Contents

Regulation

Back to the future

Addressing the extent of government involvement in US housing finance

Speculation about the future of Fannie Mae and Freddie Mac is gaining in intensity as year-end approaches. After 31 December, an act of Congress has to occur for action to be taken in respect of the GSEs. However, it appears that this debate is distracting attention from the real question that needs to be addressed.

"We believe that the discussion about the GSEs' future form is merely a detail that detracts from the real issue that must be answered by taxpayers and Congress. The true question that needs to be addressed is the appropriate extent of government involvement in US housing finance," says Rajiv Setia, US interest rate strategist at Barclays Capital.

The Obama administration is expected to unveil its plan for the GSEs next February, in conjunction with the President's 2011Budget. Setia suggests that the government is unlikely to make sweeping changes at that time, but could outline several intermediate steps, including setting a firm timeline for conservatorship and lowering the risk weight on FNM/FRE debt.

Combining FNM and FRE with GNMA in nationalisation is one possibility that is currently the source of speculation. But Jay Lown, md and senior member of the financial institutions group at NewOak Capital, points out that - on top of the logistical nightmare of merging them both - Fannie and Freddie serve a purpose and consequently there would be a lot of work for a single, combined agency to take on.

"Nationalisation is not an immediate option, as putting FNM/FRE on the government's balance sheet would increase public debt outstanding by US$2trn, further straining perceptions of fiscal responsibility," Setia adds. "Mid-term elections next year also make it likely that any drastic steps that threaten the fragile housing recovery will be stymied."

A good bank/bad bank structure for the GSEs makes sense, but not in February 2010, according to Setia. The high quality of new business that FNM and FRE are underwriting indicates that the administration has the flexibility to attempt such a restructuring in several years' time.

However, Setia believes that concrete action will ultimately only occur once Congress has had time to formulate a vision for US housing finance. "The history of the GSEs is one of glacial evolution and some co-opting for public policy purposes by Congress. Therefore, we expect the same story this time: the government will likely preserve the status quo for the foreseeable future and a resolution to the debate over the GSEs may be deferred by a decade or more."

Nevertheless, the fact that many of the authorities granted to the US Treasury to support the GSEs are scheduled to expire poses a risk because eventual losses at FNM could exceed the US$200bn backstop in a stress scenario. "Given their portfolios, it would be foolish to expect that the two entities will experience no further losses - albeit the magnitude of those losses is dependent on the economy," Lown notes.

Barclays Capital recommends that the Treasury increase the size of its Preferred Stock Purchase Agreements (PSPAs) with the GSEs to avoid triggering a receivership. FNM and FRE have already drawn US$112bn out of US$400bn PSPAs and in 1Q10 they will start paying a commitment fee for the unused amount of the facility, at a rate yet to be determined. Furthermore, under the PSPAs' terms, the GSEs must begin to shrink their portfolios by 10% per annum.

As its base case, Barclays Capital assumes that delinquencies and defaults in the GSEs' portfolios total 2x the current pipeline and average loss severity reaches 50%. Under this scenario, eventual cumulative losses are expected to total around US$275bn. In a stress-case scenario, however, total guarantee losses between the two entities could reach US$350bn.

"It is worth emphasising that of our total guaranty loss estimates, roughly 65% will be realised at FNM and only 35% at FRE. This translates to roughly US$180bn for losses from the guaranty book at FNM and US$100bn at FRE," Setia notes.

However, Lown suggests that concern about the future of the FHA is more pressing than that of the GSEs, given that it has become the mortgage lender of last resort. Certainly, difficulties are anticipated in relation to vintage of origination in light of the agency's more stringent underwriting guidelines.

"There is potentially less focus on Fannie and Freddie because there is a perception that they're more stable, especially in comparison to a year ago. It is accepted that the government needed to get involved in the short term in order for the mortgage market to get back on its feet, but that at some point it will have to take a back seat," Lown notes.

He concludes: "Ultimately, I expect that over time the private sector will figure out a way to begin originating prime mortgages again. But, until then, the GSEs and the FHA will continue to be the predominant source of liquidity for the mortgage market."

CS

Alternative assets

Challenging assumptions

Trups holders encouraged to revisit portfolios

A new analysis of Trups CDOs has challenged the standard industry assumption that all banks that defer their preferred securities will fail. The aim of the research is to overcome information asymmetry in the sector and encourage Trups holders to re-analyse their portfolios.

The analysis, published this week by PF2 Securities Evaluations, suggests that some Trups issuing banks are choosing to defer their preferred securities in order to preserve capital for a proverbial rainy day. However, the standard industry approach towards Trups portfolios is to assume a blanket worst-case scenario: that all deferring banks will default. This is being driven by auditors, regulators and risk managers, all of whom are by definition risk-averse and so are pushing the most conservative assumption.

Gene Phillips, a director at PF2, explains: "We're hoping that our analysis shows that it's wrong to assume default in all cases and that a 100% default assumption for Trups is too punitive. All else being equal, the aim is to encourage Trups holders to re-analyse their portfolios or at least to scrutinise the deferring banks."

He notes that some hedge funds and other sophisticated investors that are trading Trups CDOs are already performing this kind of analysis. "But some regulators may not be aware and so the sellers of such securities may be under pressure to use the 'worst-case' analysis for Trups, which they're considering their 'base case'. We're trying to overcome this information asymmetry; trying to make the case to all market participants to look deeper into their portfolios and analyse the assets, bank by bank - in essence, not to sell out at the bottom."

PF2's research analyses the initial quality and subsequent performance of deferring banks, whose preferred securities are held by one or more of a selection of 16 Trups CDOs. The firm's proprietary bank model ranks each bank on a scale - from 'good', 'average', 'weak' to 'troubled' - based on a variety of factors, including each bank's loan loss provisions, charge-off rates, liquidity and leverage ratios, and proportional exposure to non-performing assets.

The model categorised approximately 80% of the defaulting assets in the analysis as 'troubled' based on the semi-annual call report immediately prior to its default. Approximately 12% were shown to be 'weak', with the remaining approximately 8% categorised as 'average'.

According to PF2, there are two potential reasons for these results. First, the possibility exists that not all banks treat their assets in the same manner: some may either aggressively interpret the classification constructs in their reports or may intentionally or unintentionally hide certain truths.

Second, not all banks that default need be in poor condition. For example, under certain circumstances, the FDIC might be incentivised to close all banks - including the well-capitalised banks - operating under the same under-capitalised parent.

On examining all banks in the selected Trups CDOs that began deferring distributions in either 2008 or 2009, PF2 noticed a mild pattern that indicates an increased tendency in 2009 for 'good' banks to elect to defer, while fewer of the deferring banks were strictly 'troubled', particularly in the second half of 2009. An additional tentative reading supports the argument that the dynamic of 2009-cohort deferrers differs from that of the 2008-cohort.

All of the issuers in the study who first deferred in the first half of 2008 were likely poor-quality banks: all have since defaulted. Additionally, more than one-third of these banks had defaulted by the end of 2008. In contrast, fewer than 15% of issuers who first deferred in H109 have - at least by the time the report was published - defaulted.

However, Phillips warns that it's still early in the cycle and so these findings are preliminary.

CS

CDS

Sovereign CDS spikes again

After a brief respite, sovereign risk jumped this week on the heels of downgrades to Greek debt ratings and Spanish debt outlook. UK sovereign CDS also spiked after the publication of the country's pre-budget report.

The CDS of all members, except Japan, of the CDR Government Risk Index (GRI) trade with greater risk now than a week ago, according to Dave Klein, index manager at Credit Derivatives Research. "Spain and Italy zoomed up and their CDS trade near 100bp, while the worst performer on the week was the UK, whose sovereign risk jumped by almost 20%," he notes. "Apart from Japan, Germany and the USA held up the best this week, but USA CDS already traded over 70% higher than recent lows, among the worst performing major sovereign CDS."

