Contents

Trading

Steepener strategies

Investors seek to express specific credit index views

iTraxx index tranches have generally lagged the credit rally, but over the last two weeks they have steadily been catching up with the rest of the CDS market to reflect the benefits of bank balance sheet repair. Valuations are now attracting relative value plays utilising both tranche and vanilla index products.

"The benefits of balance sheet repair were first reflected in the cash market and then in CDS, with single names steepening to reflect the refinancing into longer maturities," confirms Suraj Tanna, credit derivatives strategist at BofA Merrill Lynch Global Research. "Together with a slight drop in volatility, this is driving investors to look at strategies that are a touch more bullish on the market."

Andrea Cicione, senior credit analyst at BNP Paribas, suggests that being outright long CDS is no longer attractive with valuations moving ever tighter. "Liquidity has returned to the CDS market and, with traders now quoting a quarter of a basis point bid/offer spread on the iTraxx Main, looking for relative value opportunities is less costly."

For example, mezzanine tranche trades have performed well, with the 3%-6% 20 points lower versus delta since the March index wides. But there was little differentiation between maturities, with all tenors tightening by a similar extent.

"We don't agree with the 3%-6% curve failing to steepen: it doesn't make sense because refinancings push defaults further into the future. The market should be concerned that the impact of a mild economic recovery will serve to push default expectations higher in the long term. In light of this, a steepener on the 5y10y should hold value in the long term," explains Tanna.

He says that while the bespoke tranche market is still seeing unwinding/restructuring activity, in the flow index tranche sector liquidity has picked up and new investors are looking at the product. "Tranches can provide an efficient way to express a specific view. For instance, rather than a steepener on the overall index, a 3-6% steepener is one way to express the view that short-term defaults are unlikely and the refinancing story has further to run."

Steepeners on the overall index remain popular, however. Cicione expects CDS curves to continue to steepen for the investment grade iTraxx indices, given the steepeners' more compelling risk-return profile compared to outright long positions.

He points out that when the net notional exposure for a 5y10y steepener is the same as that for a five-year long-risk position for the iTraxx indices, the jump-to-default risk is the same for the two trades. "Additionally, given that the five-year and 10-year S12 indices have the same standardised coupon, the carry for both steepener and outright is the same. This leaves the expected rolldown as the only differentiating variable between a steepener and an outright long, and the one that explains the attractiveness of the former over the latter."

iTraxx curves are steeper in the 3y5y section than in the 7y10y; therefore, the rolldown per unit of notional is higher for the five-year maturity than for the 10-year. Given that steepeners have a larger long-risk position in the five-year than the outright trades, their rolldown is higher. A higher carry and rolldown for steepeners means that the number of defaults that an investor can afford to suffer is higher too, according to Cicione.

"Given that at current levels the tightening potential for spreads is becoming increasingly limited, we believe that steepeners have a more compelling risk-reward profile than outright longs. Additionally, being much less directional, they also provide more protection in case investors are concerned about a possible spike in volatility resulting in spread widening," he explains.

Together with index steepeners, other relative value plays being executed in the sector include compression trades between the Main and Crossover or HiVol indices, and pair trades between single name CDS. "The first half of the year was about capturing beta, but now there is more differentiation between names, even within the same sector," Cicione concludes. "Investors are looking for nuances in a tightening market: given that the economic environment remains challenging, the difference in performance between names can make a significant difference in returns. For example, companies with exposure to emerging markets are expected to outperform because that is where growth is anticipated to come from."

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SIVs

Overruled

Sigma creditor payment decision sets SIV precedent

The UK Supreme Court last week overturned a Court of Appeal ruling dictating how the proceeds of the Sigma Finance SIV should be paid to various categories of secured creditors. The ruling - the first of its kind to reach the Supreme Court - may have ramifications for similar vehicles.

The Supreme Court ruled - by a majority of four to one - that the receivers were not required by Clause 7.6 to pay short-term liabilities as they fell due during the realisation period in a situation where there were insufficient funds available to pay all secured liabilities of Sigma in full. This overrules judgments from both the UK's High Court and Court of Appeal.

"The Court of Appeal last year ruled that Party A - creditors with the shortest maturing positions - would be paid before Parties B, C and D. In this event, there was no realistic possibility that Parties B, C or D would receive any proceeds from the SIV liquidation," explains Sue Prevezer, partner at Quinn Emanuel Urquhart Oliver & Hedges and leader of the legal team for Party D.

The Supreme Court only agrees to hear about 70 cases a year and, as a matter of English law, will only hear cases which it considers to be of general public importance. "In order to get permission to appeal from the House of Lords (now the Supreme Court), we had to convince the law lords considering the Petition for permission that the issue raised was one of public interest and that Parties D and C's construction was properly arguable," Prevezer adds.

She continues: "Even making allowances for differences in drafting between various SIV and other structured finance documents, the arguments raised on the appeal on the construction of this particular SIV document are likely to be of general significance. Further, the judgment raises an issue of general public importance as to the importance of construing documents so as to satisfy reasonable commercial expectations."

The Gordian Knot SIV, once valued at US$27bn, was the first and largest SIV. Last year it became insolvent with total liabilities in excess of US$9bn.

Following Party A's initial victory in the Court of Appeal in November 2008, the receivers (Ernst & Young) sold the SIV's assets via an auction in early December. At that time, the other parties were not prepared to indemnify Party A against any loss it might suffer if it did not sell then, but it won in the Lords and then sold at a loss.

At the auction, the firm bids for the debt securities were received from nine bidders - the highest combination of which valued the portfolio at just US$306m. The receivers accepted the highest bid prices.

The receivers are currently considering the implications of the judgment of the Supreme Court and how this affects the receivership of Sigma going forward.

AC

ABS

Lebanese auto ABS launched

Bemo Securitisation (BSEC) has completed a US$13.15m auto loan securitisation for Rasamny Younis Motor Company (RYMCO), the exclusive distributor in Lebanon of Nissan, Infiniti and GMC brands and the franchise operator of the Infiniti brand in the UK. The deal is backed by a diversified portfolio of auto loans granted by RYMCO to its clients and is the first term securitisation established under Lebanese Asset Securitisation Law 705/2005.

"The transaction's success reinforces the view that the local capital markets are in need of alternative and innovative investment opportunities, especially due to the increasing liquidity of the local banks," says Riad Obegi, chairman of BSEC.

On the closing date, RYMCO sold to the fund on a true sale basis a portfolio composed of hundreds of auto loans granted to several obligors, pursuant to Banque du Liban approval. The fund issued two classes of notes: Class A, with an expected weighted average life of 3.7 years and a yearly fixed coupon of 7.5%; and Class B, which was retained by RYMCO.

The Class A noteholders will benefit from: first loss protection of 22.5%, provided by the subordination of the Class B note; a cash reserve of 3.7% fully funded on closing; and an excess spread trapping mechanism. The structure provides for a three-year replenishing period, during which the fund may purchase additional auto loans subject to certain preset criteria. This will result in a total financing to RYMCO that could go up to US$40m.

The deal is structured, arranged and co-lead managed by BSEC, a financial institution specialised in structured finance. FFA Private Bank and First National Bank were co-lead managers.

The issuance was underwritten by FFA Private Bank, First National Bank and Banque BEMO. The legal counsel of BSEC on the deal is Nasri Antoine Diab.

This transaction provided RYMCO with an alternative source of funding and it will allow it to enhance its financial ratios, specifically its debt-to-equity ratio. "For us to maintain our leadership position in the industry we had to look at growth segments in the market; as such, we have identified the fleet business as an attractive opportunity to sustain our growth. Through this transaction we were able to secure financing needs for this segment through an attractive revolving instrument for the next three years. Our partnership with BSEC is flexible enough to match customer value attributes with cost efficient structured financed products for this and hopefully future engagements", adds Abdo Sweidan, ceo of RYMCO.

AC

CMBS

Rejected TALF CMBS indicate more cautious Fed

The list of accepted (81) versus rejected (five) bonds for the October legacy CMBS TALF funding threw another curveball to CMBS market participants, and indicated a more cautious Fed/collateral monitor, suggest CMBS analysts at Barclays Capital. For the first time, there were rejections to second- and third-pay classes from otherwise eligible deals. Some apparent deal-level inconsistency also occurred.

The rejected bonds were: BACM 07-1 A3, GCCFC07-GG11 A2, CSMC 08-C1 A2, LBUBS 04-C7 A6 and LBUBS 06-C7 A3.

"It is difficult to identify major trends and additional guidance does not appear to be forthcoming, but we do see some evidence that the Fed/collateral monitor is especially concerned about concentration issues and extension risk," note the BarCap analysts. "With additional data points, we can now conclude that the Fed/collateral monitor will be tougher than many had initially expected, including us. This may limit demand in future months and force TALF investors to carry out additional credit work before submitting loan requests."

Traditional second- and third-pay triple-As rejected were as follows : BACM 07-1 A3, GCCFC07-GG11 A2 and CSMC 08-C1 A2. In July, the second-pay triple-A bond from JPMCC 07-LDPX was rejected, but this bond has a unique 'Y' waterfall structure, according to the analysts.

Prior to October, second-pay triple-As had been the most popular TALF-eligible bond, comprising 87 of 181 bond requests, or 48%. The analysts observe that many market participants viewed these bonds as the safest, considering the additional support through time-tranching of cashflows and the potential for more term-like funding given shorter average life.

"From our perspective, the Fed's rejections indicate that it is concerned about extension risk, in addition to the potential for actual credit loss."

By vintage, the rejections were focused in 2006/2007, with an 'old school' triple-A from 2004 rejected as well - LBUBS 04-C7 A6, with 12.4% credit support.

"We also saw a trend of TALF investors focusing on previously accepted bonds, given the high number of repeated bonds," the analysts conclude. "However, this strategy may have pitfalls, as the Fed/collateral monitor decision-making process is dynamic and likely changes upon credit performance of the underlying collateral and the bond's price."

AC

Correlation

'Unobservable' risk factor needed in credit models

The OCC has published a Working Paper entitled 'Correlation in Credit Risk', which examines the correlation in credit risk using CDS data. The report's authors find that the observable risk factors at the firm, industry and market levels and macroeconomic variables cannot fully explain the correlation in CDS spread changes, leaving at least 30% of the correlation unaccounted for.

"This finding suggests that contagion is not only statistically but also economically significant in causing correlation in credit risk. Thus, it is important to incorporate an unobservable risk factor into credit risk models in future research," the authors note.

The paper also argues that, consistent with some theoretical predictions, correlation is countercyclical and is higher among firms with low credit ratings than among firms with high credit ratings. This finding does not support the recommendations in Basel 2, it says.

