Contents

RMBS

The real deal?

UK benchmark RMBS set to launch

Lloyds Banking Group is expected to launch Permanent 2009-1 - a prime UK RMBS master trust transaction originated by HBOS - imminently. If successful, it will be the first publicly-marketed UK RMBS since 2008. It is also widely tipped to be the deal that reopens the European primary securitisation market.

Comprising three triple-A rated tranches (two sterling-denominated, one euro-denominated), the £3bn-plus transaction is being led by Barclays Capital, JPMorgan and Lloyds TSB. It was arranged by Lloyds TSB.

The Class A-1 tranche, sized at £1.57m, is anticipated to be retained as repo collateral. The final sizes of the Class A-2 (sterling-denominated) and Class A-3 (euro-denominated) tranches will be subject to investor demand; however, some £1.25m of the Class A-2 bonds have been pre-placed with JPMorgan.

The Permanent 2009-1 transaction includes two unique features compared to traditional, pre-2008 UK RMBS. First is that part of the interest coupon is payable out of the revenue waterfall as normal, with the remainder payable via a dedicated yield reserve that will be funded upfront by HBOS through a subordinated loan. Second, at the step-up date in October 2014, Lloyds TSB will offer to purchase any outstanding notes at a price of par plus accrued interest, less any outstanding triple-A principal deficiency ledger (PDL).

According to securitisation analysts at Deutsche Bank, allowing the bonds to be 'put' back directly to the sponsor, along with the maturity profile of the bonds - five-year soft bullet maturities and long legal finals of 2042 - are legacy investor friendly, both in terms of non-asset trigger avoidance and aiding scheduled redemption. "Indeed, the presence of the Lloyds repurchase agreements reduces extension risk and should allow (theoretically at least) for pricing inside of current secondary paper," they note. "If successfully launched and priced in size and just outside or even indeed tighter to secondary levels, we see secondary spreads grinding tighter in the near term on the back of robust demand for paper."

Permanent 2009-1 will be the fourteenth issuance out of the Permanent master trust and the fourth from the Funding 2 issuance platform established in October 2006. The notes will be backed by a pool of first-ranking mortgages secured over properties in England, Scotland and Wales.

According to S&P, new mortgages have been added to the pool since HBOS' last issuance - the Permanent 2008-2 deal. £2.9bn was added in January 2009 and on 1 September a further £5bn was added to the trust. The pool has more arrears than series 2008-2, partly due to the seasoning effect and partly due to worsening economic conditions, and it has a higher indexed loan-to-value ratio.

Permanent 2009-1 joins VCL 11 - an auto lease ABS originated by VW Financial Services - in the European primary market (see last week's issue). While the VCL transaction, which is currently being roadshowed, has been positively received, it was a benchmark UK RMBS that participants believed was needed to truly restart the market.

"The VCL 11 transaction is a positive for the primary market, although it will not necessarily open the floodgates to new issuance. The deal itself is quite small and will likely meet strong demand from investors," Colm Corcoran, ABS trader at Société Générale said before the Permanent announcement. "What the primary market really needs to get back on track is the issuance of a benchmark UK RMBS. It would have to be a traditional transaction - not one that benefits from a UK government guarantee."

The European ABS market has, meanwhile, witnessed solid interest over the past week, with a number of bid lists attracting buyers and trading at the highest levels seen for some time. A large number of CDO liquidations have also failed to put pressure on prices.

"Since Q209, the reopening of specialised ABS accounts - real money funds - and more recently some trading accounts within banks clearly increased demand for ABS paper," confirms Jean-David Cirotteau, ABS strategist at Société Générale in Paris. "As offers remain scarce - particularly in the granular triple-A space - investors have gradually moved into more complex assets, especially CMBS platform deals [see separate News Analysis]. This move is relatively recent and is also supported by better news from the real estate market."

Cirotteau notes that, as it recovers, the European ABS market's extension into more complex transactions and more modelling-intensive portfolios is logical, and constitutes a positive evolution as investors have done their homework.

"A number of difficulties lie ahead for the market, but risk is certainly much better assessed now," he concludes.

AC

Clearing

Challenging the status quo

CME CDS clearing venture takes shape

As yet unsuccessful attempts by other clearinghouses to capture market share has sparked concern about ICE's dominance in the CDS sector. But the CME finally looks set to challenge the status quo - at least in the US - in the coming weeks.

A significant fraction of new CDS trades referencing on-the-run CDX.NA.IG and iTraxx Europe are already submitted for clearing on ICE on an ongoing basis (about 35% of CDX.NA and up to 50% of iTraxx Europe), according to Tim Brunne, senior credit strategist at UniCredit. But attempts by other clearing houses (CME, Eurex and Liffe) to capture market share have so far been unsuccessful.

"Eurex Credit Clear is apparently lacking the support of the major-dealer community," Brunne notes. "The very small volume of iTraxx CDS that Eurex Credit Clear successfully cleared since 31 July (€85m distributed among three trades as of 3 September) proves the competitive disadvantage of the futures and options exchange. To date, the principle advantages of Eurex - strict third-party compliance and easier access of a variety of CDS counterparties - do not counterbalance the advantages that ICE provides to CDS dealers, namely profit sharing as of 2010."

One CDS trader indicates that broadly speaking the dealers behind ICE have an oligarchy, rather than a monopoly. "They essentially influence the flow of information, decision-making and pricing in the credit derivatives market. But it could be argued that the CME is also an oligarchy, given that around 90% of futures business is done through the exchange and it already has a good network of FCMs in place."

He points out that in any case dealers' historical dominance of CDS market-making is being challenged by new entrants to the sector, who will potentially ally themselves with alternative clearinghouses to ICE. "The definition of 'dealer' has changed over the last 12 months," he explains. "CDS bid-offer spreads are wider now than they were before the crisis because there are fewer market-makers and so the incumbents don't need to be as competitive. This is in turn attracting new participants to the market."

Firms such as Jefferies, Citadel, BTIG, Broadpoint and Cantor are now among the top market-makers in US corporate bonds. "These institutions are using capital to aggressively build out their fixed income businesses and a natural extension of this is to move into CDS market-making," the trader adds. "Then there are another 25 or so boutiques behind them, such as Maxim and Knight Libertas, which could also become alternative liquidity providers to a clearinghouse."

Meanwhile, the CME says the pilot programme of its CDS clearing initiative will roll out in the next few weeks. Products supported at launch will include a range of Markit CDX indices and liquid single name CDS. The joint effort with Citadel Investment Group, known as CMDX, has been restructured to focus only on providing clearing services for the market.

Together with Citadel, the other buy-side founding members of the initiative are AllianceBernstein, BlackRock, BlueMountain Capital Management, the D. E. Shaw group and PIMCO. In addition, a number of sell-side participants - rumoured to be UBS, Barclays Capital and Citi - are in the process of becoming founding members.

"With the increasing collaboration of key founding members from both the buy- and sell-side, we are confident our offering remains the strongest and most effective CDS clearing solution available," Craig Donohue, ceo, CME Group, says. "Our solution offers point of execution clearing of CDS trades, the greatest breadth of products to clear - which includes single name CDS, a comprehensive and transparent risk management system, the security of our approximately US$8bn financial safeguards package and an established regulatory framework to protect customer positions and offer margining efficiencies."

The CDS trader reckons that the CME is aware of Eurex's apparent lack of success in Europe and so will likely open for business with a minimum of US$2bn-US$3bn of trades cleared in both single names and indices. "Liquidity is king," he states.

Whether opening up buy-side access to CDS clearinghouses will impact ICE's dominance remains to be seen. Jamie Cawley, ceo of IDX Capital, suggests that buy-siders will vote with their feet and use the most economic clearinghouse.

"There is a fear that investors will only commit to one clearinghouse and not the other, but I don't think this will happen," he concludes. "Fungibility of trades is a red herring: if necessary, an investor can get out of a trade on one platform by shorting the same contract on the other platform. In fact, I wouldn't be surprised if someone starts quoting ICE/CME basis trades in order to hedge this exposure out."

CS

RMBS

New proposal

Improved Australian appetite for RMBS, but additional intervention needed

The placement of an upsized prime Australian RMBS with real money investors late last week was taken as a tentative sign that investor appetite for ABS is returning, particularly for longer-tenor transactions. But, with critical mass for a functioning Australian ABS market still lacking, several plans for additional government intervention in the sector are either rumoured or under consideration.

Real-money investor demand was such for Members Equity Bank's SMHL Securitisation Fund 2009-2 that the deal was increased to A$1.26bn from A$500m, with the 2.9-year triple-A tranche pricing at 150bp over BBSW. Members Equity Bank also placed Maxis Loans Securitisation Fund 2009-1, an A$275m prime Australian RMBS, earlier this month with investors. Both deals were completed without support from the Australian Office of Financial Management's (AOFM) investment programme.

The AOFM's A$8bn RMBS investment programme - designed to support competition in Australia's mortgage markets - came to an end earlier this month (see SCI issue 148). But the Australian Securitisation Forum (AuSF) has recommended that the programme be extended, alongside other measures to improve liquidity in the market.

"The two major banks in Australia are now writing 100% of all new mortgages, so we're very concerned that for reasons of financial stability and price competition that the Australian economy will suffer unless the infrastructure of the other players is kept intact," says Alex Sell, chief operating officer at the AuSF. "Indeed, the latest economic forecast puts Australian population growth ahead of India's, so it is imperative we have the economic infrastructure with enough capacity to support that. The AOFM programme provides that 'drip' for individual non-bank financial institutions, but more is needed to fundamentally support the broader market."

While the Australian government is yet to reveal its position on the extension of the programme, Sell says the AuSF is being led to believe that the AOFM scheme will be extended in duration, value and eligibility criteria. "But the uncertainty is leading some investors and issuers to defer decisions for so long as there is that vacuum," he says.

The AuSF is no longer pushing for a government guarantee for Australian RMBS. "Governments are indicating that if anything they are trying to wean their systems off guarantees," adds Sell. "That said, the G20 is making it pretty clear that existing stimulus ought to remain, but we fear that that just prolongs the dislocation that exists between the [cheaper] government guaranteed bank funding and unguaranteed securitised funding."

