Contents

Operations

Baby steps

Call for ABS post-trade reporting to be developed sensitively

FINRA announced last week that it intends to expand TRACE to include ABS (see also separate News story), following CESR's call in July for the adoption of a mandatory trade transparency regime for the sector (see SCI issue 145). However, investors caution that it should be implemented sensitively in order to preserve fledgling liquidity.

"My concern is that if regulators begin chasing transparency at all costs, it will have a negative effect on the marketplace and serve to reduce the liquidity that investment banks are only just starting to bring back," says Rob Ford, partner and portfolio manager at TwentyFour Asset Management. "This is because post-trade reporting, for example, especially in thin markets, will likely remove the competitive advantage of trading anonymously."

Some of the bigger houses in Europe are now sending out regular pricing information on large programmes, such as Permanent and Granite, so there is already decent transparency around these deals - albeit they still have wide bid-offer spreads. However, non-benchmark bonds still have less liquidity and the market has little duration, given that there has been no new issuance for two years (except for the recent Perma deal).

"Ignoring Spanish paper or sectors with considerable extension risk, there is clear information about bids and offers already available in most well-known paper," Ford confirms. "But there are still occasions when significant discrepancies can occur."

A recent example involved the same bond being offered by two different houses at prices more than 20 points apart. It's unclear whether the person offering at the higher price hadn't done their homework and had paid the wrong price or if the holder of the bond offered at the cheaper level was simply keen to sell.

Such a case reflects the fact that different people make different decisions about credit quality, according to Ford. "The bid-offer spread represents value in the marketplace - you have to get paid for the risk. But imagine what might happen if both of those prices were published on a TRACE-like system. At present, only a handful of dealers are prepared to put their balance sheet on the line, so it's understood that they'll only deal at certain levels."

While Ford is sympathetic to the arguments against introducing post-trade reporting for securitisations, his recent experience in dealing with the daily liquidity requirements of TwentyFour's RMBS fund - the Monument Bond Fund - has prompted him to reconsider this position. "It's not practical to source daily valuations from trading desks on every bond in a diverse portfolio - they typically provide them on a monthly basis, with ad-hoc updates as required during the month, which is acceptable in stable markets. The alternative is to use pricing information - either contributed or evaluated - from vendors," he notes.

It appears that in practice some dealers don't update their quotes as regularly as could be desired in contributed pricing offerings, which is particularly problematic now that European ABS is experiencing the biggest market rally in its history. The mechanism for cleaning for outliers is also potentially flawed, since it's difficult to determine what the outliers are, given the disparities in the market at the moment.

Evaluated pricing, on the other hand, involves combining an understanding of prices, with documentation and analytics in order to model cashflows and extrapolate levels. But there is some scepticism about this process too, as the vendors don't appear to be staffed by ex-investors or ex-traders and there is no clarity as to how they are plugged in to movements in the markets.

"At least with both contributed and evaluated prices, you can challenge the levels a vendor gives you - which is a great idea, although it actually means that an end-user is doing their job for them," Ford observes.

Consequently, he suggests that implementing some form of post-trade reporting for ABS may potentially be helpful for the market in terms of providing another pricing source. Evaluated pricing services could, in turn, price bonds off the system and contributed pricing services could rebuild their cleaning algorithm around it.

"There is a fine line: I've always resisted the idea of ABS post-trade reporting, but my experience of pricing agencies hasn't been as simple, clear and helpful as I'd like. I'm not sure what the solution is - do you promote transparent valuations over liquidity or vice versa?" Ford asks.

Illiquid asset trading platform SecondMarket tried to initiate a post-trade reporting solution when it expanded into MBS and CDOs in April, but the firm met with resistance from both buyers and sellers at that time. Instead, current bids and offers only are published on the platform.

However, Sal Cincinelli, CDO market specialist at SecondMarket, still believes that the implementation of a TRACE-like system for the ABS/CDO sectors would be helpful. "Dealers have been making money since the Whistlejacket auction, precisely because of the lack of information out there," he says. "The market's opacity obviously works in their benefit, but the structured credit universe needs to be opened up to all investors."

If post-trade reporting is implemented for ABS, it will have to be done sensitively. One possibly problematic issue is whether pricing is actually published on the trade-date or not.

"Perhaps the solution is to publish prices with a delay of a number of days or even weeks, introduce reporting according to issue size or even have a formula whereby it is based on the amount of transactions done in a given asset class (in other words, more timely publishing on deals which trade more regularly). Pricing agencies could also build this into their algorithms and potentially de-weight dealer contributions that haven't been updated," Ford suggests.

Elton Wells, head of structured products at SecondMarket, agrees that too much information flooding the market too soon could be detrimental for liquidity. He suggests that any post-trade reporting platform should be developed gradually; for example, by beginning with triple-A securities and then moving down the ratings spectrum or focusing on new issues first before introducing secondary securities.

Meanwhile, the growing number of CDO liquidations has highlighted that timing, as well as transparency is an issue: investors typically aren't given enough time to do the credit work (see last week's issue). SecondMarket says it provides solutions to both of these problems, however.

First, it doesn't force sellers to undertake auctions. They can take as long as they need to prepare.

Second, SecondMarket members can download centralised documentation for any securities listed on the platform. Wells explains: "Sellers are happy to provide the relevant documents because they recognise that they could end up with a higher bid by doing so. Every security has a tear-sheet, which comprises a two-page summary of the transaction and a link to the full documentation."

CS

Trading

Arbitrage activity

Trading drives majority of re-REMIC issuance

Re-REMIC issuance in the US is continuing apace, with several billion dollars worth of bonds being sold each month. While the IMF's latest Global Financial Stability Report suggests that the deals are being used to rid banks of legacy assets, rating and regulatory arbitrage, it appears that the majority of these deals are now purely done for trading arbitrage.

"There is still plenty of re-REMIC activity going on," confirms Sam Warren, md at NewOak Capital in New York. "The top broker-dealers are issuing around US$2bn each a month in re-REMICs - purely for trading arbitrage. Around 90% of re-REMIC issuance is being driven by trading arbitrage - and the other 10% is solutions-based."

Warren notes that NewOak Capital has been working on a number of solutions-based re-REMICs for insurance companies and banks across a broad range of assets. These include RMBS, CMBS and also consumer ABS deals.

"We're well off the lows in these deals in terms of valuations and many firms are looking to improve their balance sheets before year-end," he says.

According to the IMF's October Global Financial Stability Report, about US$25bn worth of re-REMICs were issued during H109, mostly against MBS backed by prime mortgages. The report notes that although these transactions have a useful role in dealing with the overhang of legacy assets, they are partly driven by rating and regulatory arbitrage.

"Maintaining triple-A status can result in substantial capital requirement reductions," the IMF report notes. "For example, the new Basel 2 risk weight on a double-B rated tranche is 350% under the standardised approach, whereas it is 40% on a triple-A-rated resecuritisation."

For single security-backed re-REMICs, the default probability-based rating methodologies used by DBRS, Fitch and S&P will typically pass the underlying bond's rating through to the new mezzanine tranche. "In this regard, it is notable that Moody's has been virtually shut out of the re-REMIC rating business, possibly because it rates on the basis of expected loss, which is tougher on mezzanine tranches than the default probability basis [Fender and Kiff, 2005], and thus issuers prefer not to have Moody's rate their potential securitisation," adds the IMF.

"Another way of looking at the differential rating treatment is that under the expected loss rating basis, a weighted average of the ratings on the two new tranches cannot exceed the old rating, so it cannot create new triple-A-rated and double-B rated tranches from a double-B minus rated legacy tranche," the report continues. "However, because the probability of default on the new mezzanine tranche is the same as that on the double-B rated legacy tranche, it also gets a double-B rating."

Re-REMICs also serve to illustrate the vulnerability of ratings-based regulations to gaming and shopping, the IMF says, adding that the new securities remain exposed to further downgrades if economic and housing market conditions worsen.

Indeed, two recently-launched RMBS re-REMICs have already been subject to downgrade. S&P has lowered its rating on the JPMRT 2009-3 Class 2-A-2 notes from triple-B minus to single-B.

The rating agency cited rapid decline in the performance of the mortgages backing the underlying certificate. The deal launched in May.

S&P also downgraded five classes of CSMC 2009-8R from double-B to single-B plus - again due to rapid deterioration in the performance of the mortgages backing the deal. That transaction launched in June.

"When a mezz bond such as that is 5 times levered to convexity and credit, a couple of bad months' performance in the underlying collateral can have a big impact. I'm not surprised that it led to a downgrade," Warren concludes.

AC

CLOs

CLOs brush off broader market sell-off

CLOs brushed off the broader market sell-off last week and set a near-term high in weighted average price of US$77 as mezzanine bond levels rose, according to structured credit analysts at JPMorgan. They note that - similar to the trend in consumer ABS - paper is very well bid and, on the mezzanine side, there is demand from both short-coverers as well as investors seeking higher yield through outright risk.

On the week, US single-A CLO spreads were up by US$10 to US$60, triple-Bs were up US$10 to US$45 and double-Bs were up US$10 to US$35. Meanwhile, European triple-As tightened by 25bp to 475bp, double-As were up €3 to €60, single-As up €2 to €42 and triple-Bs up €3 to €25.

"While a broader market pull-back could slow the pace of the rally in CLOs, we see no major impediments to the spread tightening trend in the face of strong investor demand and negative net supply," the analysts notes. "The lower prices/higher yields of CLOs relative to most comparables should act as a meaningful buffer to any spill-over of price volatility. In fact, CLO debt is still one of the few fixed income asset classes offering 'equity-like' returns for an acceptable level of risk."

Credit deterioration among US CLO transactions continued to plateau in August 2009, according to S&P's latest CLO performance index. Although speculative-grade corporate defaults continued to have a negative impact on the performance of loans in the transactions' collateral portfolios, the average senior overcollateralisation (O/C) ratios for the 2003-2008 vintage CLOs improved from July.

Defaults among corporate leveraged loan issuers dropped to four in August from 11 in July, which resulted in a decrease in the percentage of defaulted loans in the average CLO collateral pool. The percentage of loans from triple-C rated obligors remained largely unchanged in most of the cohorts. The rise in market prices continued to contribute to an improvement in the O/C ratios, as many transactions carry the triple-C rated assets at market value for purposes of calculating the O/C ratios.

The percentage of underlying defaulted assets in the average US CLO fell in August, as only four US leveraged loan issuers defaulted during the month. Comparatively, 11 obligors defaulted in July, seven in June, eight in May, 10 in April, six in March, five in February and six in January.

AC & CS

Distressed assets

Global loss estimates lowered

The IMF has lowered its global loss estimates to US$3.4trn, following recent mark-to-market improvements and capital raisings. However, estimates of bank write-downs were left broadly unchanged at US$2.8trn. With actual write-downs of around US$1.3trn through the first half of 2009, this estimate implies that losses still to be taken are around US$1.5trn globally, according to credit strategists at BNP Paribas.

In terms of the breakdown, US domiciled banks have recognised around 60% of total losses, with US$418bn in write-downs still to come. The reverse is true for the eurozone and the UK, for which the IMF estimates that only 40% of the losses have already been recognised. This leaves the eurozone with estimated additional losses of US$467bn.

