service is also accessible for buy-side firms from day one.

The company achieved operational readiness by 27 July 2009. The first market participants have also achieved operational readiness, with more members expected to connect to Eurex Credit Clear in the upcoming weeks.

Meanwhile, ICE began clearing iTraxx index contracts on 27 July and cleared 141 transactions during its first week, resulting in €382.5m of open interest. Each of the initial clearing members (see separate Job Swaps story) participated during the first week.

Paul Swann, president of ICE Clear Europe, comments: "The successful launch prior to the 31 July deadline, coupled with the participation by each initial member, demonstrates the industry's commitment to improving the transparency, standardisation and counterparty risk profile in the CDS markets. We commend these participants for their leadership in solving for these objectives in both Europe and in the US. We look forward to delivering our segregated funds offering to buy-side participants in October [see last week's issue]."

Robert Pickel, ISDA executive director and ceo, has applauded the "rapid and significant progress" made by the industry to increase market transparency, robustness and confidence in light of the introduction of central clearing in Europe. However, he points out that additional work remains to be done.

"The industry is engaged in ongoing efforts toward clearing all eligible CDS contracts through a central counterparty," Pickel notes. "Our membership continues to devote the greatest number of resources possible to meet these challenges and, with our help, is striving to build on the many improvements to the mechanics and infrastructure for these important risk management instruments. We look forward to continuing to work with the European Commission and regulators globally in these efforts."

The major market changes ISDA has introduced over the past several months range from the standardisation of trading conventions, such as coupons and effective dates, and the treatment of restructuring as a credit event in certain key markets to changes in the way transactions are handled post-trade and the incorporation of a global market-standard settlement mechanism into standard CDS trades (SCI passim).

Parallel efforts to reduce the body of existing transactions, increase the use of electronic processing and tighten up collateral practices have had a major impact on the ability of firms to service their outstanding trade populations and better manage their risks, the Association says. As a corollary to these initiatives, ISDA has made freely available a standard pricing model for CDS transactions. All of these measures have facilitated the greater standardisation of trade terms and processes without sacrificing the flexibility and utility of the bilateral CDS contract.

The European Commission has welcomed the fact that, through ISDA, dealers have developed the standards necessary to allow central clearing for European CDS, in particular standards for the treatment of the restructuring credit event incorporated in the 'Small Bang' Protocol, to which the vast majority of market participants has already adhered (SCI passim). It also welcomes the considerable efforts made by the CCPs to implement these standards so as to offer a solution by the set deadline.

The Commission expects that dealers will now begin using all available CCPs for all eligible trades. It says it will monitor the migration of CDS onto CCPs and will take account of the progress made by market participants in the CDS space when formulating its policy orientations for OTC derivatives in general, which are due to be published by the end of October 2009.

CLOs

US CLOs resume rally

US CLOs have responded to the July rally in broader markets and were subject to further spread tightening last week. According to data from JPMorgan structured credit analysts, triple-As moved in by 25bp to 575bp, double-As stayed at US$55, single-As moved up by US$5 to $35, triple-Bs moved up by US$8 to US$20 and double-Bs by US$5 to US$10.

"For triple-As we see limited volatility as downgrades intensify (price tiering will obviously increase) - though fear of extension has emerged as the main impediment to incremental spread tightening, as credit stress moderates and obligors push out default risk," the analysts note.

CLOs

CLO liquidity facility agreement amended

Amendments to Halcyon Structured Asset Management European CLO 2007-I's documents last week will not, result in a reduction or withdrawal of its ratings on the seven classes of notes due 2023, according to Moody's. The amendments affect the terms of liquidity facility agreement between Lloyds TSB and the SPV.

In March 2009 the Class C and D notes were downgraded by more than two notches, resulting in a breach of a condition ruling the drawing of the liquidity facility. With the proposed amendments, Lloyds agrees to extend the facility to January 2010, at which point any drawn amount would have to be repaid in full. The size of the liquidity facility has, however, been reduced from €10m to €2.5m and the spread over Euribor of the fee associated to any drawn amount on the facility has increased from 62.5bp to 625bp.