The AuSF is, however, continuing to push for the introduction of covered bonds in Australia - an asset class currently prohibited by the Australian Banking Act. "We were encouraged by recent BIS papers and a consultation paper sent out by APRA, which have as their logical conclusion the need for a more diverse and longer tenor liquidity profile. Covered bonds would tick those boxes," Sell continues.

Meanwhile, there's also talk that a scheme resembling the US TALF might be in the offing in Australia. However, Sell says it is unlikely it would be presented as such because TALF is a US solution to a serious US collateral quality problem; one that neither the Australian government nor investors believe exists in their country.

"We have no troubled assets to speak of; ours is mostly a MBS/ABS liquidity problem and a market dislocated by triple-A government guarantees for the banks, making the economics of securitisation challenging to say the least," says Sell.

He concludes: "The rumoured proposal could be presented as some form of government-sponsored quasi-warehouse - so I think we'd be happy to borrow the concept, albeit deployed to confront a different set of circumstances."

AC

Investors

Positive indications for write-downs and defaults

Investors appear to be revising up their growth and earnings forecasts, as well as revising down their US speculative grade default estimates. At the same time, tail risk related to bank write-downs is said to be plummeting.

Indeed, ABS analysts at JPMorgan indicate that concerns over what the next 'shoe to drop' will be - which are keeping some investors out of riskier assets - are overblown. "Credit losses will continue to be experienced in the years ahead, but capital raises - either pledged or forthcoming - will easily absorb those losses," they explain. "More importantly, however, the ongoing broad-based rally in credit and securitised products means that write-ups of previously written down securities increasingly will be there as at least a partial offset to the credit losses."

To date, just over US$1.6trn in write-downs have been taken and US$1.3trn of capital has been raised. Of the write-downs, roughly US$1trn is attributable to securities markdowns and US$600bn to credit losses. But the write-down loss curve appears to mirror a typical mortgage loss curve - ramping up over the first few years and then levelling off.

The most recent aggregate write-down estimate from the IMF, which was released in April 2009, was US$4trn - reflecting the extreme distress in financial markets that immediately preceded the release of the report. However, given the dramatic recovery in financial markets since then, it is clear that the IMF estimate should be revised dramatically lower - by a full 60%, the JPM analysts suggest.

For example, the IMF's CMBS loss rate estimate was 35%, reflecting an aggregate dollar price of US$65. That dollar price today is around US$82, heading towards the low-US$90s, the analysts note.

They indicate that a more reasonable aggregate loss estimate is US$2.25trn, suggesting an additional US$560bn in losses will be incurred. "Importantly, since these losses are credit losses and will be recognised over many years - particularly as restructuring and loan modification activities proliferate - banks will have latitude to earn their way out of these losses, build capital as needed and minimise the systemic shock associated with these losses," they continue.

Losses have been front-loaded, with the first 75% occurring in the first two years of the crisis. The market is now moving into a phase where loss recognition will occur gradually over the next five to ten years, at an incremental rate of US$15bn-US$30bn per quarter, JPMorgan suggests.

Meanwhile, structured credit strategists at Citi expect the fall in speculative-grade defaults to be sharper in magnitude and earlier in timing than the current consensus holds. Such a surprise to the upside would be bullish for high yield spreads, they note, which in turn would mean that institutions with exposure to loans will benefit - thereby helping to fuel risk appetite. It would be even more beneficial for CLO investors, however.

"A shift lower in cumulative default rates is critical for mezzanine tranches, as the outcome for thinner junior tranches is typically binary - either they will pay out in full or defaults will wipe them out," the Citi strategists explain.

If cumulative losses on loan portfolios are closer to 12% than 18%, senior tranches look much safer and principal loss on junior tranches looks less likely. Even if cumulative losses do reach 18%, excess spread may be high enough to save senior mezzanine tranches. Furthermore, as expectations for cumulative defaults fall by 5%-8%, spreads on 'borderline' tranches are likely to shift radically.

Using both regression and vector autoregressive econometric models, the strategists forecast that the issuer-weighted 12-month trailing speculative grade default rate will peak this quarter at 11.5% and fall to 6.5% this time next year. Thereafter, a plateau of 6% seems likely, with cumulative loss rates over five years of only 12%-20%.

CS

Structuring/Primary market

Barclays restructures structured credit portfolio

Barclays has announced the restructuring of US$12.3bn of credit market assets by a sale of the assets to Protium Finance - a newly-established fund whose objective is to purchase credit market assets from third parties and manage those assets over time to benefit from their long-term cashflows. The move has been dismissed by some as an attempt to hide the extent of the bank's losses on the portfolio, however.

The portfolio in question comprises structured credit assets insured by monolines (accounting for US$8.2bn), RMBS/other ABS assets (US$2.3bn) and residential mortgage assets (US$1.8bn) held by Barclays Capital. The structured credit assets have a fair value of US$3.6bn and the monoline guarantees are valued at US$4.6bn. At the date of the transaction, the US$12.3bn book value of the assets was net of credit reserves of US$2.3bn for the associated monoline exposure.

Protium is run by C12 Capital Management, an independent asset management firm, the principals of which are Stephen King and Michael Keeley. King was head of Barclays Capital's principal mortgage trading group and Keeley was a member of the bank's management committee covering European financial institutions.

The pair ceased to be employed by Barclays Capital upon completion of the transaction. Neither Barclays nor any of its employees is an investor in the fund, the bank says.

Chris Lucas, BarCap group finance director, says: "We are not seeking through the transaction to effect a change to our underlying credit risk profile. But we are restructuring a significant tranche of credit market exposures in a way that we expect will secure more stable risk-adjusted returns for shareholders over time. We also bring in investors with an appetite for the cashflows arising from the assets."

The activities of Protium will initially be supported by US$450m of new funding provided by the partners of Protium and by a loan to the vehicle of US$12.6bn by Barclays. The loan will be used primarily to fund the purchase of the assets from Barclays. As part of the transaction, any excess cashflows following repayment of the loan to Barclays will accrue to the partners of Protium.

Although this transaction does not result in a different underlying credit risk profile at the commencement of the loan period, it creates a structure through which the expected value of the long-term cashflows from the assets can be maximised over time. Barclays expects it to enhance shareholder value by:

• Restructuring exposure to the risk in the assets, thereby mitigating the potential impact of short-term movement in market values and monoline downgrades;
• Delivering more stable risk-adjusted returns, given the assets' multi-year duration and their cashflow characteristics; and
• Securing long term access to an experienced team specialising in managing credit market assets.

The assets will remain on balance sheet for regulatory purposes. Consequently, the transaction will not reduce the regulatory capital required for these assets and may lead to an increase.

The assets will be sold at current fair values and therefore Barclays expects that it will record neither a gain nor a loss on completion of the sale. It will not consolidate Protium for accounting purposes and will derecognise the assets. In order to provide reporting transparency in the future, the bank says it will disclose "appropriate information" in relation to the valuation of the loan to Protium, including the performance of underlying cashflows and the fair value of the underlying assets.

Moody's vp - senior credit officer Elisabeth Rudman suggests in the agency's 'Weekly Credit Outlook' publication that Barclays' key reason for the transaction appears to be to avoid large mark-to-market fluctuations on the assets. This is particularly relevant for the monoline-wrapped securities included in the asset pool, given the deteriorating credit profile of some of the monolines. In this sense, it is not dissimilar to the approach that many other banks have taken under IAS 39 by transferring assets from the trading book to the available-for-sale or held-to-maturity categories.

"However, we are concerned that the deconsolidation of the assets from the financial statements may reduce the level of information available for investors or make the information harder to track," Rudman notes.

In particular, it is important that the fair value of the monoline insurance coverage for the securities - which would have been otherwise recorded under mark-to-market accounting rules - is disclosed, according to Rudman. "Although Barclays will report an impairment of the loan if the underlying assets and consequently the credit profile of the loan deteriorate, we expect there will be greater discretion regarding the timing and the amount of the impairment charge than would be the case for mark-to-market disclosure," she concludes.

The US$450m of new funding through the issue of limited partner interests will entitle the holders to fixed payments of 7% per annum for 10 years on their initial investment and will be amortised in equal installments over five years. Any excess cash remaining in the fund after full repayment to Barclays of principal and interest in respect of its loan will accrue to the limited partners at the end of the 10-year period.

AC & CS

ABS

UBS makes strategic ABS hires

UBS has made two key securitisation hires. Frank Byrne has been appointed head of securitisation and Andrew Dennis has been appointed head of EMEA ABS sales.

Byrne joins UBS having spent a number of years at Deutsche Bank, most recently as global head of asset finance. He will be based in the US. Dennis moves over from the family office team in UBS Wealth Management; however, he previously held a number of roles in the ABS business at UBS including research, syndicate and trading.

Dennis reports to Eric Lafon, EMEA head of the client solutions group, and will be supported in his new role by Olivier Carsoule and Naseem Janjua.

In November 2008, UBS announced that it would refocus its real estate and securitisation activities, following the departure of the bank's former ABS head Ramesh Singh.

Advisory

Advisory firm names new partner

Vertical Capital Solutions has appointed Jason Howell as a partner. Howell has over 17 years of experience as a strategist in the financial services industry.

He joins from JPMorgan Chase, where he was an md in the portfolio strategies group within the financial analytics and structured transactions department. Previously, he was a senior md at Bear Stearns & Co for 16 years, where he held a leadership role in advising institutional accounts on asset-liability management, portfolio strategy and relative value across the fixed income and derivative markets.

Charles McLendon, managing partner for VCAP Solutions, says: "We are excited to have Jason join our team as he brings a wealth of experience in advising large financial institutions on portfolio strategy and risk advisory. His specific expertise in the structured finance and derivatives markets will be invaluable in our ongoing development of valuation and risk solutions for our clients."

CMBS

CRE investment md hired

Redwood Trust has hired Scott Chisholm as md, leading the company's commercial mortgage debt investment activities.