The BNP Paribas strategists point out that these estimates are the result of an improved methodology for European bank losses, with a more detailed analysis across single economies following previous criticism of homogeneous treatment. In particular, there were significant changes to estimations of loan losses in the eurozone.

In contrast with the April estimate, where loan losses were based on the forecast profile of the US and relative security prices, the latest forecasts are based on a model that forecasts bank loan losses developed in coordination with the ECB. As a result, the cumulative loss rate for the eurozone loans over the period 2007-2010 was estimated at 3%, down from more than 4% previously and well below both the US (8.1%) and the UK (7.4%).

Even so, estimates of total losses and losses still to be taken from eurozone banks are higher than those provided by the ECB - which estimates total losses at US$650bn (versus the IMF's US$814bn).

"The good news is that, given capital raising to date and accounting for estimated earnings over the next two years, estimates of capital needs are manageable," the strategists note. US$150bn of new capital would be needed by eurozone banks to reach a Tier 1 ratio of 8%, according to the IMF. This compares with a total of US$437bn raised since the start of the crisis, of which US$92bn has come this year.

Results of the EU-wide stress test suggest that under the baseline scenario, reflecting current macroeconomic projections, banks' aggregate Tier 1 capital ratios will be well above 9%, compared to the present Basel minimum requirement of 4%. However, should economic conditions be more adverse than currently expected, this would have significant impact on the potential losses for the banks concerned. Under such an adverse scenario, the potential credit and trading losses over the years 2009-2010 could amount to almost €400bn, according to the stress-test results.

Nevertheless, the financial position and expected results of banks are also sufficient to maintain an adequate level of capital under such negative circumstances. Notably, the aggregate Tier 1 ratio for the banks in the sample would remain above 8% and no bank would see its Tier 1 ratio falling under 6% as a result of the adverse scenario. This resilience of the banking system reflects the recent increase in earnings forecasts and, to a large extent, the important support currently provided by the public sector to the banking institutions - notably through capital injections and asset guarantees - which has augmented their capital buffers, CEBS notes.

The objective of the stress-test exercise was to increase the level of aggregate information among policymakers in assessing the resilience of the European financial system, using a sample of 22 major European cross-border banking groups.

CS & JA

Emerging Markets

Major price dislocations persist in Asia

While the Asian public markets have traded up in line with global markets over the past few months (see also Talking Point article), major price dislocations persist in the region's private illiquid markets.

According to Janak Kapur, md at Asian alternative asset investment manager Pacific Alliance: "We continue to see stress and distress across the capital structure in Asia, particularly in the leveraged bank loan and private placement space."

Pacific Alliance recently bolstered its absolute return and distressed investment franchise with four new appointments (see SCI issue 151). Presently, the firm is wholly Asian focused, with investors from across the globe. The firm is targeting a range of distressed credit assets, including structured credit instruments to the extent that they are being offered at meaningful discounts and where the firm thinks there is realisable value.

"We are seeing both primary and secondary distressed opportunities in the region, especially in the refi, LBO and portfolio liquidation space," Kapur confirms. "Additionally, we are seeing distressed sellers of performing assets."

However, purchasing distressed credit assets on the secondary Asian market remains complicated. "While market transparency in Asia has improved over the years, transacting at the right price requires a thorough understanding of regional idiosyncratic issues. There are only a handful of market participants, who have the experience and capital to price those real risks," says Kapur.

"Valuation of distressed assets in Asia can also be challenging," he continues. "You need to have a thorough understanding of jurisdictional risk and local enforceability issues. Pricing and valuations can vary widely, depending on the viability of a visible exit."

AC

Operations

Private sector home affordability strategies progress

The injection of private sector investment into pools of legacy assets via the PPIP is facilitating market-led initiatives to tackle home affordability issues. One such initiative that appears to be making some headway at present is SwapRent.

The aim of SwapRent is to provide a new alternative housing finance method by introducing a 'temporary own-rent switch' or 'economic renting' concept. SwapRent - which was developed in early 2006 - was never intended as a bailout tool. But its ability to offer true housing affordability and help distressed homeowners avoid foreclosures is coincidentally one of its potential applications relevant to PPIP fund managers.

As an example, an institutional fund manager could first temporarily act as an 'economic landlord investor' to offer monthly payment assistance to creditworthy homeowners and enjoy part of the future appreciation of their properties. The homeowners who may want to receive monthly subsidy assistance could be any property owners, regardless of whether they are good credits or not, because the SwapRent contract pricing will reflect their creditworthiness.

"As a free-market mechanism, SwapRent would eliminate the moral hazard of government bailouts," explains Ralph Liu, chairman and ceo of Advanced e-Financial Technologies, the firm behind the SwapRent concept. "Making it available to everyone, not only those who are underwater with their mortgage repayments, would in turn create much-needed demand for property which is vital for a property market recovery."

Conceptually similar to a debt for equity swap, the settlement of a SwapRent contract could be based on a choice of three methods - the real underlying property transaction price, a specific property appraisal or a property price index in the neighbourhood - and essentially isolates the economic value of property price appreciation. This can in turn be attached to a conventional mortgage, stripped out, traded in the secondary market and reattached to a different mortgage.

"The opportunity is in fund managers taking advantage of this short-term trading strategy. There is a profit-making motive inherent in the contract because by keeping borrowers in their homes rather than becoming delinquent or going through an expensive foreclosure, for example, the investors are adding value to the underlying legacy mortgage assets that they had bought," adds Liu.

He continues: "The PPIP represents the best channel to achieve this, as it incentivises the private sector to implement these value-adding trading strategies driven by their own profit-making motives. It is an opportunity to do well while doing good."

Fund managers can deliver the SwapRent monthly payment subsidy to homeowners in four ways: by connecting directly with the original borrower or implementing the agreement through the current mortgage servicer, another fee-earning financial intermediary or through a local government housing agency.

To better manage the counterparty credit risks with the homeowners, Advanced e-Financial Technologies has developed two additional concepts alongside the SwapRent contract. HELM (home equity locking mortgage) is a wrap-around package of the original first mortgage with a contingent second mortgage that essentially settles the payoff of the embedded SwapRent contract automatically as the new adjusted unpaid balance of the mortgage at contract maturity. There is also a co-ownership concept, FARM (flexible and reversible mortgage), which eliminates the need to foreclose in an alternative new housing finance system, according to Liu.

The PPIP framework has been criticised by some for not incentivising managers enough to make improvements to the troubled assets. But the programme's aim is to create purchasing power dedicated to legacy CMBS and RMBS; there are other government-led initiatives underway to tackle home affordability.

While there is a provision in the PPIP that requires managers to consent to loan modifications, it appears to be a soft criterion, John Pluta, svp of Declaration Management & Research, explains. "Where a lender opposes certain modifications that may hurt senior creditors, a PPIF manager is required to comply. If a manager owns 100% of a securitisation acquired for the PPIF, they are required to take the initiative in terms of modifications - but realistically they're unlikely to ever own the entire deal."

The objective of providing liquidity to legacy securities appears to be being achieved, according to Pluta. He concludes: "The PPIP will help improve market technicals, but not fundamentals. It's asking too much of PPIF managers to expend effort on fundamentals, given that the rationale of the programme is to put capital to work."

CS

Secondary markets

Structured credit reporting proposals unveiled

Two separate regulatory pushes towards improving reporting in the structured credit market were announced last week. FINRA is proposing to expand its Trade Reporting and Compliance Engine (TRACE) to include all ABS, including CDOs (see also separate News Analysis), while the Committee on the Global Financial System (CGFS) has released a report exploring how data on credit risk transfer (CRT) instruments collected under its auspices could be enhanced.

As with the original implementation of TRACE for corporate bonds in 2002, FINRA says it would initially only collect ABS transaction data under its proposal. After detailed analysis and observation of the market, it would then determine whether public dissemination of ABS data is appropriate.

"For regulators, there is a demonstrated need for ABS market information," comments Richard Ketchum, FINRA chairman and ceo. "Greater disclosure around these securities directly linked to the credit crisis will allow for more effective oversight with a deeper understanding of market dynamics."

TRACE reporting of ABS transactions would provide to FINRA trade prices, volume and other information. FINRA's ability to supervise the market would be enhanced through a better-informed surveillance programme designed to detect fraud, manipulation, unfair pricing and other misconduct that violates federal securities laws and FINRA rules.

Generally, FINRA says it favours transparency in the debt securities markets. Indeed, real-time dissemination of transaction information is provided for nearly all TRACE-eligible securities. FINRA also believes that the transparency in corporate bonds provided by TRACE today has contributed to better pricing, more precise valuations and reduced investor costs.

However, the characteristics of the ABS market differ sufficiently from the corporate debt market to the extent that FINRA believes close study of ABS information and the broader market is required to determine if dissemination of ABS market data is beneficial.

The plan for ABS disclosure to FINRA, filed as a rule change with the US SEC on 1 October, follows the SEC's approval of TRACE reporting for debt issued by federal government agencies, government corporations and government-sponsored enterprises, as well as primary market transactions in new issues. The reporting for the government agencies and the primary market goes into effect on 1 March 2010.

With that recent SEC approval, and if the SEC approves the expansion to ABS transactions, 70% of the US debt market would be subject to FINRA market surveillance, up from the current 27%. This includes market surveillance that FINRA conducts on the Municipal Securities Rulemaking Board's behalf. Firms would report post-trade data for all publicly traded debt securities except money market instruments and US Treasury securities.

FINRA notes that its proposal to collect ABS data, if approved, would also advance disclosure as an effective means of creating more stable capital markets, as emphasised by the US Treasury Department's 'Financial Regulatory Reform: A New Foundation'.

Meanwhile, the CGFS says that information on structural changes in global CRT markets and on the transfer and ultimate distribution of credit risk has not been sufficiently comprehensive or timely. Consequently, one of its main focuses is to expand its coverage of credit default swap instruments. It proposes some short-term and longer-term changes to existing CDS reporting, which are expected to be fully implemented by June 2011.

On the basis of their high degree of usefulness to analysts and low reporting costs, two items have been identified as candidates for 'quick implementation' - a new counterparty field of central counterparties (a 'priority' item) and index CDS as a new "reference entity" (an 'encouraged' item) - possibly to be first implemented in the 2010 BIS Triennial Survey of Foreign Exchange and OTC Derivatives Markets.

With a view to improving the consistency of data across reporting countries, a list of qualified CCPs will be issued to reporting agents. Separately, in order to improve the identification of counterparties, reporting agents will also be asked to record contracts with hedge funds using the EU's definition of hedge funds as a reference.

To allow reporters enough time to prepare for more complex changes, an extended template incorporating a further four recommendations have been proposed for full implementation by June 2011, which would allow the first set of new data to be published in October that year. The recommendations are:

• regional counterparty breakdowns should be recorded of the total outstanding amounts bought and sold for all CDS contracts, and a list of counterparties and their geographical location should be included in the new guidelines;
• ABS CDS should be introduced as a new reference entity under the subcategory of portfolio or structured products, with implementation subject to further work on what types of ABS should be included and a clear definition being made available to reporters;
• in the spirit of the reporting of other non-CDS derivative instruments, net market values based on the BIS guidelines for regular credit default swap reporting should be added; and
• reporting agents should be asked to also report the total amounts of synthetic CDOs being bought and sold (i.e. without any geographical or counterparty breakdowns).