On the basis of monthly changes in CDS spreads from January 2001 through to December 2006, the report indicates that changes in CDS spreads are positively correlated, with an average correlation of 21%. Observable variables at the firm level can reduce the correlation by 8%, resulting in a correlation of 13% among the regression residuals, according to the report.

The findings also confirm the existence of the industry effect and that firms in less cyclical industries have lower correlations in credit risk. Although industry variables are significantly related to CDS spread changes in the right directions, the industry effect can be responsible for less than 1% of the correlation in CDS spread changes after they were controlled for firm-level, market-level and macroeconomic variables.

When all observable variables are combined, they can account for about 14% of the correlations, leaving 7% unaccounted for. The main observable variables that contribute to correlation are firm-level variables and credit spreads, which can be affected by both contagion and systematic risks.

Excluding these variables, the mean correlation among the residuals is 12%. These findings suggest that contagion could contribute from 33% to 57% of the correlation in credit risks.

In addition to finding that correlation in credit risk is countercyclical, the paper indicates that correlation is higher among firms with low credit ratings than among those with high credit ratings. "These findings are consistent with some theoretical predictions, but not with the specifications in Basel 2 or with findings based on measures from the Merton model. We believe that the results derived from CDS spreads are more reliable because of the oversimplified assumptions behind Merton's model and the evidence in the literature that the Merton default probability measure does not forecast default probability well," the authors conclude.

CS

Regulation

Survey suggests broad IFRS 7 compliance failure

CESR has published an analysis of European financial institutions' compliance with disclosure requirements related to financial instruments. The findings reveal that, in some areas, a significant proportion of companies failed to comply with mandatory disclosure requirements, including regarding the use of valuation techniques and on relationships with SPEs.

For the purposes of the analysis, CESR reviewed the 2008 year-end financial statements of 96 listed banks and/or insurers. The aim of the exercise was to see how the detailed requirements of IFRS 7 - 'Financial Instruments: Disclosures' and certain additional recommendations had been applied.

CESR found a good level of compliance with disclosure requirements on the classification of financial assets and liabilities and their carrying amounts under IFRS 7. Many entities enhanced their fair value disclosures on certain instruments they believed to be of importance for users and provided additional information to help users to better understand the financial statements.

Although most entities disclosed the methods they had applied when using a valuation technique to determine fair values for classes of financial assets and/or liabilities, around 20% of all companies and almost 10% of FTSE Eurotop-companies did not make such disclosures. Around 40% of all companies (10% of FTSE Eurotop-companies) did not disclose the sensitivity of the fair values recognised in the financial statements to changes in the various assumptions.

However, around one-third of all companies (half of the FTSE Eurotop-companies) followed recommended practices and disclosed whether valuation techniques were based on significant unobservable inputs and, if relevant, a description of the sources of those unobservable inputs into the valuation techniques. Furthermore, although disclosures based on the fair value hierarchy were non-mandatory at the time, more than half of the financial entities CESR examined applied the hierarchy in their financial statements.

CESR's analysis also showed that for the three types of risk analysed - credit risk, liquidity risk and market risk - the general qualitative and quantitative disclosure requirements of IFRS 7 had been provided by almost all companies. However, some of the more detailed disclosure requirements for credit risk were not provided to the same extent. CESR's analysis also notes that, overall, a relatively high proportion of companies had chosen to adopt the amendments to IFRS 7 relating to liquidity risk in their financial statements early.

The analysis suggests that around 80% of all companies surveyed (90% of the FTSE Eurotop-companies) had impairment losses for financial instruments in 2008. 5% of the companies, however, did not disclose a summary in their accounting policies of the criteria they use to determine that there is objective evidence that an impairment loss has occurred relating to equity instruments classified as available for sale.

Finally, the survey shows that 20% of companies with SPEs did not disclose details of how the SPE is controlled by that entity. FTSE-companies, which tend to have both more transactions and SPEs, complied better with the requirements. In addition, around 20% of the companies having SPEs did not disclose details of how they had decided that all the significant risks and rewards of ownership of financial assets had been transferred to other entities.

CESR says it would have expected that the number of companies providing adequate disclosures regarding their activities with off-balance sheet entities to have been much higher.

Fernando Restoy, vice-chair of the CNMV and chair of CESR's group on accounting and enforcement issues, says: "The financial crisis that existed during the second half of 2008 and the beginning of 2009 has had a major impact on the financial position and performance of publicly traded companies, particularly those in the financial sector. Strengthening investor confidence requires improved transparency on the actual situation of financial companies in their financial statements. Consequently, CESR would have expected a higher level of compliance with mandatory requirements, although that a significant number of companies provided additional disclosures in-line with recommendations, published in late 2008 is to be welcomed."

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Investors

Selling on detail

Rob Ford, partner and portfolio manager, and Mark Holman, managing partner at TwentyFour Asset Management, answer SCI's questions

Q: How and when did TwentyFour Asset Management become involved in the structured credit market?
MH: TwentyFour AM was launched in September 2008. The firm is young, but has old heads, many of whom have previously worked together - Rob and I spent seven years at Barclays Capital together, for example.

We currently employ 11 people and everyone is a fixed income specialist. There are four portfolio managers, as well as three staff in management, three in operations and one in distribution.

Our skill-set is in managing client money and consequently we outsource several functions such as the middle and back office, as well as the bulk of the distribution function. By outsourcing these functions, we're not tying up portfolio manager resources with interferences such as any trade glitches that may occur - our in-house operations team deal with all of these issues before everything is outsourced. Portfolio managers should be spending 99% of their time doing their best for clients without any distractions.

Q: What do you think you do differently from other managers?
MH: I believe our philosophy differentiates us from other managers.
Mark Holman                                                    We have four senior portfolio managers managing our funds. Most of our competitors tend to employ one senior manager and surround them with analysts or junior PMs.

With credit, the very best an investor can expect is their money back at maturity, plus interest in the meantime. But, regardless of how much experience an analyst may have, there is often a hierarchical element that means some opportunities will be missed. The combined experience of our portfolio managers, who have all been through a number of cycles, means that there are four pairs of eyes looking for surprises, as well as opportunities.

Our investment process is our 'USP': we sell on detail. Our portfolio managers do their own research and deal monitoring, and their experience means that they recognise the relevance of any unusual details. We have a top-down/bottom-up approach to investment: top-down analysis determines the direction, while credit surprises typically occur bottom-up - so it is here where we do the bulk of our work.

RF: It takes about a week to analyse a new structured finance programme. We read every piece of documentation; we see it as a route map in terms of what could happen to a bond.

Before buying a bond, we present an argument for doing so to the credit committee (comprising the whole of the PM team), who will pull it apart and try to find any weaknesses. Only when there is unanimous agreement will the bond be purchased.

The portfolio managers will construct a monitoring template for each bond, outlining the key performance indicators, and should a bond start to begin performing unexpectedly, we'll decide what remedial steps to take. We underwrite the bond as if we're holding it to maturity and will typically only sell for a relative value opportunity or to divest a position we no longer like.

Q: What are your key areas of focus today?
MH: As a boutique, we cover fixed income only and major heavily in credit - from high yield to high grade bonds.

Initially, we began by offering bespoke portfolio management for institutional investors. In fragmented markets, different clients have very different views
Rob Ford                                                   which makes bespoke more attractive.

Many investors also needed credit advice. We didn't set out to be an advisory firm, but many clients have needed help in terms of valuing portfolios or undertaking risk assessments - and this has sometimes led to asset management mandates.

We currently have assets under management of over £200m. Our first mandate was £70m, which we secured shortly after launching. Given the difficult market we've endured for the last two years, it's not been easy to raise risk assets, so we're pleased with the progress we've made, and appetite is also picking up now.

Q: What, in your opinion, has been the most significant development in the credit market in recent years? How has this affected your business?
MH: Clearly, the near collapse of the banking system. Many investors were frightened about leaving their money in banks, given what happened last autumn. We began getting phone calls from many investors looking to take money out of banks to invest in bonds and wanting advice from us. So we started thinking about the need to diversify and structure a fund that appealed to a broader market - i.e. those who wanted a reasonable return with as little risk as possible.

We discussed launching a corporate bond fund as money was pouring into that sector, but decided - particularly because of the potential interest rate risk - that a forward-looking conservative strategy would be to focus on high grade credit on a floating rate basis - namely AAA/AA rated RMBS. This was the genesis of the Monument Bond Fund - the first UCITS III structure to invest solely in the broader RMBS markets (see SCI issue 140). It has exposure to the UK, European and Australian markets.

We opted for a UCITS III structure and so the fund provides investors with daily liquidity. Gemini Investment Management is the distributor for the fund.

We aimed to launch the Monument Bond Fund at the beginning of July, but the timing slipped by a month. Putting the fund together has been a long process: we began thinking about it in January, with the aim of moving away from the institutional investor base towards a broader investor base, especially retail. We've been marketing to wealth managers, large IFAs and multi-manager funds that are managing money on behalf of retail investors all around the country and are now achieving steady and consistent growth.

RF: A UCITS III structure is necessary in order to tap into the IFA community. They're not specialists and so it was challenging to educate them on the solidity of European RMBS, especially after what they may have read about the US market.

The UCITS III platform has limits on leverage, as well as rules regarding diversification and liquidity to make it safe for a broader investor base. Our fund has no leverage and has daily liquidity.

The reception to the fund has been good: we were able to stress-test the structure in front of clients and demonstrate that European RMBS is more predictable than any other asset class. Even the most sceptical investors can revise their opinion if you're transparent about the structure and your assumptions.

Q: What is your investment strategy going forward?
RF: We're getting £500,000 or £1m chunks of investment nearly every day and so we're pretty much in the market on a daily basis. The Fund is now over £30m, but it could quite possibly reach £100m by the end of the year.

By comparison, most retail funds never get above £10m. The amount multi-managers allocate to the fund can grow as Monument grows, so there's good repeat business there. On average we're probably executing a trade a day in order to maintain a broad range of maturities and investing any cash from bond amortisations and redemptions.

Currently the fund comprises around 25 positions and the aim is to try and find enhanced value by looking at smaller chunks of paper that don't necessarily suit banks or pick them up from distressed sellers. We have a universe of bonds that we've already done the work on - a back catalogue - which means that we can react nimbly if a deal is offered that's within this universe.

The market is moving quickly in terms of spreads, but not necessarily in terms of positions, so there tends to be enough time to do the credit work. Certainly, we can indicate our interest in something relatively quickly and lock in the pricing as necessary. Monument is ideally suited to this environment because money is coming in in dribs and drabs.

Looking ahead, we're preparing to launch a high grade CMBS fund with Rutley Capital Partners (see SCI issue 155), which will benefit from their direct experience in the commercial real estate marketplace and large property investment management portfolio.

