Contents

RMBS

Testing the water

Central bank puts repoed bonds up for sale

The Bundesbank is selling a portfolio of Dutch RMBS pledged by Lehman Brothers as repo collateral before its bankruptcy. Various motives have been put forward for the sale - ranging from a liquidity exercise to a test to quantify losses borne by central banks for providing the liquidity in the first place. Whatever the reason, further sales of bonds pledged by now-defaulted counterparties are expected to follow.

Morgan Stanley and AgFe have been mandated to lead and advise on the sale of the portfolio, which is understood to comprise nine senior tranches of Eurosail 2007-2 and Euro Mortgage Finance NL Series 2008-2 and 2008-APR, currently amounting to €712.1m. According to one European ABS trader, it is unlikely that the bonds on this particular list will ever be seen in the mainstream secondary market.

"The deals being sold are not something that the secondary market is very familiar with, given that they were structured specifically for repo purposes," he says. "They would stand out a mile if they were to be sold in the secondary market. They will most likely trade very much within their own universe and will probably be bought by buy-and-hold investors."

Securitisation analysts at UniCredit suggest that the sale will be a test to quantify the implicit cost borne by central banks for providing liquidity. "It is hard to determine the level of losses that the German Bundesbank might incur," the analysts note. "Despite the haircut, the amount of collateral pledged in exchange for cash is still unknown. However, the collateral includes Dutch non-conforming paper, which is not among investors' preferred paper."

They continue: "We also expect to see more sales as Lehman was not the only bank that defaulted after pledging collateral to repo facilities with the ECB. However, since we are talking about dismissed assets, prices will not be a direct indication of ABS."

"It will all come down to which banks and asset managers Morgan Stanley and AgFe can get on board and what they can get them to pay," the ABS trader adds. "I imagine Morgan Stanley will have to offer the bonds at a pretty decent concession."

The fierce rally in European ABS prices over the past eight months may work in the Bundesbank's favour, however. A European ABS investor says it is not impossible that the central bank will be able to take a profit from the sale.

"I guess that the bonds will not be bid above the 100-haircut level though," he indicates. "It is more probable that the central bank has taken the decision to sell the bonds because the repo terms and conditions can no longer be fulfilled by Lehman. It may also be in order to draw back some liquidity from the market. This liquidity may be used later for other market support initiatives."

ABS analysts at Société Générale add that while Dutch originators and accounts have been some of the most active participants in the market throughout this year, the year-end period may not be as favourable. "However, any setback from this asset class should be viewed as a buying opportunity," they note.

The Bundesbank sale can, however, be seen as a turning point for European securitisation and highlights just how far the market has come. It also raises the broader issue of how the ECB moves to wean banks off their reliance on ABS repo funding.

"We see a gradual increase in repo haircuts as likely the easiest way to encourage banks to re-engage with term investors; certainly, the current ECB financing proposition continues to impede a wider issuer/sponsor engagement in securitisation market re-opening," ABS analysts at Deutsche Bank conclude.

AC

Documentation

Dispute resolution?

Aiful case highlights ambiguities associated with default

Disgruntled protection buyers appear to have created a storm in Japan after their attempts to trigger credit derivatives contracts on Aiful Corporation failed three times. But the case has wider implications for the market in terms of the ambiguities associated with default.

"I believe that the Aiful issue points to a structural problem with triggering CDS contracts. The ambiguities around whether an entity has actually defaulted suggest that this case will likely be the first of many such cases to hit the market going forward," says risk consultant Satyajit Das.

Aiful reported on 18 September that it would delay payments on Y280bn of loans while it worked to restructure its debt through the alternative dispute resolution process in Japan. ISDA's Japan Determinations Committee subsequently ruled that neither a restructuring credit event nor a bankruptcy credit event had occurred in connection with the company and finally dismissed the question on whether a failure to pay credit event had occurred at the end of October (SCI passim).

Nevertheless, last week a slew of news articles emerged indicating that Aiful's lenders are unable to collect on their CDS contracts due to the lack of publicly available information proving that the payments weren't made. While such publicity may be in the interests of certain Aiful lenders, it has highlighted the fact that standardised documentation and processes can sometimes be problematic.

Prior to the implementation of the 'big bang' protocol, there had historically been two potential issues with calling a credit event, according to Das. The first was determining whether the event had occurred, which is fairly straightforward in the case of non-payment, while the second was the need for publicly available information to objectively confirm it. Further, in line with the 2003 ISDA confirmations documentation, two public sources of information were deemed to be necessary, but with the provision that a credit event couldn't be called if either the buyer or seller of the protection was the sole source of the news.

Das points to the case of Deutsche Bank versus ANZ Banking Group from 1999 as one historical example of the ambiguities around triggering a CDS. The case involved Daiwa buying protection on the City of Moscow, which subsequently only made a partial payment on a loan.

Daiwa then attempted but failed to trigger a failure to pay credit event based on two news items because they cited Daiwa as the source. But Deutsche Bank in turn was able to trigger the contract against ANZ, based on the same two news items.

"Triggering a CDS contract has always been problematic and so, as part of the 'big bang' implementation, ISDA revisited the issue and superimposed the Determinations Committees on the market to try and solve it," Das explains. "However, the concept of deciding by committee whether an entity has defaulted is bizarre: either it has or has not defaulted. It highlights the problem that unless you are a party to the bilateral contract, how can you be sure whether an entity has actually defaulted? Bankruptcy is the only non-ambiguous credit event in this regard."

Furthermore, he says, in a purely hedging market - such as the insurance sector - the obligation is on the buyer to prove loss because relying on publicly available information is problematic.

Das highlights the nature of a Determinations Committee decision if an entity, upon which a credit event has been called, or a counterparty to a CDS contract challenges the determination. "The DC is a private, bilateral contractual arrangement. If subsequently it is found that there was in fact no default and the decision has damaged an entity's financial fortunes, for example, then are there some legal or regulatory consequences? I frankly am unclear on this."

However, one structured credit investor voices his concern that if cases like Aiful are allowed to expose weaknesses in the CDS market infrastructure, confidence in the product could diminish. He warns that delays in resolving disputes could ultimately cause end-users to question the value of buying protection.

University of Texas professor Henry Hu has expounded the theory that the nature of needing to trigger CDS is changing the behaviour of lenders. Das suggests that cases like Aiful are only likely to exaggerate such behaviour.

"The majority of credit events have so far been triggered by bankruptcies, but the more ambiguous cases have the capacity to destabilise the market," he concludes.

CS

Regulation

Safe harbour extended

New accounting and regulatory rules expected to depress issuance

The FDIC last week provided some relief to the market by extending its securitisation safe harbour, following significant lobbying from the industry (see SCI issue 150). However, the broader implementation of both FAS 166/167 and the securitisation framework being developed by US bank regulators is ultimately expected to increase the cost of issuing ABS and thus drive volumes down.

Dan Castro, chief risk officer at Huxley Capital Management, confirms that the FDIC's interim rule has provided some relief for the market. "Securitisation may ultimately become more expensive than other sources of funding, but at least it appears that regulators are trying to balance what's technically correct from an accounting perspective with public policy in terms of keeping consumer lending alive," he says.

The FDIC Board of Directors adopted an interim rule that will provide a transitional 'safe harbour' for existing securitisations, as well as any transactions in process through the transitional period, that would have potentially been affected by the implementation of FAS 166/167. This safe harbour will remain in place until 31 March 2010, by which time the FDIC expects to have final rules in place that will create a sustainable framework for securitisations.

ABS analysts at JPMorgan agree that the ruling "should put to rest investors' fear of rating downgrades due to true sale status. In addition, those credit card ABS issuers awaiting this positive ruling should now be able to return to the ABS market."

The FDIC intends to propose rules in mid-December to fully address the potential treatment of any participation or securitisation completed after 31 March 2010 by adding conditions required to satisfy true sale. Such criteria will likely include 'skin in the game', compensation structures for rating agencies and underwriters, and servicing flexibility (for loan modifications), according to the JPMorgan analysts.

The proposed final rules will be developed with the involvement of other bank regulators. The regulators had previously issued a Notice of Proposed Rulemaking (NPR) in August, acknowledging the FAS166/167 changes and soliciting public comment.

Katie Reeves, research analyst at Deutsche Bank, suggests that even if the final regulatory rules are softened from the initial proposal (which essentially assumes assets stay on-balance sheet), there is very likely to be a significant increase to regulatory capital requirements. "This will, all else equal, make ABS more costly than it would have been with more preferential capital treatment," she says.

The NPR proposes leaving capital requirements pegged to accounting sale treatment. The key criticism expressed to regulators in response to the NPR is that the new securitisation accounting framework is largely driven by who has the 'control' to direct economic outcomes in a transaction. This replaces the old framework that more closely tried to identify who held the most risk in a transaction.

"To the extent that the regulatory capital requirements are in place to mitigate against asset risk, the bank regulators' current NPR - by tying proposed requirements to the changed accounting framework - are in effect saying that the concept of 'control' is a good enough proxy for the concept of risk. While in many cases 'control' and 'risk' will dovetail to a common result, in other cases it will not," adds Reeves.

She notes that, under the new accounting rules, a sponsor could probably still avoid consolidation if they do not play a lead servicing role and if they do not retain any subordinated tranche or equity in the securitisation. However, these tests are not likely to be met very often, with the result being that many programmes will be accounted for on-balance sheet.

Castro suggests that with FAS 166/167 standard setters got it right but at the wrong time. "The reality is that the economic risk of a securitisation never changes hands (unless there are catastrophic losses), so issuers already have 'skin in the game'," he says. "The new rules capture this, but at the same time present difficulties in today's market. Their introduction needs to be coordinated carefully if securitisation is to continue its crucial role in facilitating consumer lending."

Castro explains that based on a generic credit card transaction - which has, for example, a yield of 24% from the underlying pool of assets, a coupon of 5%, a servicing fee of 2% and losses of 10% - the issuer will have a net excess spread of 7% remaining. If the losses on the underlying reduce, the excess spread increases and vice versa.

"In a normal market environment, senior bondholders aren't affected by any increases in losses. Furthermore, all securitisations have reps and warranties that stipulate the issuer has to buy back the underlying collateral if they're violated - so the issuer also has a legal obligation to the deal. Consequently, the idea of risk retention is redundant because the issuer already has a significant stake in the deal, which is often greater than the 5%-10% being suggested by regulators," he argues.

Indeed, the accounting requirement that risk be transferred appears to be in direct conflict with draft securitisation-related legislation moving through the US House of Representatives that includes a requirement that securitisers retain a portion of the credit risk of a transaction. "Beyond examples of regulatory initiatives appearing to work at cross-purposes, there has rarely been a time when so many pillars of securitisation - accounting true sale, legal true sale and regulatory capital treatment - have been up in the air," Reeves continues.

In the short-run, she expects some degree of paralysis until issuers, investors and rating agencies can be certain of the capital implications and insolvency treatment of a new securitisation. "Over the longer run, assuming that capital costs do move higher, the relative attractiveness of securitisation in a bank issuer's funding toolkit will drop versus the alternatives. We might also expect differences begin to develop in the ABS issuing strategies of regulated bank entities versus entities that are not subject to bank regulatory capital rules, as well as differences between US entities versus international issuers."

According to Glenn Schultz, senior analyst at Wells Fargo Securities, FAS 166/167 ensures the emphasis of securitisation is as a funding tool and not an arbitrage opportunity. Consequently, he expects that the implementation of the new rules will ultimately drive securitisation volumes down.

However, he concludes: "Holding deals on-balance sheet shouldn't prevent sponsors from electing debt for tax treatment, as long as they don't have to reserve against losses. Indeed, some institutions would like to grow the size of their balance sheets. The question was how to achieve this without double-counting losses."

CS

CMBS

DDR CMBS uptake has limited effect on legacy prices

Developers Diversified's long-awaited TALF-eligible new issue CMBS has priced. The US$400m deal - DDR 1 2009 - attracted a strong investor response across the capital structure. However, analysts have cautioned against extrapolating too much from the success of newly underwritten and issued CMBS bonds to legacy bonds.

One CMBS investor confirms that the DDR transaction's clean structure - backed by a single loan, with high levels of credit enhancement - is very attractive and has even prompted cash buyers to participate in the offering. It seems that the Fed also favours this type of structure, given that the CMBS new issues in the pipeline are said to be similarly structured. Indeed, TALF issuance is now expected to shift from being dominated by ABS towards CMBS.

James Frischling, president of NewOak Capital, adds that the demand for the DDR bonds is a strong indication that when the right amount of leverage is applied to quality assets, it results in a product that attracts a great deal of attention. "That's what the Federal Reserve's TALF programme is trying to achieve, by offering to play the role of the temporarily sidelined private sector in terms of providing the financing to quality commercial real estate securitisations," he notes. "If orchestrated and managed correctly, expect to see the spreads on these commercial assets driven tighter... The long-term success, however, will depend on the markets learning from history, as opposed to repeating it, and remembering that quality assets and proper levels of leverage must always be part of the equation."

DDR's five-year US$323m triple-A notes priced at 140bp over swaps - slightly tighter than initial guidance of 145bp-160bp over. The deal's non-TALF eligible double-A and single-A rated tranches priced at 575bp and 625bp over.