Brett Nicholas, Redwood's cio and co-coo, says: "Scott's leadership abilities, experience, relationships and his seasoned credit perspective in commercial mortgage debt investment will enable Redwood to judiciously expand its commercial business at a time in which there are increasingly attractive investment opportunities."

Chisholm was formerly an md at Prudential Mortgage Capital Company in its New York City office and was responsible for commercial loan originations, including the life company portfolio, CMBS, Fannie Mae, Freddie Mac, FHA and structured balance sheet loans. Prior to Prudential, he was a director at Deutsche Bank and held similar positions at Lehman Brothers and Chase Manhattan.

Distressed assets

Distressed specialist taps Greywolf md

Oak Hill Advisors has hired Alexandra Jung as co-head of its European business. Jung is based in London and, along with Richard Munn, will direct investments in European companies and manage the firm's European operations.

Jung joins Oak Hill Advisors with more than 15 years of leveraged finance, distressed debt and special situations experience, particularly in Europe. Most recently, she was an md at Greywolf Capital Management, where she helped the firm expand into Europe and was responsible for investments in European performing and distressed credit.

Jung started her career at Houlihan Lokey Howard & Zukin in the financial restructuring group. In 1999, she joined Goldman Sachs' distressed bank loan group and moved to London, where she was a founding member of Goldman's European special situations group.

Munn, the former head of European loan syndications at Deutsche Bank, joined Oak Hill Advisors in May 2005 with the opening of its London office.

Jung's arrival highlights the firm's commitment to distressed market opportunities, it says. Since January 2008, the firm has grown its global investment team by 16 professionals who focus across the credit spectrum, including the distressed corporate and structured product markets. During this time, the firm has raised more than US$3bn of net new capital.

Investors

Start-up launches debut credit hedge fund

Start-up hedge fund Raven Rock Capital has launched its first credit fund. The portfolio has two sub-strategies: directional credit and relative value. The firm's three founding partners - Nate Brown, Guy Caplan and Bobby Richardson - worked together for over ten years at Argent Funds Group.

Investors

Fixed income portfolio manager named

Schroder Investment Management has appointed Dina Welch as senior client portfolio manager to coordinate the development of its fixed income client portfolio management capabilities. Welch will report to Karl Dasher, Schroder's global head of fixed income, and will be based in Philadelphia, working between Schroder's offices there and in New York City.

She will be responsible for ensuring the consistency of processes across Schroder's fixed income teams and reinforcing recognition of its innovative products and solutions to a broad section of North American-based investors.

Welch joins Schroder from SEI Investments, where she managed portfolios starting in 2003 as senior investment analyst, US taxable fixed income. At SEI her responsibilities later evolved to senior portfolio manager, global fixed income, and since 2007 as head of global fixed income.

Investors

Deloitte expands hedge fund team

Deloitte has hired Ellen Schubert and Ray Iler to the hedge fund team of its asset management services practice.

Schubert joins Deloitte in the newly-created role of chief advisor to the asset management services practice. Based in New York, she will advise the firm's hedge fund clients on issues including operations, product structuring and regulation.

Prior to joining Deloitte, Schubert was an md and global head of the fixed income hedge fund business for UBS Investment Bank. Previously, she was appointed to the investment bank board of directors and was a member of the company's prime services committee.

Schubert says: "Global regulation poses a triple threat to hedge funds' competitive advantage by increasing portfolio transparency and costs, and decreasing leverage. This comes at a time when investors are pulling funds and pressing for reduced management fees. Gone are the days when any 'mom and pop' could hang out a shingle, call themselves a hedge fund and launch with US$500m. This new environment will require a more sophisticated and robust infrastructure to operate profitably. Deloitte's deep bench of regulatory and operational professionals is well-positioned to aid funds on this transformational journey."

Iler has been named as Deloitte's Northwest Pacific hedge fund leader. Based in San Francisco, he is responsible for hedge fund industry matters involving audit, tax, financial advisory and consulting.

Iler has 12 years of hedge fund advisory and consulting experience. Prior to joining Deloitte, he served as cfo and corporate secretary for Quadrise Canada Corporation, an oil and gas technology company. He founded the tax practice and served as audit partner for Deloitte's Grand Cayman practice, where he advised clients on hedge fund structuring, due diligence procedures, service provider selection and incentive fee structuring.

Investors

Investor relations md promoted

Structured Portfolio Management (SPM) has promoted Chris Sutter to head of marketing and investor relations. In his new role, Sutter will lead SPM's worldwide marketing efforts, with all members of the client management group reporting to him.

Senior members of the client management group reporting to Sutter include: Alex de Calice (md of the EMEA region), Masahiro Watanabe (md of Japan and the East Asian countries) and Brooke Wise (svp of investor relations and marketing).

Sutter joined SPM in April 2008 as an md and will retain this title. Prior to joining SPM, he was a vp at Atlantic Asset Management, where he was responsible for hedge fund marketing to institutional clients globally.

Legislation and litigation

KBC settles CDO case

Belgian bank KBC says it has come to an 'amicable settlement' with a number of private and banking clients in relation to the markdowns incurred on CDOs it sold. The 40 private banking clients and companies - represented by Deminor - have unanimously accepted KBC's proposal, thus definitively closing the settlement case opened by Deminor in February 2009.

The group of Deminor clients had invested in various CDOs sold by KBC, primarily the junior tranches that were subsequently marked down. KBC Bank and Deminor started negotiations in March 2009 and reached an agreement in principle in August.

The compensation offered varies depending on the specific facts of each case. The clients unanimously accepted the agreement at the start of September.

In reaching agreement, KBC and the group of Deminor clients have brought closure to the dispute. Deminor says it will not represent any other clients in cases relating to CDO investments sold by KBC.

In August, KBC reported that it had set aside €200m in relation to CDOs sold to customers (SCI passim).

Listed products

Permacap reports

Permacap Carador has reported that, as at the close of business on 28 August 2009, the unaudited net asset values per share were €0.4058 (a decline of -1.77%) and US$0.5234 (-1.56%). The month's calculations include an estimated €992,809.64 of net cashflow interest received in the month (to be allocated between capital and income), which equates to €0.0078 or US$0.0112 per share.

Ratings

Euro ABS business development team expanded

Fitch has hired James Simeons as a senior director for ABS business development in the EMEA region. He reports to Karen Skinner, md and head of structured finance business development for EMEA.

Skinner says: "Within his role, James will manage the implementation of numerous initiatives Fitch has developed to further support investor decision-making in the ABS markets."

Simeons has spent the last nine years at JPMorgan and heritage organisations working, most recently as an executive director, within the conduit securitisation group covering a variety of asset classes including: auto finance; credit cards; consumer loans; lease receivables; and trade receivables.

Real Estate

Annaly REIT to invest in CMBS

Annaly Capital Management has completed an IPO on the NYSE for its new specialty finance company, CreXus Investment Corp. CreXus will be externally managed by Fixed Income Discount Advisory Company, a wholly-owned subsidiary of Annaly, and will acquire, manage and finance commercial mortgage loans and other commercial real estate debt, CMBS and other commercial real estate-related assets.

13,333,334 shares of common stock were sold in the IPO at a price of US$15 per share, for gross proceeds of US$200m. Concurrent with this offering, Annaly will acquire 4,527,778 shares of CreXus common stock at a price of US$15 per share. Deutsche Bank Securities and Bank of America-Merrill Lynch acted as joint book-running managers, with JMP Securities, Keefe, Bruyette & Woods and RBC Capital Markets acting as co-managers.

Real Estate

CRE loan servicing business acquired

The Situs Companies has acquired the primary and special loan servicing business of Global Servicing Solutions Germany (GSSG). The acquisition of the firm, which has been renamed Situs Global Servicing (SGS), supports Situs' expansion into the distressed loan servicing and debt advisory business.

Ralph Howard, principal and ceo of Situs, explains: "This acquisition is a natural extension of our European commercial real estate consulting business and specifically allows us to extend our life of loan services to our existing client base. GSSG has an experienced staff of multilingual loan workout professionals that will allow Situs to immediately address opportunities associated within the deteriorating global commercial mortgage market."

SGS will remain in GSSG's offices outside of Frankfurt, Germany. The firm is currently rated by S&P as a primary and special servicer, which specifically qualifies it to service and provide debt advisory for publicly traded CMBS. The Situs Companies is also a rated primary and special servicer by both S&P and Fitch.

This acquisition brings Situs' total servicing and surveillance global platform to more than US$19bn.

Secondary markets

Vehicle records 21.5% write-up in CDOs

The gross asset value (GAV) of Volta Finance Ltd was €64.4m at the end of August. This equates to €2.13 per share, an increase of €0.17 per share from €1.96 per share as of the end of July 2009.

According to the July report from the company, published on 18 September, the July mark-to-market variations of Volta Finance's asset classes were: -3.2% for ABS investments, +21.5% for CDO investments and +28.4% for corporate credit investments. The increase in the GAV is mostly due to increases in prices in the CDO and corporate credit buckets, both from equity pieces as well as from mezzanine debt tranches.

Volta's assets generated the equivalent of €0.6m of cashflows during August 2009. In August the company invested in two deals - a mezzanine tranche of a corporate credit portfolio (Jazz III) and a mezzanine tranche of a CLO (Alpstar 2) - for a total of €3.7m.

Secondary markets

Alliance provides daily ARS valuations

Interactive Data Corporation has teamed up with Pluris Valuation Advisors to offer clients daily valuations for auction rate securities (ARS), including student loan ARS.

Pluris president Espen Robak says: "Since the auctions for these securities began to fail last year, we have generated monthly and quarterly valuation reports based on ARS transactions, including SLARS, in the secondary markets and we are pleased to make these, along with daily valuations for SLARS, municipal ARS and other difficult-to-value securities available to Interactive Data's clients. Working with Interactive Data provides us a venue for utilising our proprietary data and pricing algorithms to benefit clients that need daily pricing data."

