Contents

RMBS

Silverstone prepped

Strong demand anticipated, but lack of euro tranche may prove a sticking point

Silverstone 2009-1, a UK prime RMBS from Nationwide Building Society, is expected to launch this week, becoming the second publicly-distributed UK benchmark deal of the year. The quality of the transaction is said to be better than most, but its lack of euro-denominated notes may limit investor demand.

Silverstone 2009-1 will comprise two tranches of sterling notes, both of which have been rated triple-A. Nationwide has mandated Barclays Capital, Citi and JPMorgan as joint-lead managers for the anticipated £3.5bn transaction.

HBOS' Permanent 2009-1 RMBS, issued in September, priced to yield 180bp over three-month Libor, but now trades in the secondary market at around 135bp. Official guidance is yet to be announced on the Silverstone transaction, although a whisper of 150bp over mid-swaps is circulating.

Paolo Binarelli, portfolio manager at P&G Alternatives, says he is disappointed that Silverstone will be sterling-only. "As we are euro-only investors, swapping euros to sterling is going to cost a lot because banks require high fees for unrated counterparties, as do funds," he says. "We are aware that the Permanent 2009-1 RMBS included a euro-denominated tranche only because Barclays stepped in to provide the currency swap needed by the structure. As the same doesn't appear to be happening in the Silverstone transaction, no euro notes are expected to be issued."

He continues: "From our point of view, buying sterling notes and swapping them into euros from a new issue does not make much sense. We would rather buy a cheaper sterling or even US dollar (as they are even cheaper) security on the secondary market and then do an asset swap, obtaining a better economic return, at current spreads."

"On the other side, it looks like the sterling UK prime market is being well supported by dealers and investors," Binarelli adds. "I guess that the percentage of prop desks participating as investors in the Silverstone issue will be higher than for Permanent 2009-1 because they can manage the currency issue with a better efficiency (economic) versus those investors that do prefer euro-denominated exposures. "

Silverstone 2009-1 is part of the relatively new Silverstone Master Trust, which has so far issued two retained transactions. It features 100% owner-occupied residences from the UK, as well as a current LTV of 65%. Similar to Permanent 2009-1, the deal features a put option, whereby at the step-up date in October 2014 Nationwide will offer to purchase any outstanding Series 2009-1 Class A notes at a price of par plus accrued interest less any outstanding triple-A PDL.

According to David Watts and Hana Galetova of CreditSights, the Silverstone Master Trust has the lowest proportion of mortgages in arrears of any of the 11 trusts that the firm covers. "While that may be partly a result of the mortgages being relatively young, it is also likely a reflection of Nationwide's underwriting standards," they say. "Silverstone also has comparatively few problem loans, such as interest-only and high loan-to-value loans. This should help the mortgages to continue to perform better than other UK mortgages, even when interest rates begin to rise again."

"Although we think the quality of the Silverstone asset pool is better than that of Permanent, we would be surprised if Silverstone tried to come inside the 135bp level," the CreditSights analysts continue. "We remain negative on UK housing. What's more we think that RMBS investors face the threat of either low repayment rates if Bank of England base rates remain low or higher defaults if interest rates start to rise. However, given the pool performance of Silverstone versus other master trusts and the inclusion of a put option, then the Silverstone new issue may be a better option than buying outstanding deals at a discount."

Binarelli agrees: "Would you prefer to bet on a fresh horse, which looks quite good although not mature, and has good odds to win, or would you bet on an experienced older horse, which will likely finish the race in third place? In such a market environment, new horses may run better than older ones - at least in a very short time frame."

Markus Ernst, securitisation analyst at UniCredit, notes that any successful new issuance further strengthens market confidence in Europe and supports the current spread tightening, while underlining that public issuance is not impossible. He concludes: "Going forward, we expect a couple of further consumer-related ABS, especially auto deals, as well as some prime niche RMBS."

AC

Distressed assets

Liquidity boost

Infrastructure issues hinder student loan ARS recovery

Liquidity in the secondary student loan auction rate securities (ARS) sector has been boosted in recent weeks by demand from distressed investors. However, a number of infrastructure issues still need to be addressed before wider concerns about the market dissipate.

Brian Weber, senior associate at Houlihan Smith & Co, confirms that there has been an up-tick in bids for student loan ARS lately, accompanied by an increasing number of institutional distressed investors entering the market. Depending on the credit rating of the paper, bids are in the range of 70c to 95c, with one Sallie Mae deal recently being purchased at 98c. This compares with a range of 55c to 80c previously.

"The increased interest is being driven by tightening spreads in comparable student loan term ABS," he says. "Investors are getting the same safety of the underlying, including in some cases FFELP guarantees, but with a much better yield (around 50bp-100bp more)."

By way of comparison, ABS analysts at JPMorgan point out that triple-A rated long-dated Sallie Mae ABS have recently traded at around 100DM, while rate-reset notes (RRNs) and ARS in the student loan sector have traded at roughly 85DM and 200DM respectively.

Traditional investors in ARS have exited the market completely, however, having been too badly burnt by the auction failures in 2008. "ARS are complex products that were largely marketed to corporate treasurers, who had little understanding of the structure or the auction process. Investors found themselves needing to educate themselves about their holdings after the time when they most needed to understand them (at purchase). While corporate treasuries still don't typically have the capacity to do sufficient credit analysis on ARS or structured credit in general, distressed investors have a better ability to price the security and understand the auction mechanism," Weber explains.

The majority of ARS auctions are still failing, however - albeit a couple were successful recently due to the deals' higher maximum rate penalty features. Investors continue to be concerned about the market, according to Weber.

He continues: "Investors need spreads to tighten in order to get out of their positions and I believe there is a good chance that they'll be able to do so soon. But there are also infrastructure issues, which if addressed would help to create greater confidence in the sector. Trusts will have to be amended to facilitate refinancing and secondary market liquidity needs to be further developed."

Weber says that SecondMarket provides a great platform for trading secondary ARS, but banks also need to become involved in terms of providing liquidity. "They're unwilling to step into the auction process, let alone facilitate trading," he notes.

ARS activity remains concentrated in the secondary market, but while liquidity is greater than it has been in the past, the market is still illiquid. "I believe that liquidity will return eventually - though not through the auction process, but through secondary demand and refinancing activity once spreads begin tightening," Weber adds. "For example, spreads on student loan deals are currently at around 170bp over Libor, but they need to reach 100bp to facilitate more refinancing in the sector. Sallie Mae transactions are already trading at around 100bp over and this is reflected in the ARS price: there is a direct relation between tighter underlying spreads and higher prices in the secondary ARS market."

The JPMorgan analysts suggest that another concern about ARS is that the current higher coupon costs could erode excess spread in those transactions. Coupons on failed ARS step up, typically to 150bp over Libor. However, they note that for seasoned deals that have reached parity, the triple-A tranches remain well protected by the available credit enhancement.

The analysts agree that the ARS market is unlikely to recover sufficiently any time soon. At the very least, spreads would have to recover to below the ARS step-up coupon margin to consider the possibility of a successful auction. Nevertheless, they believe that the spread pick-up available on ARS relative to comparable RRNs, plus the discount price relative to premiums on term ABS, remains worth investigating for distressed investors.

Meanwhile, University of Delaware economics professors James Butkiewicz and William Latham have conducted a study of the economic impact of restoring liquidity to frozen student loan ARS. A coalition of over twenty US corporations holding such securities is seeking a solution to the problem, as the loss of liquidity has adversely affected the capital expenditures and continuing operations of these firms. Their study finds that restoration of liquidity to US$25bn of student loan ARS held by non-financial corporations would provide economic stimulus of US$64bn to the economy.

CS

ABS

Gap widens between US and Euro recovery

The contrast between the securitisation investor base on either side of the Atlantic is becoming increasingly more pronounced. Of the on-the-run asset classes for the October TALF transactions in the US, 95% of deals were purchased by cash accounts, according to ABS analysts at SG. This compares with a handful of publicly distributed issues in Europe, a large proportion of which are pre-placed.

Secondary trading activity across ABS sectors in the US averages US$1bn-US$1.5bn daily. And bid-ask levels have gone from being non-existent in early Q109 to around 25bp and more recently 5bp, as spread tightening continues.

"Given this strong demand from cash buyers, most market participants consider the consumer ABS sector as well-positioned to exit TALF and to be able to return to being a standalone sector once weaned off government support," the SG analysts note.

A recent SEC filing by auto retailer and TALF issuer CarMax echoes this sentiment. It says that "absent negative developments in the credit markets, we do not believe the expiration of the TALF programme will have an adverse effect on our ability to access the market for auto asset-backed securities".

The analysts add that other recent events pointing to improving trends in the US market include: non-TALF transactions being completed outside of TALF funding dates; off-the-run asset classes being structured (and as non-TALF transactions); and subordinate bond issuance is being seen. However, there are growing concerns that the non-agency MBS market is being left behind (see last week's issue).

Meanwhile, in a new report examining whether recent issuance signals the revival of European securitisation, S&P notes that some of the contributing factors to the depletion of investor-placed issuance in the region are gradually beginning to ease. But the rating agency also concedes that signs of a rebound in the ABS market might still prove short-lived.

"The European economic recovery is likely to slow during 2010 and, while secondary spreads have tightened recently, higher volumes of primary issuance could put that trend under pressure," says S&P. "We also believe that other funding sources may continue to hold more appeal to originators for now. Finally, the effect of evolving regulatory requirements on originators and investors remains uncertain."

At the same time, the rating agency also believes that, due to renewed investor appetite, the cost of securitisation as a funding tool may be decreasing to a point where originators might find it economical or strategically desirable. S&P points to the recent transactions that were placed with investors as an example.

Despite this uncertainty, it believes that many of the contributing factors that caused investors to retreat from the market in the past two years may be showing signs of recovery. The ratings agency explains: "The detailed characteristics of future transactions may differ from those of the past, but we believe the fundamental techniques of securitisation, when used appropriately, continue to have the potential to benefit both originators and investors - and, by extension - household and corporate borrowers."

While S&P believes there are likely further collateral losses to come in outstanding structured finance transactions, the effect of weaker fundamentals on their ratings has been relatively mild in many European sectors. So far, most ratings have performed largely as intended, given the current economic environment.

For example, of the 4,478 European ABS, CMBS and RMBS ratings outstanding in mid-2007, only 10 (0.22%) had defaulted by mid-2009. And only 0.05% of bonds rated investment grade in mid-2007 defaulted over the period, compared with 1.9% of speculative-grade bonds, demonstrating that these ratings have acted as a relative measure of creditworthiness.