CMBS

Record CMBS loans transferred to special servicing

A record US$36.1bn of CMBS loans has been transferred from master to special servicing since year-end 2008, according to a new report from Fitch. With US$49.1bn in special servicing as of 30 June 2009, compared with US$16bn at year-end 2008, the current volume represents 6.1% of all CMBS by balance.

Fitch estimates the volume of loans in special servicing will continue to grow at the same rate and approach US$100bn by year-end, representing approximately 12% of all CMBS loans or US$96.5bn of total outstanding CMBS today. While the agency expects specially serviced loan volume to grow to 12%, it does not expect delinquency rates to mirror special servicing volume rates; rather, delinquency is expected to rise as high as 5%.

The brisk rise in special servicing transfers and the expectation of further increases continue to stress the resources of CMBS servicers (SCI passim) and thus intensify Fitch's scrutiny of their preparedness. The agency assesses a servicer's preparedness by measuring workload and capacity.

Currently, there is an average of 14 specially serviced assets per asset manager. Fitch believes this is a manageable ratio because servicers assign loans based on an asset manager's experience, capacity and specialty and not by loan count.

Fitch remains concerned with the servicing of highly structured, multilayered loans predominant in recent vintage transactions and master servicers' ability to address loan-level issues. Performance in this area has been uneven and, while the agency acknowledges the challenges associated with servicing these types of loans, servicer performance will be closely monitored.

CMBS

Defaulted US CRE loans enter special servicing

Eight newly defaulted loans greater than US$100m have entered special servicing, according to Fitch in the latest edition of it's 'What's in Special Servicing' US CMBS report. Recent defaults include two hotel portfolios, Red Roof Inn and Extended Stay (SCI passim).

Since Fitch's last update in April, US$17.4bn in Fitch-rated loans have entered special servicing (see also separate News Round-up story), excluding the Extended Stay portfolio, which on its own totals over US$4bn.

Fitch md Mary MacNeill says: "Four of the 10 largest delinquent loans have experienced appraisal reductions as a result of value declines, indicating that losses may be significant in their respective deals. Of over 2,000 specially serviced loans, 64 have balances in excess of US$100m."

Property performance has not deteriorated significantly since Fitch's last update among loans of concern, such as the Riverton Apartments and Peter Cooper Village/Stuyvesant Town. However, MacNeill explains: "Cashflow from Riverton and Peter Cooper Village/Stuyvesant Town still requires significant reserves to cover debt service obligations, and these reserves will likely be depleted by the end of the year."

Fitch has classified over US$75bn or 18% of its rated US CMBS portfolio as loans of concern. Recent vintage loans account for over 11% of the US$75bn.

Emerging Markets

CEEMEA securitisations remain on negative trend

Fitch expects the performance of securitisations in central and eastern Europe and the Middle East (CEEMEA) to continue to worsen for at least the next six months. This is due to deteriorating economic conditions in the region affecting originators, businesses and households. However, the agency notes that most transactions have so far performed in line with expectations.

In its report, Fitch says that at the macroeconomic level most of the CEEMEA countries continue to suffer from large current account deficits, macroeconomic imbalances, correction in the credit and asset markets, as well as from significant local currency depreciations. The rise in unemployment, combined with the rapid depreciation of the local currencies, has put considerable pressure on households' ability to meet their loan repayments.

At the same time, the global economic crisis has led to a drop in trade volumes, resulting in a slowdown of export-oriented CEEMEA economies. Notwithstanding a rapid increase in delinquencies and defaults since early 2009, performance data shows that the majority of rated transactions have so far performed in line with Fitch's expectations. The climb in defaults, combined with the significant drop in asset values, has prompted originators to look for amicable debt recovery solutions to avoid selling collateral in current market conditions.

In two transactions (Moscow Stars and Kazakh MBS 2007-1), the deterioration in the creditworthiness of the originators has triggered an option to transfer part of the servicing operations to back-up servicers. In both RMBS transactions these stand-by servicers are preparing to take over the operations, but Fitch expects this transition to be cumbersome. Both transactions benefit from reserve funds that cover at least nine months of interest payments in the event the issuers do not receive any cashflows during this period.

Future flow transactions have historically posted strong flows, but Fitch has observed a steady decline in collections since the start of 2009, which appear to be recovering in some cases since April 2009. As an outlier, the continued drop in flows for Alliance DPR Company since the summer of 2008 triggered the start of the amortisation period in April 2009.