Technology

Securities class action data service formed

Interactive Data Corporation's pricing and reference data business has formed an alliance with Goal Group to provide an outsourced service designed to support investors and corporations throughout the entire lifecycle of a securities class action.

Information from Interactive Data's class actions service has now been incorporated into Goal's fully-outsourced solution designed to help clients manage and navigate the securities class action process and recoup funds where applicable. This information includes details of securities class action litigation filed, with critical dates and data, and the relevant security identifiers.

Anthony Neville, European divisional director of Interactive Data, comments: "Class actions provide potential redress to investors who have suffered loss as a result of violations of the securities laws - and these actions have been increasing with the market turmoil. Finding a system that is capable of compiling and disseminating class action information is critical."

Most securities class actions have historically been filed in the US, but - with the introduction of legislation to support strong corporate governance - such lawsuits are spreading across Europe, Australia and Asia. As a result, financial institutions are increasingly paying closer attention to developments related to securities class action litigation.

Using its ISO 9001 accredited technology, Goal undertakes research, analysis and calculations on behalf of clients, and completes any applicable claim documentation. Goal's solution allows clients to access an online reporting facility that provides the security identifier, together with the class period, settlement fund and any applicable proof of claim deadline. Also available are a current case settlement diary that provides an overview of impending cases and an activity statement with information on the status of ongoing and collected claims.

Global institutional investors do not always submit claim forms in situations where they may be eligible for recovery possibly because investors are not aware that a judgement has been entered or that a lawsuit has been settled or even filed, the two firms note. According to research conducted by Goal, between 2000 and 2007 more than US$12bn in settlement compensation awarded by the courts was unclaimed in class actions, bankruptcies and disgorgements. To date, Goal has helped its clients recover over US$280m in compensation.

Technology

Novations partnership established

ConvergEx has integrated its order management system, the Eze OMS, with ICE Link, an electronic affirmation and novation consent platform for OTC derivatives trading. The partnership is expected to provide clients with a simple and fully automated process to submit and affirm derivatives trades prior to processing. The streamlined workflow reduces the difficulties often associated with novations and terminations by providing an electronic, transparent and auditable process, the two firms say.

The solution enables clients to meet the standards set by the ISDA Board Oversight Committee (IBOC) and provides a connectivity tool for clearing in the CDS markets.

Rob Keller, md of global product management for ConvergEx's Eze Castle Software, says: "It is our job to provide our clients with the tools they need to remain efficient and this connection with ICE Link offers clients even more automation to process OTC derivates. In addition to drastically improving operational efficiency through time, money and resources saved, this will also make it easier for clients to comply with regulatory and industry guidelines."

Technology

New development director for riskart

Gerrard Mahony has joined riskart as EMEA business development director, based in Milan. In his new role, Mahony will support strategic expansion and drive business growth. He will be concentrating on developing riskart's suite of services to enable clients to more effectively manage financial risk and compliance in the middle and back office.

Mahony brings to the company over twenty years' experience in sales and marketing in the financial services industry in areas such as information, trading, risk management and financial technology. riskart's modular software covers the administrative, accounting and compliance requirements of middle and back offices. In particular, the software is easily adapted to the management of OTC derivatives and structured products.

Technology

Prime broker solution offered

JPMorgan and Sophis together have launched a technology solution allowing hedge funds to manage their portfolios across multiple prime brokers and asset classes. Called iSophis, the offering provides integrated portfolio and risk management services through a simple application service provider (ASP) model.

iSophis can provide hedge funds with in-depth reports on P&L analysis, performance attribution and risk exposure. The solution can also help calculate risk measurements, including stress testing, as hedge funds scale up their trading volumes or broaden existing strategies to include additional asset classes.

The offering is operated through a compliant and secure platform on a hosting site. With offsite hardware operated by Sophis, JPMorgan's prime brokerage clients can access the service from any internet connection.

Pascal Xatart, Sophis ceo, explains: "Sophis and JPMorgan are uniquely positioned to offer this innovative, powerful solution to the hedge fund market. At a time when hedge funds are seeking to rebuild investor confidence, having access to the right technology to manage their risk and portfolios across different assets and prime brokers is of paramount importance. iSophis will make it possible to provide hedge funds with a powerful, simple and secure solution that they can access instantly and remotely."

Technology

Vendor expands into Asia-Pacific

Calypso Technology has expanded its presence in the Asia Pacific region through a new subsidiary company in Hong Kong. The firm has appointed Nigel Ford to head up the office.

Ford will work with existing Hong Kong-based global clients and respond to the commercial interest from Greater China-based financial institutions. He joins Calypso from similar positions at Sophis, Misys and Thomson Reuters. He was also previously Asia regional treasury manager at ABN AMRO and Wells Fargo Bank.

Trading

Broker-dealer appoints ABS head

The PrinceRidge Group has named William Haley head of its ABS banking group, reporting to Ahmed Alali. The group will provide select clients with capital market advisory and execution services across the entire capital structure.

Haley says: "Disruption in public and private ABS channels has created a need for intermediaries like PrinceRidge to provide advisory services and custom-tailored financing packages that will facilitate and deepen client access to investors in senior and subordinated securities, as well as the whole loan market."

Haley brings more than 25 years of financial services industry experience to PrinceRidge. Prior to joining the firm, he served as corporate md and group executive at ABN AMRO, where he ran investment grade capital market origination. Previous to this, Haley was an md and head of frequent issuer ABS coverage at JPMorgan Chase.

PrinceRidge Group is a new institutional client-oriented broker-dealer founded by John Costas (chairman), Michael Hutchins (ceo), Alali, Colette Dow, Ronald Garner and Matthew Johnson.

Trading

New debt brokerage launched

Two high-profile London traders, both with extensive experience in the European distressed market, have launched a new debt brokerage firm called Yorvik Partners.

Simon Mullaly and Lars Lemonius founded the business, which aims to provide fundamental credit research and conflict-free dealing in securities, bank debt and trade claims within select European credits. While the firm will primarily focus on corporates, these may have a structured credit aspect to them, according to Lemonius.

Prior to the formation of Yorvik, Mullaly was md and head of trading within Deutsche Bank's distressed products group. Previous to this, he was head of high yield and distressed trading at Lehman Brothers in London. Mullaly has also worked at Goldman Sachs.

Lemonius previously worked at Morgan Stanley for 16 years. Most recently he served as an md in the bank's institutional securities division and head of its European principal strategies investment group.

Yorvik's customer base is institutional clients and corporates. The firm says it does not employ any proprietary capital in its dealing with clients in order to remove the conflict of interest between clients and the broker.

Trading

New ABS sales head for agency broker

Agency broker Hoare Capital has expanded its credit and ABS teams.

Amongst those joining the firm is Mark Rogers, who has been named head of ABS sales. He has 23 years of senior sales experience at HVB and UBS prior to his move from Commerzbank.

Richard Gathercole has been recruited to head the corporate credit sales team, concentrating on high yield and distressed debt. He has 27 years of experience and joins from the Bank of Scotland, where he held a similar capital markets role.

Finally, Andrew Sheppard has been named the new head of dealing at the firm. He has 23 years' experience trading at JPMorgan, WestLB and LBBW.

Hoare Capital's credit business is headed by ex-JPMorgan and Dresdner salesman Tim Cartmell.

ABCP

ABCP ratings to remain stable into 2010

Moody's latest ABCP review reveals that the sector stabilised in the first half of 2009. According to the report, funding spreads returned to more normal levels; market reliance on overnight funding declined; institutional investors came back to prime money funds; and dependence on government support programmes generally seemed to be diminishing.

Moody's notes that the market now primarily comprises bank-sponsored multi-seller programmes, as the more esoteric issuers such as SIVs, CDOs and securities programmes are less prevalent.

The agency further notes that the outstandings of multi-seller ABCP programmes have declined. It believes that this is largely because of declining business opportunities; either as perceived by the bank sponsors, who are unwilling to renew or replace maturing transactions, or as realised by their customers - who are simply borrowing less in response to the weak economy.

Moody's expects that ABCP issuance volume for the rest of this year will largely depend on economic recovery. The report notes that with recovery, banks are more likely to find transactions they are willing to add to their multi-seller conduits and sellers are more likely to draw on those borrowing facilities.

Longer-term growth will be affected by the evolution of the regulatory and accounting environment, particularly the impact of the Basel 2 process, the agency adds. It notes that the viability of conduits will depend on the regulatory capital, balance sheet and liquidity advantages that they provide their sponsors with.

Moody's downgraded New Center Asset Trust (NCAT) and Lockhart Funding in the first half of 2009. NCAT was downgraded due to asset deterioration, while Lockhart was downgraded due to a rating action on the support counterparty. The long-term rating of Curzon Funding Limited MTN programme was also downgraded, while its short-term rating was affirmed in line with the support provider's rating.

These rating actions are consistent with the agency's negative credit outlook for ABCP, which remains negative mainly because support providers and funded assets remain under pressure. However, Moody's believes that ABCP ratings in 2009 and 2010 will largely remain stable because conduits' credit enhancement and structural protections will be sufficient to withstand these pressures.

The outlook for the banking sector also remains negative and over three-quarters of the ABCP market receives support from sponsoring banks. However, most sponsor banks benefit from strong systemic support, which mitigates bank deposit rating volatility. Similarly, many of the asset types funded in ABCP programmes will show weaker performance as consumer and business obligors struggle in the continuing recession.

Moody's notes, however, that most ABCP programmes are structured with sufficient credit enhancement and liquidity support to maintain their ratings. Programmes with weaker support providers and less credit enhancement will be more vulnerable to a rating action, but these are expected to be few.

CDS

Thomson deliverables agreed

ISDA has published the initial list of deliverable obligations for Thomson, following a meeting held by the EMEA Determinations Committee on 18 September. The limitation dates have also been set at 20 December 2011 for the 2.5-year maturity bucket, 20 June 2014 for the five-year maturity bucket, 20 December 2016 for the 7.5-year maturity bucket, 20 June 2019 for the 10-year maturity bucket, 20 December 2021 for the 12.5-year maturity bucket, 20 June 2024 for the 15-year maturity bucket and 20 June 2029 for the 20-year maturity bucket. These limitations are based on a restructuring date of 15 June 2009.