S&P has lowered a larger number of ratings over the period, but the rate of downgrades has been relatively modest at the higher rating levels. For example, 96.8% of bonds that were rated triple-A in mid-2007 were still rated triple-A (or had been redeemed in full) by mid-2009. Many ratings remain on credit watch negative, however.

CS & JA

Alternative assets

Investor outrage at 'improper' Trups offer

Trust Preferred Solutions (TPS), a vehicle affiliated with TPG Credit Management, is reportedly seeking to buy Trups of almost US$500m in face value across seven different CDOs. The offer, which would - if accepted - involve 5% of the face amount of each security being paid to both the issuer and the preferred shareholder, has sparked outrage among senior investors in the transactions.

Hildene Capital Management, an investor in three of the targeted deals, describes the move as being equal to "making an improper payment to preferred shareholders for their assistance in fleecing noteholders and approving the sale of assets by the issuers for a token amount". Under normal circumstances the preferred shareholders would not be entitled to any payments from the issuers due to the distress experienced in the respective portfolios, but they are now being offered a payment for their vote "in what amounts to a bribe to consent to the sale".

The asset manager says it has contacted other noteholders of the targeted CDOs and all are in agreement that the proposed offer is improper and should be stopped.

Under the transaction indentures, holders representing two-thirds of the preferred shares may direct the trustee to sell an item of portfolio collateral that is the subject of an offer or call for redemption, if they certify to the trustee that the sales price for the security is equal to or greater than the price available pursuant to such an offer. Hildene points to the fact that the offers target assets which are among the best of those held by each transaction - namely obligations of financial institutions that have weathered the financial crisis well or which were deemed strong enough by the US government to receive TARP funding.

Although many of the securities that are the subject of the offers aren't actively traded, price guidance can be derived from secondary market trades of similar securities that are obligations of the same issuers, the firm says. For example, TPS has offered to pay US$150,000 for US$3m face amount of the trust-preferred securities of BUCSFINANCIAL CAPITAL TRUST I, an obligation of Susquehanna Bancshares. Trust-preferred securities of SUSQ currently trade in the secondary markets at 93.6% of par.

Fitch says it will downgrade seven classes of one of the targeted transactions - Tropic CDO V - if the TPS offer is accepted. The agency notes that the potential removal of 15% of the stronger performing collateral at a 95% loss would leave the CDO notes undercollateralised by a portfolio concentrated in underperforming Trups securities.

Its review of section 10.3(d)(ii) of the deal's indenture shows that with a two-thirds vote, the preferred shareholders can direct the trustee to accept offers for securities provided that an event of default has not occurred. Events of default defined in the Tropic V indenture include provisions, such as failure to make payments on notes when due. However, they do not include provisions for a minimum senior note collateralisation level.

Fitch has not been notified that Tropic V is in default, nor is it aware of any existing or proposed amendments to the transaction that would change its understanding of the indenture.

Additionally, the indenture provides that an offer to purchase securities as described in section 10.3(d)(ii) be made to all of the holders of such a class of security. The TPS offer letter states that other offers have been made to the holders of other securities.

At Fitch's last review of the transaction on 9 April 2009, nine Trups representing US$95m had defaulted, an additional four Trups representing US$41m were deferring and the agency deemed another 21 Trups representing US$166.5m were at imminent risk of deferral. The total combination of actual defaulted, deferring and imminent risk securities represented approximately 38.5% of the Tropic V collateral portfolio.

At the last review, the weighted average adjusted bank score for the securities subject to the TPS offer was 3.33, which is representative of BB/BB- credit quality. This is higher than the BB-/B+ credit quality of the entire portfolio at that review.

"The potential removal of 15% of the stronger performing collateral at a 95% loss would leave the CDO notes undercollateralised by a portfolio concentrated in underperforming TruPS securities," says Fitch.

As of the 15 July 2009 trustee report, all of the Tropic V overcollateralisation (OC) tests were failing the respective performance triggers. At the last payment period the Class A-1 notes received full interest payments. Additionally, the class A-1L1 and A-1L2 notes received approximately US$1m of remaining proceeds as OC redemptions of principal resulting from the senior OC test failure. In July, the senior OC test was at 115.19% compared to a trigger of 127%.

Fitch projects that if the TPS offer is accepted, then the senior OC test will drop to approximately 94%, indicating that the three classes of A-1L notes would be undercollateralised by this action. Additionally, the agency projects the loss of approximately US$957,300 of interest proceeds from these securities each quarter if this offer is accepted.

At the July distribution date, the interest proceeds from the Trups subject to the TPS offer and the amount of excess interest to service the Class A-1 notes both totalled approximately US$1m. If the offer is accepted in its entirety, Fitch expects the Class A-1 notes would likely receive interest at the next payment date, as the US$5.75m principal payment would be available to pay interest.

However, in subsequent payment dates there is a real possibility that interest proceeds would be insufficient to pay the trust expenses and interest on these notes. If the notes do not receive full interest payments when due, an event of default would occur and Fitch will downgrade the A-1 notes to single-D.

The agency says it will resolve the rating watch status of the notes pending the outcome of the TPS offer. Should the offer be accepted in full, it is likely all the ratings on the notes would be downgraded to distressed levels of triple-C or lower.

Meanwhile, Moody's has downgraded the seven classes of Tropic V notes, affecting US$750m worth of securities, citing larger than anticipated par loss and credit deterioration in the collateral pool, as well as an increase on the assumed defaulted amount. The rating agency says it is aware of the TPS offer, but because it is yet to be executed, the rating action does not address any potential credit risk resulting from the offer. But Moody's warns that the execution of such an offer may result in future negative rating actions on the rated notes.

Among the other transactions subject to the TPS offer are Tropic CDO II, Soloso CDO 2005-1 and Soloso CDO 2007-1. The solicitation comprises an offer of US$3.485m for US$69.7m Tropic II notes, US$3.25m for US$68.5m Soloso 05-1 notes and US$2.35m for US$47m Soloso 07-1 notes.

Hildene has strongly objected to any acceptance of the offer. It says the move violates its rights as a creditor of the three issuers and "would cause irreparable harm to the issuers and their creditors generally".

By offering to pay the preferred shareholders, the solicitation contravenes the indenture requirement that the issuer receives the full proceeds and further that it applies the proceeds as any collections would be under the priority of payments in Section 11.1 for the related due period, according to Hildene. The trustee holds the assets of the issuer in trust for the benefit of the noteholders and is consequently obligated to ensure that it takes actions to protect the assets to ensure repayment of the issuer's creditors in the order of priority set forth in the indentures, in each case to the exclusion of the preferred shareholders. The asset manager warns that if the trustee continues to assist with the TPS offers, it intends to hold it liable for any losses incurred on the notes.

Further, Hildene suggests that such coordinated action by TPS seems to violate numerous State and Federal laws, including New York's Martin Act. The firm notes that if the preferred shareholders join with TPS in this action, the Federal Racketeering Influenced and Corrupt Organizations Act (RICO) permits civil actions by private parties for treble damages against each participant in the enterprise.

The preferred shareholders have until 23 October to agree to the TPS solicitation.

AC & CS

Investors

Coalition rejects 'aggressive' IO proposals

The Mortgage Investors Coalition (MIC) has called on the US Treasury Department to reject banks' proposals on interest-only loan modifications. The move comes amid reports that members of the financial services industry are considering lobbying the Treasury to include more aggressive interest-only periods for mortgages modified under the Obama Administration's mortgage modification programme. However, doubts about the effectiveness of HAMP persist.

"Modifying homeowners into mortgages that have future payment increases and adjustable interest rates will not improve a homeowner's situation," explains Micah Green, a partner at Patton Boggs who represents the coalition. "Doing so would ignore the fact that many of these homeowners are already in interest-only or other non-traditional mortgages and owe more on their mortgage than their home is currently worth."

Over the past three years, mortgage modification guidelines primarily have been established by banks and loan servicers. Policymakers, homeowners and investors have grown frustrated with the lack of successful modifications that have been completed, according to MIC.

The coalition adds that mortgage securities investors are now organising efforts to create new ideas and complementary solutions that would address the mounting foreclosure problem. "The Mortgage Investors Coalition is focusing on solutions to re-equitise homeowners," says Green.

MIC was formed in March 2009 by asset managers who currently hold over US$100bn in RMBS, on behalf of pension funds, college endowments and other investors. The coalition joins a growing number of noted scholars and economists who believe that restoring equity through a refinance is the only true way to assist homeowners suffering hardships.

"The Mortgage Investors Coalition believes any changes to HAMP should focus on refinancing homeowners into long-term affordable fixed rate mortgages, so homeowners and the housing market don't have the threat of interest rate resets, balloon payments or large payment shocks in the future that could drive additional foreclosures," Green notes.

Loan modifications have declined over the last few months due to the recent implementation of HAMP (SCI passim). With the trial period for these modifications coming to a close, they should become finalised modifications, Fitch notes in a new analysis of the programme's effectiveness. However, servicers report that many borrowers are not providing the required documentation and often do not make the required trial payment.

Fitch md Diane Pendley says: "Ultimate mod performance or sustainability will still primarily hinge on whether the borrower wishes to keep the property, as well as having sufficient cashflow to make the modified payments. While the HAMP guidelines ostensibly allow for sufficient cashflow for the new modified housing payment, recent evidence is showing that borrowers may still be unable - if their other debts are excessive - or unwilling to continue making payments on a home where they will see little or no timely possibility for equity return."

If the borrowers do not complete the HAMP trial modification requirements, servicers will be expected to either offer their own version of a modification or work with the borrower to find another solution to their problems. What this most likely leads to is a short sale, deed-in-lieu or foreclosure. Loans that do not meet the basic requirements for modification, or where the borrower re-defaults after a modification, are expected to once again increase the number of assets entering REO status.

At the end of 2008, Fitch projected that 65%-75% of defaulted mortgage loans would default again within 12 months - a projection that still stands. What is important to note upon a closer look within this projection is that 11% of all RMBS modified loans, including 17% of the loans modified in the third quarter, have failed their first mod and have received a second modification.

Pendley concludes: "With all servicers being directed to use the HAMP modification programme as a first step, the effectiveness of the HAMP programme figures to be a material outlier as to how successful loan modification as a work-out strategy will be over time."

CS & JA

Investors

Finding opportunity in the eye of the storm

Vishal Bhutani, md at Structured Portfolio Management, answers SCI's questions

Q: How and when did Structured Portfolio Management (SPM) become involved in the structured credit/securitisation markets?
A: SPM has been involved with structured credit and securitisation since its beginnings in 1997. Best known for its work in the mortgage markets, SPM has a well-established, rigorous analytical framework for identifying and profiting from short-term displacements in markets as well as longer-term structural anomalies, each of which creates opportunities for alpha capture.