Indices

CMBX performance worsens 'slightly'

CMBX credit performance in July worsened at only a slightly faster pace compared with the prior three-month average, according to ABS analysts at Barclays Capital. The latest index remittance reports indicate that the overall 30+ day delinquency rate (excluding GGP-related loans) rose by 39bp to 3.49% this month across the fixed rate universe, versus an average increase of 38bp over the prior three months.

"We continue to see a rotation of delinquencies outside of the multi-family sector to other property types," the analysts note. "Delinquencies were led by the hotel sector again, which posted a greater-than-1% gain, followed by industrial. Office delinquencies also began to pick up, partly attributable to consolidation in the financial industry." A significant pick-up in the pace of new delinquencies throughout the rest of 2009 is anticipated, especially in more recent vintages.

More seasoned loans posted the weakest performance by vintage. However, this is magnified by the small total balance of very seasoned loans; the total loans in more recent vintage categories are 3x-5x larger. Across CMBX, Series 4 deteriorated the most this month, followed closely by Series 3.

Combining loans that were special serviced current or 30+ days delinquent, CMBX.3 shows the worst cumulative performance at 6.1%. After adjusting for GGP-related issues, CMBX.1 remains a relative outperformer, the BarCap analysts conclude.

Indices

CDX short protection candidates identified

The Markit CDX IG12 has rallied from 199bp on 20 March to 116bp on 29 July 2009. In an attempt to estimate the potential for continued tightening, credit strategists at Barclays Capital have determined a likely near-term floor for the index through a combination of historical and forward-looking metrics.

The CDX IG12 currently trades about 11bp rich to intrinsic, the BarCap strategists explain. The traded-intrinsic basis has significantly decreased from levels of late 2008, so that projected movements in intrinsic levels can be assumed to indicate future movements in traded CDX levels.

With this assumption, they analysed the spread composition of the index constituents to estimate a potential floor for traded index levels. The results suggest that the most likely floor for the IG12 index is in the low-90s.

Further, BarCap approximated a bullish case within an exercise that inherently assumes a positive outcome in three of the four widest, highly idiosyncratic names; significant tightening among the 25 higher-beta credits; and a further notable reduction in systemic risk. "In our view, the most potential for tightening comes from mid-tier credits - based on the extent to which the tightest credits have already rallied and on our view of the potential for tightening out of the widest, most idiosyncratic credits. Using a screening process incorporating qualitative and quantitative factors, we believe some of the best short protection candidates in this cohort include Nordstrom, Macy's, Xerox, Southwest, Whirlpool and Alcoa," the strategists conclude.

Indices

Fourth monthly improvement for troubled companies

The Kamakura index of troubled public companies made its fourth consecutive dramatic improvement in July after reaching a peak of 24.3% in March. The index dropped by 1.7 percentage points to 14.7% of the public company universe in July. Kamakura defines a troubled company as a company whose short-term default probability is in excess of 1%.

Credit conditions are now better than credit conditions in 38.8% of the months since the index's initiation in January 1990, the firm notes. In March, by contrast, credit conditions were better than only 3.6% of the monthly periods since 1990.

Kamakura's president Warren Sherman says: "During the month of July, the rated public companies showing the sharpest rise in short-term default risk were CIT Group, Chem Rx Corporation, American Axle and Sharp Holding Corporation."

In July, the percentage of the global corporate universe with default probabilities between 1% and 5% decreased by 0.9 percentage points to 9.8%. The percentage of companies with default probabilities between 5% and 10% was down 0.4 percentage points to 2.3% of the universe, while the percentage of the universe with default probabilities between 10% and 20% was down 0.1 percentage points to 1.5% of the universe.

The percentage of companies with default probabilities over 20% was down sharply by 0.3 percentage points to 1.1%. In March, by contrast, 3.1% of the total universe had default probabilities over 20%.

Indices

Historical high for credit card charge-off index

The UK aggregate credit card charge-off index has grown by 46.5% over the past year, says Moody's in its latest index report for UK credit card ABS. This growth rate breaches the 10% mark for the first time since the index's inception in 2001, reflecting the continued deterioration in the sector. Moody's expects this trend to continue through the course of 2010 as rising unemployment rates feed through to increased charge-offs.