There is an enormous amount of money being allocated to commercial property right now. Prices declined by 45% between June 2007 and June 2009, which is proving an attractive investment for foreign investors. Our new fund should produce similar returns to direct property investment, but with a different risk profile.

Q: What major developments do you need/expect from the market in the future?
MH: There has essentially been a rally in rates products for 20 years, with base rates dropping from 15% to 0.5%, and so logically the next trend in rates can only be up. Consequently, there's a lot at stake for fixed rate investors, so we believe having a floating rate approach to credit makes sense at the moment.

We also think there is more value in ABS than plain corporates at the moment. Yields on corporate bonds are lower than yields on RMBS, which is just plainly wrong, but it demonstrates that pockets of value remain out there.

Consequently, we're starting to see institutional investors taking profits on corporate bonds and moving into other sectors, including RMBS. This will help to grow our AUM quite quickly going forward.

RF: We may look to launch a dynamic bond fund in the future. Our overall view is that the market is currently on a strong roll and it will take a major event to knock it off course. But there is likely to be a slow-down in the rally as we approach year-end - although this is fairly typical, as banks begin calculating their capital ratios.

ABS remains fundamentally cheap for the credit quality available; there is also a supply versus demand imbalance. But the lack of new issuance is likely to continue for the foreseeable future because the economics still don't make sense for issuers - there's not enough margin in the underlying loans to sustain issuance.

However, issuers such as Nationwide and HBOS are building platforms for the future and demonstrating that they can stand on their own feet. Ideally, banks will also now begin moving away from central bank repo facilities and open out to new issues. We view this as a positive both for them and the market.

CS

ABS

ABS sales group expands

Southwest Securities has opened a new taxable fixed income office in San Francisco to serve institutional customers.

The office is staffed by Martin Gamboa and Jason Evans, fixed income sales personnel, and Wallace O'Leary, who supports the desk. The office specialises in the sales of taxable fixed income products, including ABS and MBS.

Evp Dan Leland, who heads Southwest Securities' taxable fixed income division, says: "We plan to add additional taxable fixed income sales people in the new office. We want to continue growing our mortgage presence and we offer the capital, inventory and attractive account packages that many brokers are seeking. We have a great platform for brokers to expand their business and the San Francisco area provides a large talent pool to draw from."

Earlier in the year, Southwest Securities expanded its ABS and CMBS trading capabilities by adding Derek Rose to its Chicago office. Rose is a veteran of RBC Capital Markets, ABN AMRO and Sutro, and reports to evp Pat Price.

In July, Steve Palmer, formerly with JPMorgan, joined the mortgage trading area reporting to Southwest evp Rob Nash. Palmer manages the mortgage desk in New York and works with Jeff Bohnsack, who manages the mortgage desk in Dallas.

ABS

RBS analyst joins credit boutique

Former RBS credit analyst Michael Cox has joined Chalkhill Partners in London as a strategist. In his new role, he will continue to cover CMBS and fixed rate ABS.

Founded in 2009, Chalkhill Partners is an independent, privately-owned boutique investment bank offering research, advice, structuring and execution in credit markets to financial institutions and corporations. In the structured finance arena, Chalkhill's vertically-integrated business model spans arrangement, restructuring, trading and sales. Its product focus encompasses consumer and commercial asset-backed financing, PFIs and CLOs.

A number of additional ex-RBS employees are also believed to have joined the firm, including Chander Gupta. Gupta most recently worked at Jeffries as head of ABS trading, having previously headed up European ABS trading at RBS.

Advisory

Capital markets advisory hires for GSE activities

NewOak Capital has appointed Jay Loan as md and senior member of its financial institutions group. He will be responsible for coordinating all activities relating to the US government-related mortgage lending programmes through Fannie Mae, Freddie Mac and the FHA, as well as developing mortgage advisory solutions and focusing on bank advisory and recapitalisation at the firm.

"After nearly three years of non-stop surprise and chaos in residential mortgage credit, neither the private sector nor the government has yet figured out the magic solution," says Ron D'Vari, NewOak ceo and co-founder. "We are glad to have Jay joining our team of financial industry leaders at NewOak Capital focusing on developing practical solutions for the banks and financial institutions and partnering with government to achieve socially equitable balance and speed. Jay has lived all aspects of the mortgage market from origination, operation and trading. He also brings in an informed view of the government perspective that is very valuable to realistic solutions."

Prior to joining NewOak Capital, Lown was a fellow at the Office of Thrift Supervision (OTS). At OTS, he served as an advisor to the Senior Deputy Director's office focused on mortgage origination and securitisation. Noteworthy assignments included participating in the creation of the Obama Administration's Making Home Affordable modification programme, the review of TARP capital purchase programme applications for OTS thrifts and working with the acting deputy director of examinations, supervision and consumer protection and regional staff on troubled institutions.

Before the OTS, Lown spent six years at UBS in mortgage trading. Initially hired to build out a subprime mortgage whole loan trading desk, he built the group into a team of 15 professionals that executed over 20 billion in securitisations. At UBS, he also managed an internal mortgage origination platform specialising in Alt-A mortgages, overseeing all units within the organisation, including sales, capital markets and operations.

CLO Managers

Co-manager removed on Asian CDO

Noteholders of Straits Global ABS CDO I have voted to remove Straits Lion Asset Management as the collateral co-manager. The deal experienced an event of default in May last year; however, the termination of the collateral co-manager is not effective until the appointment of a replacement collateral co-manager. Declaration Management & Research, the chief collateral manager for Straits Global ABS CDO I, has agreed to assume the role of replacement collateral co-manager.

Straits Lion was originally appointed collateral co-manager to provide expertise on debt securities domiciled in Asia. The transaction is no longer expected to invest in any such securities.

Fitch does not anticipate that the replacement will impact future performance of the transaction and does not expect that this replacement will have an impact on the ratings of the classes of notes issued by Straits Global I.

Straits Global ABS CDO I closed on 28 October 2004. The portfolio is composed of RMBS (64.6%), structured finance CDOs (21.7%), CMBS (7.1%) and ABS (6.6%).

CLO Managers

Replacement manager for ABS CDO

Princeton Advisory Group has been appointed the replacement collateral manager on Cherry Creek CDO II, following the execution of a collateral management agreement between the issuer and Princeton dated as of 12 October 2009. Moody's has determined that the ratings currently assigned to notes issued under the deal will not, at this time, be reduced or withdrawn solely as a result of the appointment. The issuer experienced an event of default under the indenture as of 14 November 2007.

Correlation

Risk reducing trade platform launched for correlation

Tullett Prebon and Calypso Technology plan to launch the TP Correlation Service in order to provide Tullett Prebon's bespoke synthetic CDO clients with the ability to explore a range of transactions from a pool of anonymously-provided liquidity.

Tullett Prebon and Calypso's Galapagos unit have developed a platform on which clients will be able to upload individual trading objectives and constraints to the highly secure and confidential Galapagos environment. The platform's evolutionary algorithms will then identify the optimal risk reducing trades in the market at any one time. The service is due to be launched to clients in Q110.

Emerging Markets

Broker creates global EM sales platform

Knight Libertas has established a global emerging markets sales team with offices in the US, Hong Kong and London. Effective immediately, the following have joined the institutional fixed income broker-dealer: Augusto Castilho, Eamon Tubridy, Alfredo Viegas and Elena Antonova in the US; Alesandro Gherzi, Alisa Mujagic, Nipun Ramaiya, Darren Reiss, Richard Segal and Will Trossell in the UK; and Jay Lee and Felix Sun in Asia.

Castilho is sales director Latin America, emerging markets sales for Knight Libertas. Prior to joining Knight Libertas, Castilho was the head of emerging markets fixed income for Itau USA Securities, covering institutional investors of all types in North America.

He also sold alternative investments to pension funds, endowments and foundations in the US. He specialises in international, sovereign and corporate securities and also has a deep knowledge of structured credit products and derivatives.

Viegas is a director, emerging markets sales for Knight Libertas. Prior to joining Knight Libertas, Viegas managed global credit and multi-strategy hedge funds. At Advent Capital, he co-managed the convertible arbitrage and multi-strategy funds, and at Tiedemann Investment Group he managed a global event-driven hedge fund.

Gherzi is a director, emerging markets sales for Knight Libertas in London. Prior to joining Knight Libertas, he was employed by JPMorgan, where he worked in credit, cash, foreign exchange and structured product sales primarily covering CIS accounts.

Prior to joining Knight Libertas, Ramaiya traded and structured emerging market products at RBS. Before joining RBS, he traded emerging markets for Merrill Lynch. There, he traded FX options, local markets and emerging markets CDS.

Reiss is a director, emerging markets sales for Knight Libertas in London. Prior to joining the broker-dealer, Reiss was director of emerging markets sales at HSBC covering UK hedge funds. Previously, he set up the UK sales team of MarketAxess. He began his career at Hambors/RBC, responsible for investment grade credit sales to the Benelux markets.

Trossell is a director, emerging markets team for Knight Libertas in London. Prior to joining the firm, Trossell established the emerging markets sales desk at Calyon, focused on trading credit and CDS. Prior to this, he was on the emerging markets sales team at UBS.

Lee is a director, emerging markets sales for Knight Libertas in Hong Kong. Prior to joining Knight Libertas, Lee was the head of structured credit and credit sales at Calyon, where he was responsible for covering the Korean markets.

Sun is a director, emerging markets sales for Knight Libertas in Hong Kong. Prior to joining Knight Libertas, Sun worked at RBC for two years in fixed income and structured product sales. Previously, he was a bond portfolio manager at Ping An bank for six years.

Emerging Markets

Emerging markets fixed income team expands

BTIG is expanding its emerging markets fixed income platform with the addition of Alfredo Chang and Patrick O'Sullivan. Both professionals bring more than 15 years of experience to the firm.

Chang and O'Sullivan join the firm's recently formed emerging markets team, headed by Alex May, a 15-year veteran of Smith Barney and Salomon Brothers/Citigroup. The team also includes William Dolan, emerging market bond trader, previously of Merrill Lynch and Citigroup/Salomon Brothers; Ralph Dalton, emerging markets sales, formerly of Merrill Lynch; and Ariel Grignafini, emerging markets desk analyst, who joined BTIG from Deutsche Bank.

Chang joins BTIG's fixed income team as md of emerging markets sales. He was previously the global head of emerging markets fixed income for Lehman Brothers Asset Management. Prior to joining Lehman, he spent seven years at GE Asset Management leading its US$1.5bn emerging markets fixed income build-out and co-managing its high-grade fixed income portfolio.