The proposed extended CDS reporting template takes into account the usefulness of new data for analysis and the need to minimise the burden on reporting agents, the Committee notes. This was achieved via a two-stage merits and costs consultation process.

A questionnaire was first sent to member central bank and official sector analysts to evaluate the benefits of a set of possible improvements to CRT statistics. On the basis of the results of this evaluation, the proposed changes were streamlined and sent to reporting agents for another round of consultation.

The report also reviews the potential for using the DTCC global CDS data to supplement BIS data for the purpose of monitoring market developments. Initial results suggested that DTCC data captured a significant part of global markets between reporting dealers but not with non-dealers. Given that the DTCC is in the process of improving its records on non-dealers' transactions, the report recommends that further comparison exercises be conducted for end-June and end-December 2009 BIS data.

CS

ABS

Primary revival?

Japan leads Asia-Pacific ABS recovery

Eight Japanese ABS transactions were completed towards the end of September, making it one of the few Asia-Pacific countries where primary ABS and RMBS issuance is continuing. However, there are signs that investor appetite is now beginning to improve in other Asian financial centres.

Here, SCI talks to Moody's analysts about existing and potential securitisation activity across the region.

Activity in Japan
"ABS is currently one of the most active sectors in the Japanese structured finance market due to investor appetite for a diversified portfolio and stable rating performance," says Yusuke Seki, svp at Moody's in Japan. "There have been no rating downgrades for recent-year issues, except in the very esoteric areas."

He adds: "Investor appetite has been recovering following a difficult patch in late 2008 and investors have money to invest. Insurance companies and banks - especially Japanese megabanks - are now enthusiastic about buying this type of asset."

Moody's has rated about 30 deals so far this year, amounting to ¥500bn/US$5bn. The agency anticipates more issuance over Q409, with upward potential in volume in the latter part of 2010.

The origination of new mortgage loans in Japan has, however, been on a decreasing trend due to the economic downturn over the past year. As a result, issuance of Japanese RMBS has also been shrinking.

"Last year we rated 40 RMBS, but so far this year we have just rated 20," says Yasushi Furuya, vp and senior credit officer at Moody's in Japan. "Japanese issuers have historically issued RMBS in order to hedge interest rate risk. However, as it is expected that interest rates will remain low for the foreseeable future, it is not so important for originators to hedge this risk. This also explains why RMBS issuance is decreasing."

Currently, mortgage loan default and delinquency rates are not particularly high in Japan, and obligors are generally able to pay their mortgage loans. One reason for this is Japanese banks' strict screening criteria for obligors, meaning there are practically no sub-prime mortgage loans in the country.

"Nevertheless, the unemployment rate is going up (historic high of 5.7% at the end of July) and some economists predict it could go as high as 6% this year," adds Furuya. "At that point, we may see delinquency rates going up and the performance of RMBS deteriorating somewhat. However, in terms of ratings, downgrades of Japanese RMBS are very limited."

CMBS activity in Japan is also limited for the time-being. Tetsuji Takenouchi, svp at Moody's, explains that the asset class is a fundamentally distressed sector.

"The majority of market participants that have been involved in the sector in the past are not actively involved at the moment, so most participants now are domestic banks," he says. "As there are no government support programmes, such as the TALF in Japan, only private sector transactions are structured. We've also seen some existing programmes being refinanced."

Small steps in Korea
The cross-border Korean ABS market has recently seen the first issuance of a benchmark RMBS in over a year. The US$669m dual-currency deal from Shinhan Bank is understood to have been arranged by HSBC and BNP Paribas.

According to Marie Lam and Jerome Cheng, vps at Moody's, Korea was - and still is - a major market for cross-border securitisation transactions in ex-Japan Asia. However, since Lehman's bankruptcy, just a handful of transactions were completed this year in the region.

"I doubt there will be many more public transactions for the remainder of 2009. There may be some private deals, but pricing issues are hindering issuance," they say. "Although the cross-currency swap market gives some pricing benefit, the all-in price for cross-border issuance is generally higher than local funding alternatives."

All outstanding Korean ABS were downgraded last month by Moody's when it lowered the country's currency ceiling (see SCI issue 151). However, Lam and Cheng note that the performance of Korean structured finance bonds has been very good.

"Delinquencies and defaults remain at low levels. Although the underlying asset performance may deteriorate, we don't expect the ratings of the bonds to be hit: The rating outlook is still stable," they say.

Singapore CMBS refinancing solutions
The Singaporean structured finance market, previously dominated by CMBS issuance, has also seen conditions improve during the course of 2009. Five CMBS needed to refinance in 2009 and - despite concern that this would be difficult - four of the five have now refinanced using various different methods, such as bank loans, rights issues or CMBS. The sponsor of the remaining deal has already found a funding source to repay the maturing debt.

The ratings on existing deals are also expected to hold up. "Cashflow from the underlying properties should still be healthy, despite the economic downturn. This is because the majority of deals were rated some time ago and have built up some cushion," continue Cheng and Lam.

For instance, because of the upcoming supply and reduced demand due to the economic crisis, the office sector will be under pressure in terms of both rental and occupancy rates. However, the rental rate at 2004-2006 was relatively low. So, even if offices are under pressure today, CMBS deals can still cope with the revised rental rate (the current rental rate is still higher than the 2004-2006 levels).

The analysts add: "Singapore CMBS deals have got strong debt service coverage ratios of more than 4x. However, as we have seen in other markets, mortgage loan borrower defaults may cause cashflow disruption. As S-REIT, the underlying CMBS borrowers, are an operating entity and may run into insolvency, we are currently reviewing its implication on the cashflow."

Nevertheless, some investors are showing renewed interest in the asset class. "We've also been approached with new proposals. This is a positive development, but it will take time for the markets to really pick up again," Cheng and Lam note.

Balance sheet CLOs
Demand for Asian arbitrage synthetic single-tranche CDOs has inevitably diminished, but several banks have completed balance sheet CLOs over the past couple of years - the majority of which reference Asian portfolios. "There is potential for some more balance sheet synthetic CLO transactions in the coming year," says Elaine Ng, vp and senior analyst at Moody's.

She concludes: "Other than that, we receive enquiries from time to time for non-leveraged transactions. These are not CDOs per se - more of a repackaging of an asset with an asset swap. It does not involve leverage. We're also seeing plain vanilla structures that are mainly exposed to the credit risk of one or a few reference entities."

AC

Investors

Filling the void

John Uhlein, founder and managing principal of Grenadier Capital, answers SCI's questions

Q: How and when did Grenadier Capital become involved in the structured credit market?
A: I put together a team of six credit professionals, including myself, to fill the void created by both the decline of the financial guarantors and the loss of credibility by the rating agencies. My team has extensive credit assessment, valuation and quantitative skills in most of the structured/ABS/commercial products. Three people worked with me previously at Ambac; one is a PhD/JD with extensive quantitative and valuation skills, and the other is from the life insurance side of the business.

I am looking to use this talent in two very complementary ways: to invest in distressed-priced assets (today) as well as new issues, and provide fixed income investors with the underwriting, surveillance and remediation that was provided in part by both the rating agencies and guarantors. Investors are seeking an alternative to both and we're aiming to provide it.

The idea is to invest in the mezzanine tranches of these deals - at a level where we are comfortable and comparable to where we attached at Ambac, but unleveraged and without tail risk - at the same time as providing investors with our credit analysis, surveillance and remediation capabilities. In other words, we will have 'skin in the game' - investors would buy senior to where we are investing.

Q: What, in your opinion, has been the most significant development in the credit market in recent years?
A: Looking at the securitisation landscape, many investors have lost faith in the rating agencies and are disillusioned with the process. The monoline model has also been severely damaged: no entity is likely to take on as much leverage or guarantee everything above the BBB/A level again.

It was the tail risk, and not being paid for it, that finished financial guarantors in the end. With the exception of ABS CDOs, most of the transactions they insured are still performing well. The industry became too comfortable with the concept of low frequency of risk in the CDOs they insured, without understanding the potential severity if something went awry.

Q: How has this affected your business?
A: This scenario prompted us to think about what the new paradigm might be for the securitisation market. Obviously, banks have shut down their channels of credit to most structured finance asset classes and many transactions aren't getting financed, while mezz tranches are typically being retained by originators to demonstrate alignment of incentives with investors.

The rating agencies have also tightened their criteria, so many deals that would have been rated triple-A before the crisis are typically now only rated triple-B. These factors are making it very difficult for issuers to come to the market.

We're a small team, but hoping to expand and aiming to be the best in class at risk underwriting. Clearly, there is demand for this skill; plus, we'll get paid for the investment.

Q: What are your key areas of focus today?
A: We're still in the formative stages of the business, which means going out to potential investors and and generating interest from private equity and hedge funds. Many are looking to deploy assets in this area, with attractive risk and returns.

Q: What is your strategy going forward?
A: As well as being risk underwriters, the other side of the business that we're developing is advising on and valuing assets. Whereas monolines are buy-and-hold investors and their investments weren't marked to market, except when in CDS format, we're aiming to ensure that we're not overpaying for assets and can divest them where necessary.

We will manage money for investors with certain criteria; for example, they want to buy a piece of a given transaction. However, the idea is to also focus on valuations because we care where an asset is trading today.

We could ultimately also become involved with refinancings, but the terms of the transactions will have to be different. For instance, covenants will have to be stronger and the equity piece greater.

It's an exciting period for the industry, but there aren't that many teams of true risk professionals out there yet. We're confident that the flow of investors will increase. While we don't necessarily have to make an investment to do the advisory work, doing so gives us additional strength.

Q: What major developments do you need/expect from the market in the future?
A: The major challenge to the business is from a regulatory perspective. We're not trying to replace rating agencies; we are complementary to them - which could be an obstacle for some investors unwilling to spend resources on both. Nevertheless, the in-depth analysis and surveillance of individual transactions isn't really provided by rating agencies, so this is where we intend to pick up market share.

Looking ahead, there is no question that ABS activity is picking up, but there won't be as many banks participating in the sector as there were before the crisis. Consequently, the industry will need more specialty finance companies focusing on junior risk to enter the market. Investor-driven retention levels will also be required, which I think is a good development.

Ultimately, I believe it is possible to revitalise the market for many asset classes. But it will take time - and expense - before we even get close to the volumes seen before the crisis.

CS

ABCP

Write-downs prompt Canadian ABCP sale

Strategem Capital Corporation has sold 100% of its holdings in the MAV 2 vehicle - the Canadian ABCP restructured under the Montreal Accord (see SCI issue 121) - for proceeds of C$1.9m and purchased units in a managed fund that will provide similar exposure to the ABCP market. The sale price represents C$0.40 per C$1.00 of face value of the MAV 2 A1 notes and C$0.28 per C$1.00 for the A2 notes.

The company paid C$2.34m for 234,000 units of the Absolute Core Return Fund, managed by KCS Fund Strategies. The fund currently has approximately 80% of its assets invested in a portfolio of various classes of the restructured ABCP, including MAV 2 A1 and A2 notes. The balance of its assets is invested in publicly listed securities.

By selling its ABCP holdings and buying fund units, Strategem says it retains similar exposure to the ABCP market and also benefits from a fund management team with experience in structured finance.

Strategem held C$6.5m of ABCP in 2007 when the products matured, but were not redeemed. The firm has recorded a series of write-downs on the ABCP since 2007 and at 30 June 2009 valued its ABCP holdings at C$1.3m.