Cher Chua, a Moody's avp, analyst and co-author of the report, says: "UK unemployment is continuing to rise and Moody's Economy.com forecasts a 9.55% peak in Q1 2010. This suggests that the economy has some way to go before recovery. Moody's believes that charge-offs will continue to increase, peaking in H2 2010 (lagged approximately six months behind the peak in unemployment)."

In the report, the agency says that assuming charge-offs increase in line with unemployment, an increase of 25% by the end of next year from today's 10.12% level should be expected, resulting in charge-offs exceeding 12.5% by H2 2010. However, the rating agency cautions that certain other factors could lead to an index charge-off rate of greater than 15%.

Moody's further notes that 30+ day delinquencies, a leading indicator of charge-offs, have largely stabilised over the past quarter for numerous trusts. Durga Bhavani, a Moody's analyst and co-author of the report, explains: "It is early to conclude whether this abatement is temporary or more permanent. However, other key credit card indices, such as the payment rate and yields, remain broadly stable. Credit card excess spreads remain positive at present, but are under pressure due to increasing defaults."

Bhavani continues: "Furthermore, it is possible that the passing of proposals in a recent Government White Paper could result in increased negative pressure in the future if proposals to restrict originators' ability to raise interest rates on existing credit cards is enacted."

Moody's continues to have a negative outlook for the UK credit card ABS sector. It has placed several classes of notes issued out of some UK credit card trusts on review for possible downgrade due to concerns surrounding performance deterioration and a review of the purchase rate assumption.

Monolines

Moody's cuts Ambac to Caa2

Moody's has downgraded to Caa2 from Ba3 the insurance financial strength ratings of Ambac and Ambac Assurance UK. In the same rating action, the agency also downgraded the credit ratings of Ambac Financial, lowering the rating of the senior unsecured debt to Ca from Caa1. The ratings outlook for Ambac is developing, but is negative for Ambac Financial.

The rating action was prompted by Ambac's recently-announced large loss reserve increase and credit impairment charge estimated for 2Q09 (see the last issue). With the risk of regulatory intervention now elevated, Moody's believes there will be increased pressure on Ambac's counterparties to commute outstanding exposures on terms that could imply a distressed exchange.

For Ambac Financial, the greater regulatory risk further reduces the likelihood in Moody's view that the holding company will be able to access operating company resources over a reasonable timeframe to satisfy its obligations. This raises the risk of distressed exchanges of outstanding debt with moderate-to-high estimated severity due to the holding company's modest cash position and limited financial flexibility.

Ratings

Argentine securitisation market adjusts to changes

The volume of domestic securitisations in Argentina should remain stable at roughly 2008 levels in 2009, says Moody's, with slightly more activity in the second half of the year than in the first. Securitisations of consumer loan and credit card receivables, as well as infrastructure deals, are expected to continue to make up the bulk of issuance.

In all, domestic structured finance volumes in Argentina totalled US$1.513bn during the first six months of 2009, an increase of 2.4% year-over-year. However, if two large infrastructure transactions are excluded, the amount of issuance decreased by 47.3%. While volume remained stable, there was a 25% decrease in the number of deals.

Moody's associate analyst Federico Perez says: "During the first half of the year, the Argentine securitisation market adjusted to the elimination of some income tax benefits for securitisation - which reduced the incentive to securitise for certain issuers - the nationalisation of the private pension fund system and increasing concerns about servicing risk."

Since mid-2008 conditions for loan origination have tightened in Argentina, with loan interest rates increasing between 300bp and 500bp. Securitisations of personal loans and consumers loans, in turn, dropped in the first half of 2009 compared with 2008, down to 17.35% of total issuance from 38.23% in the same period of 2008.

In originations, Moody's notes a 'flight to quality' as investors concerned with breakdowns in servicing moved towards securitisations with highly rated seller/servicers, such as private banks. The shift follows the filing for bankruptcy of a seller/servicer, leading to difficulties in the transfer of loan servicing.

Moody's states that one new development in the structures of securitisations was the introduction of additional mezzanine bonds, which lessen the impact of the new income tax on residual bonds.