O'Sullivan joins BTIG's emerging markets trading team. He brings over 20 years of experience in the financial arena, and 15 years' trading/sales experience in the emerging markets corporate/sovereign/structured product space. As a director at Merrill Lynch/BOA, O'Sullivan had senior sales/trading, syndicate and structured product development responsibilities on the private banking trading desk, and prior to that he had trading responsibilities on the institutional cash trading desk in the Latam space.

Investors

Cohen subsidiary hires five in credit

EuroDekania Management, a wholly-owned subsidiary of Cohen & Company, has hired five senior credit staffers for its European capital markets business.

Linda Koster has joined the firm as md - head of credit sales and origination Benelux and France, and head of origination and distribution asset management products, Europe. She will join the Executive Committees of Cohen & Company's asset management and capital markets divisions.

Koster has extensive experience in fixed income sales, having held md positions at Merrill Lynch and more recently at Goldman Sachs. She brings strong institutional relationships and in-depth knowledge of corporate credit, structured products and alternative assets.

Michael Freilich has joined EuroDekania as md - credit sales and origination, to cover institutional clients in the UK and Ireland. He has over 24 years of experience in credit sales, having worked at Credit Suisse, Merrill Lynch, Deutsche Bank and most recently at Heritage Capital.

Mehrin Karim has joined the firm as director - credit sales and origination, also to cover institutional clients in the UK and Ireland. He previously worked in sales at Societe General's structured solutions team, and before that at Morgan Stanley in the structured credit sales team.

Paul Murphy has been appointed md - credit trading. He will trade flow credit products, having previously worked at Bear Stearns, Nikko Securities, Mizuho International and Nomura.

Finally, Henrik Woergaard has joined the firm as md - head of sales and origination for the Nordic region. He has over 20 years of experience in fixed income sales exclusively focused on Scandinavian investors. Prior to joining Cohen & Company, he worked at Citibank, BNP, Greenwich NatWest, Lehman Brothers, Commerzbank and Bank of America.

Investors

AFME launches following trade associations' merger

AFME will launch with effect from 2 November, as leading trade associations LIBA (the London Investment Banking Association) and the European operations of SIFMA join forces. AFME will represent a broad array of European and global participants in the wholesale financial markets and its 197 members comprise all pan-EU and global banks, as well as key regional banks, brokers, law firms, investors and other financial market participants.

The organisation aims to help members to do their business and improve the environment in which they do it, providing members with an effective and influential voice through which to communicate the industry standpoint on issues affecting the European, international and UK capital markets to regulators, policymakers and the general public.

Gaël de Boissard, md and head of global securities at Credit Suisse, has been named as chairman of the new entity.

Monolines

Change of name, direction for FSA

Assured Guaranty, the holding company for Assured Guaranty Corp and Financial Security Assurance (FSA), has announced that - pending regulatory approval - it will change the name of its subsidiary FSA to Assured Guaranty Municipal Corp. The company also plans to change the names of the FSA companies worldwide.

Assured Guaranty acquired FSA on 1 July 2009 (SCI passim). Assured Guaranty Municipal Corp now serves the municipal market exclusively, while Assured Guaranty Corp will provide financial guaranty insurance to both the municipal and structured finance sectors.

Dominic Frederico, president and ceo of Assured Guaranty, says: "Since completing the acquisition, we have been contemplating this name change to highlight the role of the municipal-only bond insurance company and to better communicate that we are offering municipal bond issuers and investors a choice between two proven, financially strong guarantors."

He adds: "We see an important role for Assured Guaranty Corp to assist in the recovery of the structured finance sector as the economy improves. Our value proposition, which goes beyond the guaranty and includes providing liquidity and valuation, as well as credit analysis, surveillance and, if necessary, remediation, is more necessary than ever given the current economic environment."

Real Estate

Industrial real estate investment firm formed

A new privately-held industrial real estate investment firm has been formed, to be headed by Michael Brennan, former president and ceo of First Industrial Realty Trust. Brennan Investment Group will opportunistically acquire, develop and operate industrial properties in select major metropolitan markets throughout the US. The firm's managing principals will co-invest with private and institutional capital, pursuing single asset and portfolio acquisitions, including acquisitions of debt.

Joining Brennan as co-founders and managing principals at the firm are Peter Murphy, Kareem Fikri, Robert Krueger, Britten Shuford and Kevin Smith.

Murphy is vice-chairman and is responsible for transactions in the eastern US. Murphy joins the company from First Highland Management and Development Corporation, where he remains a principal.

Fikri is responsible for transactions in the Midwestern US, with a focus on Chicago. Prior to this, Fikri was founder and president of Fik Investment Corporation and is credited with managing the first Sharia-compliant industrial fund in the US, a joint venture between First Industrial and the Kuwait Finance House.

Krueger is responsible for transactions in Central Florida and joins the company from First Industrial. Shuford is responsible for investments in the Western US, with a focus on Southern California. Shuford is co-managing partner and principal of Pacifica Capital Group.

Finally, Smith is responsible for transactions in Cleveland, Columbus, Cincinnati, Nashville, Memphis and Indianapolis. Smith joins the company from First Highland Management and Development Corporation, where he remains a principal.

Brennan, chairman and managing principal of Brennan Investment Group, says: "The industrial real estate sector is a large, stable and diversified investment class offering a compelling opportunity for both current income and appreciation. Our firm will use a disciplined investment approach to strategically exploit investment opportunities."

Prior to forming Brennan Investment Group, he co-founded First Industrial Realty Trust and served as the REIT's president, ceo and a member of the board of directors.

Real Estate

CRE consulting head appointed

Waterstone Capital Advisors has hired Webster Hughes to join the Charlotte, NC-based company as an md of its new consulting and investment banking business unit.

A primary focus of the new business unit is to provide real estate loan valuation and advisory services to institutional real estate investors and lenders. In addition to client business, Hughes is responsible for managing Waterstone's CMBS defeasance loan portfolio.

Hughes started his Wall Street career in mortgage security research and sales at Salomon Brothers in the late 1980s, and later became senior md at Bear Stearns. In the late 1990s, he moved to Charlotte as md for First Union Capital Markets. Prior to joining Waterstone, Hughes provided proprietary consulting in the area of institutional real estate risk management.

Real Estate

Two Harbors to begin investing in RMBS

Capitol Acquisition Corp and Two Harbors Investment Corp have completed their merger transaction (see SCI issue 143) and Two Harbors will immediately begin conducting business as a REIT investing in RMBS. The vehicle will be externally-managed by PRCM Advisers, a wholly-owned subsidiary of Pine River Capital Management. Co-cios Steve Kuhn and Bill Roth will lead the investment team.

Kuhn has over 16 years of experience investing in and trading mortgage-backed, asset-backed and related securities at Goldman Sachs, Citadel and Cargill. Roth recently joined Two Harbors from Citigroup Global Markets, where he was an md in the firm's proprietary trading group managing MBS and ABS portfolios.

Technology

Strategic partnership to enhance risk reporting

Paladyne Systems and RiskMetrics Group have formed a strategic partnership in order to provide intra-day, daily and monthly risk reports to hedge funds and service providers. RiskMetrics' RiskManager has been integrated with Paladyne Analytics Master to provide both firms' clients with a two-way connection enabling them to seamlessly communicate position data to RiskManager and receive back a full-set of risk analysis reports within Paladyne Analytics Master.

Additionally, hedge funds that use Paladyne Analytics Master as a firm-wide custom reporting solution will not only have access to RiskMetrics' risk analytics and investor reporting platform, but also accounting, position, P&L and investor information. The partnership will enable RiskMetrics to provide its hedge fund clients with access to Paladyne Analytics Master.

Brian Schmid, head of RiskMetrics' alternative investments business, says: "Many of our hedge fund clients are collaborating with us to further develop market standards in independent risk management, transparency and investor communication to ensure their solutions are optimised for robust position modelling with minimal operational overhead. This strategic partnership will deliver on both fronts to mutual clients."

Technology

Markit acquires ClearPar

Markit has acquired ClearPar from FIS. ClearPar is an automated syndicated loan operations platform used for the settlement of par and distressed loan trades in the US and Europe. Markit will integrate ClearPar with parts of its WSO division, a provider of portfolio management software and services for the syndicated loan market, to create an electronic loan settlement platform for buy-side and sell-side market participants.

Trading

Citi adds md to global securitised market sales team

Citi has hired Nicholas Letica as an md in global securitised market sales based in its New York office. Letica will report to Jim Wohlbruck, head of New York global securitised markets sales.

Previous to joining Citi, Letica was an md and head of collateralised mortgage obligation trading with HSBC Securities. Prior to this, he was head of agency CMO trading with Deutsche Bank. Letica also has experience as an md with both Bank of America and Bear Stearns.

ABS

No further ratings action for CIT ABS

Following the CIT Group's bankruptcy petition, Moody's has announced that no further ratings action will be taken on the sixteen ABS which CIT - through its subsidiaries - acts as the servicer, master servicer, administrator or servicing administrator for. Importantly, the rating agency notes that the prepackaged reorganisation plan did not include any of these or any other of CIT's operating subsidiaries.

Moody's had previously placed a number of CIT-sponsored ABS under review for possible downgrade, following the emergence of bankruptcy as a distinct near-term possibility. As such, a high likelihood of a CIT bankruptcy was already reflected in Moody's ABS ratings and the agency will therefore not be taking further rating action at this time.

The assets backing the transactions are equipment leases, small business loans, student loans and aircraft leases.

ABS

Italian leasing ABS defaults at highest level since 2001

The performance of the Italian leasing ABS sector continued to deteriorate in Q309, according to Moody's, due to rising delinquencies and defaults among SMEs - which account for the majority of lessees in Italy.

Moody's net default index rose to 2.13%, which is the highest level since the rating agency began measuring the sector in 2001. Moody's delinquency index, an indicator of the expected increase in defaults, has increased to 5.59% from 4.18% in the past year.

In the report, the rating agency notes that the continuing recession is weighing on the financial sustainability of Italian SMEs as their liquidity is strained due to persisting declines in revenues and profit margins, as well as tight credit conditions.

Moody's recognises that the situation could be eased for SMEs as a result of the payment holiday measure that was introduced on 3 August 2009 by the Italian Ministry of Economy and Finance and the Italian Bankers' Association. This allows SMEs to suspend the principal portion of their leasing payments for twelve months for real estate leases and six months for other leases to help them overcome temporary liquidity problems.

ABS

Future of Canadian securitisation analysed

While it remains to be seen whether ABS issuance in Canada will return to pre-financial crisis levels, securitisation in the country does have a solid future, according to DBRS.

"Individuals and businesses will continue to purchase real estate and vehicles, just as they will continue to use credit cards and generate receivables," the rating agency says. "And all of these activities must be financed. Securitisation will remain a viable funding source for these financing needs."