Advisory

CRE capital markets group formed

NewOak Capital has appointed Amy Levenson md and chairman of its newly formed commercial real estate loans and properties capital markets group, responsible for creating and executing real estate capital market solutions for clients. She has over 25 years of experience on Wall Street, primarily at Goldman Sachs and previously at Barclays Capital.

At Goldman Sachs, Levenson divided her tenure between institutional bond trading and sales to the hedge fund and insurance industries. Her brief tenure as md at Grubb and Ellis gives her experience in integrating real estate and capital markets to provide clients with a broad range of solutions.

Reporting to Levenson are: Jon Fischer, who is an md and previously served as the director of corporate real estate for Prudential Insurance Company; and Farrah Lakhani, an associate director, who was recently at the private equity firm Lightyear Capital and was formerly at Credit Suisse as an investment banker, where she focused on REITs and financial institutions.

James Frischling, president and co-founder of NewOak Capital, says: "Amy will lead an important part of the NewOak Capital business as she and her team will help our clients transfer risk or identify investment opportunities."

NewOak's commercial real estate loans and property capital markets group will offer structuring and execution solutions for entities looking to dispose or recapitalise real estate and related assets and loans. Asset types include REOs, CMBS, CLOs, CDOs, whole loans, mezzanine debt and stable to busted individual properties or pools of properties. The team has relationships with hedge funds, private equity funds, banks, insurance companies and REITs, and access to experienced developers, MAI appraisers and construction consultants.

CDO

CDO structurer recruited

Fifth Street Finance has added a new team member to its investment adviser subsidiary, Fifth Street Management. Lawrence Beller joins the firm as a vp in the execution team.

Beller has over 12 years of experience managing financial transactions. Most recently, he worked for JPMorgan, where he was an executive director in the CDO structuring and execution group.

Prior to JPMorgan, Beller was an md principal at Bear Stearns, where he originated and structured securitisations of various fixed income assets.

CDS

IDB adds to Euro high grade team

Colm Ryan has joined the Phoenix Partners Group and will be responsible for building its European high grade cash business while also helping to develop the existing high grade CDS business. He will report to md Alex Hucklesby and is based in the firm's London offices.

Ryan joins Phoenix following five years' at RBS, where, as md, he established and ran hedge fund sales in all credit products. Prior to this, he was at Goldman Sachs for three years as co-head of UK bank sales for all credit and derivative products. He started his career with equity and convertible trading positions at Kleinwort Benson and structured credit roles at Dean Witter and Deutsche Bank.

CMBS

CMBS investment vehicle to begin road-showing

The investment vehicle established in a joint venture between TwentyFour Asset Management and Rutley Capital Partners, the real estate investment management arm of the Knight Frank property group, is expected to begin road-showing this month. The vehicle - understood to be the first of its kind - will purchase senior debt secured on portfolios of prime commercial properties in the UK and Europe.

With senior commercial property debt currently trading at deep discounts, the two firms believe that the combination of their skills is essential at this stage in the cycle. Mark Holman, managing partner at TwentyFour, says: "With triple-A rated commercial mortgage debt trading at significant discounts to face value, the opportunity has probably never been so compelling. We have been working with the partners at Rutley for six months now and are convinced that the partnership will provide clients with the optimal opportunity in our sector. Understanding both what the physical property markets are doing, as well as the specialised debt markets will ensure that we cover all angles in making our investment decisions."

The vehicle will aim to deliver returns of approximately 10% per annum over the medium term. But the two firms acknowledge that, with many markets normalising, it is possible that returns could come in quicker and higher than expected - in which case investors would be offered an early redemption opportunity.

CMBS

Real estate debt strategy group formed

Urdang, the real estate investment subsidiary of BNY Mellon Asset Management, has created a new real estate debt strategy group by hiring eight team members from Capmark Investments. Urdang has been named as a non-discretionary sub-advisor to Capmark Investments for Capmark Structured Real Estate Partners and Capmark VII-CRE.

Capmark Structured Real Estate Partners and Capmark VII-CRE were both formed in 2006 and originally capitalised with US$1.1bn and US$1bn of institutional investor commitments respectively.

Todd Briddell, cio and md of Urdang Capital Management, says: "The formation of a new real estate debt strategy group within Urdang complements our focus on private-market and publicly-listed equity investments in real estate. In addition to the opportunity to service Capmark Investments, we believe that the persistence of tough credit conditions within real estate capital markets makes now the ideal time to strengthen and grow our real estate investment business. We see attractive opportunities for Urdang's clients to purchase and originate commercial mortgages and structured credit instruments."

Investors

Paris-based firm to focus on credit arb strategies

A new Paris-based asset management firm focused on credit and merger arbitrage strategies has been launched - Mereor Investment Management and Advisory. The firm's founding partners are Georges Gedeon, formerly an asset manager at GLG Partners and an executive director in investment banking at Goldman Sachs; Jean-Luc Biamonti, formerly a partner in investment banking at Goldman Sachs, who co-headed the France and Belgium region and then the European consumer retail group; and Philippe Gedeon, formerly head of fixed income and structured products distribution for the MENA region at Daiwa and head of equity derivatives distribution for the MENA region at Citi.

Investors

Credit fund adds head of sales

Assenagon has hired Ulrich von Altenstadt as head of credit sales. He will be responsible for the distribution of credit funds and for the coverage of institutional investors in risk management solutions.

Von Altenstadt joins from HVB, where he had worked in various leading positions in the fixed income and credit area since 1998. As md he developed the international customer business of the bank and built up the European branch network in the markets area. Von Altenstadt started his career in 1990 at Bayerische Hypotheken- und Wechselbank in fixed income sales and subsequently changed to the debt capital markets division of Bayerische Vereinsbank.

Vassilios Pappas, Assenagon founding partner, comments: "After a most successful start in the credit business with the two fund managers Dr. Jochen Felsenheimer and Dr. Wolfgang Klopfer at the beginning of the year, we decided to invest in the expansion of this area."

Legislation and litigation

Law firm names three partners

Allen & Overy has appointed three new senior counsel in its New York office to work across three practice groups.

Both Andrew Baraff and Michael Karol have joined the firm as senior counsel, while Lisa Kraidin has been promoted to that position, effective from 1 October. Karol is in the derivatives and structured finance group, Baraff is in the real estate group and Kraidin is in the restructuring group.

Kevin O'Shea, managing partner of the New York office and head of the US real estate practice at A&O, says: "Andrew and Michael are both highly talented and experienced lawyers, who will add depth to our real estate and capital markets practices, and we are excited that they have become a part of the continued growth of our New York office. We also want to congratulate Lisa on achieving this milestone and her continued success."

Karol's capital markets practice includes the representation of issuers, underwriters, banks, hedge funds, insurance companies and others in a broad range of novel and complex transactions. He has expertise in structured finance, derivatives, general securities, corporate, banking and leveraged leasing. Prior to joining the firm, he was counsel with Skadden, Arps, Slate, Meagher & Flom in New York.

Kraidin joined A&O in 2002. Her practice includes all aspects of restructuring, including Chapter 11 proceedings, cross-border proceedings under Chapter 15 of the US bankruptcy code and bank insolvency proceedings. She also advises on insolvency issues that arise in connection with acquisitions and structured financings.

Baraff will continue his real estate and real estate finance practice, which includes purchases and sales, financings, leases, joint venture and real estate restructurings and bankruptcies. He was most recently a senior counsel in the New York office of Sullivan & Cromwell.

Real Estate

CRE CDO specialist added for special servicing

The Situs Companies has recruited Ginn Downing as director in its rated special servicing group. She will be responsible for asset management and loan restructuring associated with the firm's advisory business and highly structured loan portfolio. Downing will be based in San Francisco.

Bruce Nelson, principal and head of Situs' global asset management operations, says: "Ginn is highly regarded in the industry, brings tremendous CRE CDO collateral management experience and will be focused on a number of key client relationships. Her hire is consistent with our long-term strategic growth plan to focus on collateral management opportunities and follows our recent acquisition of GSSG in Europe, a rated primary and special servicer."

Downing brings more than 15 years of commercial real estate investment expertise in risk assessment, financial analysis, asset management and underwriting of over US$1trn of debt and equity investment opportunities. Prior to Situs, she worked as svp for the Capmark Finance balance sheet as a programme specialist. For Capmark Investments Fund, she developed new business and provided management within the fund platform, totalling more than US$10bn of debt, mezzanine and subordinate investments.

Technology

Partnership to offer TALF loan valuations

Interactive Data Corporation will offer valuations for loans made available by the Federal Reserve Bank of New York in connection with TALF through an agreement with Prism Valuation. Interactive Data will offer valuations for TALF loans, along with other complex financial instruments, such as OTC derivatives and structured products.

The TALF loan valuation process takes into account the value and assumptions of the underlying ABS and CMBS collateral, the terms of the loan and the value of the theoretical put option embedded in the loan. Borrowers under the TALF programme must value both the TALF-eligible securities and liabilities (TALF loans) for financial reporting purposes.

Interactive Data already offers independent evaluations for the underlying TALF-eligible ABS and CMBS. In collaboration with Prism Valuation, it now offers valuations for TALF loans.

Liz Duggan, md of evaluations at Interactive Data, says: "The TALF programme has afforded US companies a new avenue to raise capital and we have observed that an increasing number of our clients - mutual funds, institutional asset managers, insurance companies and hedge funds - believe the programme offers investment opportunities. A valuation provider needs a comprehensive understanding of these hard-to-value instruments, including the optionality embedded within the loans. We have collaborated with Prism Valuation to provide our clients with valuations that reflect the unique characteristics of TALF loans."

Dushyant Shahrawat, senior research area director for TowerGroup, says: "Under financial reporting standards, many financial institutions that choose to borrow under the TALF programme will value these loans at fair value. Data providers like Interactive Data (and their solutions) can fill a unique industry need by providing valuation information for these loans that is not otherwise available in the industry."

According to the terms of a TALF loan, interest and principal cashflows from the collateral are directly applied to the interest and principal payments owed under the loan. In the event that the cashflows from the collateral are not sufficient to service the cashflows due on the loan, the borrower generally has the ability to surrender the collateral to the Federal Reserve Bank of New York with no additional liability. This feature generally provides the borrower with the economic equivalent of an American-style put option.

Trading

Credit platform appoints ABS trading head

Manish Peshawaria is understood to have joined Knight Libertas UK as head of ABS and MBS trading. Peshawaria joins the firm from Tullet Prebon, having previously worked at Calyon until June 2008 in European ABS/MBS marketing and trading.

Knight Libertas UK announced in June this year the establishment of a European credit sales trading team, with a raft of new hires - many coming from UBS (see SCI issue 140).

ABCP

Shift in ABCP conduit activity observed

S&P has observed a shift from securities arbitrage conduits to large multi-seller conduits, according to its quarterly European ABCP report card.

S&P surveillance credit analyst Benjamin Benbouzid says: "In our opinion, this is due to the difficulties related to operating securities arbitrage conduits in the current climate and due to sponsors focusing on funding their core client bases."

In addition S&P-rated conduits have continued to experience a decrease in volumes outstanding. Benbouzid explains: "We believe this is due to continuing weak investor appetite for European ABCP and a decrease in European sponsors' use of the US Federal Reserve's commercial paper funding facility (CPFF) as market conditions show improvement. As stated in [last week's] report card, several conduit sponsors have mentioned to us that they have not re-rolled their positions in the CPFF because of pricing or because they are getting funding from other sources at cheaper levels. The USCP outstandings of these issuers have decreased substantially as a result."