Separately, the credit derivatives auction for SSP Financing has been scheduled for 8 October.

CDS

Initial sovereign CDS index due

The Markit iTraxx SovX Western Europe index is to begin trading on 28 September. This is the first of the new indices, which were first announced in July (see SCI issue 143), to be tradable.

The SovX family of indices has been designed to offer a transparent and standardised tool to monitor the sovereign CDS market and gain access to the asset class on a regional and global basis, Markit says. The creation of this investment and hedging tool is expected to encourage investor demand for sovereign credit.

Market makers for the index include Bank of America Merrill Lynch, Barclays Capital, BNP Paribas, Citi, JPMorgan, Morgan Stanley and Nomura.

The trading of sovereign CDS has previously been limited to emerging markets, reflecting the credit risk associated with the government debt of these countries. An actively traded CDS market in industrialised sovereigns has now emerged as a result of the financial crisis and growing investor concerns relating to the solvency of developed economies.

The SovX indices are calculated daily on a theoretical basis.

CDS

TMT continues to drive Euro CDS liquidity

Market uncertainty over the future direction of the European telecom and technology sectors has driven European CDS liquidity in the past two weeks, according to Fitch, ensuring that Europe remains in aggregate more liquid than the Americas CDS market.

Thomas Aubrey, md of Fitch Solutions in London, says: "Despite a general increase in CDS liquidity across all regions, the European telecom and technology sectors stand out."

He adds: "With much of its sales occurring internationally, the European technology sector is heavily exposed to foreign currency movement and any sharp decline in the US dollar against the euro would therefore be negative for firms, creating growing uncertainty for the sector."

As of 22 September, Fitch's European CDS liquidity index closed at 9.87 versus 10.10 for the Americas.

Fitch's commentary also highlights that Harrah's Operating Co is now the most liquidly traded entity in North America, OJSC Gazprom remains the most liquid European name, South Korean companies continue to dominate liquidity in the Asia-Pacific region and that Russia and Mexico remain the most liquid sovereign CDS.

CLOs

Euro CLO triple-C assets drop, defaults rise

S&P's European CLO performance index report for July shows that all four of its CLO cohorts witnessed a decline in the percentage of assets rated in the triple-C category. However, all four cohorts witnessed a corresponding rise in the level of defaulted assets.

S&P's European CLO performance index report provides aggregate monthly performance statistics across its rated universe of European cashflow CLO transactions, which are backed primarily by loans to speculative-grade firms. The cohorts are classified by vintage year from 2004 to 2007.

CLOs

CLO brings in collateral eligibility changes

MC Funding CLO, a middle market CLO launched in 2006, has been subject to a number of changes to collateral eligibility as a result of the issuer's execution on 18 August of a supplemental indenture.

The supplemental indenture brings in changes that include:

• Reducing the concentration limit on second lien loans and participations related to second lien loans to 10% of the portfolio collateral amount from 25% of the portfolio collateral amount;
• Reducing the concentration limit on Partial PIK securities to 7.5% of the portfolio collateral amount from 25% of the portfolio collateral amount;
• Increasing from 10% to 15% the portion of securities that can be excluded from treatment as deep discount obligations, provided however that such assets have (i) a purchase price between 82.5% and 85% of par and a Moody's default probability rating of at least B3 at the time of purchase or (ii) a purchase price between 85% and 90% of par.

It also modifies a condition which required that a credit-improved obligation be sold for a price that is at least equal to the par amount of such asset to a price that is at least equal to the purchase price of such credit-improved obligation.

With respect to the first three elements of the amendment, Moody's says that the changes do not depart from its methodology and do not materially affect the credit risk posed to the noteholders. Regarding the fourth element of the amendment, the primary risk posed is that the sale of a credit-improved obligation may now result in a decline in the overcollateralisation (OC) ratios.

However, any such decline in the OC levels is permissible only to the extent that all then-current OC tests are in compliance. In considering the current depressed OC ratios, Moody's assessed this change as not having a material ratings impact at this time.

Moody's has been informed that the supplemental indenture has received the consent of a majority of each class of notes.

CMBS

Call for industry response to Windermere XII case

A "fast and firm" reaction from the marketplace to recent developments surrounding the Windermere XII transaction is needed in order to support French securitisation, according to SG ABS analyst Jean-David Cirotteau. He suggests in a recent research note that, although the decision on the validity of the true sale has not yet been resolved, both borrower-friendly judgements - on 'procedure de sauvegarde' (PDS) and 'cession Dailly' - could be disastrous for the French securitisation sector.

"This case has deep implications for the whole French securitisation framework. And the consequences of a misjudgement could be even worse for any sale of assets under cession Dailly," Cirotteau explains. "We understand the interest of using PDS procedure to protect operating companies from temporary financial issues and try to maintain their activity. But in the case of Windermere XII, both entities (HOLD and Dame) are non-operating companies with no employees to protect: the reasons invoked by the borrower for protection are fallacious."

The holdco company Heart of La Defense (HOLD) and Dame Luxembourg, the owner of 100% of HOLD's shares, obtained the PDS from a French judge in December. Rent payments from the underlying property have since been retained in a specific account, which has triggered drawing on the liquidity facility to pay the coupons for the notes under the liquidity agreement. This has, in turn, precipitated ratings downgrades for a number of subordinated tranches that aren't covered by this agreement.

A subsequent court hearing was held on 14 September to discuss the validity of the claims on the rents by the Windermere XII issuer, the outcome of which is still to be decided (see also separate News Analysis). The rents had been secured under a cession Dailly, which is the strongest true sale process under French law.

CMBS

TALF CMBS loan requests in

US$1.4bn of loans have been requested through the CMBS TALF for legacy loans programme. No loans were requested for new-issue CMBS.

Some US$2.28bn in loans were requested for legacy CMBS in August and US$669m in the July window.

CMBS

South African CMBS tap finds four investors

South African listed property loan stock company Vukile has raised R²50m via a tap issuance of Vukile Investment Property Securitisation (VIPS), a CMBS programme established by the company in October 2005. The funds were raised through the placement of two tranches of notes in the South African markets to four investors in July and September this year.

The notes were rated Aa2/AAA.za by Moody's and were placed at 200bp over Jibar for an all-in cost of funding, including the note margin, of 10.42%. The notes have a tenor of 2.7 years and mature on 7 May 2012. This is the first tap issuance from VIPS since its establishment in October 2005 and increases the total outstanding amount under the programme to R1.02bn.

Chief executive of Vukile Gerhard van Zyl says that, due to the appreciation of property values within the company's portfolio and the escalation in rental income, no additional properties needed to be added to the portfolio to effect the transaction.

VIPS was the second CMBS programme to be implemented in South Africa and was arranged by ABSA.

CMBS

Robust performance for Singapore CMBS

Singaporean CMBS transactions still enjoy strong cashflow from the underlying properties, despite the economic downturn and the abundant upcoming supply in some of the sectors, according to a recent Moody's report. In addition, refinancing risk has eased with the improved liquidity conditions.

According to the quarterly report, most transactions enjoy at least four times actual debt service coverage ratio and appraisers' loan-to-value ratios are in the 17%-31% range.

Marie Lam, a Moody's vp/senior credit officer and co-author of the report, says: "Four Moody's-rated transactions have or have had their expected maturities in 2009. Three were refinanced successfully and the fourth has a refinancing plan in place; there are also two more Moody's-rated deals expected to mature in 2010."

Lam continues: "Currently, the market has seen syndicated loans, rights issuance and CMBS issuance used as funding avenues. With improved liquidity conditions, we expect all three deals to be able to obtain the necessary funding."

Distressed assets

Irish bad-bank details released

The Irish Finance Minister, Brian Lenihan, has disclosed details about the implementation of the domestic bad bank - National Asset Management Agency (NAMA). Under the proposals, the Irish government will buy €77bn in troubled real estate assets at an average 30% discount, with the estimated market value of the loans currently estimated at €47bn.

The participating banks will be paid in government-backed bonds, all of which are eventually expected to be repo-able with the ECB.

Structured real estate assets, such as CMBS, are unlikely to be included at this stage, according to one source with knowledge of the structure. He says that NAMA will likely enforce some of the loans very shortly after acquisition.

Meanwhile, a tender is said to be underway for special servicers for NAMA, with the source suggesting that CBRE, Morgan Stanley and Capita are all in the running.

The completion of the transfer of loans is expected by the middle of next year. It is projected that 36% of the assets will be land, 28% development property and 36% in associated commercial loans. An estimated 40% of these loans are cashflow producing.

The approximate breakdown for the Irish banks involved in the scheme is: Allied Irish Bank with €24bn; Anglo Irish Bank with €28bn; Bank of Ireland with €16bn; EBS with €1bn; and INBS with €8bn.

Emerging Markets

Changes made to EM CDS trading convention

Market practice changes to the trading convention for CDS in emerging markets have been announced by ISDA as an additional step towards achieving increased standardisation, transparency and liquidity. These changes, as of 21 September, include the adoption of standardised trading coupons and a move from monthly to quarterly payment dates in emerging market CDS transactions.

Robert Pickel, executive director and ceo of ISDA, says: "ISDA and the industry continue to work on standardising the way in which credit default swaps are traded and settled. These changes have increased market transparency, robustness and confidence in the privately negotiated derivatives business."

The changes see market participants in central and eastern Europe, the Middle East, Africa and Latin America adopting standardised coupons of 100bp and 500bp. Additional coupons for trading or back-loading could be introduced at a later time if and when the need arises, ISDA says.

Participants have also switched from semi-annual to quarterly payments and full first coupons. The move to quarterly payments applies to both existing EM transaction types and the new standard EM transaction types, but has no impact on trades prior to 21 September, which will maintain their semi-annual payments even upon novation or assignment.

With regard to trades for emerging markets in Australia and New Zealand, firms will adopt standardised trading coupons of 100bp and 500bp. Additional coupons for trading or back-loading could also be introduced at a later time if and when the need arises.