In Canada, total ABS outstanding shrunk from a total of C$178bn in August 2007 to approximately C$117bn as of 31 August 2009. A decrease of C$40bn in bank-sponsored ABCP outstanding between August 2007 and August 2009 is responsible for approximately half of the decrease in total Canadian ABS outstanding during this period, DBRS notes.

It adds that some of the reduction can be explained by higher funding costs, together with the increased internal allocation of capital by bank sponsors of ABCP to support securitisation activities. "These higher capital allocations are recognition by the banks of the risk represented by their contingent funding obligations in support of securitisation programmes and the bank's role as both underwriter and originator," notes the agency. "Changes to regulatory capital treatment upon implementation of the Basel 2 framework may reinforce this trend."

Alternative assets

Tropic, Soloso deals downgraded

Moody's has downgraded the ratings of certain notes issued by the Tropic CDO I, II, III and IV deals, as well as the Soloso CDO 2005-1 and 2007-1 transactions. The rating agency cites a significant increase in the assumed defaulted amount for the Trups CDOs, as well as failure of some coverage tests.

The rating action also reflects the continued pressure in the Trups sector as the number of bank failures and interest payment deferrals continue to increase. According to FDIC data, 106 US banks have failed to date in 2009, as compared to 25 in all of 2008. Although US banks recently benefited from a dramatic improvement in market conditions, the banking sector outlook remains negative.

Separately, Fitch downgraded seven classes of notes issued by Tropic CDO V and removed these notes from rating watch negative. The downgrades incorporate the transaction's non-payment of the full interest due to the Class A-1L1, A-1L2 and A-1LB notes on the 15 October 2009 payment date. All available proceeds went to pay partial interest to the Class A-1L notes, pro rata.

In aggregate, the Class A-1L notes received only 77.8% of their US$1.1m interest due. Tropic V entered into an event of default on 22 October as a result.

The rating actions are attributable to a decreased amount of interest proceeds to service the notes due to continued credit deterioration on the underlying portfolio and a failed interest rate hedging strategy.

All of the Tropic V overcollateralisation and interest coverage tests were failing their respective performance triggers, as of the October trustee report. The senior OC ratio was at 104.86% and the senior IC ratio was at 77.84%, compared to a test trigger of 127% for both.

CDO

CIT CDO exposure analysed

According to S&P, 643 rated US synthetic CDOs and 12 rated US cashflow and hybrid CDOs have collateral exposure to CIT Group, which the rating agency downgraded to single-D on 2 November.

In addition, three publicly rated US non-traditional structured credit transactions - CIT Aviation Finance I, CIT Aviation Finance II and CIT Small Business Loan Trust 2008-1 - have exposure to CIT entities acting as servicer, while CIT is the back-up servicer on two other non-traditional structured credit transactions: RASPRO Trust 2005's Class B notes series 2005-1 and RASPRO Class G Pass Through Trust 2005-1.

On 21 July 2009, the rating agency placed its ratings on the Class A-1 notes from the CIT Aviation Finance trusts on credit watch with negative implications following the downgrade of CIT Group to double-C. CIT Aerospace International, a unit of CIT Group, acts as a servicer in these transactions. The credit watch placements reflect the specialised nature of CIT's servicing role for these transactions, as well as S&P's view of possible servicer risks because the transaction documents for these trusts do not specify a backup servicer.

CDPCs

CDPC set to access TALF

Theta Corporation has amended its eligible transaction guidelines in order to be able to participate in the TALF programme. Under the amendment, the CDPC will be able to purchase assets (directly or indirectly) that are partially funded with a loan from the TALF programme.

As a condition to receiving funding under TALF, Theta is required to fund a certain proportion of the asset on a first-loss basis. In order to fund its portion of the assets, the CDPC proposes to issue unrated capital notes subordinated to its obligations to its CDS counterparties and to senior note holders.

The assets funded under TALF may mature after the maturity of the TALF loan. Theta may, if it has funds available, refinance the asset - providing the asset meets its eligible transaction criteria and at the time of such financing that the vehicle is not in restricted operating mode or that retaining the asset will improve its capital adequacy.

If neither condition is satisfied, Theta will surrender the asset under the terms of TALF. Losses incurred by doing so will be borne by the unrated capital notes.

Theta will continue, under its current restrictions, to be prohibited from increasing its credit exposure through CDS, issuing any debt under its CP and MTN programmes or using liquidity facilities to fund the purchase of an asset through TALF. There are currently no debt securities outstanding under the CP and MTN debt programmes.

Moody's says that the amendment will not cause the reduction or withdrawal of the counterparty rating or the senior note programme ratings assigned to Theta. The last rating action for the CDPC was taken on 17 March 2009, when Moody's downgraded its counterparty rating to Baa2, from Aa2, on review for downgrade; its Euro and US MTN programmes to Baa3/Prime-3, from Aa2/Prime-1, on review for downgrade; and its Euro and US CP programmes to Prime-3, from Prime-1, on review for downgrade.

CDPCs

Proposed criteria change for rating CDPCs

S&P is reviewing its assumptions and methodologies used to rate CDPCs in order to determine what the potential implications of its updated methodology for rating CDOs with corporate exposures could have on the vehicles.

S&P highlights the fact that each CDPC is different in terms of portfolio strategies, capital and leverage. For example, the six CDPCs with outstanding issuer credit ratings have a variety of asset exposures: four have corporate credit exposure, one has mainly corporate credit exposure with considerable exposure to senior tranches of an ABS CDO, and another has municipal housing exposure.

The rating agency expects to address the following topics in the criteria review:

• Proposed changes to its assumptions on corporate credit risk;
• Concentration tests and other capital capacity tests relating to 'event risk';
• Counterparty exposure; and
• CDPC corporate governance.

CDS

Credit event called on CIT

ISDA's Americas Credit Derivatives Determinations Committee has resolved that a bankruptcy credit event occurred in respect of CIT Group Inc, a provider of financing to small businesses and middle market companies. The Committee also voted to hold an auction for CIT, with auction terms to be published in due course.

On November 1, CIT Group Inc filed voluntary petitions for relief under Chapter 11 of the US Bankruptcy Code. The petitions were filed in the US Bankruptcy Court for the Southern District of New York.

Meanwhile, the MGM LCDS auction will be held on 10 November.

CDS

Structural shifts in CDS liquidity

Fitch Solutions reports that liquidity across the CDS market is back at similar levels to where it was in the months preceding the Lehman Brothers bankruptcy. However, it has identified two major structural shifts in the sector's liquidity that distinguishes the current levels of liquidity from those back in April 2008.

The percentage of names with liquidity scores below 7.5, or the most liquid names, has dropped significantly from 12.6% as of 30 April 2008 to only 5.1% as of 30 October 2009. "This would appear to suggest that liquidity has to an extent dropped out of the market," says Thomas Aubrey, md at Fitch Solutions. "However, the other crucial difference is that the semi-liquid section of the market has become much more liquid."

This increased liquidity is indicated by the significant increase in the percentage of names between 7.5 and 10.5 to 59% from 47% between 30 April 2008 and 30 October 2009. "This shift in the CDS market shows how it has responded to the demand for credit protection across a broader set of names as a result of the uncertain economic outlook, resulting in improved liquidity for a wider set of credits," adds Aubrey.

Fitch also notes in the report published today that Europe remains more liquid than the Americas. The European index closed on 2 November at 9.77, with the Americas at 9.99.

In addition, in another heavy week of earnings announcements, a number of travel and leisure companies are showing rising liquidity with tightening spreads, while spreads are widening among some major media companies. "There remains concern in the travel and leisure sector, despite tightening spreads, of the strength in the pick-up in consumption on hotels, car rental, luxury cruises and gambling," continues Aubrey. "Additionally, widening spreads among cable and media companies may be pointing to prolonged tension between various US television networks and their affiliates regarding cable and satellite television revenues."

CLOs

CLO triple-As forecast at 150bp by Q110

Structured credit analysts at JPMorgan have revised their spread targets for CLOs and expect triple-As to be trading around the 150bp mark by Q110. They also expect triple-A spreads to hit 100bp by the middle of 2010, if not sooner.

"Moving down, we raise our double-A target from the US$70s to the US$85-US$90 range (implies spreads in the 300bp area) and raise our single-A target from the US$60s to the high US$70s/low US$80s range," they write. In subordinates, JPMorgan has raised its triple-B target from the US$50s to the US$60s and its double-B target from the US$40s to the US$50s.

"We believe these targets are realistic as risks decline and as the investor appetite for yield meets very limited supply of bonds," they note.

Last week strong technicals pushed prices up in the top half of the CLO structure. Triple-As tightened by 50bp to 300bp, double-As were up five points to US$80, single-As were up five points to US$70. However, triple-Bs remain at US$55 and double-Bs traded down five points to US$40, reflecting slightly weaker sentiment and increased tiering, according to JPMorgan data.

CLOs

October CLO BWIC activity lags September records

CLO secondary market activity has abated somewhat after record-breaking levels in September (U$2.3bn plus). Nonetheless, this month's public BWIC activity still totals around US$1.2bn.

According to structured credit strategists at Citi, the drop in trading volume is primarily due to a lack of triple-A bonds on offering lists. In September triple-A CLO tranches accounted for 56% of BWICs, but only for 12% of those in October as no SIV unwinds or high grade ABS CDO liquidations - the primary source of triple-A paper so far - have taken place recently.

"Moderation in US loan defaults continues and might be further aided by continued distressed debt exchanges, like TXU's discounted bond-for-bond swap," note the Citi strategists. "Distressed debtors have found such swaps an efficient way to lower their debt load and thus likely circumvent potential defaults on loans."

The strategists observe that overcollateralisation and interest diversion cushions continue to improve in the US - the average OC cushion has improved month-over-month since June. In Europe, meanwhile, OC and ID cushions continue to erode.

"Hurt by low diversity, lower prices and high exposure to mezz debt, improvement in the CLO market in Europe will most likely come on the heels of recovery in the US," the analysts add.

CMBS

Capmark's Chapter 11 'best alternative' for investors

Capmark Financial's Chapter 11 reorganisation is the best alternative for Capmark to maximise recovery to bondholders and continue operations, given the fragile value of its franchise in commercial real estate finance, its excessive balance sheet leverage and the continuing credit deterioration in its asset portfolio, says Moody's in its latest Weekly Credit Outlook.

In September 2009, Capmark entered into a US$490m asset 'put' agreement of its mortgage origination and servicing business with Bercadia III, a joint venture between Berkshire Hathaway and Leucadia National Corporation. Bercadia III now becomes Capmark's 'stalking horse bidder', setting a floor on the value of its businesses. Any other suitor will now need to pay more and have the substantial financial resources to fund Capmark's capital-intensive businesses, according to the rating agency.