Indeed, the spike in the UK sovereign's CDS liquidity follows the publication of the Chancellor of the Exchequer's pre-budget report, according to Fitch Solutions. The UK has shown the biggest jump in liquidity of any developed market sovereign over the last week, with a six-point jump in percentile rankings to a score of 9.8.

Fitch Solutions md Thomas Aubrey says: "The UK's pre-budget report drove the rise in sovereign CDS liquidity as the report lacked detail on budget cuts and fiscal tightening that the market was anticipating."

While the speech itself had limited impact on the UK's five-year CDS (which widened to 76bp, a slight increase from 72bp), the spread level is over three times wider than where other triple-A rated sovereigns such as France (22bp) and Germany (20bp) are trading. The triple-A median five-year spread currently trades at 34bp, whereas the double-A minus median five-year CDS spread is trading at 63bp.

Meanwhile, Klein observes that the CDS of the major sovereigns performed much worse than corporate CDS this week. "While low volumes and other market technicals may have exaggerated the disparity, volatility is leaking into a part of the CDS market that had been exceedingly stable from late summer through mid-November. It remains to be seen whether this latest spike up in risk will be followed by a quick move back down," he says.

He continues: "While lesser-rated countries like Spain and Greece grab the headlines, better-rated countries like the USA and the UK lagged this autumn among members of the GRI. Spain's CDS jumped 40% since late October. The UK's CDS level almost doubled over the same time period. With systemic risk rising in the guise of sovereign CDS, it will be increasingly difficult for corporate credits and equities to buck the trend."

Away from sovereign CDS, activity in the US healthcare sector has also been notable over the last week, as debate continues to surround the proposed healthcare reform bill currently with US Congress. CDS on North American healthcare companies widened by 10.9% over the last three months, according to Fitch Solutions, compared to 6.3% CDS tightening observed in the broader market.

In general, the liquidity of a credit derivative asset increases when it is showing signs of financial stress in combination with a significant amount of debt outstanding and/or changes in its capital structure, including new issuance. The liquidity scores of assets have historically traded between 4 at the most liquid end through to 29 at the least liquid end. Entities also tend to be more liquid when there is agreement about present value but disagreement about future value due to heightened uncertainty surrounding the entity.

AC & JA

Indices

Call for clarity around Prime index construction

Markit's intension to launch the ABX.Prime index next year has raised a few eyebrows among industry analysts. The firm has released further details about the index since its initial announcement last week (see SCI issue 164 for more).

Securitisation analysts at JPMorgan note that they have been recommending buying non-agency RMBS on the dips, but now caution that the announcement of ABX.Prime is likely to put pressure on prime cash prices. "In response to this new information, we curb our enthusiasm on the prime sector. Unknowns around the timing and index construction prevent us from having stronger views at this point," they say.

Meanwhile, ABS analysts at Wells Fargo - who have previously made their views on the ABX.HE index clear (SCI passim) - recommend that cash portfolio investors BWIC their prime non-conforming positions to the nine dealers that approved the ABX.Prime launch. They point out that - having downloaded the CDS prices from Markit - the underlying reference CDS were not all priced each day, yet the ABX.HE was priced on a daily basis.

Consequently, the Wells Fargo analysts call for the CDS of each of the reference entities as well as the cash bonds in the new ABX.Prime index to be priced on a daily basis. These should then be reported and averaged up.

"In this manner we can see the basis between the [index] and cash," they explain. "The current practice with the ABX is not only sloppy and amateurish, but also the equivalent of pricing Treasury bond futures without a Treasury bond price."

Markit says the intent of the ABX.Prime index is to create a liquid, tradable tool that allows investors to take positions on prime RMBS via CDS contracts. Liquidity and standardisation provided by the index will allow investors to accurately gauge market sentiment around the asset class and to take short or long positions accordingly, it adds.

The firm will initially launch three different index series referencing the 2005, 2006 and 2007 vintages. For each vintage, one index references fixed rate collateral and one index references hybrid ARM collateral. There will also be an aggregate index combining vintages and collateral types.

CS

RMBS

Remarketing trend gathers pace

RBS has remarketed to third-party investors the Class A tranche of Eleven Cities 4, a prime Dutch RMBS originated by Friesland Bank that was originally printed in May 2008 as a retained transaction. Analysts expect such activity to gather pace, as the ECB tries to ween banks off its suppot.

The €808m Eleven Cities deal comprises seven tranches rated by Moody's and Fitch from triple-A down to triple-B. The underlying pool consists of NHG (24%) and non-NHG guaranteed (76%) prime mortgages secured on residential properties. The pool has 70.3-month seasoning and a weighted average LTfV of 77.2%.

The €560m 4.7-year triple-A notes priced at 130bp over three-month Euribor (guidance was in the 130bp area). Securitisation analysts at Deutsche Bank note the fact that the tranche had a high coupon of 140bp and step-up of 200bp makes this an unusual bond in the retained universe and probably aided execution (the deal was reportedly sold at above par to give a spread of 130bp).

The analysts suggest that the release of previously retained deals into the publicly syndicated space is set to gather pace. In a seperate but similar move, BBVA is believed to be remarketing the government guaranteed A2G tranche of its BBVAP 8 Spanish SME CLO, which was issued and retained in July of last year. "High coupon or government guaranteed tranches may not be the norm in retained deals, but such attributes are likely to give them a head start in the post-crisis market," they observe. "Caixa Catalunya also syndicated a new government guaranteed SME CLO tranche, GATGE 09-1 A1G, at attractive levels."

Eleven Cities 4 is the second Dutch RMBS to be offered publicly this month. The two-year triple-A notes from Delta Lloyd's Arena 2009-1 priced at 110bp over one-month Euribor, following significant investor demand (see last week's issue).

AC & CS

RMBS

Re-REMIC collateral evolution analysed

DBRS notes in a new report that re-REMIC underlying collateral has evolved during the year. Following heightened performance pressure in the prime sector, the collateral for re-REMICs has migrated from primarily Alt-A securities to a blend of Alt-A and prime bonds, the rating agency says.

At the same time, due to competitive pricing on the underlying securities, issuers have lately expanded the re-REMIC universe to include many non-standard collateral types such as non-front-pay seniors that are currently locked out from principal payments, as well as subprime or even option ARMs. Non-standard assets were issued on a much more limited basis, however.

While most of these assets can be resecuritised, the resulting credit enhancement levels are often very conservative due to performance and cashflow concerns, according to DBRS. On the other hand, re-REMIC capital structures have become simpler.

Pro-rata pay or z-accrual structures common in 2008 and early 2009 are now largely obsolete. Plain sequential-pay structures (along with higher credit enhancement) also allowed investors to get comfortable accepting a rating lower than triple-A for some transactions. Many more re-REMICs issued in 2009 incorporated precautionary structural features in the form of exchangeable securities to protect against future potential rating volatility.

With respect to core securitisations in 2009, DBRS has rated a total of six (five public and one private) transactions and provided credit assessments on two. All deals were backed by seasoned collateral ranging from two to seven years.

Pools were often positively selected to exclude any delinquent loans; however, many did contain mortgages that were modified to 'current' from a previously delinquent status. Several of the transactions did not require servicers to advance any principal and interest payments on delinquent mortgages.

Further, the capital structures generally consisted of a plain-vanilla senior class and overcollateralisation, and sometimes a mezzanine tranche. Principal was almost always paid sequentially to the senior class without any trigger mechanism.