Emerging Markets

Mexican RMBS performance deteriorates

The economic slowdown in Mexico continues to impact the performance of RMBS in the country, according to Fitch, as delinquency levels have continued to rise across most transactions in the agency's portfolio.

Macroeconomic issues, such as unemployment, are affecting the overall portfolio. While collateral performance has deteriorated, Fitch believes the capital structures for many of the transactions remain resilient. Thus far, the agency has maintained its original ratings on 70% of the portfolio.

During 2009, Fitch downgraded 21 RMBS-related tranches and two bonds backed by RMBS, while four tranches remain on rating watch negative. The negative rating actions are due to the large increase in delinquencies observed during the past 12 months in the Mexican RMBS market. Fitch has assigned rating outlooks to 71 Mexican RMBS tranches, of which 46 were assigned a stable outlook and 25 were assigned a negative outlook.

Fitch's report summarises the general performance of more than 80 tranches rated by the agency; in addition, this update provides further loan-by-loan analysis based on a subset of 67,000 loans.

The loan-by-loan analysis confirmed previously reported trends, such as that older vintages have performed better than 2007 and 2008 vintages, peso loans have performed better than UDI loans, and Sofoles-originated transactions have performed worse than those of other originators. In addition to these previous conclusions, the analysis provided a number of other insights.

First, loan-to-value (LTV) is one of the main drivers of payment behaviour. Loans with original LTV (OLTV) lower than 60% perform almost four times better than loans with OLTV greater than 80%, in terms of 180 days or more delinquency (1.59% as compared to 6.22%).

Second, the report found that segment of income - determined by property appraisal value - is a helpful explanatory variable of performance. Loans granted to the social/economic housing segment perform worse than the rest of the segments, while residential loans perform best.

Co-financed loans (loan portion granted by Sofol or a bank) and 'Apoyo' loans perform better than loans without any kind of Infonavit support. It should be noted that this analysis was undertaken using a reduced sample of 41,400 mortgage loans.

The two states with significant concentration and the worst performance - Quintana Roo and Baja California Norte - are two of the three states that have suffered the largest increases in unemployment. According to data provided by Instituto Nacional de Estadistica y Geografia (INEGI), unemployment rates in Quintana Roo rose to 5.28% in Q209 from 2.66% in Q208, while in Baja California Norte the rate grew to 5.84% from 2.79% over the same period.

Indices

Constituent changes for CDX

The Markit CDX.NA.IG and HVOL indices rolled into their thirteenth series, the CDX.EM into its twelfth series and the CDX.EM.DIVERSIFIED into its tenth series on 21 September. At the request of market participants, the index roll and start of trading of CDX.NA.HY 13 has been postponed by one day to 29 September. The final annex will be published as scheduled on 25 September, with an effective date of 28 September.

Six constituents have been replaced in the CDX.IG index, five in the HVOL index and seven in the CDX.HY. The constituents of the CDX.EM and CDX.EM.DIVERSIFIED indices remain unchanged.

Legislation and litigation

Fraud firm to investigate mortgage securitisation

MFI-Miami, a Florida-based mortgage fraud investigation company, has launched a nationwide service investigating the US mortgage securitisation process. The service will be managed by Elizabeth Jacobson, who will oversee this project for MFI-Miami's sister company, MFI-DC.

MFI-Miami will investigate the pooling and servicing agreements, as well as the contents of the certificate that the trustee alleges to contain the mortgage. The company will also determine if the certificate was part of a CDS that may have been paid as part of TARP or by a third party. These three items are essential for determining if the lender can legitimately enforce the terms of a homeowner's mortgage or if the lender or trustee is committing securities fraud.

MFI-Miami president Steve Dibert says: "I'm very excited about starting this new service. Not only will we be able to prove or disprove the legitimacy of any claims made by the lender, but we'll also be able to determine if the lender is trying to collect from the homeowner after already being paid with TARP funds."

Massachusetts attorney Glenn Russell agrees: "This is a valuable tool for any attorney doing foreclosure defense or loan modifications. This report is like firing a first strike nuclear missile at the lender. With one shot, the battle is over!"

Ratings

Global corporate CDO criteria updated

S&P has published revised methodologies and assumptions it uses to rate global CDOs backed by corporate debt. These revisions represent a significant recalibration of the agency's CDO criteria and will likely result in downgrades to many rated corporate CDO tranches.

Following this update, S&P says it will place approximately 4,790 global public rated corporate CDO tranches on credit watch negative with an approximate equivalent US dollar amount of US$578bn. Excluded from the actions will be certain tranches with short maturities that are unlikely to be affected by the criteria changes based on S&P's assessment of their credit support.

The most notable update is the addition of qualitative and quantitative tests that supplement the default simulation model that the agency uses in its portfolio analysis. Henry Albulescu, global criteria officer for structured credit, says: "Our goal with these 'supplemental tests' is to address both event risk and model risk."

Additionally, S&P's CDO Evaluator simulation model has been recalibrated to achieve 'targeted portfolio default rates' at each rating category that the agency believes CDO tranches should pass to be assigned a particular rating. In the updated criteria, asset default rates, correlation, recovery and other model parameters to produce asset portfolio default and loss results were adjusted.

Albulescu adds: "We believe that adding quantitative and qualitative elements to our analysis - entirely apart from the Monte Carlo default simulations we run - will provide a more robust analysis than using only simulation models. We also consider that by achieving specific targeted portfolio default rates in CDO evaluator we have made it easier and more transparent for investors to understand our ratings and analysis."

Another important update to the criteria is that S&P's review of a corporate CDO transaction now also includes a sensitivity to model parameters. This tests what the effects would be on a CDO tranche's ratings if four key portfolio parameters are changed: correlation, recovery, spreads and default bias. This aspect of the criteria is intended to assess whether the model results and transaction structure display high sensitivity to changes in input parameters.

In summary, the updated criteria:

• Introduce additional quantitative and qualitative tests, including certain stress tests, concentration limits and minimum capital (equity) levels;
• Recalibrate the CDO Evaluator default model to target triple-A default rates that S&P believes are commensurate with conditions of extreme macroeconomic stress, such as the Great Depression;
• Recalibrate the CDO Evaluator model to target triple-B default rates consistent with the highest actual corporate defaults that have occurred over the past 28 years, as recorded in S&P's Credit Pro database;
• Introduce tiering of recoveries for synthetic CDOs;
• Reduce the expected level of recoveries based on the expected stress levels for CDO tranches, commensurate with their ratings;
• Update some cashflow stress parameters, such as the starting time of defaults and tranche break-even default rate analysis;
• Consider credit stability in CDO analysis; and
• Consider sensitivity to modelling parameters in CDO analysis.

These criteria are effective immediately for cashflow CDOs backed by corporate loans and bonds, and for synthetic CDOs that reference pools of corporate obligations. It also applies to CDO transactions that are backed by corporate assets consisting of a mix of cash and synthetic instruments. Additionally, it is relevant for CDOs of corporate CDOs, and CDOs of hybrid trust preferred securities.

S&P's preliminary estimates are that outstanding synthetic CDOs will likely experience an average downgrade of four notches. Super-senior triple-A tranches of such transactions will probably be affected less, with an estimated average downgrade in the 2-3 notch range. Tranches rated triple-A will likely be affected more, with an estimated downgrade of 4-5 notches.

Outstanding cashflow CDOs will likely experience an average downgrade of three notches. The senior most triple-A rated cashflow tranches that are above other junior triple-A rated tranches will likely be affected less, with an estimated average downgrade of 1-2 notches.

Ratings

New calibration for Hedge Fund Evaluator

S&P has updated the calibration of Hedge Fund Evaluator v2.2 (HFE), its analytical tool for rating obligations backed by the performance of funds of hedge funds or a diversified pool of hedge funds or CFOs. However, the agency does not expect the new HFE calibration to affect the current ratings on CFO transactions.

This update comes in light of market conditions and the performance of specific hedge fund indices. It incorporates the available historical performance of a number of hedge fund indices through April 2009 and reflects the agency's view of stressed future performance commensurate with its rating definitions.

The HFE incorporates a recalibration on the following hedge fund indices:

• CSFB Tremont (13 sub-strategies);
• HFRX (equally weighted and asset weighted; eight sub-strategies);
• HFN (31 sub-strategies); and
• MSCI (equally weighted and asset weighted; five sub-strategies).

S&P anticipates that the new HFE calibration will produce a higher degree of volatility, reflecting the economic conditions observed in the hedge fund industry during the past year. Over the next few weeks, the agency expects to incorporate the results of the new HFE calibration into its review of each rated CFO transaction.

Ratings

IDRs won't be assigned to SPVs

Fitch says it will not assign issuer default ratings (IDRs) to SPVs used in structured finance, due to their lack of standalone commercial substance. The agency emphasises that its comments regarding SPVs relate only to IDRs that would be assigned to the SPV itself. They do not relate to the issue ratings (IRs) that are assigned by Fitch to securities issued by SPVs, most commonly seen in the structured finance sector.

IRs for securities issued by SPVs will continue to be assigned by Fitch in accordance with the relevant structured finance rating criteria. "SPVs in structured finance generally have no commercial substance of their own - for example, they have no employees and are restricted from taking on their own liabilities. As such, an SPV is basically an 'empty shell', established primarily with the intention that its assets are legally segregated and isolated from corporate risks. This isolation includes limiting risk from the SPV itself by restricting its activities," says Stuart Jennings, risk officer for EMEA/APAC structured finance at Fitch.

"The assessment of whether an SPV operates as intended is essentially a legal matter rather than a credit one - its structure either works or it doesn't. Since Fitch's ratings are primarily intended to address credit matters, to assign an IDR to an SPV would have limited meaning. Little or no credit analysis would be involved and, apart from the structured finance securities which have their own IRs, the SPV has no financial obligations of its own to which such a rating could apply."

Fitch notes that some national regulators require issuers to have credit ratings in order that the securities they issue be qualifying investments for certain purposes. However, where the issuer is an SPV, Fitch would not be able to assign credit ratings to meet such regulatory requirements.