"The successful bidder will have an opportunity to fuse its financial resources with the expertise of Capmark's existing personnel and operating platform," it notes. "Without a sale of its servicing business, Capmark flirts with a material loss in value from possible contract terminations. Concern over its ability to fund CMBS servicer advances could prompt its replacement by CMBS trustees and the GSEs. This would not be a constructive outcome for any of Capmark's stakeholders."

Moody's suggests that a key variable to any plan's success is the viability of Capmark Bank, the banking subsidiary not included in the bankruptcy proceeding. Capmark Bank has been Capmark Financial's lifeline through the credit crisis and is now facing balance sheet pressure from the sharp credit deterioration in its CRE loan portfolio. As a result, Capmark Financial's liquidity is further pressured by the obligation to downstream capital to the bank in order to keep it well capitalised and avoid claims by the FDIC under a capital maintenance agreement.

"Ensuring that Capmark Bank is well capitalised will decrease the possibility of an FDIC seizure or of additional senior claims on Capmark Financial Group resulting from the agreement," says Moody's. "While a formal restructuring plan has yet to be filed with the bankruptcy court, we expect the plan will be similar to that previously proposed to creditors. Part of this plan outlined a recapitalisation of Capmark Bank with up to US$1.4bn (inclusive of the US$600m contribution made on 30 September 2009) meant to cover expected future losses while keeping it well capitalised. This will allow Capmark to administer and liquidate the bank's existing loan portfolio in an orderly fashion, to the benefit of Capmark's bondholders."

However, the rating agency continues to believe that losses to bondholders will be material, as indicated by its single-C rating. However, the impending reorganisation - which likely will include the sale of Capmark's mortgage origination and servicing businesses, a recapitalisation of its bank subsidiary and orderly liquidation of its remaining assets - should lower bondholders' already significant loss exposure, it concludes.

CMBS

Singaporean REIT defaults on CMBS loan

Saizen Real Estate Investment Trust has announced a maturity default of the CMBS loan of YK Shintoku, one of the nine tokumei kumiai (TK) operators of Saizen REIT. The YK Shintoku Loan was originally provided to YK Shintoku in 2005 by Credit Suisse Principal Investments (Tokyo Branch). It was subsequently securitised and transferred to an issuer of the CMBS.

In the worst case scenario, the maturity default could lead to the foreclosure of YK Shintoku, including the foreclosure of all of the properties under YK Shintoku. However, the manager believes that the lender will not immediately take foreclosure action upon this maturity default and that it is possible to refinance the YK Shintoku loan (with the approval of the lender) as long as the YK Shintoku Properties have not been foreclosed on.

CMBS

US CRE delinquencies climb in October...

US commercial real estate loan delinquencies continued to climb in October, with the lodging sector seeing the largest jump from 6.72% last month to 8.67% - over ten times the delinquency rate at the end of October last year, according to the monthly Treppwire CMBS Delinquency Report. Five US states now have an overall CMBS delinquency rate of over 10% - NC, MT, MI, AZ and FL. Among the largest MSAs for delinquencies are: Tallahassee (27%), Fort Myers (23%), Tucson (18%), Las Vegas (16%), Detroit (12%) and Riverside (11%).

Despite weak fundamentals, CMBS bond spreads rallied for most of the month. "Investors stiff-armed away fear and drove spreads lower as they have done for most of the last four months. Overall, spreads on recent vintage 10-year triple-A super senior moved 50bp lower on average," note analysts at Trepp. "While that might sound impressive, that sector of the market was clearly outdone by virtually every other segment. Short average life super seniors were tighter by 70bp during the month, while A4 bonds from 2004 and earlier were tighter by a similar amount."

Down the credit stack, all segments of the market saw dramatic tightening. Trepp notes that spreads dropped sharply from AM paper through the triple-B stack - in some cases by hundreds of basis points. They also point out that a move from US$50 to US$55 can represent a drop in spread of over 200bp.

"A move of 'hundreds of basis points' for low priced paper is not as impressive as it might sound," Trepp adds. Meanwhile, weaker paper - bonds on watch for downgrade - continues to severely underperform bonds without that stigma.

CMBS

... while CMBS delinquent unpaid balances rise

In September 2009 the delinquent unpaid balance for CMBS increased to US$31.73bn from US$28.16bn a month prior, according to Realpoint. This delinquent unpaid balance is up some 583% from one-year ago when only US$4.64bn of delinquent balance was reported for September 2008. It is also now over 14 times the low point of US$2.21bn in March 2007.

An increase in four of five delinquent loan categories was noted in September, with a slight decline experienced in the REO bucket (reflected in the increased liquidations for September). Despite such decline, Realpoint notes that foreclosure and REO categories grew in aggregate for the 22nd straight month - up by US$1.48bn (8%) from the previous month and over US$16.65bn (547%) in the past year (up from only US$3.044bn in September 2008).

The past two months' delinquency increase followed the previously-reported July 2009 decrease, which had marked the first decrease for CMBS delinquency since August 2008. The decline in July came after nearly US$4.8bn of GGP-sponsored loans were returned to current payment status following a 30-day delinquent status in June.

Realpoint adds that if these GGP-sponsored loans were omitted from the reported delinquency stats in June, the monthly trend of growth for CMBS delinquency would have continued. Specifically, after removing these loans, CMBS delinquency would have increased to a hypothetical US$23.85bn in June 2009 (2.92%) from US$18.78bn in May 2009 (2.275%), and then to US$25.68bn in July 2009 (3.135%).

The total unpaid balance for CMBS pools reviewed by Realpoint for the September 2009 remittance was US$805.3bn, down from US$811.4bn in August (affected by amortisation, repayments, liquidations and some servicer or trustee reporting delays).

CMBS

EMEA CMBS performance deterioration continues

Weaker occupational markets and adverse tenant performance across EMEA property markets are having an increasingly negative impact on CMBS and multi-family transactions in EMEA, says Moody's in its latest surveillance report for the sector.

Market participants have started to become more optimistic as Q309 showed the first signs that property values in some markets have reached the bottom and values are now slightly increasing. "We, however, remain sceptical of this recovery and anticipate further value declines until 2010 in all EMEA CMBS markets," says Christian Aufsatz, a Moody's svp and co-author of the report.

"The overall performance deterioration that started during 2008 and accelerated during H109, as property values continued falling and occupational markets weakened further, continued unabated into Q309," says Viola Karoly, a Moody's analyst and co-author of the report.

As a consequence of declining occupancy levels, increasing rental arrears and the additional costs that result from these problems, a growing number of loans are either already experiencing cashflow problems or anticipating them in the near future. In turn, this has led to an increasing number of loans that have defaulted as a result of breaching their interest or debt service cover ratio covenant requirements.

"Payment defaults during loan term have also become significantly more prevalent," says Karoly.

The rate at which defaulted loans were transferred into special servicing also increased, as fewer events of default are expected to be cured with many sponsors unable or unwilling to support their loan.

Documentation

Standardised CDS coupons rolled out in Asia

ISDA has announced market practice changes to the trading convention for CDS in Japan and Asia ex-Japan. These changes, which will go into effect following the 20 December index roll, include the adoption of standard coupons and full first coupons in CDS transactions.

Firms will now trade Japan CDS with standard coupons of 25bp, 100bp and 500bp and full first coupons going forward. Asia ex-Japan CDS will be traded with standard coupons of 100bp and 500bp and full first coupons going forward.

Standardisation of coupons in Japan and Asia ex-Japan follows similar changes in North America, Europe, Australia/New Zealand and emerging markets in the Middle East and Latin America (SCI passim).

Indices

Further improvement in troubled company index

The Kamakura index of troubled public companies has made its seventh consecutive improvement in October. The index declined from 10.90% in September to 10.68%, with credit conditions at the best levels since December 2007. Kamakura's index had reached a peak of 24.3% in March.

Kamakura defines a troubled company as a company whose short-term default probability is in excess of 1%. Credit conditions are now better than credit conditions in 63.9% of the months since the index's initiation in January 1990 and 3.02 percentage points better than the index's historical average of 13.7%.

The all-time low in the index was 5.4%, recorded in April and May 2006, while the all-time high in the index was 28.0%, recorded in September 2001. The index is based on default probabilities for almost 27,000 companies in 30 countries.

Kamakura's president Warren Sherman says: "While credit quality continued to improve in October, the rate of improvement has slowed. Within the rated company universe, a number of companies have shown a significant increase in default risk. The rated firms showing the largest increase in short-run default risk in October include Citadel Broadcasting, CIT, Allied Irish Bank, Bank of Ireland and Ambac."

Indices

Continued negative trend for credit card indices

The performance of the UK credit card master trusts continued to deteriorate during Q309, reflecting the negative impact of the current recession on cardholders' ability to meet payments, according to a new Fitch report. The agency retains its negative outlook for the sector, in light of recent transaction performance and its expectations for UK economic performance.

The Fitch charge-off index reported its eighth consecutive monthly increase, reaching a new high of 11.4% in September 2009. The elevated level of charge-offs was driven most notably by MBNA's CARDS I and CARDS II trusts.

In contrast, the Fitch delinquency index recorded its fourth consecutive monthly decrease. At 4.8% for September 2009, delinquency levels were in line with those last seen at the start of 2009. The gradual improvement in delinquencies is a potential positive factor; however, Fitch remains concerned by the ongoing impact of the current economic environment and does not expect to see improved charge-off performance in the near term.

The Fitch monthly payment rate index and Fitch yield index finished the quarter positively, increasing 0.6% and 0.8% respectively, relative to June 2009. However, the increased charge-offs caused the Fitch excess spread index to fall by 0.3%.

The high charge-off levels are consistent with personal insolvency levels. Recent data shows that, for Q209, personal insolvencies in England and Wales totalled 33,073 - an increase of 7,290 over Q208. The 2009 data included 1,978 insolvencies under the new debt relief order scheme, introduced in April 2009.

Investors

Improved outlook for Australian fixed income investors

Fitch has released its third semi-annual investor sentiment survey of Australian fixed income investors and found an improved outlook, with an overwhelming view that markets across all asset classes are past the worst of their disruption.

Some 79% of respondents are acquiring fixed income assets, 4% of which are doing so most aggressively. This is significantly higher than in Fitch's December 2008 survey, when only half were buying fixed income.

The latest survey also asked investors for their views on seven new topical questions that explored attitudes towards the Australian asset-backed bond market. Nearly half of those surveyed were buyers of primary Australian RMBS issuance during 2009, in a market where investors have been cautious of secondary market liquidity, asset pricing and asset quality.

Investors remain cautious towards Australian CMBS and structured credit, with property prices being the primary concern with respect to CMBS. There appears to be a lessened desire among investors to consider investing in structured credit, the survey indicates.