As for the performance of securitisations, the agency says that delinquency levels in the Argentine financial system have increased moderately during the first half of 2009, affected by the weakened labour market. "The trend of delinquencies in the future will depend on the degree of pressure the economic contraction applies to labour market indicators," says Perez. "Further increases in the unemployment rate accompanied by inflation would be the worst scenario."

Ratings

Australian SF outlook negative, despite positive signs

Moody's maintains its negative outlooks for the collateral performances of Australian ABS, CMBS and RMBS over the next 12 to 18 months. These outlooks are unchanged from Moody's report published in January 2009, though the agency expects the collateral performance's implications on ratings to be limited.

Richard Lorenzo, a Moody's vp/senior analyst, says: "Specifically, while the performance of Australian ABS transactions continues to be relatively good, the economic deterioration through H109 and uncertainties surrounding the used motor vehicle market are translating into worsening arrears and losses."

He continues: "Although there is no immediate short-term unease with regard to the performance of RMBS collateral, Moody's is nevertheless concerned with the situation over the next 12 to 18 months, as expectations of increased unemployment and an uncertain global economic climate filter through the Australian economy."

Meanwhile, with regard to CMBS, the supply-demand imbalance evident in 2008 continued in H109 as commercial real estate transaction volumes have decreased from their 2007 levels. On the supply side, institutional property owners are looking to de-lever their balance sheet by unloading non-core assets and thus providing a supply overhang in the market. On the demand side, property investors are facing hurdles in obtaining debt funding from banks that are weary of over-exposing themselves to the commercial real estate sector, notes the report.

However, although the outlook for collateral performance remains negative, there are some positive signs. Macroeconomic factors that could influence the performance of Australian underlying assets include Q109 GDP growth of 0.4%, which defied expectations and global trends, as other major developed economies contracted sharply. This means Australia has so far avoided two consecutive quarters of contracting GDP, the technical definition of recession.

In addition, though unemployment is increasing, Australian unemployment rates are proving to be relatively resilient. As of June, unemployment stood at 5.8%, with the government's official forecast of 8.5% by late 2010. This is within Moody's range of 7.5% to 8.5%, according to the report.

Ratings

Ratings outlook assigned for Korea and Singapore

In a new report Moody's says that the sector outlook for Korea RMBS is stable, while that for Korea ABS and Singapore CMBS is negative.

Jerome Cheng, a Moody's senior credit officer and co-author of the report, says: "Korea RMBS - which have a stable outlook - benefit from the low LTVs of its mortgage loans and the stable state of property markets in the major cities in the country. Meanwhile, Korea ABS, which is backed by unsecured receivables, has a negative outlook as the receivables are susceptible to the deterioration in the macro-economic environment. Singapore CMBS also carries a negative outlook because the office, retail and industrial properties in these transactions are all adversely affected by the current economic downturn."

Cheng adds: "The rating implications of these outlooks depend on the structural features of the transactions and the available headroom within existing rating assumptions."

Marie Lam, also a Moody's senior credit officer and another co-author of the report, says: "Currently, Korea RMBS and ABS's subordination levels and structural mechanisms, and Singapore CMBS's strong cashflows and low LTVs provide sufficient protection against expected performance deterioration, and there are no rating implications for all three."

"Moreover, Moody's sector performance outlooks for all three asset classes are unchanged from our previous update in March 2009," continues Lam.

She concludes: "Since Moody's March update, there have not been any rating actions as performances are still within our original assumptions. However, given the level of uncertainty in today's markets, Moody's will continue to assess macro-economic developments and asset performances, and will express our opinions in our regular performance reviews."

Regulation

Derivatives oversight bill introduced

The final draft of Senator Barney Frank's bill to improve oversight of the OTC derivative markets was revealed yesterday, 30 July. The much-hyped proposal to ban 'naked' CDS is included under the 'Limitation on Speculation' section, with the subtitle 'Prohibition of any purchase of credit protection using a CDS contract'.

Analysts at Credit Derivatives Research (CDR) note that counterparties are exempt from this ban if they own the reference security (or have an economic interest that will be protected) or if they are a "bona fide" market-maker. They suggest that the proposed reliance on owning the underlying reference entity will squeeze liquidity out of the market, as so many dealers know exactly who holds many of the bonds from new issue allocations that the market could become much more segregated in terms of pricing.