CMBS strategists at Barclays Capital estimate that the triple-A guidance spread range would translate into potential TALF yields to equity of 6.4%-7.4% - well below potential yields in the legacy TALF market for multi-borrower deals. However, they caution against extrapolating too much of the success of newly underwritten and issued CMBS bonds to legacy bonds.

They note: "We agree with the sharp divergence in pricing between CMBS 2.0, i.e. bonds issued post-bubble, and the legacy CMBS from recent vintages. In CMBS 2.0, we believe traditional relative value analysis to other high quality sectors - including heavily seasoned CMBS, consumer ABS and investment grade corporates - is more relevant."

Analysts at Trepp, meanwhile, suggest that once the DDR deal makes its way through the system, it will hopefully re-set the bar for underwriting standards and spread expectations. "Aside from balance sheet constraints, one of the biggest impediments to lenders making loans has been the absence of an exit strategy," they note. "Even those institutions without balance sheet limitations were unwilling to pull the trigger without some indications of buyers' spread expectations and rating agency subordination levels. With the lack of any new issuance, these benchmarks were non-existent. The hope now is that with these levels established, other lenders will feel enough confidence to put some capital to work."

Last week, the legacy CMBS market saw limited spillover from the favourable response to the DDR deal. Recent-vintage triple-A cash spreads were unchanged to slightly wider, while AMs and AJs came under pressure because of heavy bid list activity, especially in the AJ sector.

"We believe the limited response is appropriate, as the new-issue TALF deal highlights the widening gap between newly originated and legacy loans, especially those from 2005+ vintages," add the Barclays Capital strategists. "Based on the trailing 12-month NOI of US$66.2m, the initial debt yield on the DDR loan is 16.6%, or 17.8% exit debt yield based on the 30-year amortisation schedule."

This is in sharp contrast to recent-vintage CMBS loans. For example, in CMBX.4 - a proxy for 2007 vintage collateral - the average debt yield is only 9.1%, with downward pressure given the lack of amortising loans and declining NOIs.

DDR 1 2009, underwritten by Goldman Sachs, is backed by a pool of 28 retail properties across 19 states. The loan is a five-year balloon with a 30-year amortisation period.

AC & CS

Regulation

Euro body refuses to endorse IAS 39 substitute

The European Financial Reporting Advisory Group (EFRAG) says it will not, at present, endorse the IASB project to improve accounting for financial instruments - IFRS 9. The move is expected to lead to greater fragmentation of reporting.

"It has been decided that more time should be taken to consider the output from the IASB project to improve accounting for financial instruments," says EFRAG. "Therefore, at this stage, EFRAG will not finalise its endorsement advice on IFRS 9."

It has been suggested that EFRAG yielded to pressure from the German financial industry, as German banks - as well as French and Italian institutions - would be hit the most by the accounting changes and would have to book more losses on their large derivatives books. Conversely, HSBC has reportedly been pressing the group to accelerate the adoption of the new rules, which it says are badly needed on the grounds that less transparency would put EU banks at a competitive disadvantage.

"Such divergence of view is a reflection that the financial crisis will continue to expose the differences between 'winners' and 'losers', with some banks having been more prompt at recognising losses - and therefore being better positioned for the future - compared to others," credit strategists at BNP Paribas note.

However, Moody's analysts indicate in the agency's latest Weekly Credit Outlook that the new rule was suspended over concerns that it does not strike the proper balance between fair value accounting and amortised cost accounting. "The EC's decision to delay implementation within the EU was based on concerns that the changes do not go far enough to limit the use of fair value accounting," they note. "In a letter sent to the IASB prior to the finalisation of the rules, the EC indicated its opinion that IFRS 9 could lead to more instruments being carried at fair value for certain firms, potentially exacerbating income volatility and affecting financial stability."

The analysts say that the EC's decision is concerning in that it will likely lead to greater fragmentation of reporting and deals a significant blow to the IASB/FASB convergence effort. FASB's preliminary conclusions around its financial instruments project differ significantly from those adopted by the IASB, they explain. In particular, the majority of financial instruments will be recorded at fair value.

The IASB on 12 November issued a new reporting standard on the classification and measurement of financial assets. IFRS 9 will use a single approach to determine whether a financial asset is measured at amortised cost or fair value, replacing the many different rules in IAS 39.

The approach in IFRS 9 is based on how an entity manages its financial instruments (its business model) and the contractual cashflow characteristics of the financial assets. The new standard also requires a single impairment method to be used, replacing the many different impairment methods in IAS 39.

The views expressed to the IASB during its consultations resulted in the proposals being modified to address concerns raised and to improve the standard. For example, IFRS 9 requires the business model of an entity to be assessed first to avoid the need to consider the contractual cashflow characteristics of every individual asset. It also requires reclassification of assets if the business model of an entity changes.

The IASB changed the accounting that was proposed for structured credit-linked investments and for purchases of distressed debt. It also addressed concerns expressed about the problems created by the mismatch in timings between the mandatory effective date of IFRS 9 and the likely effective date of a new standard on insurance contracts.

Furthermore, in response to suggestions made by some respondents, the IASB decided not to finalise requirements for financial liabilities in IFRS 9. It has begun the process of giving further consideration to the classification and measurement of financial liabilities and it expects to issue final requirements during 2010.

The publication of the IFRS represents the completion of the first part of a three-part project to replace IAS 39 Financial Instruments, the IASB notes. Proposals addressing the second part, the impairment methodology for financial assets were published for public comment at the beginning of November (see last week's issue). Proposals on the third part, on hedge accounting, continue to be developed.

The effective date for mandatory adoption of IFRS 9 is 1 January 2013. Consistent with requests by the G20 leaders and others, early adoption is permitted for 2009 year-end financial statements.

EFRAG says it is currently considering how it will proceed in its work to address the package of standards that are expected to replace IAS 39.

AC & CS

RMBS

Fortis CBs to channel repoed RMBS to investors

Fortis' new covered bond issuance is to be backed by structure-to-repo senior RMBS bonds from the Dolphin Master Trust programme. The bonds are expected to experience significant investor interest and analysts are also speculating whether this structure is a reasonable model to refinance parts of the retained RMBS market.

"We expect to see significant interest for Fortis' new covered bond," note securitisation analysts at UniCredit. "One reason for this is its unique structure, with covered bonds being collateralised by RMBS notes - only CIF Euromortgage has a similar structure."

They add: "Another reason is the question if this structure will have a model character for other potential issuers. While this approach could be a reasonable model to refinance parts of retained RMBS debt, we note however that the currently retained senior RMBS volume is definitely too high to be absorbed by the covered bond market."

There is currently €28bn of triple-A RMBS outstanding from the Dolphin Master Trust, according to UniCredit data.

Moody's notes that while a triple-A rating is required at inception and for all new RMBS notes placed in the cover pool, a downgrade over time would not automatically require a replacement of the RMBS notes within the cover pool or additional collateral to be placed in the cover pool. However, if the RMBS notes become ineligible for repo with the central bank (currently single-A), they would not qualify for the quarterly asset coverage test (ACT) for the covered pool.

"Despite the additional 10.5% of credit enhancement (on top of the Dolphin subordination) required for the covered bonds, a placement looks likely to be cheaper than the haircut demanded by the ECB for self-originated (and self-swapped) RMBS," adds UniCredit.

At this stage it remains unclear whether the bonds will be placed with third-party investors, with a central bank as repo collateral, or if the issuance will, in fact, go ahead.

AC

Documentation

Forensic analysis

Richard Barrent, president and coo of The Barrent Group, answers SCI's questions

Q: How and when did The Barrent Group become involved in the RMBS markets?
A: The Barrent Group began working on forensic mortgage loan reviews for clients in September 2008, looking to take action to recover losses on pools of loans that were purchased for residential mortgage-backed securities. Prior to that, our group was part of Wells Fargo. Last September we had 12 employees, but that has since risen to 20.

Q: Which market constituent is your main client base?
A: Our clients are, for the most part, monoline bond insurers or bond investors. We have also done some work with national banks on whole loans they purchased.

Our main focus is to re-underwrite and complete forensic reviews for mortgage loan files and also to help clients put back the loans to the responsible party. We analyse the details of the loans that have breaches of the representations and warranties within the securitisation, and then take it all the way through the process, so that the client can get the loans repurchased.

Thus far in 2009, our clients have benefited from our services by avoiding realised losses totalling US$52m. This loss avoidance was associated with 444 loans that were made whole by responsible parties through repurchase demands. Our website lists our historical loan review statistics.

We're also expanding our servicing reviews - not only are we looking at how the loans were originated, but also looking at how the loans were serviced once they were originated and pooled together. With high defaults and delinquencies, particularly in 2006- and 2007-originated loans, there may be instances where the servicer did not handle the loans according to their standards.

Q: What are your current strategies?
A: We launched the Bond Board and Reports service in July of this year. The idea of the service is for investors to find other common bond holders, so they can take action to get problematic loans reviewed. Normally, there is a 25% threshold required by servicing agreements for certificate holders to take action, so in many cases several bond holders will have to take collective action to get the loans reviewed.

The investor community has been very open to the concept, in that they can confidentially register and share the holdings that may be of interest, particularly if a bond is underperforming significantly. The service is free, but if, for example, the loans contain breaches, then we can then help the bond holders with repurchase obligations.

There's plenty of deal-specific information available on the web, but nothing that tells you who owns what. We see the Bond Board and Reports as a valuable tool - and the more investors that use it, the more useful the product becomes.

Investors are still at the stage where they are analysing loan pools and making decisions on which bonds they want to take action on, and looking at which ones would be most meaningful for getting a recovery.

Right now we have 238 securitisations on our Bond Board and Report, which represents 328 CUSIPS with a balance of US$9.6bn.

Q: Which challenges/opportunities does the current economic environment bring to your business, and how do you intend to manage them?
A: To some extent, the crisis has spurred our business on. There's a lot of need out there - and investors recognise that delinquencies keep rising, option ARM mortgages are re-setting and defaults are going up.

However, the turmoil experienced over the past year has had an effect on the business. Investors have wanted to take action, but there has been a lull, as investors waited to see what the government would do with initiatives such as TARP, TALF and the PPIP. There was also a lot of uncertainty over the nationalisation of banks.

Although the dust hasn't completely settled, it is calming down to a point where decisions can be made. A lot of 2006- and 2007-vintage loans potentially have high breaches, delinquencies and defaults. The economy isn't responsible for all those defaults - there were also things that were missed by the lenders.

Q: What major developments do you need/expect from the market in the coming year?
A: Our hope is the ABS market - in particular, the non-agency RMBS market - will come back. We would love the opportunity to be able to review loans at the front-end of transactions, where our clients may be purchasing or securitising loans. We could be the eyes for a rating agency, for example, and say if these loans are high quality/investment quality, as well as checking to assure there is no fraud or misrepresentation.

We do look forward to the securitisation market coming back, but when that will be remains questionable. Until there's more reform with the servicing agreements or the representation of warranties and until there's skin in the game for investment bankers or lenders, it's going to be a while before the asset class comes back.

AC

ABS

Debt capital markets division reorganises

NAB's wholesale banking division has launched a new debt capital markets business. The bank's securitisation, syndicated loan and agency teams - together with the traditional capital markets origination team - are now a unified debt markets origination business. The entire team will be led by Steve Lambert, global head of debt markets, and will be focused on NAB's syndicated loan portfolio.

Lambert says: "These changes will sharpen our focus as a provider of specialist products and services to NAB's customers. This team is all about supporting our customers across the group - whether it be directly through a more active involvement in their capital markets transactions or indirectly helping our business bankers optimise their lending portfolios. The new team approach allows us to take advantage of further rejuvenation in domestic markets."

Graham McNamara, previously head of loan syndications, has taken on the new role of head of non-traded credit portfolio. After 13 years in syndicated loan origination, 11 at NAB, he will now be responsible for managing wholesale banking originated loan assets.

Replacing Graham as head of loan syndications and agency will be Mark Garrick, who was previously global head of capital markets origination. He has been a part of NAB's debt capital markets team for over nine years and his knowledge of both the domestic Australian market and Australian issuers overseas will bring significant value to the team.

Patrick Mullins and Geoff Schmidt will replace Garrick as joint heads of global capital markets origination. Mullins has successfully led BNZ's debt capital markets team in New Zealand for the past four years and Schmidt has led NAB's US private placement team for two years. Meanwhile, John Marsh has been appointed head of capital markets origination at BNZ, working closely with Mullins to further develop the BNZ DCM business.

To lead the origination of these solutions to clients, Joe Azzam has been appointed global head of debt syndicate. Azzam has over 15 years' global fixed income experience gained at TD Securities and NSW treasury corporation. He will be responsible for leading the debt syndicate team to cover frequent borrower coverage and will also take responsibility for secondary loan trading.

John Barry will continue to head up the securitisation origination business at the bank.

ABS

Bank strengthens DCM group

Deutsche Bank has hired Patrick Käufer to join the firm as an md in the debt capital markets (DCM) group. Käufer will lead DCM's origination effort for aircraft and equipment financing and is based in New York. He reports to Marc Fratepietro, md and head of industrials origination within DCM.