Q: What are your key areas of focus today?
A: We at SPM have always looked to create niches in different areas of the financial markets as opportunities have opened up for exploitation. One such opportunity has been in the corporate debt markets where the turmoil of last year had left credit spreads much higher than what the fundamentals would suggest. They were pricing in a depression in the global economy and the debt of companies in a very strong financial position was trading at well below historical trading levels.

We looked at the opportunity and, after extensive due diligence, decided to add corporate capital structure trading to our mix of products. We now specialise in our core mortgage-related products, as well as a rapidly growing presence in the corporate debt markets.

As in the mortgage markets, we have created a niche for ourselves in corporate capital structure trading. We have also devoted considerable time analysing the volatilities of the term structure of interest rates.

We would look to take advantage of opportunities in that space when they present themselves. There is a common thread uniting all the strategies we employ: they are backed with a great deal of analytical rigour and thought.

Q: What has been 2009's most transformative change in the credit market?
A: We should look at 2009 in two phases. The first phase was one of extreme fear and flight to quality that lasted until March; the second phase started after the March bottom and has seen an explosion of risk taking.

The first phase was precipitated by a high degree of suspicion regarding the collapse of the global banking system. The share price of Citigroup trading below US$1 did not inspire market participants with confidence in the health of the US financial system.

In response, the stimulative measures announced by the US Treasury and the never-before-seen accommodative measures by the US Federal Reserve (and other central banks) initiated a second phase and helped liquidity return to the financial markets. With the advent of liquidity came the return of risk taking, which caused the capital markets to open up - first for high quality corporates and, then, for lower quality ones.

As credit started to become available (ever so slightly) to Main Street, it resulted in the American economy starting to recover from the depths of this 'Great Recession'. Together with renewed growth in the BRIC economies, this helped global growth to perk up.

The opening up of the capital markets and stabilisation of the global economy has caused a flood of new money entering the credit markets, which has resulted in massive tightening of credit spreads. The Fed's TALF programme has also helped open up the frozen ABS markets.

Q: How has this affected your business?
A: We have been a beneficiary of the shake-out in the hedge fund industry. The turmoil of 2008 created many opportunities for SPM.

The firm positioned itself to benefit across all its products and add new products in areas that were witnessing a liquidity squeeze. SPM employed sophisticated risk management techniques to survive last year (undoubtedly the most difficult year for our industry) and utilised a balanced risk-reward framework to add assets when others were deleveraging to meet margin calls.

As credit markets returned to a degree of normalcy, we benefited tremendously in our mortgage derivatives portfolio. We predict that the structural changes in the markets we operate in will continue over the next two to three years and we expect to reap rich rewards over that timeframe.

In addition, as discussed above, SPM has added new products in corporate debt investing and is looking to build that into a pre-eminent investing platform. We are also looking to make additional, selective hires in this environment, as there is abundant talent in the marketplace with not a lot of openings.

Q: What major developments do you expect from the market in the future?
A: We expect great opportunities to appear as the global economy continues to be in a relatively unstable state. Such instability is usually mirrored in outsized financial market volatility, which can lead to great gains in wealth - but also presents great dangers to those who fail to properly identify and mitigate the relevant risks.

The challenge, as we see it, is to position ourselves to continue to benefit from the short-term dislocations and longer-term structural changes we see, while continuing vigilance in risk matters. We know one thing with certainty: phase two will be followed by phase three.

ABS

DTZ taps Barclays' research co-head

DTZ has appointed Hans Vrensen as global head of research. Vrensen will be responsible for leading DTZ research worldwide, managing the research teams in the UK, CEMEA and APAC regions, as well as the the global forecasting and real estate strategy teams. He will officially join DTZ on 9 November and report to Isaac Krymolowski, global head of consulting and research.

Prior to his appointment at DTZ, Vrensen held the position of co-head of European securitisation research at Barclays Capital. He has held several positions in equity and debt analysis and investment management, in the USA and the UK, including senior credit officer at Moody's and vp of LaSalle Investment Management.

Advisory

Real estate boutique formed in JV

FTI Consulting and Compass Advisers have established a new investment banking firm dedicated exclusively to the global real estate sector. The joint venture - called EdgeRock Realty Advisors - will build on FTI's growing market leadership in the real estate sector, which expanded with its acquisition of The Schonbraun McCann Group in 2008.

EdgeRock will leverage its strategic partners' expertise in real estate, capital markets and restructuring, the two firms say. EdgeRock will advise real estate companies, owners and institutional investors on M&A and divestiture transactions, private capital raising, and IPO and other capital markets strategies, while also providing clients with access to FTI's industry-leading restructuring and real estate capital markets advisory expertise.

Serving as co-ceo's of EdgeRock are Bruce Schonbraun, currently senior md and head of global real estate for FTI Consulting, and Stephen Waters, the founder and managing partner at Compass Advisers. In addition, David Lazarus, formerly md in the global real estate group of Lehman Brothers/Barclays Capital, will serve as a senior md.

The company says it has already engaged with several clients for ongoing advisory assignments and is actively recruiting professionals for its New York office.

CLO Managers

Management fees reduced for ABS CDO

Verde CDO, an ABS CDO, has entered into a supplement to the indenture with Bank of America. The supplement provides that the base collateral management fee to be paid by the issuer to the collateral manager will be reduced and that there will be no subordinated collateral management fee or incentive collateral management fee.

Moody's has determined that performance of the activities contemplated within the supplement will not cause its current ratings of the notes to be reduced or withdrawn. The agency has not expressed an opinion as to whether the agreement could have non-credit related effects on the transaction.

Investors

Asset manager continues credit expansion

Investec has continued the expansion of its structured credit department. Following the recent hire of Jeff Burch as global co-head of credit, Investec Asset Management has announced the appointment of Theodore Stamos, who will also join its credit team. Stamos will have portfolio management responsibility for investment grade credit and credit analysis responsibilities for both investment grade and high yield issuers.

Stamos joins from Blue Mountain Capital, a specialist credit hedge fund, where he was a senior credit analyst. Before Blue Mountain Capital, he worked at BNP Paribas, where he was a vp within the high yield and leveraged loan origination group.

Legislation and litigation

Testimony to spark new Bear Stearns claims

Claims against Bear Stearns on behalf of investors in the firm's High-grade Structured Credit Strategies and High-grade Structured Credit Strategies Enhanced Leverage Funds are expected to increase, following the start of the criminal trial of the former managers of the Bear funds, Ralph Cioffi and Matthew Tannin.

The testimony and evidence that will be presented over the course of the criminal trial could provide additional supporting and corroborating evidence in the civil litigation and arbitrations currently pending against Bear Stearns, according to securities law firm Klayman & Toskes. Moreover, with this information coming to light, aggrieved investors of the Bear funds who have not yet sued may now feel that the time is right to attempt to recover their losses.

When the Bear funds were liquidated in July 2007, investors lost more than US$1bn. Last week, the criminal fraud trial of Cioffi and Tannin began in New York, with both the prosecution and defense presenting their opening statements.

The US government has charged Cioffi and Tannin with securities fraud, wire fraud and conspiracy. Cioffi was also charged with insider trading.

In particular, an email written by Tannin on 23 November 2006 regarding his concerns over the Bear funds has been revealed. It states: "As I sat in John's office, I had a wave of fear set over me that the fund couldn't be run the way that I was 'hoping', and that it was going to subject investors to 'blow-up risk'. Spreads are tight and credit is only deteriorating. I was worried that this would all end badly and that I would have to look for work."

Steven Toskes, a partner at Klayman & Toskes, says: "We expect the testimony and evidence that will be presented at the criminal trial to confirm what we have heard from investors, who believe that Bear Stearns made misrepresentations and engaged in fraudulent conduct in connection with the Bear funds."

Listed products

Shares up for Carador

Carador's NAV per share as of 30 September was €0.425 or US$0.55 - up by 4.88% and 5.31% month-on-month respectively. September's calculations include an estimated -€22,646.52 of net cashflow interest received in the month (to be allocated between capital and income), which equates to -€0.000178 or -US$ 0.0002613 per share.

The net cash outflow resulted from the lower level of scheduled distributions in the month, which was further reduced by the effect of the cashflow diversion from subordinated notes to repay senior notes in certain transactions following breaches in their overcollateralisation tests.

During the month, Carador sold half of its investment in the tranche E of Inwood Park CDO at a price of 38%, realising profits of US$0.720m. The permacap acquired a total of US$8m notional at a price of 20% of par (US$1.6m consideration) in October 2008. Following the September month end, it sold the balance at a price of 50%, realising additional profits of US$1.2m.

In addition, Carador has received aggregate income of US$0.35m from this investment, giving total cash-on-cash return of 2.84x the initial investment over the holding period.

Ratings

Fitch achieves eligibility under CSCF

Fitch has announced that it is to be considered as one of the eligible rating agencies in connection with the Canadian Secured Credit Facility (CSCF). The CSCF involves the federal government purchasing term ABS backed by loans and leases on vehicles and equipment, with an allocation of up to C$12bn, to help restart the ABS market in Canada.

Under the programme, all ABS that are backed by assets originated by large and small enterprise originators must be rated triple-A by any two of DBRS, Fitch, Moody's or S&P. The relevant paragraphs of the CSCF Amended Program Outline and the Commitment Letters will be amended to reflect this update.

Real Estate

Ventras expands into CRE asset management

Ventras Capital Advisors has hired Gregory McManus as a principal in the firm's Philadelphia office. This comes shortly after MBH Enterprises announced the formation of Ventras - a company that will specialise in both residential and commercial real estate funds management and distressed asset management and disposition (see last week's issue).

McManus has over 21 years of experience in commercial real estate, with an extensive background in capital markets, asset management and resolution of distressed assets. He previously served as Capmark's cfo and was responsible for the restructuring of the firm's affordable housing equity group. During his tenure at Capmark, McManus served as a member of Capmark's executive committee, president of Capmark Securities and chairman of Capmark Bank.

Secondary markets

Investment bank expands in valuations

Houlihan Lokey has hired Kai-Ching Lin to its firm's New York office as an md, specialising in the valuation of complex securities, including structured products and derivatives. Prior to joining the firm, Lin was an md in the financial engineering practice of Duff & Phelps. Previously, he was the global head of quantitative methodology in the valuation risk group at Credit Suisse, where he was responsible for developing valuation risk methodology for the trading of derivatives tied to products such as: equities, interest rates, credit, mortgages, commodities and life insurance.