A total of 112 re-REMICs were issued in the RMBS sector for the 11 months ending November 2009, representing a 58% increase from last year, according to DBRS. Although core securitisations emerged in mid-year when Citigroup Mortgage Loan Trust 2009-A was rated by the agency, they were greatly outnumbered by the re-REMIC volume.

In addition, DBRS notes that the market also completed five servicer advance securitisations this year after such transactions became eligible under the TALF programme. Overall, re-REMICs dominated market issuance and accounted for approximately 92% of the total transactions that closed in 2009.

JA

Technology

The regreening process

Richard Bennett, European president of Razor Risk Technologies, answers SCI's questions

Q: How and when did Razor Risk Technologies become involved in the structured finance market?
A: Razor Risk Technologies is an Australian firm listed on the ASX, which has been around since 1999 - although the risk management side of the business came about in 2003. We've built up our client roster steadily since then. It now includes leading financial institutions, such as LCH, HSBC, RBC, Man Group and MF Global. They use us for anything from sophisticated risk management to straightforward limit/excess management.

Clients tend to have global implementations and we have a global reach, with three main centres in Australia, New York/Toronto and London. Our staff have technology and risk consulting/trading consulting expertise.

Q: Do you focus on a broad range of asset classes or only one?
A: The Razor product suite manages a broad range of different asset classes and includes market risk, credit risk and economic capital calculators. The service enables institutions to measure risk, manage it and gain control of it in terms of limits. Typically, the board of directors will define the risk appetite of the institution and consequently its limits.

Our software enables simulation of the evolution of a portfolio or transaction through time. The software identifies different potential future market movements and then develops appropriate risk/hedging strategies for them.

This involves capturing data of the underlying and combining it with our analytics. The aim is to help clients risk manage the exposures associated with those instruments. If a particular CMBS tranche, for example, is underwater, we can simulate it forwards to gauge how the tranche will perform under different scenarios.

A risk management implementation typically involves a discovery phase, in which we apply some risk consulting rigour and come up with a plan to address the issues that have been highlighted. This is followed by the implementation process, which includes getting everyone appropriate in the organisation to agree on the plan.

We typically speak to chief risk officers and heads of trading (or whoever looks after the portfolio), as well as discussing the plan with an organisation's IT department because it needs to fit into the organisation's infrastructure. In some cases we talk to an organisation's board of directors or senior management - this is becoming more common, as regulators and shareholders step up their scrutiny of risk management. We've always typically met with senior staff, but they're getting involved earlier in the process now.

Q: How do you differentiate yourself from your competitors?
A: Our clients tell us that what differentiates us from other risk management system providers is our ability to execute. Rather than taking 12-18 months, like some of our competitors, we typically take eight or nine months for an implementation. We even managed to get one client up and running in four weeks, but that was an exception.

If an implementation takes too long, project motivation becomes difficult to sustain.

We send staff on site to do the systems implementation and knowledge transfer, so clients don't need to call on us (though they can if they want to) and they can modify the system themselves. From time to time, we'll have a planning session with clients to discuss and execute new product initiatives or changes in risk appetite.

Another aspect of our service that clients like is our ability to add new risk methodologies over time. We spend time doing research to keep up with new methodologies; for example, our internal research or university white papers. Clients help drive this aspect too; for instance, if they have a particular view in terms of how methodologies will change going forward.

We have internal model approval by many regulatory authorities, which means that implementations have to be embedded into the institution from both a qualitative and quantitative perspective to ensure that senior management is fully involved with risk decisions. The qualitative aspect of this is how the implementation is embedded and the quantitative aspect is the mix of data and analytics that is employed.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: It has been a 'good' global financial crisis in the sense that it pulled the market into unusual situations. The upshot is that there'll be more rigour involved in risk management: market participants will have to spend more time discussing and agreeing on risk appetite and models, as well as coming up with evidence that they've done so.

Risk management is also changing and moving away from the risk model used in the last 10-15 years towards newer risk methodologies. This involves questioning the original assumptions; for example, what constitutes 'market normality'. We've begun including samples of defaults into our market risk models to move away from the 'normality' assumption.

The old way of risk management was to assume that the portfolio of today would be the same tomorrow and in the future, and that if the portfolio got into trouble, you could trade out of it in 30 days. But that assumption has been severely stressed over the last two years.

Our clients have embedded rules that adjust their portfolios through time, taking into account for example any coupons received or options being executed. This approach better reflects how a portfolio changes through time helping our clients to manage their risks with better forward-looking hedges. But many firms are still using the old static portfolio assumption, which has proved to be very dangerous.

It's interesting to note that the institutions that queried their risk model assumptions and incorporated new ideas, such as adjusting their portfolios through time, had a 'better' financial crisis than the institutions which did not question the assumptions in their risk models.

Consequently, there has been an uptick in demand for our services: we're up 40% from last year (June to June). This is being driven both by the current volatility in the market and by what has happened over the last two years. The desire to manage risk differently from how it was managed in the past is certainly increasing: when things are going well, it is easy not to worry that much about risk management.

We're busy working on a number of projects in terms of both updating methodologies and implementating new risk systems. We typically update them depending on how a client's business model changes. But, assuming a client's business remains the same, this process is usually done every year or so.

Q: What major developments do you need/expect from the market in the future?
A: Regulation is the proverbial elephant in the room. Many regulatory actions are occurring across different jurisdictions and so it will be interesting to see whether the various regulators manage to keep a level playing field across the different jurisdictions.

Equally, liquidity remains an issue and this will take time to work its way through the system. For example, we are seeing more bank recapitalisations.

It will also take time before investor appetite returns, with for example the ratings issue still needing to be resolved. One consequence of this is that investors are demanding more data in deal documentation.

In any case, it's clear that the structured finance market needs to go through a regreening process in terms of models and data.

CS

Advisory

Ex-TCW team forms new advisory

Former TCW cio Jeffrey Gundlach has established DoubleLine, a new investment advisory company which will operate in strategic relationship with Oaktree Capital Management.

Gundlach, who was recently dismissed from TCW (see last week's issue), is partnered by former group md of the company's MBS group, Philip Barach. More than 30 former members of their previous team at TCW are set to join DoubleLine, with this number expected to grow in the future.

Gundlach says: "I'm excited about starting a firm that will be absolutely dedicated to excellence in investing and client service. I'm particularly gratified that so many members of our former team at TCW are joining us in this new venture."

Oaktree will help DoubleLine establish its own operational infrastructure and in return will receive a minority equity position in the company. Gundlach explains: "Our agreement with Oaktree, one of the world's leading investment advisory firms, will provide DoubleLine with invaluable administrative support and resources while my seasoned team focuses on bringing our proven investment and risk management services to our valued clients. Looking beyond the start-up phase of our firm, I also envision rich possibilities of shared product offerings by blending our team's core fixed income and mortgage-backed capabilities with Oaktree's widely recognised franchise in the active management of fixed income and alternative investments."

Howard Marks, chairman of Oaktree, comments: "I've known Jeffrey and Phil for over 20 years and supervised them at TCW during a difficult investment period in 1994. Given our long history, a shared philosophy that emphasises the importance of risk control and the extraordinary performance record that they built at TCW, we were happy to agree to help them establish their new business. I'm confident that Oaktree's association with DoubleLine will help bring exceptional management to DoubleLine's clients, while benefiting Oaktree's clients through enhanced market insight and possible joint product offerings."

DoubleLine has started the process of registering with the US SEC as an investment adviser. Pending application approval, the firm will conduct its business within the limits established by the Investment Advisers Act of 1940.