ABS

Fed steps up risk review of TALF deals

The New York Federal Reserve has announced two changes to the procedures for evaluating ABS pledged as collateral to the TALF.

First, a rule has been proposed that would establish criteria to determine the NRSROs whose ratings are accepted for determining the eligibility of ABS. The proposed rule, which would require a certain minimum level of experience in rating deals of any particular type, would likely result in an expansion of TALF-eligible NRSROs for ABS. It is intended to promote competition among rating agencies and ensure appropriate protection against credit risk for the US taxpayer.

Second, starting with the November subscription, in addition to continuing to require collateral for TALF loans to receive two triple-A ratings from TALF-eligible NRSROs, the Fed will conduct a formal risk assessment of all proposed collateral - ABS in addition to CMBS - which are already subject to a formal risk assessment. The change to the collateral review process will enhance the Fed's ability to ensure that TALF collateral complies with its existing high standards for credit quality, transparency and simplicity of structure, it says.

To facilitate the risk assessment, each issuer wishing to bring a TALF-eligible ABS transaction to market will be required to provide - at least three weeks prior to the subscription date - information including all data on the transaction the issuer has provided to any NRSRO. The Fed says issuers of ABS complying with the TALF terms and conditions and the statement of principles may reasonably expect an indication of acceptability based on its risk assessment at least one week before the applicable subscription date.

Meanwhile, US$2.5bn in TALF loans were requested during the 2 October application window. Loans were requested for auto, credit card, equipment dealer floorplan, servicing advances, small business and student loan ABS. No requests were submitted for premium finance ABS.

ABS

Safe harbour uncertainty plagues credit card ABS

Many triple-A rated US credit card transactions could be placed under review for possible downgrade due to the ongoing uncertainty over whether the FDIC will continue to grant 'safe harbor' status to the securitisations of banks in receivership once new accounting rules are in place, says Moody's in a new report.

If the safe harbor issue remains unresolved, Moody's will likely place under review for downgrade those outstanding triple-A rated credit card transactions that are not sponsored by banks rated at least Aa3. The timing of any review would coincide with the effective implementation date of the new accounting rules (i.e. with fiscal years beginning after 15 November 2009).

On behalf of market participants, the American Securitisation Forum submitted a proposal attempting to address these concerns to the FDIC in September (see SCI issue 150) and the dialogue between them is expected to continue.

William Black, a Moody's svp, says: "There are a variety of possible outcomes, ranging from full protection from repudiation and stay risk to no protection at all. In the worst case, absent further clarification from the FDIC, we believe that some credit card ABS will be exposed to repudiation and stay risk."

According to the report: "These incremental risks amplify the linkage between the ratings of the sponsor bank and the related credit card ABS and, assuming they remain unmitigated, there will likely be rating downgrades on some credit card ABS."

The credit strength of the sponsor will be among the factors that determine the magnitude of any downgrade. Black adds: "Generally, the weaker the credit strength of the sponsor, the more likely that these incremental credit risks will materialise and the greater the magnitude any rating action to senior ABS - virtually all of which are currently rated Aaa."

Credit card securitisations that are structured as legal true sales may be less at risk of repudiation and stay, despite the loss of the safe harbor. "Even so," says Black, "a multi-step true sale transfer does not allay all our concerns."

Moody's will continue to assess new transactions and, to the extent they are sponsored by banks rated at least Aa3, may assign triple-A ratings. According to Black: "Despite the uncertainty surrounding the future actions of the FDIC, the likelihood of a downgrade to ABS sponsored by Aa3 or above rated banks is low and, should it occur, the degree of rating transition will be very limited."

ABS

No ratings impact due to SLM forbearance policy

The recent decline in performance of Sallie Mae's private student loan securitisations is due to the more restrictive forbearance policy introduced in early 2008, says Moody's in a new report. Overall, though, the agency does not expect it to have a material impact on the cumulative losses of Sallie Mae transactions and the changes will therefore have had no impact on their ratings.

Moody's explains that, as the US economy weakened in 2006 and 2007, Sallie Mae applied forbearance more liberally. Starting in early 2008, it implemented several changes to tighten its forbearance policy, leading to fewer and shorter forbearances being granted. Since the forbearance tightening, Sallie Mae's private student loan transactions have seen their delinquency rates and, most recently, default rates rise more sharply than those of the other major issuers.

Moody's avp Tracy Rice says: "We believe that changes in Sallie Mae's forbearance policies account for a significant portion of the differences in patterns between Sallie Mae's performance data and those of the other major issuers. Specifically, the tightening of the forbearance policy and the decline in forbearance rates caused a corresponding increase in delinquency rates, as some borrowers who encountered difficulties making loan payments and previously would have been granted forbearance by Sallie Mae instead became delinquent."

The delinquency rates on Sallie Mae's private student loan transactions rose from 3.7% in Q108 to 9.3% in the Q209. During that period the percentage of loans in forbearance dropped from 16.5% to 4.9%.

The default rate has shown a pattern of increase similar to that of the delinquency rate, but with a lag, explains Moody's. The agency notes that in Q209, the most recent full quarter for which complete data are available, the average default rate for Sallie Mae's transactions jumped by two full percentage points to 5.1%, while the default rate for the other major issuers increased by a much more moderate 0.2%.

Moody's expects Sallie Mae's delinquency rates to stop rising relative to those of the other major issuers in the near term and then to fall a bit relative to the others, and its default rates to follow a similar pattern, but with a longer lag.

ABS

Ratings impact of CIT bankruptcy analysed

Moody's has published a special comment discussing the implications of a possible bankruptcy of the CIT Group on 16 ABS transactions where CIT, through its subsidiaries, acts as the servicer, master servicer, administrator or servicing administrator.

The report describes the risks associated with servicing disruption, presents a framework to evaluate the likelihood and extent of servicing disruption in the affected transactions, and summarises the agency's current view of strengths and concerns around servicing disruption risk in CIT-serviced ABS. The asset classes covered in the report are equipment leases, small business loans, student loans and aircraft leases.

On 15 July nine of the 16 securitisations were placed under review for possible downgrade in connection with the downgrade of the company's long-term rating. The review for downgrade reflected the increased risk of a near-term bankruptcy filing by CIT, based on its current rating of Ca, and the related servicer disruption risk.

Moody's explains that, in general, the bankruptcy of a servicer may disrupt its operations, with possibly detrimental effects on serviced ABS - the servicer's employees may lack proper motivation or seek employment elsewhere, disrupting normal workflow. Collection activities may stall. Also, access to the funds that are available in trust accounts may be delayed and the available funds may not be distributed to the noteholders in a timely fashion if the servicer is unable to instruct the trustees to make the payment.

Moody's considers a number of key factors in assessing the magnitude of servicing-related risks in the transactions. First is that the servicer is generally responsible for invoicing the borrowers, performing pre- and post-default collections, and repossessing and remarketing the assets collateralising defaulted receivables.

In addition, the servicer may also act as the custodian, calculation agent and cash manager in the transactions. The broader the role of the servicer, the greater the extent of a possible disruption, the agency notes.

Second, servicing platform durability is considered in order to ascertain the likelihood that the servicing platform for the specific asset will survive a CIT bankruptcy, which is a function of the platform's scale and profitability.

Successor servicer provisions are also considered. The presence and terms of a back-up servicing arrangement are important, as well as whether in the absence of such agreement the trustee is willing and able to either perform the servicing duties or find a replacement servicer in a timely fashion.

The ease of servicing transfer is a further consideration. The transfer can be easier to execute if the number of assets to be transferred is small, the servicing tasks involved are not highly specialised, the servicing platform is standardised and a number of other companies (possible successor servicers) engage in third-party servicing for the asset.

In addition, some assets are more servicing-intensive than others and some borrowers may be more predisposed to pay timely in the absence of a monthly statement than others.

Moody's will also consider the control of funds and commingling. Securitisations where the borrowers make payments directly to a trust account, rather than to the servicer, may be better positioned in a servicer bankruptcy. Conversely, the longer the servicer can delay the remittance of collections to the securitisations, the greater the risk that the timely payment flow on the related securities may be disrupted.

Liquidity is also under consideration as a sizeable reserve account and the ability to use principal collections to pay interest on the notes can help mitigate the risk of payment delays. However, even if the trust's internal liquidity is sufficient, when the paying agent relies on the servicer for instructions on distributions, the noteholders may still not receive their payments on time upon a servicer bankruptcy.

Finally, Moody's considers credit enhancement. The higher the credit enhancement compared to the expected level of losses, the higher the protection for a given class against an increase in delinquencies and losses.

During the ratings review period for CIT's ABS transactions, the agency will continue to evaluate the balance of the risks and mitigants with respect to servicer disruption.

ABS

Further reserve fund draws likely for auto deals

S&P has taken rating actions on all notes issued by the BBVA Autos 2 and BBVA Finanzia Autos 1 deals due to expectations that a sizeable portion of delinquent loans may default in the short to medium term, leading to increased draws on the reserve fund and reduced credit enhancement.

BBVA Autos 2 drew on its cash reserve on the May and August IPD, which now stands at 2.73% of outstanding note balance. Cumulative losses now at 3.61% of original balance have been on the rise and this may result in deferral of interest payments on the Class C notes (trigger 10%).

Meanwhile, BBVA Finanzia Autos 1 drew on its cash reserve for the third time in a row on the July IPD, leaving it at 1.3% of current note balance, with cumulative defaults more than doubling since March to 3.25% of original balance.

ABS

Spanish consumer ABS continues to deteriorate

Spanish consumer ABS transactions have continued to deteriorate during 2009, with the impact of the worsening economic environment leading to large increases in arrears and defaults, according to a newly published report from Fitch.

Will Rossiter, associate director in Fitch's European ABS performance analytics team, says: "Performance across many consumer ABS transactions in Spain has continued to feel the impact of the domestic economic environment, with rising unemployment and high overall consumer-debt levels weighing heavily on consumer ABS transactions."

Rui Pereira, md in Fitch structured finance in Madrid, adds: "While there are some positive signs, including the effects of government stimulus measures that are helping to moderate the deterioration in the labour market, Fitch expects consumer ABS credit performance to remain under pressure over the near-term until economic conditions stabilise."

Alternative assets

Second buyback for Euro ABS CDO

M&G Investments has approved the repurchase a portion of Pallas CDO II's €67m Class A-1a notes. The move is designed to improve the deal's par value ratios.

As per condition 7(i) of the transaction prospectus, the issuer may at any time - subject to the approval of the portfolio manager - purchase notes in the open market or in privately negotiated transactions, at a price not exceeding 100%. Under this clause, a repurchase of €4.9m of the Class A-1a notes is being undertaken at a discounted price of 60%. The notes will subsequently be cancelled, thereby increasing available credit enhancement to all rated notes.

The buyback follows an earlier repurchase of €7m of Class A-1a notes in May 2009, which was settled at a price of 50%.

The current buyback will be funded using cash available in the principal collection account. As of September 2009, €7m is available in the principal collection account.