Käufer was previously at PK Advisory, a structured finance advisory service firm, where he was a founder and managing member. Prior to PK Advisory, he was an md and head of the leasing and equipment finance group at Morgan Stanley, responsible for origination, structuring, execution and placement of secured corporate debt.

Erich Mauff, co-head of DCM for North America at Deutsche Bank, says: "The depth of experience and sector expertise that Patrick brings will help us leverage our existing strengths, including recent hires such as Michael Masterson in transportation banking, Scott Hoffman in credit research and Jerry Cudzil in credit trading, to expand our full-service aircraft and equipment finance platform."

Advisory

Advisories combine to create full-service SF house

Green Street Capital - which was founded by Ian Robinson in 2008 - has acquired SCTS Ltd, the advisory boutique headed by Dean Atkins. The two business founders have been joined by a third partner, Dan Watkins, who was latterly European head of the bank solutions group at RBS. The three have previously worked together in various roles over the past eight years and aim to use their complementary backgrounds to give the new-look Green Street Capital a broader product set than either firm could previously offer.

Atkins says: "The pooling of our resources means that there's nothing within the ABS, CDO or broader structured product markets that we can't cover, and cover well. Between us we have decades of trading, structuring and accounting experience that we can now use for the benefit of our client base."

Green Street specialises in advising clients on their structured product exposures, providing assistance with everything from capital efficiency and accounting issues to distressed asset valuations and expert witness testimony. The group is split between London and Dublin and is currently working on projects that include asset restructuring, portfolio modelling and valuation and investment strategy advice. They have also been advising a government agency on the treatment of ABS within its bank assistance programme.

"We've already seen the benefits of combining our skill-sets, as well as having a presence in both Dublin and London, in terms of the mandates we've won over the past few months," says Watkins.

Robinson, who was formerly head of CDOs at Nomura, adds: "It's been a busy few months since we got our FSA authorisation and, now that the immediate infrastructure and hiring requirements have been dealt with, we're looking forward to focusing 100% on delivery of our current projects."

The group intends to build on its success to date by continuing its expansion to a full-service structured product house during 2010.

Advisory

Knight Libertas appoints credit specialist

Knight Libertas, a subsidiary of Knight Capital Group, has hired Brian Yelvington as a director, fixed income research - strategy. He will focus on treasury and spread products, with an emphasis on corporate credit.

Yelvington joins Knight Libertas from CreditSights, where he was senior macro strategist, developing the credit macro view for the firm as well as serving as the firm's derivatives specialist. Previously, he was with Collineo Asset Management, where he was a director responsible for developing and managing the firm's credit arbitrage strategy and co-managed an internal bank (Hypo Real Estate) prop book totalling US$4bn in assets.

As vp at Deerfield Capital Management, he assisted in the management of over US$3.5bn in CBOs and total return accounts across synthetic and cash instruments. He began his career at Lehman Brothers on the FX desk.

Alternative assets

Alternatives group adds in business development

Future Capital Partners (FCP) has appointed Andrew Derrington to its business development team, where he will be responsible for business development and client liaison. Derrington has over 10 years' experience within the investment arena, the last four of which have been spent within FCP's alternative investments division.

He joined FCP from Mercury Tax Group, where he was actively involved in business development and technical work. Prior to this, Derrington worked for Ingenious Media, where he was responsible for the promotion of structured investments (both personal and corporate) covering sectors such as film partnerships, venture capital trusts, enterprise investment schemes, and inheritance and corporate tax solutions.

Tim Levy, ceo of Future Capital Partners, says: "We are pleased to have someone of Andrew's calibre joining our team. His experience in the structured investment world will play a major part in further strengthening our relationships with the IFAs and intermediaries who help to distribute our products. Future has enjoyed rapid growth in our clientele of late and we hope that Andrew can help to continue that momentum."

CLO Managers

Aladdin takes on CSO business

Aladdin Capital Holdings has completed what is believed to be the largest European CSO consolidation, with the acquisition of Solent Capital Partners' CSO business.

Michael Gibbons, head of Aladdin's European investment banking business, says: "The acquisition of the Solent CSO business, one of Europe's largest, adds impetus and growth to our market leading CDO business."

Jonathan Laredo of Solent Capital adds: "We are convinced that the strength and depth of the existing Aladdin Credit team will add significant value to the investors in the CSO platform built by Solent. In addition, I believe that Aladdin's proven ability to raise hedge fund capital when allied with the credit trading expertise Solent Capital has demonstrated will help to build a significant European asset management business."

Aladdin currently manages US$10.5bn within its CDO/CLO business. Following the acquisition of Solent Capital's CSOs, the firm will manage nine additional CSO vehicles, bringing the total to 12 CSOs under management.

CLO Managers

CLO manager consolidation continues

Tetragon Financial Group (TFG) has entered into a definitive agreement with Calyon and certain of its affiliates under which TFG will acquire Lyon Capital Management (LCM) and a number of CLOs. LCM was established by Calyon as an asset manager in 2001 and currently has approximately US$2.5bn of loan assets under management. It is intended that the existing LCM management team will continue in their current roles.

Paddy Dear, a director of TFG and a principal of Polygon Credit Management (the investment manager of TFG), comments: "We are very excited about the opportunity to bring LCM, a profitable operating business, into TFG's asset pool. We think that the introduction of such a business has the potential to provide TFG with a high quality and repeatable income stream that would supplement TFG's current income, which is generated primarily from the ownership of a portfolio of CLOs, and will further position TFG to benefit from consolidation in the loan management space."

LCM currently serves as manager for two of the CLO deals held by TFG.

The consummation of the transaction is subject to closing conditions customary to similar transactions, but is expected to be finalised early in the first quarter of 2010. In connection with the transaction, LCM will enter into a joint venture with an affiliate of Polygon Management, pursuant to which Polygon will purchase a 25% equity interest in LCM. Certain Polygon affiliates will also enter into an agreement with LCM to provide operating, infrastructure and administrative services to LCM, including services that have historically been provided to LCM by Calyon.

CLO Managers

Management fees cut on ABS CDO

Belle Haven ABS CDO and Wells Fargo Bank, as trustee to the deal, have entered into a management fee supplement to the indenture. The agreement provides that the base collateral management fee to be paid by the issuer to the collateral manager will be reduced and that there will be no subordinated collateral management fee or incentive collateral management fee.

Moody's has determined that the supplement and performance of the activities contemplated therein will not cause the current ratings of the notes to be reduced or withdrawn.

CLO Managers

Second manager change for two CDOs

MBIA Asset Management is expected to be named replacement collateral manager for G-Star 2004-4, G-Star 2005-5 and Ambassador Structured Finance CDO. If the proposed change is finalised, MBIA Asset Management will assume the collateral management responsibilities previously performed by Ventras Capital Advisors for the G-Star 2004-4 and G-Star 2005-5 transactions and Deutsche Investment Management Americas for the Ambassador Structured Finance CDO transaction.

The two G-Star deals were originally managed by Capmark.

S&P has issued a preliminary rating confirmation in connection with the proposed substitution.

CLOs

Broker appoints CLO sales and trading heads

Broadpoint Capital has hired four senior professionals: Fred Engel, Philip Orenstein, Peter Carril and Jeffrey Byrne.

Engel and Orenstein join as mds and co-heads of CLO sales and trading in the firm's Broadpoint DESCAP division. Engel brings over 20 years of experience in the structured credit markets.

Most recently, he was a director in Citigroup's CDO group, responsible for new business development with a focus on the securitisation of illiquid credit assets. Prior to Citigroup, Engel oversaw the US CLO business at UBS.

Orenstein also brings to the firm over 20 years of experience in the structured credit markets and has been instrumental in the development of the CLO marketplace. He joins Broadpoint Gleacher from Structured Credit Consultants, an independent advisory firm focused on investors, portfolio managers and other participants in the bank loan and CLO markets. Prior to Structured Credit Consultants, he was a senior member of the structured credit group at RBS Greenwich Capital.

Meanwhile, Carril joins Broadpoint Gleacher as an md in the emerging markets group of its debt capital markets division. He has over 23 years of credit trading experience, 13 of which he spent working in the emerging market credit trading area.

Prior to joining Broadpoint Gleacher, he was a founding partner of Palatine Hill Partners. Prior to Palatine, he was an md and head of global trading for emerging market bonds and CDS at Dresdner Kleinwort Wasserstein. He held similar positions at Bankers Trust and began his emerging markets career at Lehman Brothers.

Byrne joins Broadpoint Gleacher in the bank loan trading group. Prior to joining the firm, he was the head of bank loan trading at Z-Capital Partners.

CMBS

TALF CMBS underwriting analysis provider named

CW Risk Management Solutions (CWRMS) has been selected by the Federal Reserve Bank of New York to provide underwriting analysis services for newly issued CMBS as part of the TALF programme. CWRMS will assist the FRBNY by reviewing commercial mortgages proposed as collateral for newly issued CMBS that would be eligible for a TALF loan.

A team of CWRMS underwriters will provide analysis of property cashflows and values, as well as consider underwriting assumptions and related matters. CWRMS will not establish policies or make decisions for the Fed, including decisions as to whether to reject a loan as collateral or the structure of CMBS transactions.

Documentation

Contract solutions practice launched

ALaS Consulting has introduced Trading Contract Solutions (TCS), a new practice aimed at helping financial services clients expedite trading contract negotiations and revenue flow. The firm has named Victor Waingort and David Shimala to build out its TCS offering.

The ALaS TCS practice addresses credit, risk, operational and legal-related issues. As part of TCS, the firm's consultants assess regulatory reporting readiness relating to trading contracts and systems, analyse and document the current state process and perform gap analyses and future state workflow evaluations. They can also reengineer contract-related systems, processes, procedures and controls.

Additionally, ALaS TCS professionals support these initiatives and peaks in volume by offering full outsourcing of contract negotiations, as well as documentation, administration and maintenance of trading agreements, including ISDA Master Agreements/Schedules and Credit Support Annexes.

Waingort was most recently global manager for trading documentation at Bank of America, where he supervised a team of more than 35 trading contract negotiators. Prior to that, he practiced law at Allen & Overy, where he focused on structured finance and derivatives transactions.

Shimala has 20 years of experience in the financial services industry working at institutions, such as Bank of America and JPMorgan. His expertise encompasses the vetting and negotiation of highly complex derivative contracts and trading agreements.

Emerging Markets

Emerging markets infrastructure fund launched

PIMCO has launched the PIMCO Emerging Markets and Infrastructure Bond Fund. The underlying strategy, which is also available on a separate account basis, seeks to capitalise on the expected sharp increase in spending by developing nations on energy, transportation, water and waste treatment, telecommunications, public housing and development banks.

Emerging market governments around the world are targeting infrastructure investments as critical foundations for future growth, with over US$1trn of projects committed to or underway. Bonds that finance these projects typically offer attractive yields, often with lower volatility than seen in some other credit opportunities, PIMCO says. Additionally, the high priority that governments are giving to infrastructure may help to mitigate the credit risk of such investments, which in turn may limit correlations with emerging equity markets.

PIMCO notes that the fund is another step in its efforts to provide investment solutions developed to navigate what it calls the 'New Normal'. This refers to the firm's secular outlook that anticipates lower growth rates in industrialised countries and an increasing role of emerging economies as drivers of global growth.

Brigitte Posch, PIMCO evp and the portfolio manager of the fund, says: "As emerging markets are capturing a bigger slice of global growth thanks to their ongoing economic development and improving creditworthiness, we believe that national infrastructure is a strategically important area of opportunity in the sector. The Emerging Markets and Infrastructure Bond Fund is structured as a truly global offering designed to provide investors access to this sector as the emerging markets become an increasingly important part of their broader asset allocation strategy."

The fund seeks to benefit from PIMCO's deep resources in sovereign debt and corporate credit analysis, and from its experience in the emerging markets debt market. Posch brings 15 years' investment experience in emerging markets, as well as in the rating and securitisation of infrastructure projects. This gives her a first-hand understanding of the nature and complexities of these investments, according to PIMCO.

The fund will be added to the firm's UCITS III Global Investor Series fund range.

Investors

Long/short corporate credit fund prepped

Cairn Capital has joined forces with OYSTER Funds, the Luxembourg fund family of Swiss banking group SYZ & Co, to launch a new corporate credit fund under the UCITS III framework. The new fund, dubbed OYSTER Credit Opportunities, is a long/short corporate credit fund, targeting returns in excess of 200bp over Euribor in normal markets and in excess of 300bp-500bp over in more volatile markets.

The two firms say that the fund is aimed both at institutions and intermediaries, such as family offices acting on behalf of individuals. Cairn Capital is responsible for managing the fund, while SYZ & Co provides the fund infrastructure and distribution through its OYSTER Funds structure and client reach.

Alan Mudie, ceo at OYSTER Funds, comments: "The recent credit environment has provided great returns to investors who bought at the beginning of the year, from a pure long-only perspective. However, given the rally in credit spreads this year and the volatility still embedded in the market, this new fund is a compelling value proposition: uniquely, it can express views on the debt of the company through a combination of long exposure with the flexibility to generate alpha through short positions."