The comments come after the publication of the updated structured finance criteria report 'Special-Purpose Vehicles in Structured Finance Transactions', which - as well as addressing this point - also emphasises that SPVs, although generally bankruptcy remote, are not bankruptcy proof.

Real Estate

US CRE prices resume steep decline

Commercial real estate prices renewed their steep declines and low transaction volume in July, according to Moody's/REAL Commercial Property Price Indices (CPPI). The CPPI was down 5.1% from June after having declined by only 1% the prior month. It is now 30.8% below what it was a year earlier and 38.7% below the peak measured in October of 2007.

Overall market transaction volume continued the pattern of calendar 2009. Moody's md Nick Levidy says: "The market has averaged about 375 sales per month for the seven months in 2009. Over the same time period in 2008, sales were averaging nearly 1,100 a month."

Moody's regional property type indices show prices for apartments in the eastern US performing significantly better than in other regions (and also better than other property types in the east). In the east, apartment prices have declined by 6% in the past year and 10.5% in the past two years, which is smaller than the decline of any other regional property type for just one year. Nationally, apartment sector prices have declined 24.4% in the past year.

Apartments in the southern US have posted the steepest drop over the past year, at 44.2%. Florida apartments have also seen dramatic declines in the past four quarters, declining by 39.8%. These prices are now 49.8% from their peak prices.

Other notably weak markets the indices point to are the office and industrial markets in southern California. In that area, office values have declined by 25.8% and industrial values by 24.2% since a year ago.

Regulation

Proposals should foster, not suffocate, securitisation

The IMF calls for a return of 'sound securitisation' in its latest Global Financial Stability Report (GFSR) and warns that a failure to restart this market would come at the cost of prolonged bank funding pressures, a diminution of credit, and a continuing need for central banks and governments to take up the slack. The report also highlights that the variety of proposals to restart sustainable securitisation - such as increased capital requirements, tighter accounting standards for off-balance sheet entities, retention requirements and enhanced disclosure requirements - could, if implemented in combination, make restarting securitisation too costly.

"Impact studies should be conducted before such proposals go into effect to ensure that, in combination, they foster - not suffocate - sound securitisation," the IMF says.

In particular, the report evaluates initiatives put forward in both the US and Europe to introduce a minimum 5% retention requirement for originators to have more 'skin in the game', ensuring that someone takes responsibility for diligent underwriting and monitoring. The IMF demonstrates that flexible implementation is required to achieve a broad-based alignment of incentives because, as default probabilities change, as well as economic conditions and loan qualities, originators of securitised products have varying incentives to screen loans.

Several policy proposals arise from the IMF report, some of which encompass activities already under consideration and which also build on earlier GFSR proposals. These include:

• Policies should reduce incentives for 'rate shopping' and for ratings-related arbitrage of regulatory requirements, including by having rating agencies disclose their methodologies and publish their rating performance data, and reducing regulatory reliance on ratings;
• Retention requirements should be tailored to the type of financial product, its underlying risks and forward-looking economic conditions - barring this, policymakers should choose a second-best retention scheme that covers most outcomes;
• Financial statement disclosure and transparency should be enhanced, especially as regards off-balance sheet exposures. However, disclosures should concentrate on materially relevant information and not overburden securitisers or investors with irrelevant data.
• Securitiser compensation should be revised towards a longer-term horizon and recent changes to accounting standards for securitisations move the market closer to this goal. Securitised products should be simplified and standardised in order improve liquidity, ensuring prices better reflect actual transactions.

Regulation

Proposed OTC derivatives regulation rebutted

While highlighting that the Association supports many key public policy concepts contained in the US Treasury department's proposal on OTC derivatives regulation, ISDA executive director and ceo Robert Pickel outlined a number of aspects of the bill that work against its broad public policy goals at a US House of Representatives Committee on Agriculture hearing.

First is the scope of firms that would be subject to the legislation. The bill's definition of 'swaps dealers' and 'major swap participants' are overly broad and would include firms that are in no way systemically significant.

Second, both of the proposal's methods for determining when an OTC derivatives contract is standardised need to be revised, according to Pickel. The need for consistency amongst policymakers regarding what is standardised and what is not argues for broader participation by federal regulators in this process. And due to commercial considerations, the willingness of a clearinghouse to accept a transaction for clearing should not create a presumption of standardisation.

Third, not all standardised contracts can be cleared. Contracts that are infrequently traded, for example, are difficult - if not impossible - to clear, even if they contain standardised economic terms. As a result, clearing of OTC derivatives contracts should not be mandatory, the Association says. Mandating that OTC derivatives contracts trade on an exchange would undercut their very purpose: the ability to custom tailor risk management solutions to meet the needs of end-users.

Finally, ISDA and its members oppose the introduction of capital requirements for cleared swaps because capitalisation of the derivatives clearinghouse is designed to provide adequate protection to swap counterparties. In addition, the clearinghouse imposes its own layer of additional protection in the form of collateral requirements on its counterparties.

"These provisions would reduce or restrict the availability of customised risk management tools without contributing in any significant positive way to the Treasury's goals of reducing risk and ensuring financial stability," Pickel comments. "As a result, they would make it more difficult for American companies to effectively manage their business and financial risks."

Regulation

SEC to take action on NRSROs

The US SEC has voted unanimously to take several rulemaking actions to bolster oversight of credit ratings agencies by enhancing disclosure and improving the quality of credit ratings. In particular, the SEC voted to adopt or propose measures intended to improve the quality of credit ratings by requiring greater disclosure, fostering competition, helping to address conflicts of interest, shedding light on rating shopping and promoting accountability.

Realpoint has welcomed in particular the SEC's move to grant NRSROs access to the necessary underlying data that will allow competing credit rating agencies to offer unsolicited ratings for structured finance products. Robert Dobilas, ceo and president of the rating agency, says: "This change will provide more choices for investors, who will now be able to choose an agency based on the quality and transparency of its ratings and analysis."

He adds: "With more ratings agencies analysing the creditworthiness of [structured finance] securities, there will be less ambiguity and less chance for some to take advantage of the system. Ultimately, investors will be provided with a better understanding of the risk profile of structured finance investments."

Among the SEC's actions to create a stronger, more robust regulatory framework for credit rating agencies are:

• Adopting rules to provide greater information concerning ratings histories - and to enable competing credit rating agencies to offer unsolicited ratings for structured finance products, by granting them access to the necessary underlying data for structured products.
• Proposing amendments that would seek to strengthen compliance programmes through requiring annual compliance reports and enhance disclosure of potential sources of revenue-related conflicts.
• Adopting amendments to the Commission's rules and forms to remove certain references to credit ratings by nationally recognised statistical rating organisations (NRSROs).
• Reopening the public comment period to allow further comment on Commission proposals to eliminate references to NRSRO credit ratings from certain other rules and forms.
• Proposing new rules that would require disclosure of information, including what a credit rating covers and any material limitations on the scope of the rating and whether any 'preliminary ratings' were obtained from other rating agencies - in other words, whether there was 'ratings shopping'.
• Voting to seek public comment on whether to amend Commission rules to subject NRSROs to liability when a rating is used in connection with a registered offering by eliminating a current provision that exempts NRSROs from being treated as experts when their ratings are used that way.

RMBS

Hermes tender attracts investor interest

The results of SNS Bank's Hermes Dutch RMBS tender offer have been announced, with €556.8m nominal amount purchased out of a maximum €1bn. Of the 23 tranches offered for tender, ten - all rated below triple-A - were not taken up by investors. The purchased tranches were all at the minimum of the tender offer range, apart from Hermes 8A, which was closer to the maximum.

ABS analysts at Barclays Capital note that the participation rate of over 55% suggests that investors found the prices on offer, particularly at the triple-A level, fairly attractive. The prices paid varied between 92.5% and 96.5% for Class A notes, 74.75%-88.25% for Class Bs, 75.25%-81.75% for Class Cs and 68.5% for the HERMES XIII Class D notes.

RMBS

US RMBS ratings approach updated

Moody's has updated its approach to evaluating US RMBS to account for seasoned and non-performing residential mortgage collateral. The updates affect the agency's enhanced criteria for assessing originator quality, representations and warranties and independent third-party reviews.

Linda Stesney, team md of Moody's RMBS ratings group, says: "The new guidelines address the trend we are seeing in issuers bringing us seasoned collateral for credit analysis. Often the originators of the loans being shown to us have long since been defunct or, if they are still in business, their underwriting guidelines have materially changed, so it doesn't make sense for us to conduct an originator assessment for these types of loans."

Instead of originator assessments, the agency is requesting additional loan-level information pertaining to the seasoned loans, such as life-of-loan payment history, updated credit scores, updated property value, updated occupancy information and loan modification terms. In addition to the elimination of originator reviews for seasoned and non-performing pools, Moody's criteria for representations and warranties and independent third-party reviews have been modified such that references to underwriting guidelines and originator process for verifying income, assets and employment are removed.

Although the credit review portion of the pre-securitisation review has been eliminated, Moody's is still looking for independent third-party reviews to confirm the accuracy of the updated information it requests for seasoned loans.

Stesney adds: "As we have stated in the past, if a securitisation to be rated does not meet some of our criteria, we may decide that more credit protection is needed to achieve a given rating, we may decide to assign lower ratings, or we may decline to rate the transaction."

For example, Moody's will not rate any US RMBS that has not had an independent third-party review of the loans prior to securitisation, whether or not they are seasoned.

Secondary markets

CMBS spreads react to new US tax rule

US CMBS spreads have tightened following publication of the Treasury's new tax rules that allow borrowers to speak to servicers about potential modifications to securitised loans that are at risk of default without triggering tax penalties (see last issue). Ten-year triple-A spreads finished tighter by 15bp to 25bp on Wednesday, following the announcement.

"The market, sensing this ruling might stem the rising tide of delinquent loans, bid the market up," Trepp analysts say. "Spreads on A4 bonds from the 2006 and 2007 vintages are now regularly nestled in the 350bp to 450bp range over swaps. For 2005 paper and earlier, spreads of 275bp over swaps or better are the norm."