According to the latest monthly report for the deal dated 6 July 2009, all par value tests were in breach and therefore diverting the relevant cashflows towards redemption of the senior notes. Following the discounted buyback, all par value ratios will improve and consequently the amount of cashflows diverted to the senior notes on future payment dates to cure the par value tests will be reduced.

CDPCs

CDPC commutes large CDS portfolio

Primus Financial has terminated US$1.3bn notional principal of CDS with what it terms as a 'significant counterparty'. These swaps represent the counterparty's entire portfolio of CDS with the CDPC.

Primus paid US$6.5m to the counterparty - a significant discount to the market value of the portfolio - to terminate these swaps. Included in this portfolio were a small number of reference entities which the CDPC concluded had a high risk profile, including certain financial guarantors.

This is the second credit mitigation transaction that Primus has completed and announced in recent months (SCI passim). Through these transactions, it has terminated approximately US$1.4bn of single name CDS and has capped its exposure to an additional US$1.2bn of CDS, assigning them to a newly-formed subsidiary.

The company says it is continuing to discuss with its counterparties potential credit mitigation transactions. Its previously-announced strategy is to address certain concentration issues in a small number of higher risk sectors, including insurance, building/development and retail.

CDS

Additional Thomson compression cycles completed

TriOptima has completed two additional portfolio compression cycles for Thomson single name and Thomson-related index tranche transactions after the implementation of ISDA's 'small bang' protocol.

In the Thomson single name cycle, 31 banks terminated 8105 trades with a notional value of US$19.6bn. The single names terminated represented over three-quarters of the current population of single name trades held by the cycle participants in the DTCC's Trade Information Warehouse.

With 26 banks participating, 5232 index tranche trades from iTraxx series 1-7 that include the Thomson name were terminated with a notional value of US$215bn.

Athanassios Diplas of Deutsche Bank and co-chair of ISDA's credit steering committee says: "The last single name compression was tailored to meet the inherent challenges of the restructuring credit event. It employed a new methodology that allowed us to reduce a much larger number of trades than a regular compression would have achieved. As a result, we were able to eliminate the bulk of outstanding trades among participants and thus significantly reduced both economic and operational risk. It was a great example of the industry teaming with TriOptima under a very tight timeframe and delivering a robust risk solution."

CDS

Significant rise in global CDS liquidity reported

Fitch Solutions reports that market uncertainty over the pace of global economic recovery led to a significant rise in global CDS liquidity last week, with the US and European basic materials sectors most impacted. Average global CDS liquidity improved from 10.51 last Wednesday to 10.42 by Friday's close, according to the firm.

Thomas Aubrey, md of Fitch Solutions in London, says: "The release of worse than expected US jobs data last Friday caused a significant rise in CDS liquidity on both sides of the Atlantic and was particularly channelled through the basic materials sector."

However, he adds: "Europe still remained more liquid than the Americas region, with Fitch's European CDS liquidity index closing at 9.81 on Friday 2 October versus 10.02 for the Americas region."

More generally, Russia, Mexico and South Africa remain the most liquid sovereign CDS names, while in the Americas MGIC Investment Corporation and Radian Group are now trading with the most liquidity. Kabel Deutschland, Nielsen Company and OJSC Gazprom remain the most liquid European names, with Korean companies continuing to dominate liquidity in the Asia Pacific region.

CDS

Australian dollar curve added to valuations platform

PricingDirect has begun to offer credit derivative valuations based on the Australian dollar curve. With this addition, the firm can now value single name CDS in the following currencies: US dollar, Canadian dollar, euro, sterling, Japanese yen, Swiss franc, Swedish krona and Australian dollar.

All of PricingDirect's swap curves undergo quality control processes before they are utilised for valuation, the firm says.

Clearing

Single name CDS clearing approval imminent

Both ICE Trust and ICE Clear Europe are operationally ready to begin clearing single name CDS contracts and are working with regulators to secure the required final approvals, according to the exchange operator. Approvals are expected to be received this month.

ICE also expects to complete the development of its buy-side solution for CDS clearing by the end of October. Pending regulatory approvals, testing and soft-launch are expected in November, with a full launch anticipated by 15 December 2009, keeping with industry commitments to regulators for a customer solution by that date.

CDS clearing revenues for the exchange in Q309 are expected to be approximately US$13m. As a result, ICE expects full-year 2009 CDS clearing revenues to be at or above the high end of prior guidance of US$20m to US$30m.

Its guidance for CDS clearing expenses is also being updated, with US$10m expected in Q309 due to increased professional services expenses associated with the development of key CDS clearing initiatives during the quarter. Fourth-quarter CDS clearing expenses are expected to remain in line with prior guidance of US$6m to US$8m, however.

CMBS

Strong gains for US CMBS spreads in September

Ten-year triple-A US CMBS super seniors were 60bp tighter at the end of September than at the beginning of the month, Trepp md Manus Clancy points out in a recent report from the firm. "At one point in the month, that number was closer to 100bp, but it is tough to complain considering the strength in CMBS bonds up and down the credit curve in September," he says.

On Thursday of last week spreads widened modestly. Recent-vintage 10-year super seniors moved out by 5bp to 10bp. The benchmark GSMS 2007-GG10 A4 bond finished at swaps plus 610/615bp (mid market).

Trepp's September 2009 delinquency stats show that overall delinquencies increased by 33bp to a rate of 4.36%. Twelve months ago, the delinquency rate was 0.65%. That number reflects the percentage of loans 30 or more days delinquent, but does not include loans that are still current on their interest but have missed their balloon maturity.

Included in the denominator for such calculation are all defeased loans. Had defeased loans been removed from the denominator, the actual delinquency rate would have been 4.69%.

The percentage of multifamily loans 30 or more days delinquent is now above 7%. "As we have said in the past, if Stuy Town were to become delinquent, that rate would surpass 10%. Hotel loans are not far behind multifamily with a delinquency rate of 6.72%," adds Clancy.

Month-over-month, hotels had the greatest increase in delinquency levels, with a 57bp uptick. Office loans were second, with an increase of 43bp.

Among the various vintages, 2002 and 2003 are the strongest performers. According to Clancy, after 9/11 there was a period of more cautious underwriting and that is reflected in the delinquency levels of those two years.

Distressed assets

First PPIFs past the post

The initial closings of five public-private investment funds (PPIFs) established under the legacy securities public-private investment programme (PPIP) have been announced by the US Treasury (see also separate News Analysis). AllianceBernstein sub-advisors Greenfield Partners and Rialto Capital Management, as well as BlackRock, Invesco and Wellington Management Company have so far completed initial closings, each with at least US$500m of committed equity capital from private investors.

Under the programme, fund managers have established relationships with small, minority- and women-owned businesses. Firms that are partnering with the mandated managers include Advent Capital Management, Atlanta Life Financial Group (through its subsidiary Jackson Securities), Altura Capital Group, Muriel Siebert & Co, The Williams Capital Group and Utendahl Capital Management. These partner firms have roles including: involvement in managing the investment portfolio and cash management services, raising capital from private investors, providing trading related-services, identifying investment opportunities, and providing investment and market research and other advisory services to the PPIFs.

The PPIFs' private sector capital commitments have been matched 100% by the US Treasury, which will also provide debt financing up to 100% of the total capital commitments of each fund, representing approximately US$12.27bn of total equity and debt capital commitments.

The pre-qualification of nine fund managers under the legacy securities PPIP was announced on 8 July (see SCI issue 145). The Treasury expects the remaining four initial closings for the other PPIFs to occur throughout October.

Following an initial closing, each PPIF will have the opportunity for two more closings over the following six months to receive matching Treasury equity and debt financing, with a total Treasury investment in all PPIFs equal to US$30bn (US$40bn including private sector capital).

Treasury Secretary Tim Geithner says: "I am pleased with the progress we have made in launching PPIP. This programme allows Treasury to partner with leading investment management firms to increase the flow of private capital into the market for legacy securities and give taxpayers a chance to share in the profits."

"The PPIP continues to grow," adds Herb Allison, assistant secretary for Financial Stability. "Private capital is being drawn into the market for legacy securities and taxpayers are being given a chance to share in the profits."

In recent months, financial market conditions have improved and the prices of legacy securities have appreciated. In addition, the results of the supervisory capital assessment programme enabled banks to raise substantial amounts of capital as a buffer against weaker than expected economic conditions. While these developments have enabled the Treasury to proceed with the PPIP programme at a scale smaller than initially envisioned, it says it remains prepared to expand the amount of resources committed to the PPIP, should conditions deteriorate.

Documentation

Determinations committees spring into action

ISDA Determinations Committees (DCs) have determined a slew of potential credit events this week.

ING Bank has requested that the EMEA DC decide on whether a succession event has occurred in connection with Fortis Bank (Nederland) after its merger into Fortis Bank Nederland (Holdings). A failure to pay credit event has been determined with respect to NJSC Naftogaz of Ukraine, with the credit event called on 5 October.

Separately, the Japan DC determined that neither a restructuring credit event nor bankruptcy credit event had occurred in respect of Aiful Corp following its filing for a business revitalisation proceeding. The Committee also voted that a bankruptcy credit event has not occurred in connection with Joint Corp.

Meanwhile, the Americas DC has determined that a succession event has occurred with regard to Petro-Canada and that Suncor Energy Inc is the sole successor. The succession event date was determined to be 1 August.

Documentation

Small bang given another chance

ISDA is set to reopen its 'small bang' protocol, in response to demand from new entrants. The protocol allows for the incorporation of auction settlement terms following a restructuring credit event into standard CDS documentation.

The adherence period for the protocol will reopen on 5 October and run until 31 January 2011. It was originally open from 14-24 July (SCI passim), with over 2,000 parties adhering.

Robert Pickel, executive director and ceo of ISDA, says: "The successful implementation of our small bang protocol was a major achievement for ISDA and for the industry. I am pleased to see demand from new entrants to sign up to the protocol and benefit from its efficiencies."

A particular feature of the small bang protocol is its forward-looking provisions, which will amend transactions prospectively to incorporate the amendments to industry documentation - such as index documentation - that are affected by the protocol. This feature will allow parties to continue to trade using existing industry standard documentation even while these documents are being updated to incorporate the provisions contained in the protocol. The process of updating these documents will be completed by the end of the new adherence period.

Indices

LCDX, MCDX roll

The Markit LCDX.NA and MCDX.NA indices rolled into their thirteenth series on 5 October. 11 constituents have been replaced in LCDX, while the MCDX constituents remain unchanged.

Indices

Subprime RMBS CDS index holds steady

Market prices within US subprime RMBS continue to show signs of stabilisation, although there is little sign of any increase in value, according to the latest figures for Fitch Solutions' RMBS CDS indices. The Total Market Index fell slightly this month by 3bp to 8.31bp as of 1 September, compared to 8.34bp last month. However, asset values have not shown any signs of recovery, as highlighted by slight falls in the 2004 and 2005 vintage indices.

However, Fitch Solutions md Thomas Aubrey says: "What is important to note is that one of the most maligned subprime vintages did show some signs of relative improvement."

Considered by most market participants to be among the worst performing subprime deals, the 2007 vintage index improved by just under 5%, while the 2006 vintage index fell by just over 5% in value month-on-month. This relative shift between the two indices is highlighted by the three-month default rates showing that the 2007 rates compared to 2006 have improved somewhat over the last few months.