He adds: "We were looking for a manager to combine corporate cash bonds and synthetics in order to reduce volatility and deliver absolute returns. Cairn Capital's credit management track record and expertise proved to be decisive for our partnership."

OYSTER Credit Opportunities aims to properly address the current credit environment by combining a balanced risk/reward relationship with constant monitoring of underlying liquidity. The fund offers compelling risk-adjusted returns, given its lower volatility deriving from its investments in a more defensive asset class, according to Andrew Jackson, cio and portfolio manager at Cairn Capital.

Investors

FOHF hires credit strategist

Hermes BPK Partners, the fund of hedge fund investment partnership within Hermes Fund Managers, has appointed Pierluigi Ricchiuti as senior analyst of credit strategies based in its New York office.

Prior to joining Hermes BPK Partners, Ricchiuti was head of credit trading and first vp at Banca Intesa, responsible for the North American credit derivatives desk, having previously been a credit derivatives trader. He previously worked for RAS Asset Management as portfolio manager.

This appointment represents a further development of the Hermes BPK team, following the recent appointments of Lawrence Kissko and Marc Koslowsky as senior analysts. Ricchiuti will report to Tommaso Mancuso, head of research.

Operations

Corporate trust service beefed up

Wilmington Trust, through its corporate client services (CCS) unit, has hired corporate trust professionals Douglas Lavelle and Thomas Mackay to support the global expansion of its capital markets services. Lavelle and Mackay are based in New York and join Wilmington Trust from HSBC Bank USA.

Lavelle was an svp and head of business development in HSBC's corporate trust and loan agency group. He previously served sovereign and global corporate clients at The Bank of New York Mellon and JPMorgan Chase & Co.

Mackay was an svp and unit manager on HSBC's global debt, agency and bankruptcy team. Earlier, he spent 21 years servicing global corporate clients at JPMorgan Chase & Co.

CCS's core services include: entity management services, which help clients establish legal standing by providing administrative services for holding companies and SPVs; capital markets services, including trustee and administrative services for structured finance and other transactions; trustee services for corporate retirement plans; and institutional investment management services.

Bill Farrell, evp and head of CCS, says: "Our clients have the convenience of accessing multiple services and jurisdictions through a single, conflict-free provider with decades of experience. Our growth has helped CCS become an increasingly important component in the diverse sources of Wilmington Trust's revenues."

The ongoing global expansion of its capital markets services is the latest in a series of growth initiatives within CCS. Since early 2008, the unit has made two acquisitions in its corporate retirement services business, added a team of specialists in distressed debt, loan administration and bankruptcy services, and assumed responsibility for several corporate trustee services formerly performed by LaSalle Bank NA (a result of LaSalle's merger with Bank of America).

Christophe Schroeder, executive md and head of CCS' European business, says: "Our strategy is to be the preferred choice for corporate executives and their advisors. In Europe, we have been seeing steady interest in new securitisations and opportunities to provide loan agency and other services for distressed organisations and transactions."

Technology

Vendor acquisition completed

Quantifi has acquired Moment Analytics, a privately held risk management software vendor. David Kelly, Moment Analytics' ceo, joins Quantifi as director of credit product development and will be based in the US. This is Quantifi's first acquisition.

Moment Analytics provides trading and risk management infrastructure for buy- and sell-side institutions covering a variety of OTC and exchange-traded fixed income, FX, equity, commodity and credit products. Quantifi will integrate components of the firm's software into its product suite and continue to support Moment Analytics' clients.

Kelly brings almost 20 years of experience as a trader and quant to Quantifi. At Citigroup, he was the senior credit trader on the global portfolio optimisation desk, responsible for actively managing the credit risk in derivatives positions and establishing the CVA business. Prior to this, he ran Chase's global analytics group, where he was responsible for front-office pricing models and risk management tools for the global derivatives trading desks, including the firm's first CVA system for active counterparty risk management and credit charging.

Trading

IDB hires for post-trade services

Mark Beeston is set to join ICAP on 1 December in a new role as business development director for post-trade services. He will report to ICAP Group coo Mark Yallop and will be based in London.

Since 2005 Beeston has been president of T-Zero, a subsidiary of Creditex Group Inc. Prior to that, he served as coo for integrated credit trading at Deutsche Bank in London. During this time, the bank's credit platform expanded substantially and included securitised products, convertibles, credit derivatives and corporate bonds.

Yallop says: "Mark brings extensive industry experience and excellent relationships with our customers. I am delighted to welcome him to ICAP. We have already established a strong presence in areas of post-trade services and plan to develop additional businesses in these areas. Mark will play an important role in the expansion of our businesses and the identification of new opportunities."

Trading

Credit flow trading head hired

James Godfrey has joined Daiwa Securities Europe as executive director. He will be trading the corporate Eurobond book, charged with strengthening the company's trading capabilities in the credit arena. He will also lead the firm's push into electronic trading in the credit markets.

Godfrey joins Daiwa Europe from Nomura International, where he was head of credit flow trading, with responsibility for global trading of high grade financials and corporates. He reports to Keith Meekins, md and head of fixed income for Daiwa Europe.

Godfrey's appointment is part of Daiwa Europe's ongoing build-up, as it continues to strengthen its footprint across Europe. On 1 January 2010 Daiwa Securities SMBC will be renamed Daiwa Capital Markets, when Daiwa Securities Group takes full control of the firm, buying SMBC's 40% minority share.

ABS

Redemption of synthetic ABS delayed

Credit Logement has announced that it will not exercise the calls on the first callable dates of the FRES 2004-2 and FRES 2005-1 transactions, which are due on 27 and 21 December respectively. Both deals are synthetic ABS that transfer risk to optimise regulatory capital requirements under Basel 1.

The company indicates that it is expecting further clarification from the French regulator on the adoption of its internal model under the transition period to full Basel 2 implementation. At this stage, Credit Logement has no visibility on the timing of the final decision, which should occur at some point in 2010 - although implementation may not take place until 2011. This would delay redemption of the notes by one more year.

ABS

Imperfect hedges in EMEA ABS analysed

A new report from Moody's highlights a recently-observed trend whereby the hedging agreements in some ABS and RMBS transactions did not fully mitigate the interest rate risk. In particular, the rating agency notes that interest rate mismatches can lead to increased costs for structured deals, thus reducing the excess spread and ultimately the credit enhancement available to protect investors.

The rating agency observes three imperfections in EMEA interest rate swaps: imperfect hedges, with a mismatch between the swap notional amount and the outstanding pool balance; the existence of swap bands, which are agreed between the issuer and the swap counterparty at closing of the transaction, with minimum and maximum levels for the notional amount of the swap - outside which the interest rate risk is not covered; and basis risk, whereby floating-rate loans in the pool (specifically RMBS) and coupon on the issued notes are linked to different indexes and have different reset dates. Although Moody's models these risks and typically discloses the information related to such imperfect hedging agreements in its presale and new issue reports, the rating agency cautions that introduction of any hedging shortfall increases both the complexity of the analysis and the level of uncertainty faced by the transaction.

Such shortfalls could, in some cases, lead to a greater rating volatility in a stressed interest rate environment. Indeed, in some extreme cases where the portion of the portfolio that is either unhedged or not sufficiently hedged is judged too significant by Moody's, such shortfalls could prevent the transaction from reaching the agency's highest ratings.

ABS

Stable performance for Korean ABS

Moody's reports that it sees no rating implications for outstanding Korean ABS transactions in view of the recent performance of their underlying receivables.

Marie Lam, a Moody's vp and senior credit officer, says: "Their performance has been stable, with the cumulative default ratio for auto loan receivables at less than 1.4% of the original pool balance plus all replenishments. For credit card receivables, they exhibited stable principal payments and improvements in their delinquency ratio, charge-off rate and net yield. These improvements are in line with the improvements in the unemployment rate and Korean economy."

In 3Q09 real GDP was up by 2.9% from 2Q09 and in September the unemployment rate fell to 3.4% from 3.9% in June 2009. At the same time, Korean consumer sentiment continued to improve overall on the economic situation; for example, via spending plans, living standards and household income.

ABS

EMEA consumer loan ABS performance deteriorates

The performance of the consumer loan ABS market in EMEA deteriorated in September, according to Moody's latest indices report for the sector.

Moody's gross default trend reached 1.93% in September, which is an increase of 0.5% from September 2008, and the delinquency trend increased to 0.86% in September from 0.60% one year previously. Moody's constant prepayment rate (CPR) trend continued its stable performance and stands currently at 13.1%. At present, 14 transactions have drawn on their reserve funds and three transactions in this market recorded a principal deficiency.

Olimpia da Silva, a Moody's associate analyst, says: "The performance of the EMEA consumer loan market is closely linked to labour markets and, hence, has been negatively affected by rising unemployment, which is expected to intensify given the time lag that labour markets have to economic cycles."

Worsening labour markets increase pressure on consumer loan pools and point to an increase in delinquencies and defaults. In Spain in particular, consumer loan pools are under increased pressure as a result of macroeconomic deterioration. Indeed, Moody's notes that the large majority of consumer loan ABS downgrades occurred in Spain due to weaker than expected collateral performance.

The Eurozone economy is slowly recovering from the recession, however. The French and German economies posted positive increases in GDP in Q209 and are likely to be followed by other European economies in Q309 and Q409. However, the recovery is likely to be slow.

Moody's outlook for consumer loan ABS in this region is negative.

ABS

EMEA auto loan ABS remain stable

The performance of the auto loan ABS market in EMEA remained stable in September, according to Moody's latest indices for the sector. The cumulative loss trend remained at 0.6% since July 2009, while the 60 days plus delinquency trend has maintained its August level in September of 1.4%, which constitutes an increase of 0.2% during the past year.

Moody's constant prepayment rate (CPR) trend continued its slightly decreasing bias and currently stands at 10.9%. At present, two transactions have drawn on their reserve funds and no transaction in this market recorded a principal deficiency.

Yuezhen Wang, a Moody's senior associate, says: "While the performance of the EMEA auto loan market has been impacted by the adverse effects of the recession on labour markets, for the most part the auto loan market in EMEA has demonstrated resilience to the downturn. However, used car values might experience further downward pressure as an oversupply of used cars is one of the side effects of the car scrapping progammes. This is expected to affect recovery rates in auto ABS transactions."

On the upside, Moody's latest update of the global automotive industry outlook - which was published in October - indicates that the sharp reduction in light vehicle production in the global automotive industry has started to moderate and very modest growth trends may be starting to emerge. For instance, in October, new car sales in Germany surged by 24% on a 12-month basis as the market continued to benefit from a cash-for-clunkers bonus.

Moody's outlook for German, Portuguese and South African auto loan ABS remains negative. Historically, performance of German auto ABS has not been very sensitive to increases in unemployment and, thus, only a moderate deterioration in performance is expected in the current economic downturn.

Most transactions in Portugal, meanwhile, benefit from a high degree of seasoning which mitigates the pressure despite the economic downturn. In South Africa, an oversupply of used cars is depressing prices, which might have an adverse impact on recovery values.

CDO

SIGTARP slams handling of AIG bailout

The Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) has released a report entitled 'Factors affecting efforts to limit payments to AIG counterparties'. The report criticises the NY Fed's handling of AIG's bailout, but also outlines a number of lessons that can be drawn from its actions. These include the importance of transparency and the significant impact that the rating agencies had on the process.

SIGTARP makes a number of conclusions in the report. These are that: the original terms of the Fed's assistance to AIG inadequately addressed AIG's long-term liquidity concerns, thus required further government support; the Fed's negotiating strategy to pursue concessions from counterparties offered little opportunity for success; the structure and effect of the Fed's assistance to AIG, both initially through loans to AIG and through asset purchases in connection with Maiden Lane III effectively transferred significant amounts of cash from the government to AIG's counterparties, even though senior policymakers contend that assistance to its counterparties was not a relevant consideration; and while the Fed may eventually be made whole on its loan to Maiden Lane III, it is difficult to assess the true costs of the Fed's action until there is more clarity as to AIG's ability to repay all of the assistance.

CDO

Claris CLNs repurchased

SG has repurchased €10m CLNs from each of two transactions issued via its Claris vehicle - the Series 43/2205 Voltaire and Carmel Valley 2006-3 synthetic CDOs. In both cases a portion of the issuer fixed deposit has been liquidated to pay the termination costs of the CDS and redeem the notes. The remaining noteholders' exposure to the credit default swaps has remained unaffected, according to Moody's, despite the termination of €10m of the swaps.

The swap terminations were implemented in accordance with the terms of partial redemption deeds between the issuers and SG. Moody's has determined that these repurchases will not cause the current ratings of the affected notes to be reduced or withdrawn.

CDS

Cemex decision to be reviewed externally

ISDA's Americas Determinations Committee has sent the restructuring credit event question on Cemex to an external review panel, suspending the usual DC rules until 7 December.

Meanwhile, the date for the CIT CDS auction has been set for 20 November.

CDS

CDS notionals continue to decline

BIS OTC derivatives data for H109 indicate that notional amounts of all types of contracts rebounded somewhat to stand at US$605trn at the end of June 2009, 10% above the level six months before. In contrast, gross market values decreased by 21% to US$25trn.