Michael Fazio, md and global head of portfolio valuation and advisory services at Houlihan Lokey, says: "We are excited that Dr. Lin has chosen to join Houlihan Lokey's platform and even more excited to be able to offer his expertise to our clients. Dr. Lin has more than 12 years of experience in financial consulting, in addition to his academic tenure and deep experience valuing the complex securities currently held by many financial institutions. We look forward to having Dr. Lin as part of our team."

Houlihan Lokey's portfolio valuation and advisory services provide hedge funds, private equity firms, other investment managers and financial institutions with independent third-party valuation and advisory services for their illiquid assets. The firm values a broad range of securities and instruments including: illiquid debt and equity securities, MBS, CDO, CLO and complex derivative instruments.

The firm's expertise in the valuation of complex securities and instruments has been particularly relevant in its advisory roles to creditors of both Lehman Brothers Holdings and CIT Group. In June 2009, the firm was appointed to a new expert group formed by the International Valuation Standards Committee (IVSC) on the valuation of financial assets and liabilities.

Structuring/Primary market

Northern Rock restructuring confirmed

Northern Rock has confirmed that it is to be restructured into two separate companies (SCI passim) - Northern Rock and Northern Rock (Asset Management). The lender says the move will help it build a stronger future and deliver value to the taxpayer.

Northern Rock will become a new savings and mortgage bank, holding and servicing all customer savings accounts and some of its existing mortgage accounts. The bank will continue to offer savings and mortgage products.

Northern Rock (Asset Management), on the other hand, will hold and service the balance of the lender's mortgage and unsecured loan accounts. This company will not offer any savings products or new loans.

Both companies will remain in government ownership following the restructuring, which is expected to be completed by the end of the year. The plans are subject to obtaining approval from the European Commission and the UK Financial Services Authority.

Technology

Research tie-up to develop default risk model

Rand Merchant Bank (RMB) and Kamakura Corporation have agreed to a joint research pact focused on default risk modelling for public firms, with a special focus on financial institutions default modelling. Under the research pact, RMB will serve as a steering committee member on Version 5 of the Kamakura risk information services public firm default models. The bilateral exchange of insights will maximise the accuracy of both the KRIS models and proprietary models that RMB has developed specifically for the South African market, the two firms say.

Rautie Nel, head of credit portfolio management at RMB, notes: "RMB is very pleased to announce this research pact. Credit ratings are used as a key input in, inter alia, credit origination, limit setting, pricing, capital allocation and performance measurement. The appropriate measurement of credit risk is therefore very important for the bank. The accuracy ratio of our rating models, measured in terms of being able to differentiate between companies that have and have not defaulted, are very high if calculated on a database of listed companies in South Africa going back almost 15 years."

Nel continues: "This project will give us even more confidence in these models, as we will be able to test the accuracy ratio thereof (and make refinements if necessary) on the much larger KRIS default data base for public firms containing data for firms in 30 countries. By testing RMB's models on the 2 million 'out of sample' observations in the KRIS database, RMB can firmly establish that the fundamental economics of our insights apply consistently around the world. This kind of model testing is also required by the Basel 2 capital rules put forth by the Basel Committee on Banking Supervision."

As part of the joint research effort, RMB will have direct access from Johannesburg to the proprietary KRIS research data bases and related explanatory variables that reside on Kamakura servers in California and Honolulu.

Trading

Credit sales team expands

BTIG has bolstered its fixed income group with the addition of four key hires to its New York fixed income sales team, expanding the firm's coverage in credit, ABS/MBS and emerging markets. The firm has recruited Tim Wilson, John Christenson, Brian Heaton and Ronald Lonergan, a team of Merrill Lynch veterans that most recently worked together at Utendahl.

Steven Starker, co-founder of BTIG, says: "This is the continuation of the fixed income build-out that we began earlier this year and we are continuing to look for further opportunities to expand our group. The team we are bringing on will significantly add to the level of coverage and service we can provide our clients in the fixed income area."

Wilson brings 22 years of experience to BTIG. He spent nearly eight years at Kidder, Peabody before joining Merrill Lynch in 1995 in middle market sales. Wilson is a sales generalist, with an ABS/MBS specialty.

Christenson spent over 23 years at Merrill Lynch. He started on the retail liaison desk before moving to middle market sales and helping to grow that effort into a distinct distribution arm of the institutional sales force. Christenson is a sales generalist, with a credit and emerging market specialty.

Heaton is an MBS specialist, with more than 15 years of experience in the business. He started his career on the government/agency desk at Merrill Lynch before moving to sales.

Lonergan is an 18 year industry veteran, who spent the majority of his career at Merrill Lynch and Deutsche Bank. He is a credit and structured credit specialist.

BTIG's global fixed income group was launched in February of this year by Jon Bass, formerly of UBS, and John Purcell, formerly of Citigroup (SCI passim). The group focuses on sales and trading of credit products, covering the full credit spectrum from investment grade to distressed debt, as well as emerging markets and mortgages. The firm says it plans further expansion in the areas of high grade corporates, high yield, distressed, emerging markets and ABS/MBS.

ABCP

Basel 2 update to impact ABCP market

The new Basel 2 guidelines will impact providers of liquidity support and credit enhancement to ABCP conduits, according to Fitch. However, the agency does not expect the new guidelines to have any rating impact on the ABCP conduits it rates.

The final enhancements to the Basel 2 framework published by the Basel Committee have subtly modified the proposals originally put forward in January 2009. Under the new guidelines, regulators have considerable flexibility in how to classify structured finance exposures, which makes it difficult to make generalisations regarding the new rules and also harder for conduit sponsors to arbitrage them. However, this could also lead to inconsistencies between regulators.

Fitch's analysis indicates that the new Basel 2 guidelines largely eliminate the regulatory capital advantages of setting up an ABCP conduit. Both multi-seller and securities-arbitrage conduit sponsors are likely to face higher capital charges, particularly for any programme-wide credit enhancement (PWCE) facilities they provide.

The guidelines are likely to have a much larger impact on securities arbitrage conduits because of the greater likelihood that both the liquidity and PWCE facilities are considered resecuritisation exposures (which face higher capital charges than normal securitisation exposures). Consequently, Fitch expects the guidelines to result in the winding down of some ABCP conduits, while others may be less impacted or may restructure to survive.

Nevertheless, for most sponsors, the main motivation for setting up an ABCP conduit remains the desire to diversify sources of funding. For this reason alone, many conduit sponsors are unlikely to be deterred by the new Basel 2 guidelines, Fitch notes.

The new guidelines also expand the original proposal regarding 'self-guarantee' exposures. Under the guidelines, a bank would not be able to recognise a rating on an exposure where the rating is largely dependent on a guarantee provided by the same bank. This is intended to prevent capital arbitrage on 'back-door' liquidity support, whereby a bank buys the ABCP from a conduit it sponsors, rather than drawing down on the liquidity facility it provides.

As the ABCP is rated, the bank had been able to enjoy a lower capital charge than it would have had if it had drawn down on the liquidity facility. Under the new guidelines, this arbitrage will be eliminated, even if the bank buys the ABCP into its trading book. Nevertheless, some banks may continue buying ABCP issued by conduits they sponsor in order to enter into repurchase agreements with central banks.

In addition, the new guidelines change the credit conversion factor (CCF) for eligible liquidity facilities under the standardised approach. Originally, eligible liquidity facilities with a term under one year would benefit from a 20% CCF, while those over one year have a 50% CCF. Under the new guidelines, the CCF would be 50% for all eligible liquidity facilities, regardless of the term of the commitment.

In Fitch's opinion this is unlikely to have a significant impact, as most liquidity facilities it reviews are not eligible. An eligible liquidity facility can only support investment grade securities rated triple-B minus or higher.

Similarly, the new guidelines also eliminate the 0% CCF applicable to liquidity facilities that can only be drawn upon a general market disruption (under the standardised and internal ratings based (IRB) approaches). In Fitch's opinion, this is likely to have a negligible impact because no ABCP conduits it rates are supported by market disruption-type liquidity facilities.

Finally, the new guidelines issued by the Basel Committee also cover the requirement for banks to conduct their own risk analysis. Banks will no longer be able to rely solely on external credit ratings and must instead also perform their own risk assessment. Failure to do so could mean a securitisation exposure being treated as unrated, which would result in a full capital deduction.

While this could impact the entire securitisation market, Fitch believes the impact on the ABCP market would be minimal because most liquidity and PWCE facilities are not externally rated. Consequently, most IRB banks are aiming to use the internal assessment approach to size the capital charge on any conduit support facilities they provide.

ABS

Incentive schemes unlikely to impact auto ABS ratings

European Auto ABS transactions are unlikely to be significantly affected by the general success of the new car purchase incentive schemes launched by many European governments in the last 12 months, according to Fitch.

Fitch has previously commented that incentive schemes primarily pull forward new car purchases, rather than creating new demand. Nevertheless, the agency recognises that the schemes may have a negative impact on current and future used car prices, and in turn upon auto ABS transactions. Specifically, for auto ABS transactions lower used car prices would be expected to lead to lower recovery proceeds following repossession and lower sale proceeds in transactions that are exposed to residual value risk.

Grant England, director in Fitch's European consumer ABS team, says: "The schemes have undoubtedly had a positive impact on new car registrations, in what have been extremely challenging market conditions for the European new car market. However, Fitch's analysis of the potential impact of these schemes upon current and future used car prices indicates that the performance of European auto ABS transactions is unlikely to be significantly impacted. Rating action as a direct result of the schemes is therefore unlikely."

Alternative assets

CEDO deals hit by distressed exchange

Credit Suisse, as swap counterparty on the deals, has repurchased at a discount and cancelled in full the notes issued under seven series of equity default swap (EDS) transactions. €62.5m and US$10m of debt securities are affected by the action across CEDO I, CEDO Series 4 (CSAM) and CEDO Series 5.

Each of these synthetic CDOs refer to a portfolio of EDS. The portfolio comprises between 55 and 60 EDS in the risk portfolio, on which the SPV is protection seller, and the same number of EDS in the insurance portfolio, on which the SPV is protection buyer. At maturity of each transaction, the number of net equity events (i.e. the difference in number of equity events in the risk portfolio and in the insurance portfolio) defines the amount of loss to be paid by the SPV to the protection buyer.

The number of net equity events is the total number of hits experienced in the risk portfolio less the total number of hits experienced in the insurance portfolio. The primary performance indicator of an EDS is the barrier, which is the initial barrier multiplied by the ratio of the EDS price at closing and its current price. Stock prices are adjusted when corporate actions affect a reference entity according to the ISDA Equity Derivatives Definitions.