The difference between the three-month CDR has narrowed between the two vintages from 4.4% in May to 2.3% in September. In essence, three-month default rates for 2007 are improving at an increasing rate over the 2006 vintage, the firm says. The 2007 vintage default rates are 18% less than they were in May, whereas the 2006 vintage default rate is only 14% less.

Indices

Housing market index continues to show improvement

The S&P Case-Shiller home price index has shown its third consecutive month of improvement in the 29 September analysis, which includes data through July 2009. However, S&P reports that the current home price rally may soon lose its momentum as the season turns to autumn and winter. The agency explains that the indices lag the current date by two months, which means another month or two of summer-related positive news could emerge before the impact of the change of season is seen.

Home prices advanced again in July, marking the third straight month of improvement, which could be an early indication of a housing market recovery, S&P notes. Home prices rose in all metropolitan areas, except Las Vegas and Seattle. While prices fell in July in Las Vegas and Seattle, the monthly rate of decline improved in Las Vegas, but deteriorated in Seattle.

S&P credit analyst Erkan Erturk says: "While the monthly rate of price increase in July reinforces our view that the housing market is beginning to recover, we believe a part of this behaviour is seasonal because home prices tend to rise during the spring and summer months. Also, we believe the flat-to-positive return performance of US homebuilding stocks in recent months is supporting early signs of stabilisation in the housing market."

Key highlights of the latest home price data include:

• The month-over-month home price increases were 1.7% and 1.6% in July for the S&P Case-Shiller 10-City and 20-City indices respectively.
• The July improvement was significant and several metro areas (San Diego, San Francisco, Atlanta, Chicago and Minneapolis) experienced monthly price increases of more than 2%. Las Vegas and Seattle were the only metro areas that experienced price declines in July.
• On a year-over-year basis, the 10- and 20-City composite indices declined 12.8% and 13.3% in July respectively. This is a significant improvement from declines of about 17% or more in early 2009 reports.
• The values of the 10- and 20-City composite indices are currently back to their early 2003 levels. These indices peaked around mid-2006 in the current housing market cycle, but have since lost about 31.1% and 30.2% of their values respectively. This roughly translates to an aggregate decline of about US$740bn in the original appraisal value of homes across all regions. Among the metro areas, Phoenix and Las Vegas have experienced cumulative declines of more than 50% since their peak.

Indices

Improvement in default protection costs revealed

Despite recent increases in CDS spreads, the cost of buying default protection has shown a dramatic improvement since March, according to the latest figures from the S&P 100 CDS Index.

Spreads for higher quality entities, as represented by the S&P 100 CDS Rolling Index, decreased by 27.27% for the quarter to end at 56bp - a 60.66% improvement since year end. The S&P 100 CDS Index has seen a year-to-date total return of 4.18%. By comparison, the S&P 100 Index (equity) ended up 13.16% total return year-to-date.

Spreads for investment grade entities, mostly triple-B rated in the S&P CDS US Investment Grade Rolling Index, decreased by 42.54% for the quarter to end at 77bp. This represents a 74.89% improvement since year end.

Finally, spreads for high yield entities, as represented by the S&P CDS US High Yield Rolling Index, decreased by 44.43% for the quarter to end at 414bp. This represents a 63.91% improvement since year end.

The cost of buying default protection has come down since the beginning of the year, S&P notes, causing the value of existing contracts to go up. As a result, the year-to-date total return of an investment in a basket of credit default swaps similar to the S&P CDS US High Yield Rolling Index would be about 30.13%.

Indices

Credit conditions now better than average

The Kamakura index of troubled public companies has made its sixth consecutive improvement in September, with credit conditions now substantially better than average. After reaching a peak of 24.3% in March, the index dropped by an additional 1.5 percentage points to 10.9% of the public company universe in September. Kamakura defines a troubled company as a company whose short-term default probability is in excess of 1%.

Credit conditions are now better than credit conditions in 62.9% of the months since the index's initiation in January 1990 and 2.8 percentage points better than the index's historical average of 13.7%. In March, by contrast, credit conditions were better than only 3.6% of the monthly periods since 1990. The absolute number of companies in the 'over 20%' default probability category declined by 44 firms to 204 (a decrease of over 17%).

In September, the improvement in credit quality was especially pronounced among the riskiest credits, according to Kamakura. The percentage of the global corporate universe with default probabilities between 1% and 5% decreased by one percentage point to 7.4%. The percentage of companies with default probabilities between 5% and 10% was down 0.1 percentage points to 1.7%.

The percentage of the universe with default probabilities between 10% and 20% was down 0.2 percentage points to 1.1% of the universe, while the percentage of companies with default probabilities over 20% was down by 0.2 percentage points to 0.8% of the total universe in September. In March, by contrast, 3.1% of the total universe had default probabilities over 20%.

Kamakura's president Warren Sherman says: "The index's continued improvement, especially among high risk credits, is excellent news. It's now increasingly obvious that the recession is over for the economy as a whole. That being said, the credit improvement in September seemed to leave a few companies behind. The rated public companies showing the largest rise in short-term default risk in September were all in Japan: Japan Airlines, Pioneer Corp, Mizuho Trust & Banking, NIS Group and Takefuji."

Indices

Dutch RMBS index decreases

Prepayments in the Dutch RMBS market continued to fall in Q209 and there was a minimal increase in delinquencies, according to S&P's latest index report for the sector. While the tough economic environment continued to put pressure on borrowers, the total delinquency index for Dutch RMBS deals saw a minimal movement to 1.23% from 1.19%.

The weighted-average prepayment index decreased to 4.79% from 7.15% in Q2 and is 2.79% lower than in Q108. S&P says it raised its ratings on tranches in eight Dutch RMBS transactions, mainly due to improved pool credit quality and minimal losses.

One Dutch RMBS issuance from the Dolphin Master Issuer platform (Series 0-2009-1) was rated, totalling €11.7bn of securitised mortgages. As of June 2009, the outstanding total Dutch securitised mortgage balance rated by us was €97.1bn, up from €94.7bn in Q1.

Investors

Survey reveals continued anxiety over recovery

Despite news of economic recovery, many finance executives in Western Europe still believe that the next few years will be marked by slow economic growth and increased regulation in the sector, according to a new RBC Capital Markets survey.

The survey took into account 336 western European finance executives and was conducted by the Economist Intelligence Unit. The executives are from commercial and investment banks, hedge funds, private equity firms and non-financial companies that raise money in the capital markets.

Few executives (4%) surveyed expect a sharp economic rebound in the next six months and more than half (54%) expect a gradual recovery over the next year, with growth resuming at a below-trend rate over the following year. A quarter of the respondents (25%) do not expect a meaningful recovery for at least one year, followed by negligible growth at best. One in seven (13%) is even more bearish, expecting a prolonged period of global economic weakness lasting at least two years.

Marc Harris, co-head of global research at RBC Capital Markets, explains: "Finance executives believe that full recovery will be a slow, difficult process. However, one of the benefits of the current climate of anxiety and uncertainty is that it produces a creative tension that can help make markets. When you have both motivated buyers and motivated sellers, you have the potential for positive momentum in the markets. The huge moves in the equity markets since March, in spite of recession in the broader economy, are proof of this."

Western European executives surveyed expressed concern about the US. More than a quarter (27%) of respondents believe that the US dollar will lose its reserve currency status as soon as within the next five years. However, more than half (52%) of the executives have not yet changed their company's exposure to the dollar.

Respondents also anticipate that the dollar's successor may come from China. More executives said they have greater confidence in the growth and stability of China's capital markets over the next two years (39%) than those of the US (30 %). A quarter (26%) expressed the most confidence in the markets of the Eurozone.

Amid concerns about a muted recovery and weaker growth, the finance executives predict that transaction volumes will remain the same or even decrease over the next year. The executives were most optimistic about M&A deals, with 33% expecting them to increase in volume, while 26% expected growth in convertible debt transactions and 25% anticipated increased volume in secondary equity offerings.

Executives have a low visibility about the macro environment. Nearly half (47%) of those surveyed have little or no confidence in their ability to predict even whether prices and rates in the financial markets will go up or down within the next year. Nearly two in five executives (39%) say that deflation is the greatest threat to their companies, but nearly as many (35%) worry about inflation.

Given this backdrop, companies are taking action to rebuild balance sheets and re-evaluate sources of financing. Nearly half of the executives (47%) note that their companies hope to raise fresh financing during the next two years, but few expect to do so via investment grade debt, IPOs or secondary equity offerings; two in five executives planning to raise capital (40%) hope to obtain it from private equity funds rather than in the public markets.

Richard Talbot, co-head of global research at RBC Capital Markets, says: "It's hard to overstate the impact of the credit crisis on the capital markets, even for seasoned professionals. What we are seeing is a fundamental re-examination of traditional beliefs, such as efficient market theory, the role of the US dollar as the primary global reserve currency and credit rating agencies. That said, the resiliency of the markets should not be underestimated. Past cycles have clearly shown that some of the greatest returns have been earned during times of uncertainty as asset prices bottom out and then climb a 'wall of worry'. This is borne out by the strength of the markets during the past six months."

Legislation and litigation

Contractual alternative proposed for LBIE creditors

The joint administrators of Lehman Brothers International (Europe) have announced that they are developing a contractual alternative to their proposed Scheme of Arrangement, which is the subject of an appeal following a decision by the High Court in London that it lacks jurisdiction to implement the scheme. The new scheme will be implemented if they lose their appeal, but is being pursued concurrently with the appeal to minimise any potential delay in implementation if the appeal is denied.

The contractual alternative is expected to have substantially the same terms as the original scheme and would prescribe all aspects of the determination of the value of a creditor's net equity, as well as the allocation and distribution of trust property, according to lawyers at Schulte Roth & Zabel.

Only consenting trust property creditors would be bound by the terms of the contractual alternative. To minimise the impact non-consenting trust property creditors might have - both on the process and on consenting creditors - the administrators plan to set a high acceptance threshold, set by value of those persons having eligible claims, that must be met for the contractual alternative to become effective.

LBIE anticipates sending prime brokerage counterparties a document setting out the terms of the contractual alternative during the week of 23 November 2009.

Ratings

Ratings differentiation proposal criticised

The US House Financial Services Subcommittee on Capital Markets held a hearing on 30 September to discuss its recently released discussion draft entitled, 'The Enhanced Accountability and Transparency in Credit Rating Agencies Act', which - among other items - includes draft language on differentiation of ratings for structured finance products. To coincide with the hearing, CMSA issued a statement re-affirming its opposition to any proposals that would require credit ratings to be differentiated for certain types of financial products.

"While CMSA strongly supports efforts to strengthen our system for credit ratings in order to provide investors with the information they need to make sound investment decisions, the association continues to oppose reforms - such as differentiation - that both lack substance and undermine recovery of the commercial real estate capital market finance industry," the Association says.

Generally speaking, 'differentiation' (or the use of 'symbology', such as 'AAA.SF') is an overly simplistic and broad proposal that provides little value or information about credit ratings, according to CMSA. A broad coalition of market participants - including issuers, investors and borrowers seeking access to credit - remain overwhelming opposed to differentiation because it will only serve to increase confusion and implementation costs, while decreasing confidence and certainty regarding ratings.

The statement says that such effects would, in turn, create market volatility and undermine investor confidence and liquidity, which could exacerbate the current constraints on borrowers' access to capital. "Most concerning, these superfluous changes have been re-proposed at a time when policymakers are employing every reasonable means to get credit flowing again and the economy is struggling to regain equilibrium."