Similarly, gross credit exposures fell by 18% from an end-2008 peak of US$4.5trn to US$3.7trn. Notional amounts of CDS contracts continued to decline, albeit at a slower pace than in the second half of 2008, with CDS gross market values shrinking by 42% following an increase of 60% during the previous six-month period.

CDS

Government risk rises on Japan weakness

Sovereign risk has risen across most of the major market constituents this month and broken out of the tight range in which it traded since July. The CDR Government Risk Index (GRI) approached the 50bp mark this week for the first time since 22 July, after hovering near 40bp for the past two months.

According to Dave Klein, manager, CDR Credit Indices, Japan accounts for most of the deterioration in the index. "Japan's CDS doubled from its recent low levels and briefly traded with more implied risk than Italy and Spain. Italy and Spain have been the widest (riskiest) sovereigns in the GRI this year," he says. "Japan's double-A rating is two notches above Italy and one notch below Spain, making interpretation of ratings change expectations difficult. Japan's rapid deterioration divided the GRI into two distinct groups, with the UK trading in the middle."

The US, Germany and France trade in line with each other and at roughly one-third of the level of Japan, Spain and Italy. "With the majors separating into a stronger group and weaker group, the CDS market currently expresses a clear view on which sovereigns are best positioned for recovery," Klein adds.

According to Fitch Solutions, there is now almost as much uncertainty in the global CDS market about the outlook for developed economies as there is for emerging economies, with average liquidity on developed economies' sovereign CDS nearly matching that for emerging economies.

"Whilst emerging economies' average CDS liquidity has continued to fall back from its pre-Lehman bankruptcy highs, developed economy sovereign CDS has steadily increased and is now nearly as liquid due to market uncertainty over the impact of developed economies' increasing budget deficits and falling tax revenues," says Thomas Aubrey, md of Fitch Solutions in London.

"Of the developed economies, Japan has seen the biggest rise in CDS liquidity since the start of this year, moving from the 88th percentile to currently the 47th percentile of names with the most liquid CDS contracts across all asset classes. This has been due to market concern over the deterioration of Japan's public finances," Aubrey adds.

More generally, the global CDS market became less liquid in the last two weeks, with both Fitch's American and European CDS liquidity indices falling off from previous liquid highs at the end of October.

CDS

Tightening trend for CDS indices

Spreads for higher quality, large cap entities - as represented by the S&P 100 CDS Rolling Index - have widened by 1bp in November, according to the latest data released by S&P Index Services. This represents a tightening of 60.7% since year-end.

The year-to-date total return of the S&P 100 CDS Rolling Index is 4.1%, while the corresponding equity index - the S&P 100 Equity - is up over 17%.

Spreads for investment grade entities, as represented by the S&P CDS US Investment Grade Rolling Index, have tightened by 2.8% in November - a tightening of 77.2% since year-end. The year-to-date total return of the S&P CDS US Investment Grade Rolling Index is 11.3%.

Meanwhile, spreads for high yield entities - as represented by the S&P CDS US High Yield Rolling Index - have tightened by 2.3% in November. This represents a tightening of 66.8% since year-end. The year-to-date total return of the S&P CDS US High Yield Rolling Index is 31.8%.

CLO Managers

Restructured MV CLO hits the wall

Moody's has withdrawn its ratings on Confluent Senior Loans Opportunities - a transaction originally structured in July 2006 as a market value master-feeder fund structure arranged by Calyon, investing primarily in leveraged bank loans. The master fund was managed by Credit Agricole Asset Management as senior manager and the five feeder funds were managed by Ares Private Account Management I, AXA Investment Managers Paris, Intermediate Capital Managers, Loomis Sayles & Company and Morgan Stanley Investment Management.

In 2008, the transaction experienced an initial event of default, which was waived by the requisite noteholders. In the process of seeking the default waiver, the senior manager and controlling class began discussions with Moody's concerning a restructuring of the transaction into a cashflow CLO. The rating agency says it analysed various structuring proposals through to mid-2009.

Several structures were proposed where trading activities would not be subject to pro-forma satisfaction of the collateral quality tests as calculated by the senior manager prior to execution of the trade. One of the key features for a typical cashflow CLO, based on Moody's observation, is that various collateral quality tests are formally tested to be in compliance on a pro-forma basis prior to trade execution so as to evidence the commitment from an issuer to maintain a set of trading rules. Without this feature, Moody's considers that it is not possible to adequately assess the additional risk posed to noteholders from the trading activity of the managers.

As a result, Moody's informed the senior manager that it would be unable to provide the ratings requested on the restructuring of the transaction as proposed. Updated information on the transaction has not been received by the agency for the past few months; it is consequently withdrawing the ratings.

CLOs

FINCA and DB bring microfinance CLO

FINCA International and Deutsche Bank have secured US$21.2m for the FINCA Microfinance Fund, the first single microfinance network sub-debt deal. The two firms report that the fund, which has only private sector investors, was almost 100% oversubscribed and brings a new pool of investors to the microfinance industry.

The FINCA Microfinance Fund is understood to be the first microfinance subordinated debt deal to be completed since 2007 and was structured, placed and managed by Deutsche Bank. The offering will provide FINCA affiliates in the Democratic Republic of Congo, Mexico, Armenia, Azerbaijan, Kyrgyzstan, Georgia and Tajikistan the financial flexibility to on-lend an estimated US$100m in additional loan capital, as well as make the investments in staff, branches and other infrastructure to support its expanding microfinance lending and deposit-taking programmes.

Through the facility, and based on its average network-wide loan size of US$503, the seven FINCA affiliates will be positioned to provide an estimated 150,000 additional microloans each year to some of the world's lowest-income entrepreneurs. Investors in the fund include mainstream pension funds and socially-responsible private investors.

CLOs

Synthetic CLO's exposure reduced

The swap agreement between the counterparty in the Pro Rata Funding synthetic CLO and Citibank has been amended to reduce the transaction's swap notional amount by US$75m. The transaction is currently under-invested in reference obligations and therefore the swap notional is currently under-utilised.

As a result of this amendment, certain deal expenses that are owed under the swap confirmation will be reduced, including the retained calculation amount, the base reference portfolio manager fee amount, the subordinate reference portfolio manager fee amount and the aggregate unfunded amount.

The amendment received the consent of a majority of each class of noteholders, according to Moody's. The rating agency has determined that the amendment to the portfolio swap transaction and performance of the activities contemplated therein will not cause the current ratings of the notes to be reduced or withdrawn.

CLOs

Euro CLO triple-C assets increase in September

S&P's European CLO performance index report for September shows that the 2004, 2005 and 2007 CLO cohorts experienced an increase in the percentage of assets rated in the triple-C category. The exception was the 2006 cohort. In addition, the 2006 and 2007 cohorts experienced increases in the percentage of defaulted assets held in their collateral portfolios, while the 2004 and 2005 CLO cohorts experienced a decline.

CMBS

GRAND tender results in

The results of the tender for GRAND bonds have been announced. €11.5m of the Class C notes were accepted at 55 and €1.5m of the Class D notes at 43.

CMBS

Australian CMBS refinancing successful so far

The Australian CMBS market has successfully refinanced all 2009 year-to-date maturities, totalling A$2.8bn, and has seen a re-opening of the market with the first new issuance of CMBS after a two-year hiatus, according to Fitch. The rating agency notes that the total amount of outstanding Australian CMBS has decreased in size to just A$5.23bn from A$7.79bn, with maturities scheduled during 2010 of A$2.4bn.

David Carroll, director in Fitch's property ratings team in Sydney, says: "Despite a general continuing lack of liquidity in Australian property finance markets, the significant refinancing task identified for CMBS during 2009 appears to have been successfully managed by issuers, with much of the task having fallen to the four major Australian banks. Issuers continue to seek greater funding diversification and are hoping the market's re-opening during 2009 will provide an additional source of liquidity for CMBS refinancing during 2010."

Fitch's report notes that property cashflows generally remain strong, due to high occupancy levels and low tenant defaults. Asset values continue to be negatively impacted by expanding capitalisation rates. However, in most CMBS cases the value of the cross-collateralised asset pools remains higher than the value at origination.

The report covers all CMBS maturities taking place during the remainder of 2009 and in 2010, with a commentary on each. Of particular interest are the two Centro maturities scheduled for December 2009 which, if not refinanced or restructured, would be the first Australian CMBS transactions to pass their scheduled maturity dates without refinancing. If these maturities are not successfully resolved, the resultant asset sales may have a negative impact on asset values.

Commenting on the outlook for 2010, Fitch believes that refinancing risk and property prices will remain significant credit issues.

CMBS

US CMBS delinquencies rise

The aggregate rate of delinquencies among US CMBS rose to 4.01%, as of the end of October, according to Moody's. The Moody's delinquency tracker (DQT) rose by 37bp from September's 3.64% rate, was 0.60% a year ago and is now 379bp above the low of 0.22% measured in July 2007.

Nick Levidy, an md at Moody's, says: "The October increase is in-line with the steady rise in the delinquency rate over the past five months. We anticipate the rate to increase further."

Five of the last six months have seen gains in the delinquency rate of between 25bp to 41bp, with the average monthly gain during this period at 36bp. This average monthly change is significantly higher than that for the previous six-month period, November 2008 to April 2009, which saw an average increase of 21bp.

Of the five core property types tracked by Moody's DQT, the hotel sector had the largest increase in October, moving up 123bp to a 6.20% delinquency rate - the second month in a row it posted the largest increase. The multifamily sector remains the worst performing property type, with a delinquency rate of 6.47% - an increase of 38bp from September.

Retail properties stand in the middle in terms of their delinquency rate, which rose by 27 points during October to 4.03%. The industrial sector saw the smallest rise in its delinquency rate in October, rising by 16bp to 2.83%. Finally, offices increased by 40 points to 2.70%, the lowest rate for any of the property types.

Delinquencies increased across all of the DQT's four US regions during October, with the South continuing to have the highest rate, rising by 47bp to finish at 5.61%. The increases were especially steep among hotels and multifamily properties.

The East had the second worst performance during the month, with a 44bp rise in delinquencies - bringing the East's delinquency rate to 2.58%. Significant gains occurred in the eastern multifamily delinquency rate and also in both the office and hotel sectors.

The West performed slightly better than the nation as a whole, with a 35bp increase. The western delinquency rate is now 4.41%. Meanwhile, the Midwest had the mildest increase in delinquencies of the four regions, gaining only 17bp in October to end the month at 4.95%.

Two states surpassed the 10% rate for delinquencies during October. Michigan has the highest rate among all states at 10.78%, while Nevada is second at 10.07%. All other states have delinquency rates below 7%, except for Rhode Island at 9.81% and Arizona at 9.35%.

CMBS

Euro CMBS downgrades and criteria review

S&P says it will continue its downgrades of certain European CMBS. This will include a lowering of 11 ratings, as a result of the continuing credit problems in the real estate market.

The rating agency is also set to review its European CMBS criteria. The criteria review is intended to promote transparency and further comparability of ratings across all sectors of the fixed income markets. This review will result in new criteria for rating European CMBS that will align more closely with the criteria used in the analysis of CMBS in the US and Asia Pacific.

Due to the current difficulties in this sector, S&P has placed about 60% of 996 outstanding European CMBS ratings on credit watch negative in May and June. The outstanding volume of S&P-rated European CMBS is about €130bn. The ratings agency has also lowered 11 ratings and affirmed 37 ratings, following sharp declines in European commercial real estate market values as well as anticipated refinance problems, mostly from 2011 onwards.

S&P anticipates that properties in many European real estate commercial property markets could experience average peak-to-trough market value declines of between 20% and 50% in the current cycle. In general, secondary markets have seen greater declines in value and UK market subsectors have typically shown higher declines compared with major continental European markets.

Additionally, operational properties across Europe, including leisure and hotels, have experienced above-average declines. It also appears likely that over the coming years the amount of debt available to borrowers to refinance their loans may be materially lower than the debt outstanding in the sector. New credit in the sector has contracted markedly, financing from the capital markets is limited and some banks have either withdrawn from non-domestic commercial real estate lending or have been required to reduce their debt burden.

Even where new bank debt is available, the amount of this debt may be materially less than many borrowers' indebtedness. S&P believes this may be because not only have commercial real estate values fallen, but lenders' loan-to-value ratio requirements on new lending also appear to be substantially lower than levels prevailing in 2008.

S&P expects some further downward pressure on borrower-level cashflows as market rents continue to fall. The rating agency considers that European borrowers can be insulated from market rent falls by longer-term leases either with upward-only rent reviews or rents tied to consumer price indices.

Some markets have been through a period of severe stress and the expectation of future stress is part of the ratings analysis. S&P's approach is effectively a 'stress on stress', the agency notes. Values have already declined, yet for investment-grade ratings further declines are assumed, which is consistent with the rating definitions.

European CMBS markets typically use advance rate metrics, which is the ratio of a rated tranche balance to the market value of the real estate collateral. S&P's current advance rate assumptions are typically up to 10 percentage points higher than in mid-2007, based on its updated assessments of market value.