Alternative assets

Insurance fixed income portfolio head hired

John Melvin has joined Goldman Sachs Asset Management (GSAM) as an md and global head of insurance fixed income portfolio management. Melvin will oversee the portfolio management investment process and implementation for GSAM's insurance fixed income clients, manage a global staff of insurance fixed income professionals and work with the insurance sales and strategy teams to develop customised investment solutions.

Melvin will report directly to Eric Kirsch, md and global head of GSAM's insurance asset management business. He will also work closely with GSAM's US and global fixed income teams.

Kirsch says: "John's extensive fixed income and insurance experience will be a terrific addition to our work with global insurers. Insurance asset management is a core focus for GSAM and we are pleased to welcome someone with John's expertise to our team of dedicated insurance asset management specialists."

Melvin has over 18 years of fixed income experience. During the last seven years, he served as a md for Deutsche Insurance Asset Management, responsible for insurance fixed income for the Americas.

In addition, he was co-head of the US investment platform with oversight for credit research and trading. He also co-chaired the US asset allocation committee, where he set investment policy for insurance accounts.

Prior to Deutsche, Melvin was an svp for Lazard Asset Management, where he was a portfolio manager for core and core-plus portfolios and a sector manager following the ABS, CMBS and MBS markets.

Alternative assets

Structured settlement firm adds cfo

Client First Settlement Funding has hired Dan Fischer as cfo. He has more than 20 years of experience in the financial sector.

During his 14-year tenure with ABN AMRO Bank, Fischer helped create and manage the residential and commercial real estate capital markets divisions. He has experience in securitisation and whole loan sales and structuring, completing more than 50 domestic and international public and private securitisations totalling over US$20bn dollars in issuance.

Fischer says: "I'm glad to have joined Client First during this exciting time of growth. I believe this company is committed to helping each client find that brighter financial future and I intend to contribute all the expertise I have towards that."

CDPCs

CDPC to invest in GSE securities

Athilon has amended its operating guidelines to expand its permitted eligible investments to include corporate debt securities issued by Ginnie Mae, Fannie Mae and Freddie Mac that have maturities consistent with its existing eligible investments. Haircuts consistent with Moody's analysis of the specific investments will be applied in calculating their value for capital sufficiency purposes. These securities may not exceed 33% of all eligible investments and must have a maturity no longer than two years.

Moody's has determined that the amendment will not at this time cause the counterparty and debt ratings currently assigned to Athilon to be reduced or withdrawn. The rating agency does not express an opinion as to whether the amendment could have non-credit related effects, but confirms that it does not have a credit impact on the CDPC's ratings because the haircuts - in conjunction with the limits on maturity and quantity - constrain the risk posed by such investments.

Athilon has written protection via CDS on a portfolio of primarily static, bespoke tranches referencing corporate and sovereign entities - although its portfolio also contains one CDS on an individual CDO.

CDS

New ISDA subcommittee to rule on ADR process

Following a specially convened Japan CDS meeting to discuss whether the country's alternative dispute resolution (ADR) process could constitute a CDS trigger, ISDA is to establish a Legal Subcommittee of the Japan Determinations Committee. This subcommittee will comprise a sub-group of Japan Determinations Committee members and will include the co-chairs of the Japan CDS Working Group. The move comes after widely-publicised attempts by Aiful Corp protection holders to trigger their CDS contracts failed three times (see SCI issue 161).

CLO Managers

Change of control for three CDOs

Lincoln National Corporation has agreed to the indirect sale of its subsidiary Delaware Asset Advisers to Macquarie Bank, pursuant to a purchase and sale agreement (PSA). Delaware Asset Advisers - a Delaware statutory trust - is the collateral manager for the Delphinus CDO 2007-1, Brigantine High Grade Funding and Admiral CBO transactions.

The indirect sale of Delaware Asset Advisers constitutes a change of control, which may be deemed to be an assignment of all investment advisory contracts to which the manager is a party. Despite the change in control of its parent, Delaware will continue to act as the collateral manager for the three transactions.

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

CLOs

CLO manager replaced, staff transferred

Avoca Capital Holdings has entered into an agreement to replace KBC Financial Products (KBCFP) as portfolio manager for the €350m Lombard Street CLO I transaction.

The Lombard Street acquisition, which will close on 14 December 2009 following unanimous approval from the voting noteholders and rating agency consent, will increase Avoca's AUM to approximately €5.5bn. This transaction represents Avoca's second successful replacement manager mandate this year, having been appointed to manage the €840m CLIO European CLO in July 2009, replacing Lehman Brothers International (Europe).

Lombard Street was the sole CLO managed by KBCFP. Following the transaction, portfolio manager Niall Considine and analyst Pierre van Niekerk will transfer from KBCFP to Avoca.

Chief executive of Avoca, Alan Burke, says: "The transfer of Lombard Street to Avoca is consistent with our objective to grow both organically and through acquisition. We have increased our AUM by approximately 30% in 2009 to date and will continue to take advantage of ongoing growth opportunities. We expect to see our industry continue to consolidate in 2010 as new and existing mandates move increasingly to scale players with strong track records through the current cycle. We very much welcome Niall and Pierre to the Avoca team and look forward to working with them."

CMBS

Team hired for CMBS origination resumption

Bridger Commercial Funding is to resume originating new commercial real estate loans on income-producing properties. Loans made under Bridger's new programme will be underwritten to eligibility standards for securitisation under the Federal Reserve's TALF programme. Bridger also announced that it has hired the personnel from Whitegate Advisors, a New York-based real estate capital markets specialist firm, in order to support its new CMBS origination activity.

Bridger's new programme is believed to be the first next-generation multi-borrower CMBS loan programme initiated since the onset of the credit crisis in early 2008 (see also separate News Analysis). Although the Bridger programme is designed to allow investors purchasing new triple-A rated CMBS to access TALF financing, the programme will offer commercial real estate borrowers the flexibility to access a range of alternative financing structures.

To date, individual borrowers have been locked out of TALF-supported financings because of the pooling requirement for newly originated loans. The new Bridger programme addresses this obstacle by assembling a diversified portfolio of loans from many different borrowers that will be eligible for attractive, non-recourse securitisation funding offered under TALF.

"Recent activity in the CMBS market is signalling that the credit log-jam plaguing commercial real estate lending for the past two years is starting to break," says Bridger evp Peter Grabell. "CMBS bond yields have fallen throughout the year, to the point where newly originated CMBS loans are becoming a viable financing option once again for borrowers."

Bridger's new programme is open to applications for new loans from US$2m to US$20m. Qualifying property types are multifamily, manufactured housing communities, office, retail, industrial/warehouse and self-storage. Fixed rate loan maturities from three to five years will be offered, with traditional amortisation and balloon payment features.

To expand its capital markets capabilities in support of the new CMBS programme, Bridger has added the former Whitegate Advisors team to its platform. The Whitegate team, consisting of Julian Vulliez, Edward Dale and David Weiss, brings direct capital markets execution capabilities to Bridger.

Investors

Key-man risk in the spotlight

The departure of TCW's cio Jeffrey Gundlach has prompted the US Treasury to suspend TCW's PPIP fund. A review of the TCW-managed CDOs that S&P rates found that the key-man clause does not pose a risk for those transactions, however.

Key-man provisions are often contained in the collateral management agreement and usually give certain noteholders the right to replace the collateral manager if key individuals are no longer employed by that collateral manager.

"Treasury has notified TCW that a key person event has occurred under the limited partnership agreement. Upon the occurrence of a key person event, the PPIF cannot make investments or dispositions (other than to avoid a material loss). Treasury is currently evaluating its options as an equity and debt investor in the PPIF," a Treasury spokesperson says in a statement.