Moody's has withdrawn its ratings on the affected notes. The agency says it views the repurchases as a distressed exchange, which had the effect of allowing the SPV to avoid a payment default at maturity.

CDS

Credit event auctions for MGM, Naftogaz

A failure to pay credit event had occurred in respect of the National Joint Stock Company (NJSC) Naftogaz of Ukraine, according to ISDA's EMEA credit derivatives determinations committee (DC). Naftogaz, a leading enterprise in Ukraine's fuel and energy complex, is reported to have failed to repay principal on a US$500m Eurobond that was due on 30 September. The committee also voted to hold an auction for Naftogaz.

LCDX dealers have also voted to hold an auction for LCDS transactions referencing Metro-Goldwyn-Mayer (MGM), an independent, privately-held motion picture, television, home video and theatrical production and distribution company.

MGM was reported to have failed to make an interest payment on its senior secured loan that was due on 30 September.

Meanwhile, the DC has dismissed the question on whether a failure to pay credit event occurred with respect to Japanese consumer finance company Aiful Corporation. A 'general interest question' was submitted to the committee - a category under which a matter deemed to be of general interest to the marketplace could be submitted as a potential DC issue.

ISDA's DC has already ruled that neither a restructuring credit event nor a bankruptcy credit event has occurred, following the firm's filing for a business revitalisation proceeding (SCI passim).

Separately, the auction to settle the credit derivative trades for Thomson is to be held on 22 October. And a DC vote on whether a restructuring credit event should be called on Cemex has been deferred.

CDS

Global CDS liquidity rises

Global CDS liquidity continued to rise in the past two weeks as market uncertainty about the overall strength of the global economic recovery persists, according to Fitch Solutions.

Thomas Aubrey, md of Fitch Solutions in London, says: "The industrials and consumer goods sectors have seen notable rises in liquidity as industry support schemes, such as cash for clunkers, are being wound down, thereby increasing uncertainty about the sustainability of future demand."

Global CDS liquidity peaked at 10.40 on 8 October versus a high of 10.42 for the previous two-week period. Europe still remains more liquid than the Americas, with Fitch's European CDS liquidity index closing at 9.75 and the Americas closing at 9.98, as of 16 October.

CDS

Fitch launches custom data service

Fitch Solutions has launched an integrated data service (IDS) in order to offer a single, customisable feed platform covering data from across the Fitch Group, including credit ratings, CDS pricing, market-based risk signals and fundamental financial data.

Jon DiGiambattista of Fitch Solutions says: "Integrating continuously updating data from a variety of sources, each with their own formats and identifiers, creates significant overhead for financial companies. Market participant needs for flexible, customisable data services only increase in volatile markets as internal and external demands for information rapidly evolve."

The new feed will enable users to access information on ratings, fundamental financials, CDS pricing and implied ratings and market-based probabilities of default. IDS streamlines the delivery of Fitch's content into a single data feed, which can be customised according to user preferences and is in a standard format that can easily be integrated with legacy IT applications.

Users can select daily, intraday, monthly or quarterly delivery, while data fields use customisable standard common identifiers to enable the integration of a wide range of data. IDS data sets are offered separately, all together or as part of a customised package, which also includes features such as portfolio mapping, data validation and bespoke file formats.

Clearing

Clearing opportunities outlined

JPMorgan's North American equity research analysts have published a new report on the impacts of proposed US OTC derivatives legislation. The report suggests that such legislation presents a new revenue opportunity for both exchanges and dealers, particularly around clearing and notably for CDS instruments.

The report explains: "Our analysis indicates that the various pieces of OTC derivative legislation will have a material impact on the way derivatives are traded. We believe greater capital requirements for financial services companies will drive more OTC derivatives to be cleared. As a result, more OTC trades will be standardised and will be better positioned to trade electronically on alternative swap execution platforms."

It continues: "This will likely drive OTC volumes materially higher and with them listed derivate volumes. Furthermore, we expect clearing fees and other income could rise to an US$8bn opportunity for the clearinghouses and dealer FCMs."

The JPMorgan analysts estimate that the independent and exchange-owned clearinghouses could generate US$3.7bn of revenue from the clearing of OTC derivative trades. They indicate that the biggest revenue generator is likely to be interest rate products, but argue that CDS is the most exciting sector, given the complexity of the product and the ability to generate higher fees per US$1m traded.

Consequently, the analysts forecast clearinghouse revenue of US$1.1bn, but stress that their figures do not include revenue sharing with the dealers. As a result a 50% haircut is likely appropriate.

The report adds that regulatory pressure has encouraged dealers to implement new standardised contracts, which the analysts expect will lead to a significant increase in the size of the clearable market as pre-existing contracts mature and as newer contract types permeate the OTC derivative trading world. Because of the significantly higher capital and margin charges for non-standardised transactions, the report suggests that trading behaviour will change and to migrate to standardised products that are clearable.

As a result, the analysts believe that most CDS products will be clearable within two years. "We expect the vast majority of the CDS market will be clearable, both for indexes and for single securities. Our assumption is based on the high percent of new trades that are clearable in the dealer-to-dealer business, which we think is applicable to the dealer to financial customer segment. We acknowledge that the majority of dealer to non-financial institution business is customised, but that higher capital charges for dealers and banks will lead that business to migrate to more standardised and therefore more clearable securities over time," they explain.

At the same time, the report envisages the likelihood of clearing consolidation. It notes: "There are four CCPs that will or have offered clearing services for CDS - we think that should consolidate to fewer... The rationale for consolidation of clearinghouses is that cross-margining benefits by pooling open interest within the same asset class will drive clearing customers to focus their business with one clearing entity."

CLO Managers

Deep discount amendments for two CLOs

Churchill Pacific Asset Management has amended the documentation on two transactions - Sierra CLO and San Gabriel CLO - related to the deals' deep discount obligations (DDO), according to Moody's.

The amendments allow DDO substitutions into the transactions, but these are subject to certain limitations. These include: the purchase price of the substitute asset must be equal to or greater than the sale price of the disposed asset, but in any event cannot be lower than 50%; the Moody's rating of the substitute asset must be equal to or higher than that of the disposed asset, subject to a minimum rating of B3, and any asset with a SGL-4 designation is excluded; and the Moody's priority category recovery rate of the substitute asset cannot be lower than 45% and must be equal to or greater than the Moody's priority category recovery rate of the disposed asset, unless the substitute asset has a higher Moody's rating.

In that case, the Moody's priority category recovery rate of the substitute asset can be lower if it has a higher Moody's rating, as follows:

• if the Moody's priority category recovery rate of the disposed asset is equal to or greater than 60% and the Moody's rating of the substitute asset is at least two notches higher than the Moody's rating of the disposed asset, then the Moody's priority category recovery rate of the substitute asset must be equal to or greater than 45%;
• if the Moody's priority category recovery rate of the disposed asset is equal to or greater than 60% and the Moody's rating of the substitute asset is one notch higher than the Moody's rating of the disposed asset, then the Moody's priority category recovery rate of the substitute asset must be equal to or greater than 50%;
• if the Moody's priority category recovery rate of the disposed asset is below 60% but equal to or greater than 50% and the Moody's rating of the substitute asset is one notch higher than the Moody's rating of the disposed asset, then the Moody's priority category recovery rate of the substitute asset must be equal to or greater than 45%.

The agency says the amendments will not in and of themselves and at this time cause the current Moody's ratings of the notes to be reduced or withdrawn.

CLOs

US CLO spreads firm, while European prices rise

US CLO spreads stayed firm last week, but European CLOs traded up. According to data from JPMorgan, European triple-A CLO prices tightened by 50bp to 425bp, double-As moved up by €5 to €65, single-As were up €5 to €50, triple-Bs up €5 to €30 and double-Bs up €2 to €17.

CMBS

TALF CMBS subscriptions expected to rise

As the October TALF subscription date approaches (21 October), bid list activity points to an increase in subscription volume versus last month, CMBS analysts at Barclays Capital suggest. Some US$4.8bn notional of bid list activity has been seen since the last TALF subscription date, out of which US$2.6bn or 55% is TALF eligible.

"This is the highest percentage of TALF-able bid list activity yet," the analysts note. "We expect an uptick in loan requests versus last month's US$1.4bn; our preliminary estimate is for around US$2bn in TALF loans requests in October."

CMBS

US CMBS review completed

Fitch has completed its review of 78 US CMBS conduit transactions issued between 2006 and 2008. The review encompassed approximately US$230.4bn in unpaid balance and resulted in affirmations for 80% of the tranches (US$186.1bn) and downgrades to 20% (US$44.3bn) by dollar balance.

The 2007 vintage incurred the majority of negative rating actions. In total, Fitch downgraded 89 junior triple-A classes (totalling US$16.7bn) across the vintage and five mezzanine triple-A classes (US$726m). It affirmed all 492 super senior triple-A classes in its rated portfolio (US$164bn), along with seven junior triple-A classes (US$1.1bn) and 88 mezzanine triple-A classes (US$17.6bn).

Rating actions assumed average recognised losses across these deals to be 6.3%, with the weighted average recognised losses per vintage as follows: 34 deals from 2006 at 5.4%; 40 deals from 2007 at 6.9%; and four deals from 2008 at 6.9%.

Fitch assigned negative rating outlooks to 994 bonds (US$44bn) and stable outlooks on 585 bonds (US$170.6bn). Further rating downgrades are possible, should the full potential losses associated with maturity defaults be realised.

The agency's potential loss analysis does not assume any recovery. Should those assumptions be realised, average potential losses across these deals are expected to be 8.7%. Weighted average potential losses per vintage are as follows: 2006 at 7.2%; 2007 at 9.7%; and 2008 at 8.8%.

To derive expected losses for each transaction, Fitch's analysis included prospective cashflow and value declines for each loan. Each loan was assumed to have cashflow declines of 15% and market value declines of 35%, to derive at an initial loss estimate.

Then approximately two-thirds of the loans in each transaction were examined in more in detail, including the 15 largest loans and any Fitch Loans of Concern. Loss estimates were adjusted for the two-thirds of the pool with this in-depth analysis.

Documentation

Model sale/servicing agreement adopted

The Mortgage Bankers Association (MBA) has adopted a model sale and servicing agreement. The MBA anticipates that it will become the standard form for industry participants to use voluntarily for whole loan purchases and sales made with an eye towards potential securitisation. The agreement was adopted by MBA's Residential Board of Governors (RESBOG) as an MBA supported best practice.