The benchmark GSMS 2007-GG10 A4 bond now is being quoted at swaps plus 550bp (midmarket). That is about 45bp above the tightest levels witnessed for the tranche during the first week of August.

"Equally encouraging to Wednesday's triple-A tightening were the results of a series of bid lists of 2005 and 2006 AM bonds," continue the Trepp analysts. "All of the bonds on the list covered above US$80 - with some reaching handles into the mid- and high US$80s. We had also heard that there had been strength extending to the double-A and single-A stacks as well."

While the analysts note that they are encouraged by the Treasury ruling, they say over the short term the percentage of loans going to the special servicer could spike. "We know that this particular statistic has been quoted frequently in the press over the last few months and has the potential to move the market," they comment.

"The counterintuitive twist to the ruling could be this: a jump in loans with the special servicer takes place, spooking the market at some point down the road and leading to pressure on CMBS spreads," they conclude.

Secondary markets

Smaller US ABS outperform larger deals

Small US ABS deals that have come to market in 2009 have outperformed larger issues so far this year, according to a new study by S&P's market, credit & risk strategies (MCRS) group.

The MCRS group looked at the largest and smallest ABS offerings priced this year with available pricing data and reviewed their performance since the end of July. Issues of US$1bn or more saw an average gain of 0.79% since the last trading day in July, while three issues lost ground. Picking up 2.59%, an SLM Student Loan Trust 2009-1 US$2.179bn issue maturing in July 2043 brought in the biggest gain among the large issues.

The 10 smallest issues (US$49m or less) priced this year advanced by an average of more than 2.3% during the same time. However, the bulk of that average gain can be attributed to two issues.

First, a US$46.6m tranche with a 7% coupon maturing in October 2015 from the USAA Auto Owner Trust 2009-1 deal gained more than 9.6% since the end of July. Second, a Huntington Auto Trust 2009-1 US$48m tranche offering a 6.83% coupon and maturing in September 2016 advanced by more than 6.7%.

"Without USAA and Huntington skewing the average, the smallest ABS issues gained an average of about 0.90%," says MCRS.

According to Capital IQ, 23 US ABS issues of US$1bn or more have been priced so far this year. Those issues account for about 45% of the dollar volume of proceeds from ABS issuance year-to-date, but only about 6% of the number of issues priced. The larger issues in MCRS' examination also tend to have somewhat shorter maturities than the smaller issues priced this year.

"The outperformance of smaller ABS offerings may prove to be a short-term phenomenon rather than the beginning of a longer-term trend," the group adds. "Or the answer may simply be that larger offerings may attract larger pools of investors, in which case the wider dispersal of the issue could make short-term price gains more difficult."

Structuring/Primary market

Leasing ABS restructured

The DFM Vehicle Loans Securitisation 2005 has been restructured to provide for an increase in the average loan to value (LTV) limit on the loans made by the issuer to the leasing companies to 95% from 90%. To mitigate against any increased risk, the issuer has also entered into a subordinated loan agreement in the amount of €175m. The proceeds of the subordinated loan have been fully drawn down and placed in the issuer's account.

Fitch subsequently confirmed the triple-A ratings of the deal's Class A, B1 and B2 notes.

The transaction is currently in its revolving period, which lasts until June 2010. After this time the subordinated loan can amortise, as long as the credit enhancement available to the Class A and B notes continues to be at least 26.25% and as long as the lessee concentration limits in the transaction documents have not been exceeded.

In Fitch's opinion these conditions mitigate the fact that the residual value risk is concentrated towards the end of the transaction's life by creating a floor to the level of credit enhancement. The conditions also protect against increasing obligor concentration risk during the amortisation period.

Technology

CDS market premium ratio launched

Thomson Reuters has integrated Kamakura's default probability service into its flagship financial desktop, Reuters 3000Xtra. Kamakura's default probabilities are now available via Reuters 3000Xtra, covering a universe of more than 1,500 public firms and close to 100 sovereign entities.

The two firms have also created a market premium ratio, which helps identify the portion of a traded CDS spread that indicates actual default risk and the portion of the spread that reflects other factors, such as liquidity. Thomson Reuters has also built related tools to facilitate relative value analysis on CDS spreads for purposes of arbitrage, hedging and risk valuation.

This new joint Thomson Reuters-Kamakura tool offers the following features:

• The CDS spreads, default probabilities and market premium ratios for public and sovereign entities with a default probability equal to or greater than 1%.
• The mean and median of market premium ratios by sector and rating.
• The ability to chart historical default probabilities, market premium ratios and CDS spreads.

Reuters 3000Xtra provides accurate intraday and end-of-day pricing on cash and synthetic credit instruments like loans, bonds and CDS, plus weekly traded volumes, and timely news on companies and economies.

Kamakura president and coo Warren Sherman comments: "The current credit crisis has shown very clearly that equity holders and debt holders can have different risk profiles as credit risk increases. A firm where the senior debt holders are rescued in a bailout can still leave subordinated debt holders, preferred stock holders and common stock holders with very large losses. Adding Kamakura default probabilities to Reuters 3000Xtra helps the full spectrum of liability holders distinguish between the risk of failure of a firm and the risk of loss for a given class of liabilities. This is critical to all investors in corporate common stock, preferred stock and traditional fixed income liabilities."

Technology

US CRE risk analysis service launched

Fitch Solutions and Algorithmics Advisory Service have launched a commercial real estate risk analysis and portfolio assessment service. The service aims to pinpoint US CRE and CMBS risk, which Fitch views as imperative in light of rapidly increasing cap rates and loan delinquencies, as well as falling property values.

Krishnamoorthy Narasimhan of Algorithmics says: "With a substantial number of CRE loans up for refinancing in the next few years, lacking a precise understanding of the complex risks within commercial real estate loan and securitisation portfolios has become the latest area of concern for senior management teams."

He adds: "By providing loan and portfolio risk reports to commercial lenders and institutional investors, the new service will enable market participants to isolate and monitor risk in their commercial real estate holdings."

Trading

Fixed coupons to favour iTraxx skew trades

The introduction of standardised fixed coupons with the new Markit iTraxx Series 12 indices is expected to favour skew trades, taking advantage of the difference between the index spread and the fair value implied by its constituents.

"Skew trades should be particularly active in the new indices," note credit strategists at Banc of America Securities-Merrill Lynch. "If the new indices open at similar skews to the current series, then names in Europe and HiVol should tighten - skew traders will sell protection on single names and buy protection on the indices. In contrast, the roll should have a widening effect on Crossover names - skew traders will sell protection on the index and buy protection on the constituents."

The strategists explain that at the height of market stress, index spreads diverged significantly from fair value. As liquidity in the CDS market has improved and arbitrage activity has picked up, these differences have compressed significantly. Further, having the index and individual single name CDS struck at the same coupon eliminates most of the DV01-risk from skew trades.

Under the current format, the difference between the index coupon and that on single name CDS introduces a mismatch in duration, with the mark-to-market impact for a movement in spreads changing according to where the original coupon for the contract was set. As a result, skew trades generally involved hedging the DV01-risk.

The index roll will see the Europe, Financials and HiVol indices trade with a fixed coupon of 100, while Crossover will trade with a fixed coupon of 500.

Trading

Trading ideas: rolling in cash

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at a negative basis trade on Toll Brothers Inc.

The new issue corporate bond market was on an absolute tear last week. The 16 September saw the second largest issuance of the year and Toll Brothers' took part adding US$250m to the count with a 10-year deal. Though we have held a bearish view on Toll Brothers' credit all year, the company's massive liquidity balance (+US$1.6bn) and other out of model factors provided enough comfort to the market to keep its credit spread down.

Given its solid cash footing, we believe the negative bases on its traded bonds will come in. The negative basis on its 4.95s of March 2014 bond is -182bp, which is substantially larger than the average.

Based on our valuation approach, the Toll Brothers Inc. 4.95s of March 2014 bond fair value is US$105.60. The exhibit below compares the bond z-spreads with the CDS term structure and shows that the recommended bond is indeed trading wide of the closest-maturity CDS with a basis of -183bp.

The position is default-neutral. There is a slight maturity mismatch because the bond matures on 15 March 2014 and the CDS expires on 14 December 2014, but we expect to be able to exit the trade with a profit from carry and convergence to fair value before either instrument matures.

The underlying idea of the negative basis trade is that credit risk is overpriced in the bond market relative to the CDS market. The investor buys a risky bond - and thus is paid to take credit risk on the issuer - while paying for credit risk in the CDS market by buying protection on the issuer. There are many drivers of the basis, both technical and fundamental, which we explain in our Trading Techniques articles.

Eventually, the prices for credit risk in the two markets should converge, resulting in an arbitrage-like profit. In the interim, the investor earns positive carry, because the credit spread that is collected in the cash market is greater than the spread that is paid in the CDS market.

Toll's five-year CDS trades at 108bp, which is around 200bp tight to fair value, according to our MFCI (directional credit) model. The main drivers of the wider expected spread for Toll are its anaemic margins, interest coverage levels and equity-implied factors.

The company's revenues hit rock bottom in the second quarter of 2009 at US$398m. The last time revs were this low was in the year 2000. They have since slowly started to recover; however, the company still runs on negative margins as COGS outstrips sales.

However, Toll Brothers maintained a large and growing cash balance throughout the credit crisis (see below exhibit). Clearly the company is waiting for a real estate turnaround and will be ready to jump quickly with land acquisitions.

We believe this factor is largely negating other fundamentals that we use to assess a company's credit risk, leading to our high expected spread generated from our quantitative model. We believe alpha can be best generated through a negative basis trade with its 4.95s of Mar 2019 bond.

Position

Buy US$10m notional Toll Brothers, Inc. 5 Year CDS protection at 108bp.

Buy US$10m notional (US$9.8m proceeds) Toll Brothers, Inc. 4.95s of March 2014 at US$98.00 (T + 305bp; z-spread of 290bp) to gain 182bp of positive carry.

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).