It's typical for the rating agency to use 55%-65% advance rates for triple-A ratings and 72.5%-82.5% rates for triple-B ratings in most European multi-borrower transactions. The higher end of the range is only likely to be seen for markets and transactions where there are strong indications that they are close to, or at, the bottom of the current phase in a local real estate market correction. Single-borrower single-asset transactions, loans exposed to major income decline risk and specially serviced loans with swap breakage cost risks may see advance rates outside this range, S&P notes.

The resolution of all existing credit watch placements, as well as new ratings, do not take account of any potential future criteria changes. S&P expects to finalise the three aforementioned criteria reviews in 2010.

CMBS

RFC issued on Singapore CMBS assessment

Moody's is requesting comments on its assessment that Singapore CMBS transactions should hold at least 12 months of liquidity in order to minimise rating linkages with borrowers of mortgage loans.

Singapore CMBS transactions are typically sponsored by Singapore real estate investment trusts (S-REIT), which are the mortgage loan borrowers in the deals. An S-REIT is an operating entity, can have creditors other than the CMBS issuer and is not a bankruptcy-remote entity.

Jerome Cheng, a Moody's senior credit officer, says: "If an S-REIT defaults on its obligations, the other parties can bring legal action, including bankruptcy proceedings, against it. If that happens, there may be cashflow disruption upon a mortgage loan event of default."

He adds: "In fact, such scenarios have happened in other markets. Since the onset of the global financial crisis, there have been several cases in other markets where civil rehabilitation or bankruptcy protection filings have been submitted by the defaulted REITs or property holding companies."

To ensure timely payments on CMBS transactions, certain liquidity arrangements should exist to cover the potential for cashflow disruptions, Moody's says. Such a situation would minimise the linkages between the ratings of the CMBS notes and the ratings of the S-REITs.

CMBS

CMBS underwriting model launched

The Rockport Group and Trepp have collaborated to launch a real estate underwriting model for the CMBS market. This enhancement is expected to help provide greater transparency to the commercial real estate debt markets.

Under the agreement, Trepp clients will be able to launch a pre-populated Microsoft Excel underwriting model developed by Rockport for commercial real estate-focused investors. With this model, market participants can analyse property cashflows, calculate year-over-year trends, perform discounted cashflow analysis and then upload the concluded cashflow vector back into Trepp's web products.

The Basic Rockport model is available to Trepp clients as part of their regular subscription. It comes seeded with detailed property financial statements. Clients looking to perform more robust underwriting and analysis can upgrade to Rockport's Enterprise model for an additional fee.

Will Trepp, md of Rockport, says: "Trepp and Rockport are committed to providing CMBS and distressed debt investors with a robust tool to help further their investment diligence. We are proud to announce that not only can the loans now be analysed quickly and thoroughly in Excel, but that the detailed financial statements will also be available."

Documentation

RFC on ASF's trustee reporting package

The American Securitization Forum (ASF) has released for comment the proposed ASF Project RESTART RMBS Trustee Bond-Level Reporting Package. The proposed reporting package, which consists of a standardised layout containing 28 fields of bond-level information, was developed by the ASF Trustee Sub-forum and ASF Investor Committee and represents another phase of ASF Project RESTART to increase transparency and standardisation in RMBS transactions. Standardisation of trustee reports would provide investors and credit rating agencies with consistent fields of information across issuers and enable them to efficiently review bond performance information.

Implementation of the Bond-Level Reporting Package is recommended for no earlier than the first quarter of 2011. Comments are requested on the package, including the implementation timeline, by 10 December 2009.

It is expected that the bond information contained in the package will be integrated with the loan information contained in the ASF RMBS Disclosure and Reporting Packages through a link created between the CUSIP for each bond and the recently announced industry-wide loan identifier, the ASF LINC. This linkage will enable investors and credit rating agencies to easily acquire information about the specific loans underlying a particular bond.

Indices

Performance indices launched for Euro ABS and RMBS

Moody's is launching monthly updated performance indices for all major ABS and RMBS markets in Europe to provide investors with timely information about the performance of the underlying collateral of ABS and RMBS transactions.

Monthly indices will give market participants access to frequently updated performance snapshots and provide further transparency on the performance of public term transactions through benchmarking, the rating agency says. This redesign is part of an ongoing effort by Moody's to provide the market with timely insight into credit implications affecting the ABS and RMBS markets in Europe.

Marie-Jeanne Kerschkamp, a Moody's team md, says: "Investors want to receive regular and timely information they can use regarding collateral performance to understand what will happen next."

Moody's indices are standardised and designed to aid investors' monitoring efforts. Key performance indicators of the underlying portfolios are aggregated into indices and tracked on a monthly basis along with macro-economic developments.

Investors

Student loan ARS exchange offer launched

Brazos Student Finance Corporation has commenced an offer to exchange new floating rate notes for any and all of its outstanding student loan asset-backed auction rate notes. The offer comprises senior notes from the series 2004A-5 to A-8 and subordinate notes from the series 2004B-1 and B-2.

For each US$1,000 principal amount of the senior series auction rate notes that it accepts for exchange, the Corporation is offering US$1,000 principal amount of new floating rate Class A notes. For each US$1,000 principal amount of subordinate series auction rate notes that it accepts for exchange, it will offer US$536 principal amount of new floating rate Class A-S notes and US$291 principal amount of new floating rate Class B notes.

The new floating rate Class A and Class A-S notes are expected to be rated triple-A by Fitch and Moody's. The new floating rate Class B notes being offered will not be rated by any rating agency.

The Corporation says it will also pay for all auction rate notes that it accepts for exchange cash in an amount equal to accrued but unpaid interest (other than carry-over interest) to but excluding the settlement date, which is expected to be the fifth business day following the expiration of the exchange offer. The exchange offer will expire on 11 December, unless extended or terminated by the Corporation in its sole discretion.

Legislation and litigation

ESH case threatens trust documentation

The Extended Stay Hotel (ESH) bankruptcy debtor is, in an unprecedented New York Bankruptcy Court ruling, to be given access to the list of certificateholders in a US$4.1bn CMBS securitisation trust. The judge indicated that the move is necessary in order for ESH to identify who among the certificateholders are "influential" and who are "problematic".

Moody's analysts note in the latest Weekly Credit Outlook report that the judge's ruling presages possible direct involvement of individual tranche owners in the restructuring plans of ESH, bypassing the precise representational rules laid out in securitisation documents. "If procedure precedes substance - like a filibuster vote in the Senate foretelling the real vote later on a bill - this ruling may be bad news for many structures, not just securitisation structures (for instance, loan participations) that rely on just one legally recognisable voice to speak for all beneficial owners in bankruptcy and other courts," they explain.

The debtor hotel chain had requested that the securitisation trust holding legal title to US$4.1bn of mortgages on 680 hotels reveal the names of all its CMBS certificateholders to help ESH "formulate and negotiate a meaningful plan of reorganisation, with appropriate sensitivity to whatever issues may be relevant to those stakeholders". The extraordinary request has prompted an emergency friend-of-the-court brief by the CMBS industry association, which expressed its "grave concern[s]" and "the chilling impact that [an adverse ruling] could have on the CMBS market".

Monolines

Assured downgraded, AG Muni affirmed

Moody's has downgraded the insurance financial strength rating of Assured Guaranty Corp (AGC) to Aa3 on review for possible downgrade from Aa2. The rating agency confirmed the Aa3 IFSR of Assured Guaranty Municipal Corp (formerly Financial Security Assurance) with a negative outlook. These rating actions follow, and in the case of AG Muni conclude, reviews initiated on 20 May 2009.

Moody's review of Assured's ratings has centred on the performance of RMBS exposures. Over the past year it has observed substantial deterioration in the performance of underlying mortgage collateral in virtually all the segments of the market, resulting in estimates of pool losses for some transactions that would likely breach even the relatively high attachment points of Assured's first-lien exposures (Alt A and subprime). Other exposures were also impacted by mortgage-related deterioration, specifically life insurance-linked deals backed by collateral pools that included RMBS securities.

AGC has suffered the most significant deterioration in relation to its US$2.7bn in reported claims paying resources as a result of stress in its RMBS and CDO (primarily TruPs) portfolios, and its current statutory capital position is relatively weak in relation to the possible mortgage-related losses - which Moody's estimates to be approximately US$600m - before estimated repurchases of loans that have breached contractual representations and warranties (put-backs), as an expected case and reaching about US$1.7bn in a severe stress scenario.

However, Moody's stated that capital strengthening initiatives under consideration by the group could result in a conclusion of the rating review with a confirmation at the Aa3 rating level, negative outlook, if fully implemented. Absent such initiatives, Moody's would expect to lower AGC's rating into the single-A range.

AG Muni, with a reported US$7.3bn of claims paying resources, remains adequately capitalised for its current rating level, in Moody's view, despite some additional RMBS deterioration, with losses (before put-backs) on those exposures estimated to be about US$1.9bn in the expected case and rising close to US$3.2bn in a severe stress scenario. The negative outlook on AG Muni reflects still meaningful uncertainty, over the next year or two, about the ultimate performance of the firm's insured portfolio following a period of severe dislocation in financial markets.

According to Moody's, the operational leverage inherent in the business of Assured can make the credit profiles of the operating subsidiaries rather sensitive to the performance of individual insured sectors and even, in some cases, individual transactions. This risk is mitigated - but not eliminated - by strong risk management, which has contributed to the monoline's much better performance than peers during the financial crisis. This performance has, in Moody's view, enabled Assured to attract new capital over that past few years and remain an active underwriter of risk.

The rating agency notes that business opportunities available within the structured finance market have fallen off significantly, but Assured currently enjoys a strong competitive position in the US municipal market, given the scarcity of competitors and alternative forms of credit enhancement for municipal bonds.

Moody's lead analyst Arlene Isaacs-Lowe notes: "While the value proposition of financial guaranty insurance has been eroded in some segments of the US municipal finance market, Assured still enjoys very strong demand for its insurance product from smaller and higher risk municipal issuers that would face higher funding costs absent credit enhancement. However, the municipal market remains somewhat dislocated and it is unclear how Assured's competitive position will evolve once it normalises."

Monolines

CIFG rating downgraded, withdrawn

Moody's has downgraded the insurance financial strength ratings (IFSRs) of CIFG to Ca from Caa2. The action concludes the rating review that was initiated on the monoline in August.

Moody's says it will also withdraw CIFG's IFSR for business reasons.

The move reflects increased loss estimates on some of CIFG's CDOs, primarily those referencing trust preferred collateral, and continued RMBS stress. The rating action also has implications for the various transactions wrapped by CIFG.

Material deterioration in CIFG's insured portfolio has adversely affected the guarantor's capital adequacy profile and Moody's believes that CIFG may no longer have sufficient financial resources to pay all insurance claims. CIFG Assurance, the New York domiciled primary financial guarantor reported a US$298m statutory deficit in its second-quarter financial statements, increasing its gross loss reserves by US$339m due to worsening performance trends in its RMBS and CDO portfolios.

The monoline also reported US$410m provision for reinsurance as CIFG Guaranty, its Bermuda-based affiliate, was unable to fully fund the Reg 114 trust. CIFG Assurance cedes approximately 90% of its insured risk to CIFG Guaranty.

The risk of regulatory intervention is meaningful, according to Moody's, given CIFG's failure to meet minimum regulatory capital requirements. This in turn could influence the pace of commutations with counterparties, potentially on terms that imply a distressed exchange.

The outlook for the rating is developing, reflecting both the positive and negative pressures on the rating. If CIFG is able to commute some of its more impaired insured exposures under favourable terms, the capital adequacy profile of the company could improve. However, further deterioration in its insured portfolio, or a regulatory takeover, could weaken the firm's capital adequacy metrics.

Ratings

ASIC strengthens CRA oversight

Credit rating agencies operating in Australia will be required to hold an Australian Financial Services (AFS) license from 1 January 2010. The Australian Securities and Investments Commission (ASIC) believes that the move will align its regulation of CRAs with IOSCO principles and with regulation passed or proposed in major markets such as the US, Europe and Japan.

Under the AFS licensing regime, general licensee obligations set out in the Corporations Act will require credit rating agencies to:

• manage conflicts of interest that may arise in their businesses;
• have resources available (including financial, human and information technology resources) that are adequate for the nature, scale and complexity of their businesses;
• ensure their credit analysts are trained and competent to be involved in the preparation of credit ratings;
• ensure credit rating services are provided efficiently, honestly and fairly; and
• have in place risk management systems.

In addition to the general licensee obligations, ASIC will impose specially tailored conditions on AFS licenses granted to CRAs. These tailored license conditions will require rating agencies to:

• comply with the IOSCO code of conduct fundamentals for credit rating agencies, which will be mandatory from 1 July 2010;
• annually lodge with ASIC an IOSCO code annual compliance report;
• disclose procedures, methodologies and assumptions for ratings;
• have in place arrangements to monitor and regularly review credit ratings;
• review ratings affected by material changes to rating methodologies within six months of the change;
• have in place a training programme for credit analysts that have been externally assessed as adequate and appropriate (to take effect from 1 July 2010);
• refrain from threatening to issue a lower credit rating for a structured finance product because an asset underlying the product is not also rated by the credit rating agency; and
• consent to information sharing between ASIC and foreign regulators.