The model agreement is part of an MBA initiative to help increase liquidity and efficiency in the non-conforming residential mortgage market. The agreement provides standard formatting and text for standard practices, reducing the time, effort and cost of legal and due diligence reviews. The agreement also includes standard formats for transaction-specific terms.

John Courson, MBA's president and ceo, says: "At the current time, there is virtually no private label MBS market to speak of. When the market begins to return, we expect it will start with whole loan transactions. This model agreement will provide consistency and transparency to help investors get a better understanding of the whole loans they are purchasing."

Indices

Counterparty risk index unmoved by Q3 earnings

Strong third-quarter results from JPMorgan and Goldman Sachs and a surprise profit at Citi did not translate into dramatic improvement from a counterparty risk standpoint, according to Dave Klein, manager of the CDR Credit Indices.

"Market euphoria appeared to price in earnings results prior to the actual announcements. Goldman beat analysts' expectations and yet missed its 'whisper' number," he says. "A mixed bag of profit and losses within each bank's divisions and a continued lack of transparency prevented a big swing to the upside for the CRI. Still, the index remains near recent tights and earnings announcements have been stronger than anticipated. With BAC and MS still to report over the next week and corporate earnings season in full swing, we wonder how long the current index stability will last."

CDR's Counterparty Risk Index has stayed between 90bp and 110bp for the past month.

Investors

Buyback for UCI transactions

BNP Paribas has announced a tender offer for the Class A notes issued under the UCI 8 through to UCI 17 deals. The offer expires on 30 October 2009.

Operations

UK ABS guarantee scheme unlikely to be extended

Fitch does not expect the UK government to extend its ABS guarantee scheme, primarily as structured finance issuers have not used the scheme to date. Instead, the rating agency expects market-based solutions to reopen and stimulate the RMBS market.

Such solutions could include structures offering investors explicit, albeit non-guaranteed recourse to the originator - such as seen on the recent issuance out of the Permanent master trust programme.

Gregg Kohansky, head of EMEA RMBS at Fitch, says: "A market-led solution appears to be emerging following the compression of RMBS spreads in recent months. Recent publicly-targeted UK RMBS transactions have included a backstop date as to when debt will be repaid. This structural feature appears to be an important consideration for investors, who are concerned about extension risk in the current environment."

The UK government guarantee scheme launched in April was put in place for six months and is due to expire tomorrow, 22 October. The government, however, kept its options open on a possible extension of the scheme.

It was designed to reopen the UK RMBS market and offered structured finance issuers government guarantees covering credit or extension risks at a fixed cost at approximately 25bp over Libor, plus the median five-year CDS rate for the originator. However, there has been no issuance under the scheme, primarily because CDS swaps for banks have widened significantly since the start of the banking crisis, making the scheme's economics unworkable for most originators.

The development of RMBS structures that have recourse to the originator offers more issuance opportunities to mainstream lenders with a branch network, which are typically more highly rated than centralised mortgage lenders. Investors are likely to feel more secure with a liquidity guarantee issued by a highly-rated institution, Fitch notes. Therefore, it would appear that the only option for an unrated centralised lender would be to negotiate a put to, or a guarantee of its own put obligation from, a financial institution that is perceived to have low default risk.

However, this could prove costly in the current market. Since RMBS structured with put options back to the issuer effectively mimic the core dual-recourse feature of residential mortgage covered bond transactions, the spread differential for these issuance types will also be a key consideration for issuers.

Alastair Bigley, head of UK RMBS at Fitch, says: "Fitch expects near-term public issuance to occur out of existing master trust programmes rather than new stand-alone pass-through transactions. The potentially lower weighted average funding costs for a master trust issuance might make it a more attractive option for issuers, with the added benefit of avoiding the administrative hurdle of creating a new programme."

However, although originators may favour the benefits of issuing new RMBS securities from a pre-existing structure, certain investors are wary of master trust structures because of the inability to pick or avoid a particular vintage of assets, the revolving nature of the collateral and the uncertainty introduced by asset and non-asset triggers. To the extent the present market remains a buyer's market, it is possible that originators with master trust programmes will also issue stand-alone transactions to meet investor requirements.

Ratings

NAIC ratings proposal analysed

Fitch has outlined its observations regarding NAIC's expected RMBS-related changes for insurance company ratings, from the perspective of their usefulness for analysis purposes. The Association's Valuation of Securities Task Force last week approved the core aspects of an ACLI proposal to update the risk-based capital (RBC) formula used by life insurers.

Under the NAIC's current RBC formula, the implied capital charges for downgraded RMBS held by many life insurers would increase for year-end 2009 financial reporting. The life industry estimates that it held US$145bn of non-agency RMBS securities at year-end 2008, with the RBC requirement for these securities estimated to be US$2bn at that time. Given the recent downgrades in the sector, the industry estimates that the capital requirements would increase to US$11bn under the ratio, with approximately 53% of that increase borne by the 20 largest life insurers.

Current NAIC ratings are based on NRSRO ratings, which are in turn focused primarily on the likelihood of the first dollar of loss. The resulting RBC factor does not completely reflect the potential severity of the loss, ACLI says.

To overcome this rating deficiency, it recommends a rating proposal that recognises both the likelihood of loss and the severity of loss. Life companies will appropriately hold more RBC than before the recent spate of RMBS downgrades, but will not be subjected to consequent volatile RBC requirements.

A key part of the proposal would involve the employment of risk advisory firms that will develop expected loss (EL) estimates for downgraded RMBS securities. These EL estimates would form the basis for the capital charges used in the RBC ratio for year-end 2009 financial reporting and would replace the traditional probability of default (PD) approach.

Fitch notes that moving to a more refined approach to EL for RMBS securities is useful for insurance company ratings analysis purposes, since it helps bring the NAIC formula more up-to-date with current capital markets thinking on structured finance credit risk and closer to the agency's approach to investment risk analysis. But it notes the importance of considering not only the high expected recoveries for senior RMBS securities, but also the very poor or full losses expected on mezzanine and subordinated securities.

Additionally, Fitch notes that while the expected change is only being enacted for life RBC, the property/casualty industries' exposure to RMBS is significantly lower than that of the life industry. Historically, other risk charges have also differed between the two RBC formulas, such as the charge used for common stock investments.

Further, to make the process transparent for analytical purposes, it would be helpful if the NAIC required disclosure of the ELs in insurers' investment schedules included as part of publicly available statutory annual reports. And, for consistency and to support analytical rigour, it is important that the EL factors developed by the risk advisory firms be set at the same confidence level as other risk charges in the RBC formula, since most NAIC risk factors are set at a confidence level higher than the pure expected loss.

A number of issues still need to be resolved in implementing the NAIC's expected changes in capital methodology, including final selection of risk advisory firms that will develop the EL estimates and agreement on modelling assumptions used by the risk advisors.

Ratings

Market value assumptions to be revisited

S&P is continuing its review of the assumptions and methodologies that it uses to assign ratings derived from analysing assets' market values. This expands the scope of its 31 December 2008 notice regarding market value (MV) CLOs (see SCI issue 118).

To reflect this greater scope of analysis, the agency is notifying the market about potential criteria changes on the following products: MV CLOs; leveraged funds (those that are registered under the Investment Company Act of 1940); SIVs; derivative product companies; repo conduits; leveraged super-senior structures; CPDOs; and structures that primarily and/or partially rely on asset liquidations, spread movements or collateral posting arrangements. S&P expects to announce its proposed criteria changes after seeking market participants' feedback through various forthcoming requests for comment.

Ratings

Economic downturn weighs on Spanish performance

Deteriorating macro-economic conditions in Spain are continuing to weigh on the performance of structured finance assets across different sectors, according to Fitch. The agency notes that while historically low interest rates are providing some support and banks are rolling out loan modification and restructuring programmes in an effort to minimise defaults, difficult labour market conditions will likely drive further RMBS and ABS deterioration over the near-term.

Rui Pereira, md in Fitch's structured finance team in Madrid, says: "Performance across structured finance sectors in Spain continues to be affected by the challenging domestic economic environment, with a sharp rise in unemployment and the ongoing correction in the housing market acting as key catalysts."

The agency expects that SME CDO transactions will also remain under pressure due to their significant exposure to the construction and real estate-related segments, and because of tighter credit conditions which have increased refinancing risk.

The deterioration of asset performance has resulted in a growing number of rating actions in recent quarters, with 158 downgrades recorded by the agency in H109. The most affected transactions involve collateral originated at the height of the housing market boom with more aggressive credit attributes. The agency continues to assign negative outlooks to existing transactions, particularly on more vulnerable subordinate classes, reflecting ongoing concerns about Spanish macroeconomic conditions and their impact on performance.

Despite continued difficulties in the securitisation primary market, Spain continues to represent the second-largest structured finance market in Europe, with 41 transactions issued in the first half of 2009, representing €54.2bn in debt. This represents a 9.5% decline in volume compared with the first half of 2008. Fitch expects ECB-driven structured finance volume to decline over the near-term due to weak credit growth and easing liquidity conditions for banks.

Ratings

Role of credit bureaus analysed

Moody's has released a new special report explaining how it views credit bureaus in EMEA and how the bureaus are taken into account, either directly or indirectly, in its RMBS and ABS methodologies. The report has no rating implications for EMEA RMBS and ABS transactions, however.

In the report Moody's notes that credit bureaus are an essential piece of infrastructure in the consumer lending sector in most jurisdictions, given that they help lenders to assess the creditworthiness of potential borrowers by providing key historical information on their credit behaviour. Louise Walewska, a Moody's associate analyst and author of the report, says: "Credit bureaus in EMEA are diverse and not easily comparable. Their collection of data varies depending on their status (public or private credit bureaus) and local regulations. They provide a variety of information ranging from negative and positive credit data to live and cured credit events for different amount thresholds and time periods."

The agency says that the way lenders use credit data in their underwriting and servicing guidelines is one of the components of the originator and servicer adjustments in its RMBS MILAN scoring tool. Walewska explains: "In RMBS transactions that include loans to borrowers with adverse credit history, Moody's penalises credit events loan-by-loan according to its published MILAN methodology. Meanwhile, in ABS, Moody's typically does not adjust its default probability assumptions on consumer transactions for credit bureau data, as such data is usually not provided."

However, it notes that reliance on historical data for consumer credit implicitly reflects the importance of the usage of credit bureau data, which should result in a better portfolio performance.

The rating agency has assessed countries depending on the coverage and the completeness of data provided by each country's credit bureaus. The report details the type of data provided by credit bureaus and how it is used in both the underwriting and servicing processes.