It continues: "In this regard, it is worth noting that the concept of differentiation has been examined extensively and rejected in recent years by the Committee on Financial Services, as well as the SEC and the ratings agencies themselves, for most (if not all) of the foregoing reasons. Nothing has changed in the interim. Accordingly, we urge the Subcommittee not to include a differentiation requirement as part of its CRA reform bill."

Ratings

Deterioration in EMEA securitisation expected

The performance of many asset classes in the EMEA securitisation sector will continue to deteriorate throughout the rest of the year and into 2011, according to Moody's in a new special report.

The report examines the prospects of recovery for international securitisation in several asset classes and geographies: EMEA auto ABS, UK credit card ABS, UK non-conforming RMBS, Spanish ABS and RMBS, Asia Pacific ABS and global derivatives. The rating agency expects performance volatility and uncertainty to decline in the coming months, although it cautions that a drop is predicated on achieving some level of economic moderation if not slight improvement, combined with the seasoning of securitised loan portfolios.

Moody's says that although GDP growth is expected to turn positive in many countries in EMEA later this year or in early 2010, employment and home prices will continue to deteriorate well into 2010, which will lead to securitised loan losses remaining at elevated levels throughout 2011 and 2012.

Frederic Drevon, Moody's head of EMEA securitisation, says: "While there appears to be a glimmer of light at the end of the tunnel, it is still too early to interpret improvement or slowed deterioration in a particular sector as a sign of recovery. When the securitisation markets do recover, it is uncertain what the level of receptivity will be and therefore what issuance volumes may be."

The rating agency believes that EMEA auto ABS performance will continue to deteriorate into 2011/2012. Although only moderate deterioration is expected in Germany, significant increases in losses - which have been accelerating over the past six months - are expected in the UK and Spain. Key performance factors will be the unemployment rate and used car prices.

Jean Dornhofer, a Moody's svp and co-author of the report, says: "Moody's expects the performance of UK credit cards ABS to continue to deteriorate into the first half of 2011. Losses have accelerated over the past six months. The unemployment rate will again be a key performance factor in this sector."

Moody's also expects that deterioration in the performance of UK non-conforming RMBS will continue into 2011. Losses have accelerated over the past six months. The rating agency believes that home prices and the unemployment rate will be key performance factors for this sector.

The rating agency notes that Spanish ABS and RMBS performance is also likely to continue to deteriorate into 2011/2012. Barbara Rismondo, a Moody's vp, senior credit officer and co-author of the report, concludes: "Defaults have significantly increased over the past six months. For Spanish RMBS, Moody's believes that key performance factors will be the unemployment rate and home prices, while for Spanish consumer loan ABS it will be the unemployment rate. Meanwhile, Spanish SMEs performance will be influenced by the corporate insolvency rate."

Ratings

Global servicer rating criteria published

Fitch has published its global rating criteria for assessing the operational risk of servicers of structured finance products, including RMBS/CMBS and ABS transactions. Although the servicer ratings remain country-specific, the approach, methodology and process are consistent across all jurisdictions. The agency's global criteria describe the overall rating process and provide insight into the characteristics of highly-rated servicers.

Edward Register, senior director of Fitch's European structured finance operational risk group, says: "The servicing environment within each country can vary considerably due to local customs and laws leading to national benchmarks for servicing quality. While cross-border servicer comparison should be carefully interpreted, the use of a global methodology helps Fitch to maintain consistency in the servicer rating process and to identify regional and global best practices."

Fitch's servicer rating programme currently includes over 300 ratings on more than 150 servicers across 12 countries. The analysis and disclosure of servicer ratings provides investors and other market participants with a tool to identify additional risks and benefits associated with a given servicer.

Diane Pendley, md of Fitch's operational risk group, says: "The publication of global servicer rating criteria acknowledges the expansion of structured finance worldwide and the increasing importance of servicers and their impact on asset, and ultimately transaction, performance."

Regulation

Moratorium requested on reg cap rule changes

The American Securitization Forum has submitted a letter to federal banking regulators requesting the near-term announcement of a six-month moratorium on any regulatory capital rule changes related to the implementation of accounting standards FAS 166 and 167 and the proposed elimination of the option for ABCP conduit sponsors to disregard consolidation of conduits for risk-based capital purposes, as proposed in regulators' 15 September Notice of Proposed Rulemaking (NPR). The letter represents an initial response to the NPR; the ASF says it is developing an additional, comprehensive reply that will be submitted before the 15 October comment deadline.

The rationale behind the moratorium is that by the time final rules are promulgated (i.e. sometime after 15 October), banks will likely have no choice but to begin the process of capital raising and reallocation of resources based on assumptions developed from the conservative approach that the proposed rules take, regardless of any changes that might be included in the final rules. This may have significant, negative and possibly unnecessary consequences on both the banking system and credit availability more generally, the ASF notes. If regulators are unwilling to grant the moratorium, the Association asks them to at least immediately announce a phase-in period of at least four quarters for any rule changes.

The agencies' final decisions on the issues addressed in the NPR will have substantial implications for bank capital and possibly credit availability. Even with only a one-month comment period, it is hard to see how those final decisions will be reached before late November, leaving banks just over a month to react before the accounting changes take effect. The ASF warns that this would leave banks with little choice but to plan, and perhaps begin to act, based on the conservative assumption that the NPR represents the agencies' final position on these issues.

According to the ASF, it is also important to note that the economic risks to banks will not change when the accounting changes take effect. While the agencies are likely to conclude that at least some additional capital is required, the cost of a six-month delay in implementation would not be high.

Regulation

FSA publishes liquidity requirements

The UK FSA has published its final rules on the liquidity requirements expected of firms. The new rules will require changes to firms' business models and is expected to bring about substantial long-term benefits to the competitiveness of the UK financial services sector. The qualitative aspects of the regime will be put into place by December 2009.

Specifically, the rules include:

• An updated quantitative regime, coupled with a narrow definition of liquid assets;
• Over-arching principles of self-sufficiency and adequacy of liquid resources;
• Enhanced systems and controls requirements;
• Granular and more frequent reporting requirements; and
• A new regime for foreign branches that operate in the UK.

Paul Sharma, FSA director of prudential policy, says: "The FSA is the first major regulator to introduce tighter liquidity requirements for firms. We must learn the lessons of the financial crisis and we believe that implementing tougher liquidity rules is essential to ensure we are in a better position to face future crises."

He adds: "In the current crisis some firms weathered the storm better than others. These firms tended to be those that had policies that were similar to those that we are introducing [now] - including holding assets that were truly liquid, such as government bonds. Phasing the period in which firms will build up their liquidity buffers should mitigate the knock-on effects to bank lending."

The FSA plans to phase in the quantitative aspects of the regime in several stages, over an adjustment period of several years. This is to take into account the fact that all firms at present are experiencing market-wide stress. The precise amount of liquidity that each firm will need to hold will be refined over time to ensure that the combined impact of higher capital and liquidity standards is proportionate, the regulator says.

It has noted that London's competitive position depends on counterparties' perception of the financial soundness of the firms that operate in the UK. Low-levels of financial soundness cannot provide sustainable long-term competitive advantage. The FSA explains that the new requirements are designed to protect customers, counterparties and other participants in financial services markets from the potentially serious consequences of imprudent liquidity risk management practices.

RMBS

Originator to purchase assets back

NIBC Bank, the originator and sole noteholder of the Essence II transaction, has made certain amendments to the original transaction documentation. Although such documentation changes aren't common in Dutch RMBS, Fitch notes that the amendments are unlikely to affect the transaction's ratings.

The changes made to the documentation effectively permit the originator to purchase assets back from the issuer, fully or in part, prior to the first optional redemption date in March 2011, by means of an extraordinary noteholders' resolution. The credit enhancement required to support the outstanding transaction ratings is not expected to be adversely affected by such an asset sale operation, given the pro rata nature of the notes redemption as well as the contractual requirement to abide by the substitution conditions of the transaction. Fitch had fully accounted for the substitution and pre-funding features already in its original collateral analysis, in order to capture the dynamic credit nature of the underlying pool.

A sale of approximately €700m of assets from the issuer to the originator has been approved by NIBC Bank via an extraordinary resolution. Following this contemplated asset sale, the pool will comprise 11,855 loans with an aggregate principal outstanding balance of about €1bn, compared with about €1.7bn prior to the asset sale.

RMBS

Colombian RMBS ratings criteria published

Fitch has published a criteria report introducing its approach to rating RMBS transactions in Colombia. The report provides a description of its rating process and presents the key variables and assumptions related to estimating expected and stressed defaults and recoveries on Colombian mortgage portfolios.

Fitch's approach to rating RMBS in Colombia is based on a three-step approach. First, determining expected base-case defaults and rating-specific stressed defaults through a loan-by-loan default model. Second, determining expected recovery levels given default. The last step is to run a cashflow model exercise to understand the robustness of the transaction's capital structure and elements of the financial structure.

Fitch's criteria take into consideration the significant changes in Colombia's economy and real estate market throughout the last decade. While there have been increases in property prices, they can be attributed to relatively depressed levels during the 1990s. Furthermore, Fitch believes this is a reflection of the general reform of the housing market framework, through Law 546 of 1999, an improvement in the country's credit quality and sustainable increases in GDP per capita.

On 17 July 2009, Fitch announced the completion of the acquisition of an additional stake in Duff and Phelps de Colombia, now renamed Fitch Ratings Colombia. On 28 July 2009, Fitch announced it concluded the review of over 450 national scale ratings in Colombia, including 61 RMBS ratings outstanding. The Colombian RMBS Rating Criteria is applicable for new RMBS rating assignments, as well as to the surveillance of RMBS ratings.

Technology

Loan valuation and management platform launched

RiskSpan has released its RS Velocity whole loan valuation and portfolio management platform. The offering combines comprehensive data management tools, advanced analytics and reporting capabilities on a single integrated web-based platform.

Employing a robust stochastic modelling framework, the platform incorporates powerful and flexible prepayment and credit modeling capabilities. The system enables originators, portfolio investors and secondary market players to quickly analyse credit and prepayment trends, project future performance and establish fair market values across a wide range of potential economic and interest rate scenarios.

The system will also have links to updated home price and credit information, making it easier to determine current combined LTVs and project the likely range of future prepayments, delinquencies and loss severities, RiskSpan says. By combining historical data with robust forecasting capabilities, clients can fine-tune modification programmes, establish realistic bands for loan loss reserves, enhance income projections and monitor/manage performance across individual products, origination channels and servicers.

Technology

RMBS reporting tool enhanced

Fitch has enhanced its RMBS reporting tool, Deal Compare, to incorporate transactions from Ireland, Italy and Spain. Deal Compare provides users with the ability to compare asset and liability characteristics of RMBS transactions more easily, and is already available for the UK and Dutch RMBS markets.

Gregg Kohansky, md in Fitch's RMBS team, says: "Deal Compare allows quick analysis and comparison of the metrics that drive the ratings for numerous transactions at one time. It provides an efficient means to benchmark new transactions and supports investor relative value analysis. Deal Compare also makes possible the comparison of all issuances from one originator over a specified time period."

In addition, the offering now has functionality to compare basic performance statistics, such as arrears and prepayment levels, alongside original asset and liability characteristics.