CRAs that wish to give credit ratings for investment products offered to retail investors must also comply with a general licensee obligation under the Corporations Act. Under this act, rating agencies are obliged to have a dispute resolution system comprised of an internal dispute resolution procedure; and membership of an approved external dispute resolution scheme, such as the Financial Ombudsman Service.

An alternative to court actions, external dispute resolution schemes provide quick, low-cost, independent resolution of disputes between retail investors and AFS licensees up to A$150,000 (increasing to A$280,000 on 1 January 2012).

Ratings

Fitch's cashflow CDO criteria amended

Fitch has amended its global criteria for cashflow analysis in CDOs to include all CDO types. The report, which was published on 9 November, replaces a report originally published on 30 April 2008.

The original 2008 report stated that it did not cover Fitch's approach to rating CDOs of structured finance securities, trust preferred securities or CRE CDOs. The amended report includes a new paragraph that describes that these criteria do indeed cover these additional asset classes. The core criteria have not changed.

Ratings

Recovery uncertainty to be reflected in ratings

Moody's has released a new report that details the expected recoveries of principal and interest associated with its ratings of structured finance securities expected to default.

Nicolas Weill, Moody's chief credit officer for structured finance, says: "When a structured finance security is in default, or very likely to default, we will assign a rating on that security that reflects the expected recovery of principal and interest, as well as the uncertainty around that expectation."

For a security currently in default or very likely to default, the rating agency will generally assign a rating of Caa1 or lower. However, securities in default where the median recovery rate is expected to be 95% to 100%, a corresponding rating between B3 and B1 will be assigned.

Weill adds: "Increasing uncertainty around the expected recovery rate is reflected by a lower rating. In particular, if a bond is likely to recover 100% of principal and interest but there is a higher than a 10% chance of recovering less than 90%, Moody's will assign a rating of B3 to such bond."

Moody's defines default as any one of these three events:

• a missed interest or principal payment when due and uncured by the expiration of a grace period;
• bankruptcy filing or legal receivership by the issuer; or
• a distressed exchange, whereby an issuer offers creditors a new or restructured debt or a new package of assets that amounts to a diminished financial obligation relative to the original obligation and the exchange has the effect of allowing the issuer to avoid a bankruptcy.

Ratings

DSB's ABS/RMBS ratings hit

Moody's has downgraded the ratings of five senior classes of notes issued by Chapel 2003-I, Chapel 2007-I, Monastery 2004-I and Monastery 2006-I. All the affected tranches were placed on review for possible downgrade on 13 October because of the implementation of emergency regulations in relation to DSB Bank by the Amsterdam court on 12 October 2009. On 19 October 2009, DSB was declared bankrupt by the Amsterdam court.

DSB was the seller and is the servicer in the ABS transactions Chapel 2003-I and Chapel 2007-I and the RMBS transactions Monastery 2004-I and Monastery 2006-I. Moody's notes that the uncertainty and operational risks in these transactions are the main drivers for the rating actions.

RMBS

Banks net sellers of MBS

The US National Information Center has released Q309 consolidated financial statements for bank holding companies, providing an early estimate of changes in bank assets and liabilities. Since the largest banks have historically been the primary buyers of MBS, securitisation strategists at Barclays Capital examined the data to gauge banks' activity in the sector.

The BarCap strategists found that the top 50 banks shed US$34bn of RMBS during Q309, driven primarily by a select group of banks, including Wells Fargo and Bank of America. Excluding these banks, the remainder increased their MBS holdings by US$9bn.

Aside from securities, the top banks also reduced 1-4 family residential loans by US$60bn. Holdings of CRE and C&I loans also declined.

Offsetting the decline in securities and loans, these institutions increased their holdings of cash and US Treasuries. In addition, it appears that trading accounts and reverse repo assets also grew noticeably during the quarter.

Deposit growth was strong, as the top 50 banks added US$78bn in total deposits during the quarter. Non-interest bearing deposits saw a slight decline of US$4.4bn.

The BarCap strategists suggest that overall the future landscape for MBS looks strong. "Greater allocations into cash and trading accounts may be serving as a placeholder for future securities purchases," they conclude. "Holding on to low-yielding cash may not be sustainable long-term strategy for the banking sector, especially as many banking accounts foresee higher rates and wider spreads into 2010."

RMBS

AOFM RMBS exhibit better credit quality

RMBS transactions mandated by the Australian Office of Financial Management (AOFM) have had very low arrears and no losses or claims on mortgage insurance since they were issued, according to Fitch.

Natasha Vojvodic, head of Australian structured finance at the rating agency, says: "The transactions are all performing well and, when comparing the collateral composition of a transaction in which the AOFM invested against those from the general market pre-AOFM investment, Fitch found that they were of a higher credit quality. This is as a result of a number of factors, including the AOFM criteria, tighter underwriting standards since the onset of the global financial crisis and general investor preference."

In response to the lack of competition to the four Australian major banks, the AOFM has been a cornerstone investor in all but three Australian RMBS transactions since November 2008, during which time approximately A$11.3bn of RMBS has been issued from 20 transactions by 13 lenders. The Australian Federal Treasurer has announced an extension of the current programme and has directed the AOFM to invest up to an additional A$8bn in RMBS transactions (SCI passim).

Further details are yet to be announced. However, it is expected that this extension may incorporate a widening of eligibility criteria to facilitate more lending to small businesses and may also include some form of facility to enhance Australian RMBS liquidity. This could mean an increase in the number of low-documentation loans in future pools, which Fitch views as being of lower credit quality as they experience higher delinquencies and defaults.

The report provides an overview of the transactions generated by the AOFM investment in RMBS, including an overview of the eligibility criteria for compliant transactions, a collateral snapshot of each Fitch-rated transaction as well as each transaction's performance since its closing. In addition, the report reviews the composition of a typical collateral pool for transactions issued prior to the commencement of AOFM investment and contrasts it with those where the AOFM was the cornerstone investor.

RMBS

UK prime RMBS performance stabilising

The performance of the UK prime RMBS market continued to stabilise during September 2009, according to the latest indices for the sector published by Moody's.

Moody's repossessions trend maintained its August level of 0.07% in September, which is significantly below the peak of 0.12% that it had in November 2008. The rating agency's 90-days plus delinquency trend also kept its August value of 1.9% in September, which constitutes an increase of 0.7% since September 2008.

Meanwhile, the cumulative losses trend stood at 0.11% in September 2009, which is only 0.01% above the August level but constitutes its highest level since Moody's began measuring in 2004. Moody's annualised total redemption rate (TRR) trend has displayed a decreasing trend during the past year and is currently at 12.9%.

The agency's outlook for UK prime RMBS is negative. Originators and servicers have reacted to the economic downturn and tightened their underwriting criteria. However, due to the master trust structures, rating implications are limited, despite the deterioration in performance.

As of September 2009, the total outstanding pool balance in the UK prime RMBS market was £332.2bn, constituting an increase of 12.7% during the past year.

RMBS

Australian RMBS arrears continue to decline

Australian mortgage delinquencies have decreased across the board, representing the third consecutive quarterly fall, according to Fitch.

Leanne Vallelonga, associate director in Fitch's structured finance RMBS team, says: "A decline across all arrears buckets was last seen in this same quarter in 2007. Such consistent positive movements illustrate the ability of Australia's home loan borrowers to navigate through this current cycle of global turmoil. With most arrears buckets improving by over 10%, it was the reduced documentation mortgage index covering the performance of low-doc loans which recorded, for the first time since its composition, a fall for the third consecutive quarter - resulting in more than a 15% fall for 30+ day delinquencies."

The agency notes that Australian mortgage performance, as measured by mortgage delinquencies, improved again in Q309, evidenced by the decrease in the Fitch Dinkum Index for 30+ day delinquencies to 1.21% in Q309, down from 1.40% in Q209. The majority of the decrease in arrears can be attributed to a greater decline in the 90+ day arrears bucket. A similar - if not more dramatic - positive trend was seen in the RDM Index (which details the performance of low-doc loans), with 30+ day delinquencies improving to 4.72% in Q309, down from 5.68% in Q209.

Fitch separates the performance of non-conforming low-doc loans from the performance of conforming low-doc loans. Non-conforming low-doc 30+ day delinquencies continued their decline to 15.59% in Q309, down from 18.50% in Q209. The performance of conforming low-doc loans for 30+ day delinquencies also improved to 2.83% in Q309, down from 3.39% in Q209.

Arrears are expected to remain steady for the remainder of 2009, with the risk of some increase to arrears in early 2010 brought about by Christmas seasonal credit card spending, increasing interest rates and the risk of higher unemployment.

RMBS

Continued deterioration for Spanish RMBS

The performance of the Spanish RMBS market continued to deteriorate during September 2009, according to the latest indices for the sector published by Moody's.

The ratings agency's cumulative defaults trend reached 1.31% in September, which is more than four times the level recorded one year ago. Meanwhile, Moody's 90 days plus delinquency trend increased by 0.84% during the past year and stands at 2.02% in September.

The annualised constant prepayment rate (CPR) trend has displayed a decreasing trend since mid-2006 and now stands at 6.80%. At present, 43 transactions have drawn on their reserve funds and 11 transactions in this market recorded a principal deficiency.

In November, Cajastur took over Caja Castilla-La Mancha, the only savings bank placed under administration in Spain since the start of the financial crisis. Caja Castilla-La Mancha was one of the originators of three RMBS Spanish transactions. This merger has made Cajastur the seventh largest savings bank in Spain in terms of client deposits and branch volume.

The Spanish market has recently witnessed an upturn in the number of property acquisitions as a result of the rapid deterioration of the securitised mortgage pools and the illiquid real estate market. According to the Bank of Spain, Spanish banks and savings banks are now holding more than €20bn of property on their books.

Property acquisition has also become evident in Spanish RBMS, notably from Caixa Catalunya (Hipocat) and BSCH (FTA Santander Hipotecario). According to the Spanish Mortgage Association, the residential mortgage default rate is continuously increasing, reaching 2.97% in June 2009.

The Spanish economy is not expected to start growing again until Q110, by which time the recession that started in Q108 will have lasted eight quarters, one of the longest in the Euro area. For 2009 as a whole, Moody's Economy.com expects the gross domestic product to contract by 3.9% followed by a full-year contraction of 0.6% in 2010. The Spanish labour market has been acutely impacted by the recession, with unemployment reaching 17.9% in Q309, from a low of 8.0% in Q207.

Unemployment is expected to continue to rise, peaking at over 19% in the latter half of 2010. Residential real estate prices have fallen 9.5% since the peak reached in Q108. A decrease of at least a further 10% will be needed before the market has fully adjusted.

Moody's outlook for Spanish RMBS is negative. Performance is pressured by the rapid rise in unemployment, leaving many borrowers unable to make their debt service payments. The housing market is saturated and house prices are continuing to fall from their peak at the turn of 2007 and 2008. Additionally, the housing market is currently very illiquid, which adds uncertainty to recovery and loss severity in this market.

As of September 2009, the total outstanding pool balance in the Spanish RMBS market was €147.8bn. Until 2006, the Spanish RMBS market was characterised by generally low LTV loans. However, prolonged Spanish house price inflation forced mortgage lenders to expand product offerings, including low or no equity mortgage loans as well as affordability options, such as payment holidays or the ability to defer amortisation.

Additionally, the increased competition among mortgage lenders encouraged banks and savings banks to use alternative distribution channels, such as brokers or real estate agents. Consequently, non-resident borrowers and new residents represent a substantial share of younger Spanish RMBS vintages.

RMBS

Italian RMBS performance declines

The performance of the Italian RMBS market continued to deteriorate during September 2009, according to the latest indices for the sector published by Moody's.

Moody's cumulative default trend reached 1.4% in September, the highest level since Moody's began measuring in 2004. Meanwhile, Moody's 90-days plus delinquency trend also surged to its historical high and was at 2% in September 2009.

Moody's constant prepayment rate (CPR) trend maintained a decreasing trend line and now stands at 9.6%. At present, 25 transactions have drawn on their reserve fund and four transactions in this market recorded a principal deficiency.

On 21 October, the Italian Banking Association (ABI) approved the 'Piano Famiglie' - a new scheme that allows borrowers who meet a set of criteria to enjoy a maximum 12-month payment holiday, starting in January 2010. In Moody's view, the scheme in its current form is likely to have a negative impact on Italian RMBS unless it is properly adapted for securitisations.

"Without proper implementation, certain transactions - especially those with low excess spread or no additional liquidity - could have downward rating pressure, especially on the junior notes, mainly due to an increased risk of back-loaded defaults," says the rating agency. "Nevertheless, the overall impact of the payment holiday may be positive as it could reduce arrears and defaults in the affected pools since it gives borrowers more time to search for new employment, without defaulting on their mortgage loans. Given the economic downturn, the positive impact may be limited."

Whole business securitisations

BAA's WBS bolstered

BAA has injected an unexpected £500m into its whole business securitisation structure. The injection will consist of £200m of new equity from shareholders and £300m from BAA Airports Limited and FGP Topco Limited, the ultimate holding company of BAA, which is jointly owned by BAA's three controlling shareholders.