Real Estate

CRE CDO note exchange completed

Gramercy Capital Corp has settled an exchange of US$97.5m of junior subordinated notes due 30 June 2035 issued by its operating partnership subsidiary for an equivalent par value amount of various classes of bonds previously purchased in the open market issued under the Gramercy Real Estate CDO 2005-1, Gramercy Real Estate CDO 2006-1 and Gramercy Real Estate CDO 2007-1 transactions. The exchange leaves US$52.5m of additional junior subordinated notes outstanding, the firm says.

Real Estate

CRE CDO universe under review

Credit fundamentals continue to decline for collateral within US CRE CDOs, according to Fitch. In response, the agency has updated its surveillance methodology for the sector and has placed an additional US$6.1bn (41 classes from 18 transactions) on rating watch negative. As a result, its entire rated CRE CDO universe is on rating watch negative.

Fitch anticipates substantial rating actions across the capital structures of US CRE CDOs after applying its new surveillance criteria. Few tranches will receive ratings higher than triple-B, with a majority of classes expected to be assigned below investment grade ratings.

The Fitch CREL CDO Delinquency Index reached 8.7% in September 2009, with delinquencies in individual CDOs ranging from 0% to 35%. This rate is nearly 2.5 times that of the Fitch CMBS delinquency rate of 3.58% reported in October 2009. Further, the CREL CDO delinquency index understates the full extent of underperforming loans in CRE CDOs by excluding realised losses, as well as extensions and modifications on high risk loans.

Fitch has increasingly observed asset managers removing credit-impaired assets at prices below par, resulting in realised losses to the portfolios. To date, aggregate losses to CDO collateral are estimated at US$825m, or 3.4% of initial fully-ramped collateral. The cumulative delinquency rate for CREL CDOs is likely to exceed 15% by year-end 2009 when realised losses are considered.

Delinquencies have been and are expected to continue to be tempered as asset managers continue to extend and modify many assets. Asset managers have extended, on average, 70% of loans maturing since January 2009.

Additionally, while managers are realising losses by trading out impaired assets, they are often reinvesting in discounted assets with the full notional amount counted as par. Known as 'par-building', these trades generally result in a net increase to the notional collateral balance, Fitch notes.

The effect of par-building may be to reduce the significance of overcollateralisation tests by allowing the tests to stay in compliance. Although par-building is typically permitted under transaction documents, Fitch says it may increase its expected loss on new purchases to reflect, at a minimum, the difference between par and the purchase price.

Preliminary application of the agency's updated criteria results in an average CRE CDO loss expectation of 35%, ranging from less than 20% to more than 60%. The broad range of loss expectations reflects the unique characteristics of each portfolio. For example, the lower expected losses reflect portfolios with lower leveraged, less transitional assets, while higher expected losses typically reflect portfolios with transitional, deeply subordinated collateral.

To derive the base-case expected losses for each transaction, Fitch's analysis included a prospective cashflow decline for each loan, which averages 15%. The corresponding value declines range from 35% to 60%.

Real Estate

CRE prices decline, but at slower pace

Commercial real estate prices - as measured by Moody's/REAL Commercial Property Price Indices (CPPI) - continued to decline in August, but at a slower pace than in preceding months. The CPPI was down by 3% from July after that month saw a 5.1% drop from June.

Moody's md Nick Levidy says: "Although prices have declined steadily over the past year, the rate of decline has slowed in recent months after falling by about 8% in both April and May."

Moody's/REAL CPPI is now 32.8% below its level from a year earlier and 40.6% below its peak measured in October 2007.

At 377 sales, the overall volume of transactions in August continued to be low, the rating agency notes. The number of sales, however, was a pick-up from July, which had slightly more than 300 sales.

Real Estate

Credit deterioration continues in REIT TruPS CDOs

Recent debt exchanges by US REITs, homebuilders and specialty finance companies are symptomatic of further credit deterioration among REIT TruPS CDOs, Fitch notes in a new report. These debt exchanges have generally decreased interest proceeds, while also increasing the amount of distressed assets and introducing unanticipated portfolio concentrations. This year alone, 25 REIT, homebuilder or specialty finance issuers have either restructured or exchanged debt obligations across 15 of the 16 Fitch-rated REIT TruPS CDOs.

Fitch md and US REIT group head Steven Marks says: "Ongoing recessionary pressures are still affecting the performance of REIT issuers, prompting these companies to partake in debt exchanges."

Johann Juan, a director in Fitch's structured credit group, explains: "What the rising incidence of debt exchanges is doing is eroding excess spread and increasing the chance that REIT TruPS CDOs will trigger an event of default."

To date, four REIT TruPS CDOs have triggered an event of default. Fitch placed 28 tranches in eight REIT TruPS CDOs on rating watch negative in September due to both deteriorating principal and interest coverage and negative portfolio credit migration. The agency expects to review its 16 rated REIT TruPS CDOs before the end of the year.

Fitch structured credit md Kevin Kendra notes: "The erosion of credit enhancement arising from debt restructuring and exchanges will play a more integral part in determining the severity of future rating actions."

Regulation

Legislation approved to regulate derivatives

The US House Financial Services Committee approved on 15 October legislation that would, for the first time ever, require the comprehensive regulation of the OTC derivatives marketplace. The bill was approved by a vote of 43-26 and represents a key part of a broader effort by US Congress to modernise the US financial regulatory system in response to last year's financial crisis.

Under the bill, all standardised swap transactions between major swap participants would have to be cleared and must be traded on an exchange or electronic platform. A major swap participant is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions creates such significant exposure to others that it requires monitoring.

The legislation sets out parallel regulatory frameworks for the regulation of swap markets, dealers and major swap participants. Rulemaking authority is held jointly by the Commodity Futures Trading Commission (CFTC), which has jurisdiction over swaps, and the SEC, which has jurisdiction over security-based swaps.

The Treasury Department has been given the authority to issue final rules if the CFTC and SEC cannot decide on a joint approach within 180 days. Subsequent interpretations of rules must be agreed to jointly by the two Commissions.

Regulation

Warning on exchange trading, collateral requirements

ISDA has welcomed the European Commission's continued recognition of the important role derivatives play in the economy, as expressed in the EC's Communication outlining future policy actions on derivatives markets. However, the Association says that proper consideration should be especially given to any policy requiring that standardised OTC trades be conducted on an exchange or electronic trading platform.

In light of the G20's recent agreement that exchange trading should take place "where appropriate", ISDA believes that the benefits, as well as the drawbacks, of exchange trading now need to be carefully weighed. Mandated exchange trading could limit the flexibility of derivatives users to hedge their risk exposure, the Association notes. It warns that some forms of price disclosure and inappropriate forms of standardisation will harm liquidity by disincentivising participation in derivative markets.

"ISDA and the industry have achieved significant progress improving and standardising various derivatives markets, including CDS, and we look forward to continued success in collaboration with the Commission," comments Robert Pickel, ISDA executive director and ceo. "At the same, we want to make sure that any new policies or regulations preserve and enhance the critical ability of market participants to manage their risk exposures."

For example, ISDA strongly believes that increasing collateral requirements on non-financial institutions could be excessively burdensome. The Association says it looks forward to working with regulators on the recently publicised international regulatory initiative focusing on an appropriate collateralisation framework for bilateral transactions.

Regulation

Trading book capital multipliers confirmed

The Basel Committee has released the results of its recent trading book quantitative impact study. It says it will conduct a further impact study to evaluate a floor for the comprehensive risk capital charge for correlation trading portfolios. This impact study will be completed in 2010, with the trading book requirements to be implemented no later than 31 December 2010.

The study assesses the impact of the revisions to the 1996 rules governing trading book capital, which were originally published by the committee in January and were subsequently adopted in July. Excluding the correlation trading portfolio, the report concludes that the changes to the market risk framework will increase average trading book capital requirements by two to three times their current levels, although the Committee noted significant dispersion around this average.

Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank, notes: "Increasingly complex trading book exposures were a major driver of losses in the recent crisis. The reforms will ensure that these exposures are backed by a sufficient capital cushion, help address pro-cyclicality of trading book capital requirements and limit arbitrage opportunities between the trading book and the banking book."

Based on the results of the study, the Committee has decided to maintain the original calibration as proposed in its January consultative package and as adopted in July 2009. The Committee's new trading book rules set a multiplier of three for both the current and stressed value-at-risk measures, as well as a three-month floor on the liquidity horizon used in incremental and comprehensive risk capital requirements.

The incremental risk measure includes default risk, as well as migration risk for unsecuritised credit products held in the trading book. The comprehensive risk measure can be applied to banks' correlation trading portfolios and captures not just incremental default and migration risks, but all price risks.

RMBS

FSA proposal unlikely to impact RMBS market

The UK FSA has released a discussion paper addressing regulatory reform of the country's mortgage market. The move is designed to achieve a more balanced long-term approach to lending, but in most cases lenders have already adopted such practices and consequently the measures are unlikely to have much of an impact on both the UK lending market in general and the securitisation market in particular, according to ABS analysts at Deutsche Bank.

Although an immediate outright cap on loan metrics (LTV and DTI) is excluded, more stringent affordability tests, banning of 'toxic' risk layering (for example, high LTV loans to credit-impaired borrowers), regulating buy-to-let and second-lien lending, a ban on self-certified mortgages and more stringent forbearance rules have all been put forward.

"Forbearance was the one area securitisation did come in for some pointed criticism, with the authority stating that in future securitisation covenants must not hinder fair repossession treatment," the Deutsche Bank analysts note. "However, as long as repossession leniency is limited to 'soft' reform, i.e. no cram-down, in our opinion securitisation documentation should be versatile enough to deal with any proposed changes."

RMBS

Banks prepare to consolidate certain RMBS

New US GAAP accounting rules for securitisations and other off-balance sheet structures will become effective on 1 January 2010, with the adoption of these standards expected to bring certain off-balance sheet activities back onto banks' books. According to a report in Moody's latest ResiLandscape newsletter, banks are in the process of assessing which of their structured transactions will need to be consolidated under the new rules.

Moody's says that private-label RMBS will be among those impacted and, as larger balance sheets mean higher capital requirements, banks are likely to find securitisations less attractive. "Residential mortgage transactions where the GSEs (Freddie Mac and Fannie Mae) fully guarantee principal and interest payments will remain off-balance sheet under the new rules," it confirms. "However, 'private-label' transactions without a GSE guarantee will potentially be consolidated. In most situations the decision to consolidate private label securitisations will be based on the bank holding an equity or first-loss tranche of their securitisations. As a result, some banks may try to sell this retained interest prior to the new rules becoming effective on 1 January 2010 to avoid consolidation."