S&P reviewed the US CDO transactions managed by TCW Asset Management Co that it rates to determine if recent events at the firm will trigger any key-man provisions in the transactions' documentation. After reviewing the transaction documents and following discussions with TCW, the rating agency believes that the events do not pose additional risks that would lead it to take rating action on the TCW- and MetWest-managed CDO transactions at this time.

S&P rates four CDOs managed by MetWest and 45 CDOs managed by TCW.

TCW's personnel problems came to light last week (see SCI issue 164), following the firm's acquisition of MetWest, a fixed income investment manager. TCW separately announced that Gundlach had been relieved of his duties as cio and lead portfolio manager of its high grade fixed income funds and accounts, and removed from the board of directors of the TCW Group.

Gundlach's dismissal has prompted a number of other TCW employees to resign from the company.

Investors

Investment manager beefs up multi-strategies unit

BT Investment Management (BTIM) has added two investment professionals to its multi-strategies team - Stuart Eliot and Vimal Gor. The pair will report to Robert Swift, the head of BTIM's multi-strategies group.

Eliot will be responsible for enhancing the investment processes and risk control in BTIM's multi-strategy hedge fund (TRF), global fixed income and the balanced funds. Previously he worked in London for the UBS Delta team (formerly known as CreditDelta) in an implemented quantitative finance role.

This involved working with clients across Europe and Asia on a diverse range of projects, such as portfolio transition, liability-driven investing, portfolio risk management, beta replication, alpha transfer and analysis of credit derivatives. In 2006 he moved back to Sydney to establish the UBS Delta presence in Australia and strengthen the coverage of its clients across the APAC region.

Gor specialises in the G7 markets and he has particular experience in the Dollar bloc and Japan. He has over 15 years' experience in analysing and managing global fund income & FX portfolios and strategies in both the cash and derivative spaces. He previously worked for over 10 years at Aviva Investors in London, where he was responsible for the management of the global bond portfolios within the sovereign team.

Investors

Aviva adds to growing credit team

Aviva Investors has appointed Paarus Shah as credit analyst. He will report to Tim Barker, head of credit research at Aviva Investors, and will be responsible for providing research on debt security investments - with a sector-specific focus on insurers and non-bank financial companies. He joins from M&G Investment Managers, where he was director, financial institutions.

Shah is the fourth hire in Aviva Investors' credit team in recent months, as the firm looks to bolster and develop its 20 person-strong credit capability under the leadership of Mark Wauton, who joined in April (SCI passim). Other key appointments in the team this year include: Simon Blundell as senior portfolio manager and Dinesh Pawar as head of flow trading.

Barker comments: "Paarus brings detailed knowledge of credit markets and proven analytical experience to the team. He will play a key role in providing value-added recommendations to our fund managers on debt security investments. While Paarus has particular experience in analysing UK, European and US insurance companies, he also has a thorough understanding of the broader financials market - making him a strong and complementary fit to our already significant credit research capabilities."

Wauton adds: "Growing our credit capability remains a key priority for Aviva Investors. While opportunities in the credit sector are significant, generating outperformance is likely to become more challenging, and we are determined to have a first-class research team that can add significant value to our investment decision-making process through robust and fundamental analysis."

Investors

Two Eaton Vance funds sign up for TALF

The trustees of Eaton Vance Limited Duration Income Fund and Eaton Vance Short Duration Diversified Income Fund, each a closed-end investment company, have authorised the funds' participation in the TALF programme beginning on 14 December. The terms and conditions of each fund's participation in the TALF programme will be governed by the TALF standing loan facility procedures and the master loan and security agreement (MLSA).

Legislation and litigation

Broker charged with CMO fraud

The US SEC has charged Brookstreet Securities Corp and its president and ceo Stanley Brooks with fraud for systematically selling "risky" MBS to customers with conservative investment goals. The fraud cost many Brookstreet investors their savings, homes or retirement cushions and eventually caused the firm to collapse.

The SEC alleges that Brookstreet and Brooks developed an internal programme through which the firm's registered representatives sold particularly illiquid types of CMOs to more than 1,000 seniors, retirees and others for whom they were unsuitable. It further alleges that Brookstreet continued to promote and sell risky CMOs to retail investors, even after Brooks received numerous indications and personal warnings that these were "dangerous" investments that could become worthless overnight. Finally, in a last-ditch effort to save Brookstreet from failing during the financial crisis, Brooks allegedly directed the unauthorised sale of CMOs from Brookstreet customers' cash-only accounts, causing substantial investor losses.

"These were complex mortgage derivative securities with byzantine pricing, valuation and trading characteristics," says Robert Khuzami, director of the SEC's Division of Enforcement. "Selling them to retirees and conservative investors was profoundly and egregiously wrong."

According to the SEC's complaint, filed in federal district court in Santa Ana, California, Brookstreet customers invested approximately US$300m through the firm's CMO programme between 2004 and 2007. The SEC alleges that Brooks knew, or was reckless in not knowing, that Brookstreet and its registered representatives were selling unsuitable CMOs to retail customers. Among the warnings Brooks received, for example, was one in 2005, when Brookstreet's compliance department sent him a copy of FINRA Notice 93-73 that described CMOs as suitable only for sophisticated investors with a high-risk profile.

The SEC's complaint specifically alleges that the defendants violated the antifraud provisions of Section 17(a) of the Securities Act and Sections 10(b) and 20(a) of the Exchange Act, and Rule 10b-5 thereunder. The Commission seeks permanent injunctive relief against both defendants and disgorgement of ill-gotten gains with prejudgment interest, and financial penalties against Brooks.

The SEC previously charged in May 10 Brookstreet registered representatives with making misrepresentations to investors related to the sale of risky CMOs (see SCI issue 139).

Monolines

Monoline falls below NYSE listing standard

Ambac has been notified that it has fallen below the NYSE's continued listing standard relating to the price of its common stock. The exchange requires that the average closing price of a listed company's common stock be above US$1.00 per share over a consecutive 30 trading-day period. As of 8 December 2009, the 30 trading-day average closing price of Ambac's common stock was US$0.94 per share.

Under the NYSE's rules, the monoline has six months from the date of the NYSE notice to bring its share price and 30 trading-day average share price back above US$1.00 in order to avoid the delisting of its shares. During this period, Ambac's common stock will continue to be traded on the NYSE, subject to its compliance with other NYSE continued listing requirements.

As required by the NYSE, in order to maintain the listing of its common shares, Ambac will notify the exchange within 10 business days of receipt of the non-compliance notice of its intent to cure the price deficiency.

RMBS

REIT completes RMBS purchases

Two Harbors Investment Corp has completed the purchase of RMBS and related investments with an aggregate initial acquisition price value of approximately US$488m. These purchases reflect the deployment of approximately 95% of Two Harbors' capital available for investment. The company invests in agency and non-agency RMBS.

"We're pleased by the progress we've made in putting our stockholders' capital to work since the closing of our merger transaction with Capitol Acquisition Corp on 28 October [SCI passim]," says Tom Siering, Two Harbors' president and ceo. "We look forward to continuing to add to our portfolio as and when we find attractive opportunities in our target asset classes."

Technology

Derivatives processing firm names Kushner to board

Point Nine has named Jeff Kushner as a non-executive member of the board of directors. As a member of the board, Kushner will support the middle- and back-office services provider with their current initiatives and help with the strategic positioning of the company for future growth.

Kushner, currently ceo of BlueMountain Europe, will assist Point Nine with its future plans for growth. Kushner's background includes heading up the managed CDO business and leading the trade execution function covering all traded products at BlueMountain Europe, as well as a variety of trading roles within the structured credit team at ING Financial and Merrill Lynch.