David Carroll, director in Fitch's structured finance team, comments that 2009 has been an important year for CMBS with A$3.4bn in transactions maturing. "To date, all transactions have been repaid in full at expected maturity, with capital markets investors participating in just one of those refinancings. This is a reflection of the reticence articulated by investors in the survey," he says.

The latest survey also found that some risks - namely housing market distress, inflation and hedge fund failures - had ameliorated in the second half of 2008, while others have worsened. Given the relative strength of Australia's major banks, Fitch notes a surprising change in the perception of an increased risk of a major bank collapse.

Investors

UCI results in, while another GRAND tender launched

BNP Paribas has announced the results of its tender offer on the Spanish UCI series, which will be settled on 9 November. The bank accepted €226.3m in tenders, with 78 bondholders participating.

Prices ranged from 85%-94.9% for the Series 9 to 11 deals, and from 67%-77% for Series 14-17. No bonds were tendered for Series 8, 12 and 17A1.

Meanwhile, a second tender offer has been launched for mezzanine class notes C, D, E and F of the German multifamily CMBS GRAND. The tender will close on 10 November.

Ratings

One-third of Moody's US CLOs retain top rating

Moody's has completed the review of US cashflow CLOs that it initiated on 4 March. The review of EMEA CLO transactions continues, however, and is expected to conclude by the end of the year. The rating agency has also completed its global review of SME CLOs.

Moody's has conducted rating reviews on 3,366 tranches from 542 CLO transactions totalling US$238bn rated in the US and downgraded 2,909 tranches from 530 transactions totalling approximately US$180bn. Outside the US, the agency has thus far downgraded 707 tranches from 160 EMEA CLO transactions originally totalling US$35bn.

Moody's says that, of the 996 originally triple-A rated tranches in the US CLO sector, 350 (or approximately 35%) retained their triple-A ratings, while 634 tranches were downgraded by an average of 2.8 notches and 12 were withdrawn. Out of the 634 downgraded triple-A tranches, 476 (or 75%) were downgraded to the Aa range, 140 (or 22%) were downgraded to the single-A range, seven (or 1%) were downgraded to the triple-B range and 11 (or 2%) were downgraded to Ba1 or below.

The agency observed a certain degree of correlation between triple-A ratings stability and manager strategy. In a number of cases, there were certain managers of multiple transactions where ratings for non-super senior triple-A notes remained unchanged after the sweep.

During its assessment of these managers' deals, Moody's observed consistently strong collateral performance through the economic downturn, coinciding with a propensity to select lower-risk assets in defensive industries. Additionally, these managers also largely avoided investing in risky mezzanine and junior CLO tranches.

Ratings

US RMBS/CDO ratings criteria change explained

S&P's chief credit officer, Mark Adelson, has published a note commenting on the ratings agency's recent criteria changes for CDOs and US RMBS.

S&P believes that the effect of the criteria change should be to make it more difficult for securities in the sectors that have displayed poor credit performance during the current financial crisis to receive high ratings. The changes are designed to enhance the comparability of ratings on those securities with ratings on credits in other sectors, the rating agency notes.

Adelson explains: "Comparability of ratings is important because ratings can serve as a common vocabulary to describe credit risk. When ratings are comparable across sectors, investors can better use them to compare the credit risk of securities in different sectors, thereby helping them to assess whether there are potential discrepancies in the pricing of credit risk in different sectors. When ratings are comparable, an investor can more easily assess the yield offered by a bond relative to its risk as compared to other bonds from other sectors."

In order to enhance comparability, S&P has recently embraced the use of stress scenarios as tools for calibrating its criteria. The agency uses a scenario of extreme economic stress - on par with the US Great Depression - as the triple-A calibration case. Accordingly, the agency intends for securities which are assigned triple-A ratings under the new criteria to be able to withstand that level of economic stress without defaulting, although they could suffer downgrades under such stress.

Adelson points out that the stress scenarios do not supplant consideration of sector-specific and company-specific risk factors in the agency's criteria or in assigning individual ratings. Rather, they apply in addition to these factors.

The criteria updates for both CDOs and US RMBS refer to the experience of the Great Depression as the calibration standard for triple-A ratings. Both updates utilise historical studies of that period.

The centrepiece of the updated US RMBS criteria is the specification of an 'archetypical' prime mortgage pool and its associated credit enhancement level at the triple-A rating category. The archetypical pool serves as a benchmark against which investors can compare the actual pools in real transactions. It gives investors a simple way for comparing rating criteria with those of other rating agencies, S&P says.

The new US RMBS criteria establish a triple-A credit enhancement level of 7.5% for a security backed by the archetypical pool. That level is substantially higher than the credit enhancement level under the previous criteria. Thus, under the updated criteria, investors should generally expect RMBS at each rating level to embody a larger cushion against potential losses.

S&P notes that future transactions may present pools that differ markedly from the archetype. Adelson stresses that, should the agency be asked to rate US RMBS with borrowers featuring low credit scores, little equity in their homes or certain other risk features of recent vintage mortgages, the support levels attendant to a triple-A rating would be higher than the archetypical pool's 7.5%. The adjustment mechanisms in the criteria are intended to capture the relevant risk sensitivities and to result in ratings of triple-A only when an RMBS has sufficient credit support to withstand extreme stress.

The implementation of the new criteria resulted in only a small number of downgrades, according to S&P. Many outstanding RMBS had already been downgraded because of poor performance of their underlying loans during the stressful conditions of the past few years.

Likewise, the update to the corporate CDO criteria resulted in significant changes. Specifically, the updated criteria added both qualitative and quantitative tests to supplement the Monte Carlo default simulation model.

The simulation model treats the loans or bonds that back a CDO under a mathematical framework, with characteristics and behaviours defined by the laws of probability. The additional tests are intended to address the 'model risk' associated with using a probability-based model. S&P believes this improves the criteria and helps investors by making the analysis more robust than using only a simulation model.

The updated CDO criteria produces a triple-A credit enhancement of roughly 42% for a typical nine-year CLO backed by a well-diversified pool of single-B rated credits, which is substantially higher than under the prior criteria. Similarly, the triple-A credit enhancement level will now be around 18% for a typical five-year synthetic CDO backed by a well-diversified pool of triple-B rated credits, which is substantially higher than under the earlier criteria. Upon the release of the new CDO criteria last month (SCI passim), S&P placed more than half a trillion dollars of outstanding CDO securities under review for possible downgrade.

In addition, the agency has taken steps to address what it has observed to be weak stability characteristics of certain types of credits. It accomplished this by adopting criteria that considers credit stability, not just ultimate default risk. Under this criteria, S&P may estimate that two securities have a similar default risk, but if one is more prone to sharp deterioration in periods of economic stress, it will be rated lower initially and it is unlikely that it will ever be rated in the highest rating category.

Adelson concludes: "Even though certain market participants may not welcome the changes in the short-run, the agency believes they are important to the long-term performance of its ratings. Improved comparability makes ratings more useful and valuable as benchmarks of credit risk. That, in turn, should help market participants in making informed decisions and help to re-energise the markets."

Ratings

Enhanced overviews for EMEA ABS/RMBS

Moody's has introduced additional information to its performance overviews of ABS and RMBS in the EMEA region. These changes provide further transparency both on the ratings process, as well as on Moody's opinions relating to credit quality and expected transaction performance.

Marie-Jeanne Kerschkamp, a Moody's team md, says: "In response to investor feedback, performance overviews will now contain the key assumptions in Moody's rating monitoring process on an ongoing basis. Together with the pre-sale and new issue reports, which were re-launched in June this year, this process provides investors with a unique insight into the key considerations that drive Moody's ratings."

Moody's monitoring process begins as soon as a transaction is closed and definitive ratings have been assigned. The monitoring process will continue for as long as any Moody's-rated security is outstanding, regardless of seasoning.

Ratings

CIT will not impact MAV vehicles

DBRS downgraded the ratings of CIT Group and its subsidiary, CIT Group Funding Company, to single-D following the announcement of CIT's bankruptcy. However, no rating action is expected in respect of its Master Asset Vehicle I (MAV I) and Master Asset Vehicle II.

The MAVs were created under the Montreal Accord (SCI passim) and are secured by, among other assets, 47 CDOs that reference CIT. The majority of the transactions take the form of CDS, in which the MAVs sold credit protection on a number of debt obligations. The bankruptcy filing by CIT has triggered a credit event under the standardised ISDA contracts and documentation utilised by market participants to enter into CDS transactions.

When monitoring the performance of CDO transactions, DBRS applies a probability of default to each reference entity based on the current rating and remaining term of the transaction, and a recovery assumption in the range of 33% to 40%, depending on the rating assigned to the CDO tranche. Given the severe ratings migration experienced by CIT prior to its bankruptcy filing, DBRS has been using conservative probability of default and recovery assumptions when modelling the transactions.

The potential bankruptcy of CIT was contemplated when the MAV I Class A-2 notes were maintained under review with negative implications on 26 October 2009 and when the MAV II Class A-2 notes were placed under review with negative implications on 11 August 2009. As a result, the credit event with regard to CIT is not expected to have an impact on the ratings of the MAV I or MAV II notes.

Real Estate

Survey underscores CRE market stress

The Real Estate Roundtable has released its quarterly survey of senior commercial real estate executives, in which it finds that commercial real estate markets remain extremely stressed with little prospect for significant near-term improvement due to increasing vacancies, reduced credit capacity and plummeting property values. All three indices tracked by the survey have risen considerably since the near-collapse of financial markets last autumn - a reflection of the extreme uncertainty and paralysis of last year giving way to a greater sense of acceptance of market realities.

However, the latest numbers remain well below the ideal of 100. An overall index of 100 means all survey respondents have answered that conditions today are 'much better' than they were a year ago and will be 'much better' 12 months from now.

Roundtable president and ceo Jeffrey DeBoer says: "The problems now are more clearly defined and there's a grim sense of reality setting in, but that's a long way from saying markets are stabilising or that conditions are on the mend. With job losses mounting, consumer confidence in the doldrums and a relapse of the recession still possible, additional policy action is needed to restore credit availability - the lubricant of the economy and job creation - and to address the equity shortage resulting from falling commercial property values."

An overwhelming majority of the over 100 respondents in the Q4 survey reported that property values are down at present compared to a year ago, although the percentage declined to 77% from 93% in the previous quarter. But respondents were far from optimistic about future valuations, with 71% saying they expect values to remain 'about the same' or to erode even further in the next 12 months.

DeBoer adds: "So-called 'zombie buildings' and empty storefronts on Main Street will only mean bigger budget shortfalls for local governments, more layoffs for construction, hotel and retail workers, and further devaluation of investment portfolios held by individual and institutional investors."