Moody's takes Wells Fargo as an example. In the bank's most recent quarterly report to the SEC on 30 June 2009, it indicated that it expects approximately US$50bn of private-label residential mortgages to come on-balance sheet on 1 January 2010.

This excludes an additional US$37bn that Wells Fargo intends to sell prior to the new rules becoming effective. This amounts to 7% of its reported total assets at 30 June 2009. It has US$1.1trn of off-balance sheet GSE-guaranteed residential mortgages that would not be subject to consolidation.

The rating agency also points out that Citigroup indicated that it expects approximately US$9bn of private-label consumer mortgages to be consolidated, which is less than 1% of its reported total assets on 30 June 2009. "The new rules are likely to make securitisations less attractive to banks due to the higher capital requirement associated with larger balance sheets," says Moody's. "From a risk-based capital standpoint, the impact will be partially tempered by the elimination of residual interests in consolidation and their associated capital requirement."

It continues: "The new rules also eliminate the ability of banks to record immediate gains on securitisations that have to be kept on-balance sheet. Although the new rules are closer to the economic reality of such transactions, the loss of gain-on-sale accounting is a blow to banks that otherwise would have relied on these transactions to immediately maintain or increase their reported margins."

In order to side-step these issues, banks may attempt to sell all of their residual interests in securitisations, allowing them to achieve off-balance sheet treatment, suggests Moody's. "However, in the current market, there are limited buyers of these interests and the pricing offered could potentially make this option economically unattractive," it says. "Further, the Treasury has indicated that it might consider requiring banks to maintain a residual interest (or 'skin in the game') in new securitisations, as part of its financial reform plan to promote proper alignment of incentives in such transactions."

RMBS

US mortgage market outlook published

S&P has published its outlook assumptions for the US residential mortgage market in an effort to help market participants better understand its approach to reviewing US RMBS.

Highlights of the outlook assumptions include:

• S&P's loss expectation for the archetypical prime RMBS pool and the baseline credit enhancement level it associates with a single-B rating for prime RMBS is 0.50% of the original pool balance (assumptions for prime RMBS are the starting point for analysing the other RMBS asset categories).
• S&P expects continued weakness in the US residential mortgage market through to mid-2010, followed by a period of stabilisation and a slow subsequent recovery.
• The rating agency believes that under this market scenario, the market value decline assumptions underlying the 0.50% credit enhancement level are appropriate.

RMBS

Significant decline expected for Irish house prices

Further house price declines in Ireland are expected, Fitch reports. The declines to-date amount to 24% from the December 2006 peak, according to data from The Permanent TSB/Economic and Social Research Institute, and the agency now expects a total house price decline of approximately 45% from the peak of late 2006.

Alastair Bigley, head of Irish RMBS at Fitch, says: "Tax rises, high unemployment, wage deflation and property supply overhang continue to undermine the country's property market."

Ireland is undergoing one of the deepest recessions of all advanced economies. The agency expects real GDP to contract by 7%-8% in 2009 and the poor state of public finances has left the government no room to use fiscal measures to support the economy. Fitch anticipates unemployment to rise to 12.5% in 2009 and 15% in 2011.

"Despite almost three years of house price declines, prices have yet to reach a sustainable level of affordability," explains Douglas Renwick, associate director in Fitch's sovereigns team.

This will be exacerbated by an expected increase in the cost of funding to Irish financial institutions. The three main factors driving this increase in funding costs are:

• The cost of the EU's guarantee of banks' debt issuance is set to be more expensive than compared to the current Irish state guarantee.
• Inter-bank lending rates in Ireland have increased substantially and remain at higher levels than other international banks, reflecting market concerns over the creditworthiness of Irish banks and the Irish Sovereign.
• Increased retail deposit-taking will be essential as Irish banks rebuild their balance sheets, in the face of restrictions in other funding avenues and the ensuing competition for retail deposits will inevitably raise the cost of this funding route.

Irish mortgage borrowers have enjoyed interest rates that are among the lowest in the Eurozone for much of the past decade but, to date, banks' increased funding costs have largely not been passed on to consumers. Therefore, Fitch believes it is inevitable that higher interest rates will be passed on.

Michael Greaney, associate director in Fitch's RMBS group, says: "Fitch expects all lenders to increase their mortgage rates and it seems certain that mortgage affordability will suffer against a backdrop of a generally higher tax burden, increasing unemployment and negative to zero wage inflation. Fitch therefore expects further house price declines and late-stage mortgage arrears to rise."

House prices started to fall in January 2007 and have fallen month-on-month since then. They currently stand at approximately 24% down from the peak.

Fitch estimates that the current average house price is 7.5x the average income in the country. The agency expects this ratio to revert to nearer 5.5x average individual income, which would equate to a 45% fall from peak house prices.

For the house price to income ratio to fall in line to the same ratio for the UK, which does not have a similar supply overhang problem, Fitch estimates peak-to-trough declines of over 50% would be needed. A fall of 45% would take house prices to levels seen in Q4 2000. Irish house prices rose approximately 100% from the start of the decade to the peak in December 2006.

Fitch is currently in the process of reviewing its ratings of all Irish RMBS transactions and will comment further in due course. The performance of Irish sub-prime transactions is of particular concern on the back of mounting arrears and inability for borrowers to refinance, the agency says.

Structuring/Primary market

Re-REMIC moratorium expanded to all Alt-A RMBS

Fitch has extended its moratorium on rating certain US RMBS resecuritisations to now include all transactions comprised of Alt-A loans. The agency's moratorium, which has been in place for several months, was previously comprised of US RMBS re-REMICs backed by all types of subprime loans and those Alt-A loans with overcollateralisation structures, because they depict subprime performance attributes.

Fitch has provided ratings on re-REMIC transactions backed by prime jumbo mortgages and those backed by select Alt-A transactions. But, despite signs of performance stabilisation in Alt-A collateral over the last few months, the latest monthly data suggests a return of delinquency volatility. As such, the agency says it will no longer provide ratings on any Alt-A related re-REMICs.

Fitch does not expect that the moratorium will directly impact the ratings of any recently rated Alt-A re-REMICs, as they were backed by collateral with greater performance stability, as opposed to more recently reviewed transactions that have had elevated levels of delinquencies.

Technology

Price verification application updated

Technology integration company Formicary has released the latest version of RiskSeer - an integrated independent price verification application. The offering centralises market and trade data to facilitate accurate and timely decision-making by the risk, product control and finance units of financial institutions.

Building on the original application, the new version of RiskSeer features: extended securities coverage; position valuation calculation and tolerance checks; rules-based price averaging from multiple raw data sources; and the ability to integrate custom pricing models and extended market data feed handling for Reuters, Bloomberg and Markit. It automatically pulls together data from multiple price sources and is able to feed multiple price destinations in one, consolidated view - organised by any available data attribute, such as instrument type, currency, index or counterparty.

The application enables authorised users to access, manipulate and quality-check trade/pricing data and export the information on demand, Formicary says. Product controllers, risk and finance personnel can request the market value of positions from an individual asset, book, regional or global perspective at any given time.

Alexander Millington, director of Formicary's trading and risk technology group, says: "Accurate front office market valuations play a critical role in the risk management process. Many financial institutions have created their own in-house systems for price verification, but these don't always show the full picture. RiskSeer is different in that it brings together data from multiple price sources to multiple price destinations, working alongside existing trading and market data applications to create a transparent, integrated workspace that eases every aspect of the valuation and risk process."

Trading

Trading ideas: wrapped up

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at a negative basis trade on MeadWestvaco Corp

The paper and packaging industry offers solid basis opportunities, with a few companies' CDS trading at discounts to their cash underlying. The most difficult question we face is choosing which issuer to go with.

MeadWestvaco (MWV) issued a 10-year bond back in August, which went out with a substantial negative basis. At the time, we recommended that clients buy the bond hedged with CDS. Though the negative basis has tightened since issuance, there is plenty more room to go.

Given our negative view on MWV's CDS, we believe the cash market accurately prices the company's credit risk. This will ultimately lead to further compression of the bond's negative basis.

Based on comparables, the MWV negative basis trade is the most attractive of the group. Pactiv Corp, MWV, International Paper and Weyerhaeuser bonds all trade at noticeable discounts to their CDS; however, MWV's tight CDS spread combined with its 300+ z-spread on its 2019 issue makes it the top pick (see exhibit below).

Pactiv's five-year CDS is at a similar level to MWV's (near 80bp); however, Pactiv's 6.4s of Jan 2018 bond trades with a z-spread closer to 220bp, leaving a much tighter negative basis package. We are neutral to positive on Pactiv's CDS and would actually prefer to own its bond outright rather than in a negative basis package.

On the riskier end, though IP and WY bonds trade with z-spreads roughly 50bp-75bp wider than MWV's, both companies' CDS are close to double that of MWV's. The negative basis on the Weyerhaeuser bond is roughly equivalent to that of MWV's in absolute terms; however, the lower spread issuer offers the better risk/reward characteristics.

From a fundamental standpoint, we hold a negative view on MWV's CDS spread at 80bp. MWV's CDS could easily trade much more in line with International Paper's.

MWV's debt/EBITDA of 4x, interest coverage of 3x and earnings margins of 9% all fail to top IP's. That being said, from the positive angle MWV's liquidity is solid, with US$623m in cash to total debt of US$2.4bn (see exhibit below). The bond market more accurately assesses the MWV's credit risk, which will eventually result in a tightening of the negative basis on the 10-year bond.

Based on our CDS-implied valuation approach, the MeadWestvaco Corp 7 3/8s of September 2019 bond fair value is US$122.50 against a purchase price of US$106.00. The bond trades with a cash-CDS basis of -198bp.

The position is default-neutral. There is a slight maturity mismatch because the bond matures on 1 September 2019 and the CDS expires on 20 December 2019, but we expect to be able to exit the trade with a profit from carry and convergence to fair value before either instrument matures.

Position

Buy US$10m notional MeadWestvaco Corp. 10 Year CDS protection at 105bp.

Buy US$10m notional (US$10.6m cost) MWV Corp. 7 3/8s of September 2019 at US$106 (T + 311bp; z-spread of 306bp) to gain 201bp of positive carry.

The appropriate interest rate is dependent on the portfolio in which the trade is held. Customised rate hedge information is available upon request.

For more information and regular updates on this trade idea go to: www.creditresearch.com

Copyright © 2009 Credit Derivatives Research LLC. All Rights Reserved.

Note: This article is intended for general information and use, and does not constitute trading advice from Structured Credit Investor (see also terms and conditions, below, section 12).