Kushner says: "I am very excited to join the team at Point Nine. The experienced team has continued to develop and enhance their product during the most evolutionary period in the history of markets. Point Nine provides an essential product that allows its customers to navigate the complex and evolving world of derivatives processing."

Technology

Valuations tie-up for Asia

Pricing Partners has established a distribution agreement with a new partner, Belatos. The distributor will deliver Pricing Partners' full solution suites throughout the entire Asia-Pacific region, with first-line support provided out of Belatos' Hong Kong office. Belatos specialises in the development, distribution and support of financial software and is headed by md Didier Joannas.

Joannas says: "Recent events have shown us that regional banks, hedge funds, asset managers and insurance companies alike cannot rely exclusively on the pricing given by the entities who sell them derivatives anymore. Furthermore, regulators and auditors are pushing market players to have their own in-house pricing tools or, at the very least, to have an independent valuation partner."

Xavier Deschamps, md at Pricing Partners, adds: "Working with highly qualified and experienced people in this region guarantees our Asian clients that our solution will be appropriately incorporated into their local requirements. It is also a great opportunity for us to work with Didier, who has an extensive understanding and background in this region. The next step in Asia will be the opening of a Pricing Partners office, with dedicated client support services to deliver high quality client support."

Trading

Bank hires structured credit trader

Paul Bajer, former structured credit trader at Nomura, is understood to have joined Calyon as head of funded credit derivatives trading, based in London. A Calyon spokeswoman declined to comment on the hire.

Trading

Structured credit head promoted

Citadel Investment Group has confirmed that Chris Boas, head of structured credit trading at the firm, has been appointed the new head of credit markets. This follows the recent departure of Peter Santoro, head of institutional markets.

ABCP

Conduit sponsors unlikely to achieve full disclosure

Fitch says in a new report that despite moves to improve transparency in the ABCP sector, it does not expect conduit sponsors to achieve full disclosure on underlying assets and originators. Even if full transparency was given, the rating agency notes it is unclear how this would be treated by investors in the context of marking exposures and taking into account other structural mechanics of the programme.

Historically seen as a 'black box', ABCP conduits and in particular multi-seller programmes have tended to provide a limited amount of detail on the underlying assets in the programme and are not obliged to reveal the underlying transactions, securities and assets to which they provide funding - mainly due to confidentiality issues. However, given the difficulties in the ABCP markets over the past two years, there has been a concerted move towards more transparency by many conduit sponsors to increase the amount of aggregate programme and collateral performance information for investors in their monthly reports (SCI passim).

ABS

Transfer agreement amended on Italian lease ABS

The transfer agreement between Lombarda Lease Finance 4 and UBI Leasing has been amended to enable the originator to repurchase the leases of a lessee that has formally requested a principal payment holiday under the loan modification scheme for Italian SMEs. The loan scheme was defined in August 2009 by the Italian Banking Association (ABI) and major Italian business associations under the provisions of Law Decree No. 78 of 1 July 2009.

Fitch notes that the ratings on the transaction are not likely to be adversely affected by the amendment. It provides that the repurchase option is capped at a certain share of the original portfolio amount and that the purchase price of performing leases must cover their outstanding principal and accrued interest. The principal component of the purchase price will be considered part of the principal collections and therefore used to amortise the notes, the rating agency says.

Fitch does not expect the amendment to have any detrimental rating effects as the buyback is limited to lease receivables to be renegotiated under the scheme and capped at a given amount. Furthermore, the receivables are purchased at par and the purchase price includes accrued interest, while the principal buyback proceeds are dedicated to the redemption of the rated notes and not paid out of the structure as remuneration or principal repayment of the unrated notes.

In addition, the originator has informed Fitch that it will provide the agency with the information needed to properly monitor the transaction performance and to continue rating the notes issued by the issuer, even though it did not sanction this in the transaction documents. In particular, the originator will provide updates on the performance of the repurchased portfolio and details of each receivable repurchased, including the split between the principal and interest component of the purchase price.

CDO

Third buyback proposed for CRE CDO

Fortress Investment Group is proposing a third buyback of the Duncannon CRE CDO I transaction (SCI passim), with the repurchase of €10m of the Class A notes to be undertaken at a price in the low seventies. The notes will subsequently be cancelled, thereby increasing available credit enhancement to all rated notes.

As per Condition 7 (h) of the Duncannon CRE CDO I prospectus, the issuer may at any time, at the direction of the portfolio manager, purchase senior or mezzanine notes in the open market or in privately negotiated transactions at a price not exceeding 100%.

The repurchase will be funded using cash available in the principal collection account, which as of December 2009 totals approximately €7.1m. Generally, proceeds in the principal collection account can be used by the portfolio manager to invest in new portfolio assets, limited by the eligibility criteria, or may be distributed to noteholders if no investment opportunity exists.

Due to the funding of the proposed repurchase of the Class A notes, the amount of principal proceeds available for immediate distribution to the remaining noteholders will be lower. At the same time, noteholders will benefit from an increase in credit enhancement due to the relative increase of assets compared to liabilities in the structure.

Currently the transaction's senior, second senior and mezzanine par value tests are breaching their limits. Note all par value ratios will improve as a result of the repurchase. Consequently, the amount of interest required to be diverted on future payment dates to the senior notes to cure the par value tests will be reduced.

Fitch says that the proposed repurchase of Duncannon notes will not in itself impact the deal's ratings.

CDO

CDO sub-SPE criteria released

S&P has published its methodology for analysing rating confirmation requests made in connection with amendments to the transaction documents for CDOs. These amendments strive to permit the CDOs to establish subsidiary SPEs to hold equity securities received as part of a workout or distressed exchange of an underlying defaulted or distressed asset. The agency understands that these sub-SPEs are intended to prevent CDOs from incurring entity-level taxation.

Under the methodology, to limit any potential cash outflows that might take priority over payments to the rated notes issued by the CDO, S&P's criteria looks for all of the sub-SPEs' expenses to be subject to the administrative expense cap in the CDO's payment waterfall. These expenses typically include the cost of establishing the sub-SPEs and any ongoing expenses incurred that are not covered by cashflows from the sub-SPEs' underlying assets.

Since most CDOs are not structured with provisions that are intended to address the risks presented by the ownership of real property, S&P's criteria looks for express document provisions that prohibit the sub-SPEs from obtaining title to real property or from obtaining a controlling interest in an entity that owns real property. The agency does not give any credit to equity securities held by the SPE when it performs its cashflow analysis.

It also does not include equity securities when calculating the cashflow CDO's coverage tests. S&P believes that equity securities held by the sub-SPEs should receive zero credit both in the cashflow analysis and when calculating the CDO's overcollateralisation tests because they do not have a fixed par value and their prices can fluctuate widely.

For purposes of the criteria, S&P look for any cash proceeds received from the disposition of equity securities held by the sub-SPEs to benefit the CDO by flowing through the priority of payments. The agency believes that these proceeds should be treated in the same manner as recoveries on defaulted securities because, in its experience, the equity securities were most likely received as a recovery of a defaulted asset or from a restructuring of a pending default.

Finally, for purposes of the criteria, S&P looks for any assets held by sub-SPEs to be liquidated on or before the CDO's legal final maturity date and paid out to the CDO's investors in accordance with the terms of the transaction documents.

CDS

Three credit events settled ...

Three CDS auctions have taken place over the last week.

A final price of 77.75 was reached for the Thomson (bankruptcy) CDS auction that took place on 10 December. 14 dealers participated in the auction.

The final result of the Hellas II subordinated CDS auction was determined to be 1.375 on 15 December, with 14 dealers also participating in the auction. Deliverable obligations are denominated in euros and US dollars.

And the final result of today's NJSC Naftogaz of Ukraine CDS auction is 83.5. 13 dealers participated in the auction.