"We suspect that this is typical Frank pandering and that Section 2 will be more likely to become law," the CDR analysts add. "'Enhanced Oversight of Speculative Positions' makes much more sense - position limits and reporting. This fits best with the previous sections of the bill relating to clearing, which we wholeheartedly agree with."

RMBS

No ratings impact from Granite reserve fund draw

Fitch says that the Granite reserve fund draw is unlikely to immediately impact the ratings on RMBS issued from Northern Rock's (NR) master trust or the Whinstone Capital Management notes.

Granite comprises five outstanding capitalist issuances from Granite Finance Funding (Funding) and nine outstanding series issued from Granite Master Issuer through the second beneficiary Granite Finance Funding 2 (Funding 2). The Whinstone transaction is a synthetic securitisation that references the reserve fund, which acts as credit enhancement for the five outstanding capitalist issuances from the Granite Funding platform.

Francesca Zwolinsky, director in Fitch's RMBS team, says: "Fitch was anticipating a Funding reserve fund draw following the cashflow analysis performed as part of the UK prime stress test in January 2009. Although Fitch is expecting further Funding reserve fund draws and the collateral performance of Granite to deteriorate, the issuer reserve funds of Funding are not expected to be utilised to the extent that will cause negative rating migration."

Despite the Funding reserve fund draw, credit enhancement as calculated by Fitch has increased for each class of notes issued by Whinstone and is considerably higher than that available to the notes at closing. To date, none of the Funding issuer reserve funds have been drawn upon and subsequently, as the respective notes have redeemed, the credit enhancement has built up substantially.

As at June 2009, credit enhancement for the Funding 1 issuances averaged 25.4% for Class A notes, 17.4% for the Class B notes, 13.5% for the Class M notes and 5.3% for the Class C notes, while credit enhancement for Funding 2 is 18.4% for Class A notes, 13.6% for the Class B notes, 8.9% for the Class M notes and 3.1% for the Class C notes. For Whinstone, credit enhancement for the Class C notes was 1.68% versus 0.62% at closing in November 2005.

The Funding notes are segregated into two groups - the first comprises the Granite Mortgages (GRAN) 03-2 and 03-3 notes; and the second comprises the GRAN 04-1, 04-2 and GRAN 04-3 notes. Group 1 payment dates fall in January, April, July and October, while Group 2 payment dates fall in March, June, September and December.

Excess spread within the Granite programme has been decreasing due to ongoing losses and the reduced interest earned on the reserve fund balances resulting from the low level of Libor. While the excess spread for Funding 2 is still sufficient to cover senior fees and expenses and interest payments on the notes without having to utilise the Funding 2 reserve fund, the excess spread apportioned to Funding is inadequate, Fitch notes.

Funding excess spread has further contracted as a result of the margin step-up on both the GRAN 03-3 and 04-1 issuances, which occurred in January 2009 and March 2009. Consequently, as at end-June 2009, there was a negative excess spread balance of £214,007 for GRAN 03-3 and £718,058 for GRAN 04-1. There are no further step-ups in Funding until July 2010 for GRAN 03-2.

An additional impact of the GRAN 03-3 and 04-1 notes failing to be redeemed on their step-up dates was that the issuer reserve fund required amounts for the GRAN 04-2 and 04-3 issuances to be stepped-up by £8.9m and £10.8m respectively, while the shared Funding reserve fund requirement was increased by £22m.

While there was positive excess spread of £464,647 for GRAN 04-2 and £322,890 for GRAN 04-3, these amounts are required to be trapped for the purpose of topping up their issuer reserve funds and subsequently there were no surplus issuer receipts to cover the Funding reserve fund draw of £718,058 and to top it up to its required level of £67m, which equates to 1% of the outstanding Funding notes plus £22m. As at end-June 2009, the Funding reserve fund stood at £57m.

Further Funding reserve fund draws are expected on the Group 2 payment dates at least until the GRAN 04-2 and 04-3 issuer reserve funds have been topped up to their required amounts. Following this, any positive excess spread balances can be applied to top-up the Funding reserve fund, which is expected to be drawn for the purpose of covering negative excess spread balances on the GRAN 04-1 issuance.