Capital market conditions remain extremely fragile, the survey shows, but there is now a greater mix of perspectives on the markets' trajectory. On the debt side, 28% of those polled said credit availability is worse today than a year ago, compared to 71% who said so in the previous quarter. The percentage who characterised equity availability as worse today than one year ago also dropped significantly - from 55% in Q3 to 17% in the latest survey.

DeBoer cautions that any signs of 'improvement' or of a levelling off in the rates of decline should be looked at in the context of where the market was 12 months ago. Given the depth of dysfunction in commercial real estate debt markets, almost all participants in the current survey (95%) expect debt market conditions to be at least the same or better 12 months from now.

Regulation

Draft legislation published on ABS risk retention

The US House Financial Services Committee and the Treasury Department have released draft legislation to address the issue of systemic risk and 'too big to fail' financial institutions. Included in the draft bill are guidelines on credit risk retention rules, which direct the federal banking regulators and the SEC to jointly write rules to require creditors to retain 10% or more of the credit risk associated with any loans that are transferred or sold, including for the purpose of securitisation.

Regulators can adjust the level of risk retention above or below 10%, the draft legislation states, but not lower than 5%. In the case of the securitisation of assets that are not originated by creditors, the regulators will require the securitiser to retain the credit risk.

Regulation

Rating agency act to further accountability

The US House Financial Services Committee has passed HR 3890, the accountability and transparency in rating agencies act. The bill was introduced by Congressman Paul Kanjorski, chairman of the house financial services subcommittee on capital markets, insurance and government-sponsored enterprises.

Kanjorski says: "The accountability and transparency in rating agencies act aims to curb the inappropriate and irresponsible actions of credit rating agencies which greatly contributed to our current economic problems. This legislation builds on the administration's proposal and takes strong steps to reduce conflicts of interest, stem market reliance on credit rating agencies and impose a liability standard on the agencies. As gatekeepers to our markets, credit rating agencies must be held to higher standards. We need to incentivise them to do their jobs correctly and effectively, and there must be repercussions if they fall short."

The bill enhances the accountability of Nationally Recognized Statistical Rating Organizations (NRSROs) by clarifying the ability of individuals to sue NRSROs. It also clarifies that the limitation on the US SEC or any State not to regulate the substance of credit ratings or ratings methodologies does not afford a defense against civil anti-fraud actions.

Additionally, the bill adds a new duty to supervise an NRSRO's employees and authorises the SEC to sanction supervisors for failing to do so. It requires each NRSRO to have a board with at least one-third independent directors and these directors shall oversee policies and procedures aimed at preventing conflicts of interest and improving internal controls.

The legislation also contains numerous new requirements designed to mitigate the conflicts of interest that arise out of the issuer-pays model for compensating NRSROs. Finally, the bill significantly enhances the responsibilities and accountability of NRSRO compliance officers to address conflicts of interest issues.

As a result of the bill, it is hoped that investors will gain access to more information about the internal operations and procedures of NRSROs. In addition, the public will now learn more about how NRSROs get paid.

When certain NRSRO employees go to work for an issuer, the bill requires the NRSRO to conduct a one-year look-back into the ratings in which the employee was involved to make sure that its procedures were followed and proper ratings were issued. The bill also requires NRSROs to report to the SEC, and for the SEC to make such reports public, the names of former NRSRO employees who go to work for issuers.

Regulation

Value of minimum retention requirement appraised

The Committee of European Banking Supervisors (CEBS) has published its advice on the effectiveness of a minimum retention requirement for securitisations, following the European Commission's call for advice regarding the amendments to the Capital Requirements Directive (CRD).

The EC submitted two calls for advice, requesting technical guidance on the effectiveness of the minimum retention requirement for securitisations in Article 122a. The introduction of this article aims to remove the misalignment of incentives between the interests of investors and those of originators in the securitisation market.

CEBS has examined some of the impact and market failure aspects of the retention policy and proposes in particular:

• The retention number of 5% should be kept for all four options, since a significant increase in this - or changes according to the option available - could have the unwanted consequence of undermining the ability of firms to achieve significant risk transfer. Furthermore, a higher retention requirement can be factored into the economics of a transaction by originators by increasing the pricing of such assets to compensate for it. On this basis, resetting the 5% number to a higher level does not automatically increase the alignment of interests.
• To clarify the scope of the prohibition to hedge an originator's exposures.
• All four retention options proposed by the Commission to be maintained, as each has advantages and disadvantages relative to the others.
• An additional method (so-called 'L-shaped' retention) is identified, which would require further work, should the Commission wish to consider its potential further in the future. However, there is currently no evidence that such a change is required at this point in time.

RMBS

Lloyds brings jumbo stand-alone RMBS

Credit ratings have been assigned to a £12bn prime UK RMBS originated by Cheltenham & Gloucester - now Lloyds TSB - called Cooper's Hill Funding. The transaction, 94% of which is rated triple-A, is not likely to be marketed publicly. However, rumours are circulating that Lloyds Banking Group may issue a second, publicly-distributed UK RMBS following the success of Permanent 2009-1 (SCI passim).

Cooper's Hill Funding exhibits a number of inaugural structural features, according to S&P. First, even though the liquidity facility amount committed is for a total of £384m, the liquidity facility is in effect split into two parts.

The first part (£360m) is available for the triple-A rated notes only. The second part (£24m) is available for the rest of the issued notes. Hence, the Class A noteholders can only access a maximum £360m of the liquidity facility.

Second, the issuer pays no step-up interest on the notes. The transaction allows for the payment of step-up fees. These amounts are considered and named 'fees' and do not constitute part of the definition of 'interest' in the transaction documents.

Third, 94% of the structure is rated triple-A. "This is much higher than what we normally see in a UK prime RMBS transaction," notes the agency. "However, the credit enhancement for the triple-A rated notes includes not only the structural subordination of 6% but also a 5.8% reserve fund. Hence, the total credit enhancement level for the triple-A rated notes is 11.8%, which is the level of credit enhancement that allows the Class A notes to withstand the S&P stresses at a triple-A level."

RMBS

US RMBS lifetime loss expectations revised

Moody's will update certain assumptions underlying its loss projections for each of the major RMBS sectors in the coming weeks. The update incorporates current macroeconomic forecasts for house prices and unemployment, as well as current performance on transactions backed by these pools. As a result of the changes, the rating agency is revising its lifetime loss expectations on pools backing Jumbo, Alt-A, Option ARM and subprime RMBS issued in 2005 through 2008.

The impact of the revisions is expected to be significant for Alt-A, Option ARM and some Jumbo pools backing securitisations from 2005-2007, with the most pronounced changes expected for the 2005 pools. Performance has deteriorated significantly in the last six to nine months, the agency notes, with loss severities trending higher than previous expectations. The impact will be less pronounced for subprime, but still notable for the 2005 pools.

Moody's expects that a trough in home prices will not be reached until the middle of 2010. Moody's Economy.com (MEDC) forecasts a home price trough in Q310 with a total peak-to-trough decline of 38%. Although home prices are expected to increase in 2011, the recovery is expected to be muted with a less than 5% growth in home prices in that year.

Additionally, the agency now expects that the grim employment situation will substantially delay improvement of mortgage loan performance across all sectors. MEDC projects the unemployment rate to peak at over 10% in mid-2010 and to remain in the high single-digits for the following two years.

As a result, Moody's expects new delinquencies on RMBS pools will continue to rise through 2010 and slowdown only thereafter. Its earlier loss projections forecast a peak in RMBS delinquencies by the end of 2009.

Loan loss severities have also increased throughout the course of the year. Higher loan loss severity is particularly notable for Alt-A and Option ARM loans, with severities now averaging around 55%-60%. These severities are about 5-10 points higher than Moody's previous estimates.

Jumbo severities are now trending at around 45% compared to the low 35%-40% seen earlier in the year. The current severities are slightly higher than expectations at 40%. Subprime severities are largely in keeping with expectations, however.

Moody's expects default rates to improve relative to the current stressful environment once the housing trough has been reached. To incorporate this in its analysis, the agency first established a benchmark default rate.

Currently, this rate represents a lifetime rate of default - from the beginning of the transaction to the forecasted housing trough. However, in order to avoid over-crediting high prepayments of an earlier vintage, before the stressed environment of the past few years, Moody's plans to change the default period to now start from early 2007.

This change has no impact on deals securitised in 2007 and a small impact on deals securitised in 2006. The impact on 2005 pools will be most pronounced as it eliminates the period during which prepayments were high and defaults were low.

Once the benchmark default rate is established, Moody's will assign a 'default burnout factor' that indicates the degree to which defaults will slow once the housing trough is reached. The agency's current burnout factors imply a slowdown in defaults of 15% to 50% across the different RMBS sectors.

RMBS

UK non-conforming RMBS arrears stabilise

The level of arrears in UK non-conforming RMBS transactions has stabilised, according to Fitch. The latest data for Q309 show that loans three months or more in arrears comprise 19% of the current loan balance - the same as in Q209 - following seven quarters of consecutive increases.

Peter Dossett, associate director in Fitch's RMBS surveillance team, says: "Stabilising arrears levels are a positive sign for non-conforming RMBS transactions. However, they remain at historically high levels and therefore continue to represent a significant risk."

The reducing level of loans in arrears is also matched by falling levels of loans currently in repossession, caused by fewer new repossessions and continued strong activity by servicers to dispose of repossessed properties. The disposal of properties continues to generate high levels of loss for transactions - particularly those from recent vintages - and this continues to be the main driver of negative rating action, with 55 tranches downgraded during the last quarter.

SIVs

BMO SIV debt programmes on review

Moody's has placed the Euro and US MTN programmes of the Links Finance and Parkland Finance SIVs under review for possible downgrade. The rating actions follow Moody's action on 22 October 2009, in which it placed Bank of Montreal's long-term rating of Aa1 on review for downgrade and affirmed the Prime-1 short-term rating.

Both SIVs are sponsored, managed and have liquidity support from BMO. The direct linkage between the senior debt ratings of the vehicles and those of BMO is based on a liquidity facility provided by BMO to the SIVs for the repayment of CP and MTNs as they fall due while the SIVs generate funds through an orderly unwind of their portfolio.

Technology

Risk management platform upgrades

Sophis has launched version 6.0 of RISQUE, its trading and risk management solution for investment banks. The offering now has extended asset class coverage and incorporates a dedicated environment for risk managers, including easier pricing and management of structured credit products.

The interface and grid computing technology of RISQUE 6.0 can handle multiple risk calculations and scenarios. Its integrated reporting capabilities can automate the reporting process for senior management, as well as enable drill-downs into specific report views. New capabilities also include the ability to provide detailed analysis on market data, Greeks, and transaction and day effects to outline the main contributing positions to P&L variations.