CDS

... while another is determined

ISDA has confirmed that an external review panel of the Americas Determinations Committee resolved that a restructuring credit event occurred in respect of Cemex, a Mexico-based holding company of entities whose main activities are in the construction industry (SCI passim). The DC voted to hold an auction in respect of outstanding CDS transactions.

Meanwhile, ISDA's EMEA Determinations Committee is deferring its deliberation of a potential Temirbank failure to pay until such time as further information concerning the obligations has been procured and reviewed.

The auction to settle CDS on FGIC is to be held on 7 January.

Clearing

CME begins clearing CDS ...

CME Group has begun clearing CDS through CME Clearing. On its first day of clearing, the firm cleared both dealer-to-customer and interdealer CDS trades.

"Working closely with market participants on both the buy-side and sell-side, we have begun to successfully clear CDS trades," says Laurent Paulhac, md of OTC products and services, CME Group. "We believe our solution is the most comprehensive credit default swap solution available and brings together a broad range of participants who support our offering."

CME Group's cleared-only CDS initiative, which was jointly developed with its founding members, offers both buy-side and dealer market participants the ability to clear CDS. The dealer founding members are Barclays Capital, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Morgan Stanley and UBS.

The buy-side founding members are AllianceBernstein, BlackRock, BlueMountain Capital Management, Citadel, the D.E. Shaw Group and PIMCO. In addition, Bank of America Merrill Lynch and Nomura Group are CDS clearing member firms.

Clearing

... while ICE starts clearing Euro single names

ICE Clear Europe has launched clearing services for single name CDS contracts after receiving regulatory approval in the UK. The first tranche of single name CDS launched on the platform references companies in the European utility sector.

ICE has developed a proprietary risk assessment methodology specifically for single name CDS contracts. This methodology complements the risk assessment methodology employed in clearing CDS indexes, in recognition of the unique risk profile of single name contracts. The methodology was reviewed and validated by an independent risk management consultancy as part of the regulatory approval process.

The risk assessment methodology is relied upon to determine initial margin, variation margin and guaranty fund requirements. This customised risk management model, together with ICE's industry-leading process to utilise executable pricing to provide the critical daily settlement prices of single name contracts, is the cornerstone of its risk management framework.

Paul Swann, president of ICE Clear Europe, says: "We are pleased to announce the successful launch of single name clearing on behalf of our clearing participants. This capability complements numerous industry initiatives underway to restructure the market and enables the reduction of counterparty credit risk. Together these steps promote the recovery of the CDS markets and the global lending markets."

Separately, BNP Paribas and Nomura have been approved as CDS clearing members of ICE Clear Europe and are actively clearing as of this week. The platform now has 13 CDS clearing members, but Nomura is the only member to represent the Asia region.

Georges Assi, co-head of fixed income EMEA and global head of credit at Nomura, says: "Nomura's partnership with ICE Clear Europe demonstrates its commitment to creating more efficient markets, enabling greater liquidity and providing transparency for all. This represents another significant milestone in Nomura's mission to become a dominant force in the global credit derivatives market."

On a global basis, ICE has cleared over US$4.3trn in notional value of CDS indexes and has aggregate open interest of US$343bn. ICE Clear Europe's CDS clearing commenced in July 2009, with European index (iTraxx) contracts, and has cleared more than €800bn in notional (SCI passim).

ICE Trust, ICE's US CDS clearing house, launched in March and has cleared more than US$3.1trn in notional of North American index (CDX) contracts to date. The single name reference entities cleared by ICE are components of the iTraxx and CDX indexes.

ICE has established CDS risk frameworks for ICE Trust and ICE Clear Europe that are separate from its futures businesses, including separate risk models, guaranty funds and margin accounts, as well as a CDS-focused risk management system and an independent governance structure. ICE says it is providing a common infrastructure to global CDS market participants within their respective regulatory jurisdictions, while leveraging the legal framework, operational and risk management processes, treasury systems and trade warehousing systems currently in use by the industry.

Clearing

ISDA applauds buy-side central clearing access

ISDA has commended the derivatives industry's success in achieving buy-side access to central clearing of CDS by 15 December, as stipulated by industry commitments made to regulators.

"Throughout 2009, ISDA has worked with both the buy-side and the sell-side communities to promote industry-wide dialogue and coordinated solutions to facilitate buy-side access to CDS clearing by 15 December," notes Eraj Shirvani, ISDA chairman and head of fixed income EMEA at Credit Suisse. "Our active involvement in achieving this goal demonstrates that ISDA and the industry remain committed to increasing operational efficiency and reducing the sources of risk in the privately negotiated derivatives business."

On 2 June ISDA - through the ISDA Board Oversight Committee (IBOC) and the Operations Management Group (OMG), and in collaboration with other trade associations and market participants - submitted a letter to industry regulatory groups. The letter outlined commitments towards strengthening the resilience and robustness of the OTC infrastructure through changes in risk management, processing and transparency.

Industry commitments in the 2 June letter included increased reporting of trades in centralised repositories, clearing of derivative products, delivery of robust collateral and margining processes, and updates to the industry governance structure. One of the clearing commitments stated the industry's goal to achieve buy-side access to CDS clearing (through either direct CCP membership or customer clearing), with customer initial margin segregation and portability of customer transactions no later than 15 December 2009.

Buy-side clearing is now active for credit default swaps, the Association notes. For those buy-side firms without direct access to a clearinghouse, CDS clearing is achieved via a clearing member.

CLO Managers

CLO to gain super senior exposures

An amended deed to the collateral management agreement has received the consent of the majority of the senior noteholders for the Puma CLO. The deed allows M&G Investment Management, as portfolio manager, to invest in super senior obligations for up to 5% of the aggregate collateral balance of the portfolio.

A super senior obligation is defined as an obligation of an obligor having recently undergone a restructuring of its senior debt and pursuant to which such obligation is payable in priority to that obligor's pre-existing senior debt. For coverage tests purpose, these obligations receive a similar par treatment as current pay obligations.

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

CLOs

Restructuring proposed for crisis-hit MFI CLO

Servicers of the BlueOrchard Loans for Development 2007-1 (BOLD 07-1) microfinance CLO have informed investors of the deterioration of one of the borrowers (Banex) and requested permission to restructure part of the transaction.

The restructuring proposal includes a partial conversion of the existing loan in the portfolio for senior debt in B International Capital Corp (BICC), the holding company that owns Banex, which will be lent to Banex in the form of subordinated debt and participation in a moratorium on principal payments on the loan for approximately 12 months and potentially longer. BICC is a Panamanian holding company that owns 100% of the shares of Banex, as well as 100% of the shares of ProExito, an MFI operating in Honduras.

Banex - formerly Findesa - was created in 2002 from the operations of an NGO working in Nicaragua since 1993 and was granted a banking license in September 2008, changing its name to Banco del Exito (Banex). As of year-end 2008, Banex was the largest MFI in Nicaragua.

A loan of US$6m with a final maturity of 1 June 2012 was extended to Findesa by BOLD 2007, representing 5.6% of the BOLD 2007 portfolio. As of 31 October 2009, Banex had a lending portfolio equal to US$120m, a savings portfolio of US$43m and a client base of 25,434 borrowers and 57,085 savers. Prior to the current crisis, Banex typically had high portfolio quality, with PAR30 under 2%, a compounded annual growth of 74% and an ROE over 30% per annum.

Meanwhile, a loan in the amount of US$1.5m from another lender to Banex is due for repayment on 31 December 2009 and is in default under the relevant loan agreement on the following grounds: breach of PAR30 covenant and; breach of negative-pledge clause (pledges of the loan portfolio of Banex have been created by Banex to secure loans from three other lenders in breach of Banex's negative pledge undertaking). The lender has not given any waivers to Banex but so far has refrained from calling the loan. This event has triggered an event of default under the loan extended by BOLD 2007 to Banex.