Funding reserve fund draws are anticipated on Group 1 payment dates if the negative excess spread balance on the GRAN 03-3 issuance are greater than the positive excess spread balance on the GRAN 03-2 issuance. As at end-June 2009, excess spread for GRAN 03-3 was a negative £214,007, while excess spread for GRAN 03-2 was £285,797.

Although Fitch is expecting further Funding reserve fund draws, the agency foresees that the issuer reserve funds of GRAN 04-2 and 04-3 will continue to gradually increase, which - in combination with the redemption of the outstanding Funding note balance - mitigates any further negative rating action at the present time. Nevertheless, the agency expects deterioration in the collateral performance of Granite to diminish excess spread further.

Moreover, the prepayment rate is decreasing, which will have the effect of slowing the speed at which credit enhancement accrues for the Whinstone notes. Earlier this year, the Whinstone notes were downgraded from triple-B plus to triple-B and from double-B plus to double-B minus, while outlooks were simultaneously revised to negative from positive in anticipation of a Funding reserve fund draw following the cashflow analysis performed as part of the UK prime stress test in January 2009.

The first layer of protection for the Whinstone notes is a threshold amount equal to the Funding reserve fund, which is defined as 1% of the aggregate outstanding balance of the notes of all the Funding issuers. As a result of the GRAN 03-3 notes failing to be redeemed on their step-up date in January 2009, the shared Funding reserve fund and the issuer reserve funds providing credit enhancement for GRAN 04-2 and GRAN 04-3 were required to be increased.

These stepped up amounts of £22m, £15m and £18m respectively provide additional credit enhancement to the Whinstone notes to the extent that the required increase is met by the trapping of excess spread. As at end-June 2009, the Funding reserve fund stood at £56m, while the GRAN 04-2 and GRAN 04-3 reserve funds had stepped up by a total of £18m.

RMBS

Buy-back for Irish RMBS

EBS Building Society launched a tender offer to buy back up to €100m of Class A notes of its Emerald Funding 4 deal (€999.4m Class A notes are still outstanding). The offer price varies between 77% and 81%, with the tender closing on 7 August.

RMBS

Resiliency remains to LMI rating migrations

Moody's says in a scenario analysis report on the Australian prime RMBS market that as long as the ratings of the two major lenders mortgage insurance (LMI) providers - Genworth Financial Mortgage Insurance and QBE Lenders' Mortgage Insurance - remain A1 and A2 respectively, then no ratings of senior or mezzanine notes will be affected.

Ryan Lu, a Moody's avp/analyst, says: "This Moody's report illustrates that, in a hypothetical situation where one or both of the two dominant LMI providers in Australia were downgraded, the potential for rating downgrades of individual senior and mezzanine notes among Australian Prime RMBS would be low."

He explains: "In our analysis of 271 prime RMBS senior and mezzanine notes, 207 notes, or 76.4%, are independent of the ratings of both Genworth and QBE LMI."

However, the report also notes that the remaining 64 notes are dependent on the ratings of one or both mortgage insurers. Of these 64 notes, 19 are dependent on the ratings of just one of the two LMI providers - and of these 19 notes, 15 could withstand as much as a four-notch downgrade of their respective LMI providers without having their own ratings downgraded.

The remaining 45 of the 64 notes are dependent on the ratings of both Genworth and QBE LMI, out of which 43 notes would withstand an immediate two-notch downgrade on both LMI providers simultaneously, says the report.

RMBS

Portuguese RMBS defaults increase

The default trend for Portuguese RMBS increased for all series in Q209, rising to 1% by the end of the quarter, up from 0.5% in Q208, according to Moody's latest index report for the sector.

Yuezhen Wang, a Moody's senior associate and co-author of the report says: "Cumulative losses over the original balance increased to 0.5% in Q209 from 0.2% in Q208. The highest losses were realised in the 2004 vintage, amounting to 2.3%. In addition, the weighted-average 60+ days delinquency trend continued to increase, reaching 2.1% by the end of the quarter, compared with 1.9% in Q1."

Meanwhile, the constant prepayment rate (CPR) continued on its decreasing trend that has been visible since the end of 2007, reaching 4.6% in Q209. The 2007 and 2008 vintages are displaying prepayments below the market average.