The funding will be used to pay down debt, strengthen the group's medium-term financial ratios and facilitate its access to the capital markets, BAA says.

CLOs

Hunting for value in Euro single-A CLO tranches

Madhur Duggar and Batur Bicer, structured credit strategists at Barclays Capital, gauge the sensitivity of European single-A CLO tranches across different default scenarios

We analyse 133 European single-A CLO tranches across different default scenarios and gauge their sensitivity to key risks/variables, such as extension risk and changes in credit risk premia, to highlight the most interesting bonds. We discount cashflows at swaps plus 20% to price individual bonds. The implied prices are reflective of where the market traded this portion of the capital structure in September 2009.

Market prices have rallied significantly since then and the prices shown in this piece are lower than where the market would trade them today. We chose to show prices to draw readers' attention to the large degree of variability across deals in this portion of the capital structure. We believe that the direction of our overall recommendations will remain unchanged at lower discount rates.

We focus on European CLOs because there is still a great deal of uncertainty about the speed of the European recovery, making this market more interesting to analyse. In addition, it is still unclear whether CLOs will benefit from the recovery, given the private nature of the loan market and the difficulties in refinancing in a public high yield debt market that is still nascent.

We focus on the single-A tranche because we believe this is the part of the capital structure that is likely to be the most sensitive to a systemic change in default outlook (Figure 1). We expect more senior tranches to recover par, even in stressed scenarios. Junior tranches, with the possible exception of triple-Bs, will be much more sensitive to the actual quality of the portfolio.

Bullish investors will likely prefer longer-dated lower dollar price bonds. These bonds suffer principal losses in a bearish environment, but recover full principal in our base case.

Returns on these bonds should come from both a contraction in risk premia and lower realised default rates. These bonds are also likely to show the least sensitivity to loan extensions.

Bearish investors will likely prefer higher dollar price bonds that recover full principal in both base and bear cases. These bonds are likely to be insensitive to default rates and benefit in a more bearish environment by being accelerated. Returns on these bonds should come from a contraction in risk premia.

We expect single-A bond lives to be longer than their model-implied durations. We estimate that a one-year extension in tranche life will lower prices by about 5% in our base case, with most of the drop coming from a decline in the value of the principal only (PO).

Not all deals are equally sensitive to extension risk. We highlight deals that under the base case show a small absolute and percentage drop in price.

Single-A tranches have positive convexity with respect to spreads. The average drop in price for a 10% increase in spreads is 13%, while the average increase in price for a 10% decrease in spreads is 24%.

Investors who expect spreads to tighten should consider longer maturity bonds, as they benefit the most on a percentage basis from a decrease in spreads. Investors who wish to avoid spread volatility should look at high dollar price shorter maturity bonds.

Scenario assumptions
This section lays out the main assumptions that we use to generate cashflow scenarios across our sample set of European deals.

Scenarios: We use a ratings-based approach to generate cashflows under base- and bear-case scenarios. Our base-case scenario assumes a European recovery is already under way and that ratings migrations will be similar to those observed since 2001. Our bear-case scenario is equivalent to assuming a stressed economic environment in Europe over the next four years and a recovery after that.

Defaults: Figure 2 shows our assumptions for base- and bear-case defaults. For the base case, we assume that defaults peak in 2010 at 11.4% and decline gradually to around 2%by 2017. Cumulative defaults under this scenario are 41.4%.

For the bearish case, we assume that defaults peak in 2010 at 16.9% and decline gradually to around 2% by 2018. Cumulative defaults under this scenario are 52.6%.

Recoveries: We assume that first-lien loans recover 40% under the base case and 30% under the bearish case. All other collateral items, including mezzanine securities and CDOs, are assumed to recover 10% under both scenarios.

Loan extensions: We assume that 10% of surviving loans that have maturities within the next three years will be extended by another five years. For example, 10% of surviving loans in 2010 with 2011-2013 maturities will have their maturities extended to 2016-2018. Our 10% assumption is based on the run rate of loan extensions that we have observed in the US market this year.

Loans at maturity: All loans that survive until maturity but are rated Caa1 or below are defaulted at maturity, while the remaining loans are re-issued for another five years.

Loan pay-downs: We assume an annual pay-down rate of 5% for European deals.

Reinvestment: Cash proceeds during reinvestment are reinvested in new loans trading at US$80.

Discount rate: We discount all cashflows at swaps plus 20%. The average price of a European single-A tranche in our base case is US$37 under this assumption.

Market traded levels are higher at this point. However, we do not expect changes in discount rates to have a material effect on the direction of our recommendations.

Principal recovery under base- and bear-case scenarios
Principal recovery is a concern for European single-A tranches, given the uncertainty about the nature and pace of economic recovery in Europe and the lack of collateral transparency. We find significant variation across tranches in their ability to withstand stress, with some tranches performing much better than others even under stress.

We look at principal recovery for single-A tranches across our base- and bear-case scenarios. Almost all tranches recover full principal in our base-case scenario. However, tranches show significant stress related to principal recovery in the bear-case scenario.

The average principal recovery in the bear case is 62% and 44% of the deals fail to recover full principal. 20% of the deals recover less than 10% principal (Figure 3). Lower principal recovery under stress is reflected in the pricing of those single-A tranches which are susceptible to stress.

On the other hand, deals that are expected to recover full principal in both scenarios are unaffected from a pricing standpoint. Figure 4 shows average PO and IO statistics under both scenarios.

Overall, the average tranche price drops from 37.1% in the base case to 22.8% in the bear case. Almost all the decline in price is due to lower principal recovery. This is reflected in the significantly worse performance of deals that fail to recover full principal in the bear case.

Trades for bullish investors
Figure 5 shows tranche prices bucketed by principal recovery under the base- and bear-case scenarios. Clearly, lower dollar price bonds that suffer principal losses in a bearish environment also have the greatest room for upside in an improving economic environment, which is similar to our base case.

Higher dollar price bonds have little room for upside in the short term from an improvement in economic outlook. For the latter bonds, appreciation would be mainly in the form of pull-to-par.

Bullish investors who believe that investors in Europe are likely to use more benign default vectors in the future should invest in lower-priced bonds. The risk is principal loss in a downside scenario, which is why investors would need to have a bullish view on the economy. Figure 6 highlights some of these deals.

Trades for bearish investors
For bearish investors, we recommend bonds that outperform in a bearish environment. Figure 7 highlights deals for which tranche prices are actually expected to increase in a bearish environment. All these deals, which are high dollar price bonds, should recover full principal in both bullish and bearish scenarios.

Applying a bearish scenario simply shortens the weighted average life (WAL) of the tranche, which results in a faster recovery of principal. This is reflected in a higher PO price. The shorter life of the deal also results in a drop in the IO price.

However, for these deals, the drop in the IO price is more than offset by the higher PO price. The overall effect is to increase deal price in a bearish scenario.

Other risk considerations must also be taken into account, of course, such as extension risk and sensitivity to changes in credit risk premia - both of which are likely to increase if the economic outlook turns bearish again. We address these risks in the following sections.

Default remote tranches for principal-focused investors
In order to capture the principal loss sensitivity of single-A tranches to various default scenarios, we examine the principal recovery performance for all deals by applying parallel hocks to our base case scenario in 0.5% increments up to 5%. We find that some deals avoid a principal loss even in our worst-case scenario, which generates a cumulative loss of 64.2% until 2018, compared with 52.6% in our bear-case scenario.

We believe that these deals are best for principal-sensitive investors who want to be default remote. In Figure 8 we provide a subset of these deals that do not experience a deferral of interest payment and have the biggest price appreciation from our base- to bear-case scenario. Although these are high-priced deals compared with others, they provide less volatile performance for risk-averse investors.

Effect of changes in credit risk premia on single-A tranche prices
The contraction in credit risk premia has been a major source of outperformance for senior CLO tranches in the second half of 2008. If the economic environment continues to improve, we expect risk premia to continue to contract, especially for tranches that have minimal credit risk.

However, we expect sensitivity to changes in credit risk premia to be different across deals, with shorter-dated deals showing lower sensitivity. Single-A bonds have positive convexity with respect to changes in risk premia.

Figure 9 shows the effect of a 10% yield change on PO and IO prices for all the tranches under our base-case scenario. All tranches show greater sensitivity to a decrease in yield than to an increase. A 10% increase in yield would increase the overall price of a tranche by 24%, while a 10% decrease pushes the price down by 13%.

We find that PO values of tranches with shorter WALs have greater sensitivity to yield changes in our base case. The reverse is true for IO values. On an aggregate basis, the yield effect on the overall tranche prices is stable with respect to WAL, as opposing sensitivities of PO and IO prices cancel each other out.

Since absolute changes in price in response to changes in yield are independent of WAL, investors should be indifferent toward similar tranches with different WALs. However, tranches with shorter WAL have higher prices. Therefore, short WAL tranches are likely to show a smaller percentage change than long WAL tranches.

Investors looking for less volatility in tranche prices should therefore prefer shorter WAL tranches, all else being equal. On the other hand, bullish investors who expect spreads to tighten should prefer longer WAL tranches.

The strong relationship between WAL and the sensitivity to yield changes of PO and IO prices breaks down under our bear-case scenario. We believe other factors (e.g., recovered principal) become more significant in pricing of the tranches. However, the greater sensitivity to an increase (as opposed to a decrease) in yield still holds.

Effect of tranche life extension
We have pointed out in previous publications that loan extensions are likely to be a major factor as the business cycle recovers. We also expect managers to extend the durations of their deals by selling out of collateral prior to maturity and reinvesting proceeds in new collateral items. Deal extensions will extend the lives of senior CLO tranches and reduce the pace at which these tranches pull to par.

How sensitive are single-A CLO tranches to extension risk? Figure 10 shows the change in the price of single-A tranches if the WAL of the tranche is extended by another year. We show the numbers for the base case because we want to avoid principal recovery concerns, which become an issue under the bear scenario.

In general, we find that loan extension lowers the absolute tranche value across the board, with much of the reduction in value coming from a reduction in the value of the PO. IO values are little changed. In the base case, the drop in tranche values is greatest for shorter-dated tranches, which also have the highest PO values and, therefore, the furthest to fall under an extension scenario.

The relationship between the drop in absolute tranche value and tranche life is less clear in the bearish scenario. This is because in the bearish case the relationship between PO values and tranche life is less defined.

In many instances, tranches with shorter lives also have low PO values because the deals do not recover their full principal under the bearish scenario. Although extension risk will, in general, lower single-A CLO prices across the board, not all deals are equally sensitive.

© 2009 Barclays Capital. All rights reserved. This Research Note is an excerpt from 'US Credit Alpha', first published by Barclays Capital on 23 October 2009.

Trading

Trading ideas: round II

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright short on Vulcan Materials Company

The rapid recovery of the economy is seemingly priced into credit spreads on companies poised to benefit from the turnaround. Vulcan Materials is no exception. Vulcan's credit spread rallied all year; however, a floor was established in recent weeks as its spread bounced off a tight level near 100bp.

Fundamentally, Vulcan's earnings remain under pressure while it must service a large expense load. This, combined with relatively high leverage and next to zero cash on hand, makes buying protection a solid play.

Vulcan Materials posted better than expected third-quarter earnings on 2 November, with its revenues down 23% from a year ago. This plays right into a theme we have mentioned several times recently. Corporates may be squeezing out better than 'expected' profits; however, they are coming due to cost cuts rather than increases in sales.

The future of Vulcan's earnings remains uncertain at a time when its expense load is high. Vulcan paid out almost US$200m in dividends, US$180m in interest expenses and US$105m in capital expenditures over the last four quarters.

With the continuing drag on its earnings, its LTM interest coverage dropped below 3.5x and its LTM EBITDA/total expense is at 1.3x (Exhibit 1). With regards to its balance sheet, after a US$520m equity issuance in June 2009, Vulcan paid off its bank debt and made decent steps towards reducing its leverage.

That being said, its LTM debt/EBITDA continued to increase late this year and the company still holds US$2.8bn in total debt with little to no cash on hand (Exhibit 2). Though the company will not come under any sort of serious liquidity constraint (as it still has an available US$1.5bn credit facility due in Nov 2012), we feel its leverage will be an issue if the economy slows again.

We see a 'fair spread' of 250bp for Vulcan Materials based upon our quantitative credit model, due to its equity-implied, change in leverage, liquidity, interest coverage and free cashflow factors (Exhibit 3). Along with its reduction in leverage and the overall credit rally of 2009, Vulcan's credit spread traded tighter throughout the year.

Recently, it hit a low near 100bp and since bounced off. Since the rebound, our estimation of its implied risk grew two-fold, increasing its expected spread level from 200bp to 250bp.

The risk/reward characteristics of a short credit position in such a situation are extremely good. The risk is heavily weighted towards the downside, as we believe a floor was established at 100bp. Our biggest concern is the negative carry and we will maintain the position through to its next quarterly earnings on 9 February (unless of course its spread already widened out).

Position
Buy US$10m notional Vulcan Materials Company 5 Year CDS at 123bp.

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

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

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