In the report, Moody's notes that three transactions experienced reserve fund draws during Q209. Although the rating agency did not take any performance-related rating action on outstanding Portuguese RMBS transactions over the quarter, it is closely monitoring these transactions, as well as those with an unpaid principal deficiency ledger (PDL) or any other indicators of worse-than-expected collateral performance.

Moody's also notes that some positive signs are emerging for the sector. Nitesh Shah, a Moody's economist, explains: "House prices increased by 1.7% compared to Q109, although they are still 1.5% lower than a year ago. However, it is debatable whether we have hit a sustainable turning point and house price growth is likely to remain weak, given the recessionary backdrop and rising unemployment (which is expected to continue to increase from 8.8% to 9.8% by 2010)."

At the end of Q209, 28 Portuguese RMBS transactions rated by Moody's were outstanding, with a total current amount of €22.2bn.

Technology

Quantifi adds new correlation/index option features

Quantifi has released Version 9.2 of its comprehensive pricing, hedging and risk analysis software. The move forms part of its ongoing commitment to keep customers up to date with the market's rapidly changing regulatory and operational requirements, as well as providing a broad range of usability enhancements, the firm says.

"All OTC derivatives market participants are facing significant challenges with regulatory uncertainty and volatile markets. The release of V9.2 builds upon our proven record of first-to-market innovations that directly address these challenges and allow our clients to focus on their core business. This release provides specific features that reduce operational risk, enhance real-time risk management and broaden product coverage," says Rohan Douglas, ceo of Quantifi.

New features in Quantifi V9.2 include: a streamlined interface to the DTCC/DerivSERV trade matching service; support for more complex correlation scenarios for NTD baskets and bespoke CDOs; enhancements to risk and P&L attribution reporting; better decision making; expanded SNAC/STEC support; and a second-generation loan model that more accurately captures the embedded call option related to the borrower's credit quality, as well as a new credit index option model that supports arbitrage-free pricing of credit index options using a recently published technique that takes into account correlation of default times.

Trading

Trading ideas: planes, trains and profit

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at a pairs trade on Bombardier Inc versus CDX.HY.12

Though Bombardier is positioned in a difficult industry with limited growth opportunities, the company generated solid revenues over the last quarter and holds US$2.7bn in cash. The company's liquidity position was further bolstered by the signing of its recent credit facility alleviating our biggest concern, which is the company's cashflow generation ability.

Bombardier's CDS trades roughly 180bp tight to the CDX High Yield Index. This is the tightest it's been since August 2007 and therefore we recommend selling protection on Bombardier against the CDX HY Index.

Bombardier's latest earnings report highlighted the good and the somewhat concerning. The company generated US$4.5bn in revenue, which is down from US$4.8bn in the previous year's quarter. Given that the majority of companies have reported substantial drops in sales, we find this to be encouraging for Bombardier's future prospects.

It also maintains US$2.7bn in cash against total debt of US$4bn (see below exhibit). In absolute terms that is plenty of liquidity to fund the company's ongoing expenses for several quarters.

Unfortunately, the company did burn through US$817m in cash due to negative free cashflow in the latest quarter. We expect the drain to close over the coming quarters as the economy stabilises from free fall. The company also signed a US$600m credit facility earlier this month, which will provide further support.

Bombardier's implied volatility decreased substantially over the past few months, which will likely lead to credit outperformance. High yield debt is highly correlated to moves in a company's equity price and volatility as their positioning in the capital structure is similar.

Bombardier's market cap is now well over C$6bn and its three month implied volatility trades at around 40% (see below exhibit). We do not believe the improvement in equity signals is fully reflected in Bombardier's credit spread.

We see a 'fair spread' of 217bp for Bombardier based upon our quantitative credit model, due to its implied volatility, liquidity and accruals factors. We are leery of taking an outright position due to the recent rally in spreads; therefore, we recommend buying CDX HY protection against a BOMB long.

The exhibit below shows that the differential between the two spreads are at the lowest levels of the past couple of years. We believe the payout of the combined position will be positive in both up and down markets.

Position
Sell US$10m notional Bombardier Inc 5 Year CDS at 2.75% upfront.
Buy US$10m notional CDX HY12 5 Year CDS at 789bp (US$89.70).

For more information and regular updates on this trade idea go to: 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).