The portfolio quality of many MFIs in Nicaragua has deteriorated significantly in recent months, due in part to the negative impact of the global financial crisis on local economic activity and on the level of remittances from Nicaraguans working abroad. In addition to the macroeconomic turmoil, other local factors have contributed significantly to the current situation, including a "no pay" movement in the north of the country and exposure of MFIs to the cattle farming sector, which has suffered from depressed commodity prices for beef.

An exchange notice about the proposed restructuring explains that Banex has been particularly hard hit due to a recent change in product mix that emphasised SME lending (which has suffered more than micro lending), high concentration in livestock loans and high leverage.

As of end-October 2009, portfolio at risk past 30 days at Banex had risen to 16% and restructured/refinanced loans had reached 19% of the MFI's portfolio. As a result of the high provisioning costs associated with this portfolio deterioration, year-to-date losses at Banex had reached US$8.6m as of end October 2009, resulting in a capital adequacy ratio of 10.59% (the minimum required is 10%). In order to maintain its capital base at a level compliant with Nicaraguan regulations, a comprehensive recapitalisation is required.

A restructuring plan has been put forward by a steering committee of shareholders of BICC and preliminarily agreed to in negotiations with the largest creditors. BlueOrchard Finance has been actively involved in numerous meetings with the shareholders' steering committee as well as other lenders to Banex.

CMBS

GGP submits more than 90 loans for restructuring

The law firms overseeing GGP's bankruptcy have published a document that lists the loans subject to the proposed extension agreement. The document, entitled 'GGP's Joint Plan of Reorganization', lists an increased 95 properties, up from the 70 originally reported in November. This document is made available by Kurtzman Carson Consultants, which provides technology support for companies undergoing corporate restructuring.

Realpoint notes that of the 83 properties in CMBS that filed for bankruptcy, it found only nine that were not listed in the reorganisation document: Beachwood Place Mall (MSC06T23); Cache Valley Plaza (PFCR07PL); Columbia Mall (BSC07P18); Marketplace Shopping Center (BSC07P18); Regency Square Mall (WBC03C07 & WBC03C08); Tucson Mall (WBC03C08); Valley Plaza Shopping Center (LBUB03C7); Visalia Mall (LBUB03C7); and Washington Park Mall (WBC04C12).

"While it was previously reported that the lenders expect the properties to emerge from Chapter 11 by the end of 2009, we are awaiting the outcome of a hearing for the proposed plans that is scheduled for 14 December 2009," notes Realpoint.

CMBS

CMBS special servicers evaluated

Fitch has released a report regarding attempts made by market participants to establish the 'best' CMBS special servicer. The rating agency says that trying to gauge which servicers are having the most success goes beyond simply which companies show the highest loan recoveries.

For instance, Centerline has the highest recoveries by dollar for loans with losses at 47% for 2009 year-to-date, but their results are based on 27 loans with an unpaid principal balance of US$110m. Conversely, Capmark has a lower recovery rate of 35%, but worked out a substantially larger volume of 46 loans with a higher unpaid principal balance of US$194m.

What this means is that determining which special servicer is 'best' depends on the portfolio attributes being measured. Consequently, results will likely differ on a year-by-year basis.

Another factor to consider in gauging servicer performance is which companies have substantial exposure to vintages with actual or expected low recoveries and/or highly leveraged loans. These troubled vintages include CMBS originated in 2005, 2006, 2007 and 1998. This does not bode well for servicers such as Capmark, CW Capital and LNR, which have the largest exposure to these worst performing vintages as part of their active special servicing portfolios.

These questions are increasing as the volume of specially serviced CMBS loans continue to rise, with just under US$60bn at the end of Q309. Additionally, recovery rates for CMBS loans with losses continue to drop, with a 33% average for y-t-d 2009 (down from 59% for 2008).

Fitch md Stephanie Petosa says: "Most servicers are adding staff quickly enough to keep pace with the volume growth, but some are already at capacity, which is a concern."

As a result, the servicing landscape may look notably different in the coming year. Petosa continues: "Consolidation among existing servicers is becoming more likely, while some new names may enter into the sector."

CMBS

CMBS ratings contingent on terrorism coverage

As new issuance in the US CMBS sector begins to slowly re-emerge, so may a pair of issues that remain integral to the health of CMBS transactions, according to Fitch in two new reports.

The issues regarding terrorism insurance and environmental due diligence became dormant when CMBS new issuance hit a prolonged standstill beginning last year. But, with a handful of TALF and non-TALF CMBS deals coming to market, these issues remain important structural safeguards for bondholders.

Fitch md Bob Vrchota explains: "An unknown or insufficiently remediated environmental condition can have a significant impact on the value of a commercial real estate property. As such, Fitch expects that all properties within CMBS transactions will have environmental due diligence performed in accordance with EPA and ASTM guidelines."

Fitch continues to believe that terrorism insurance coverage remains an important component of the US CMBS market, as well as a vital structural protection for bondholders. As a result, the rating agency expects all loans to include coverage against terrorism attacks as part of their standard all-risk insurance policies.

Vrchota adds: "Based on its review of the coverage in place and the ongoing loan requirements for coverage, Fitch may decline to rate certain transactions with inadequate terrorism coverage."

CMBS

US CMBS loan delinquencies jump to 4.47%

The aggregate rate of delinquencies among US CMBS conduit and fusion loans is at 4.47%, based on data through the end of November, according to Moody's. The 46bp increase over the previous month was the largest yet of the economic downturn, it says.

The Moody's report notes that the balance of delinquent CMBS loans stood at US$6.7bn in December of 2008 and has increased by more than US$23bn in the past twelve months. Moody's md Nick Levidy says: "The delinquency rate has now increased 29-fold over its low point of 0.22% reached in July 2007. Most of this increase has occurred in 2009, as delinquencies started the year at 0.95%."

Moody's also delineates a substantial variation in delinquency rates among property types and geographic regions, with hotel and multifamily properties experiencing the sharpest increases and highest rates. The delinquency rate on loans backed by hotel properties has increased by 160bp during November to end the month at 7.80%. Multifamily properties saw the second largest increase in its delinquency rate, increasing more than 90 points to 7.40%.

Meanwhile, the delinquency rates on loans backed by industrial properties increased 28bp to 3.11%, while office property delinquency rate rose 25 points to 2.95%. Levidy adds: "As we pointed out in our recent commercial real estate and CMBS outlook, the property sectors with the shortest lease terms have suffered the most so far in this downturn. However, those sectors are also expected to be the first to recover."

The delinquency rate continues to rise across all regions of the country, with the South and the Midwest experiencing higher levels than the West and the East. The South saw the largest increase in its delinquency rate in November, jumping by 66bp to 6.27%, the highest rate of the four regions.

The Midwest has the second highest rate, at 5.16%, but saw a relatively mild 21bp increase during November. The East and West saw similar increases during November, with the East's delinquency rate rising by 37bp to 2.95% and the West increasing by 36bp to 4.77%.

Four states - Nevada, Rhode Island, Arizona and Michigan - have delinquency rates over 10%, while all the other states have rates less than 8%, according to Moody's. The four states, however, account for less than 7% of all outstanding loans. The two states with the largest shares of outstanding loans have rates lower than the country as a whole - California with a rate of 3.88% and New York at 2.47%.

Documentation

Project RESTART Model Reps released

The American Securitization Forum (ASF) has released the final version of the ASF Model RMBS Representations and Warranties (Model Reps). The development of the Model Reps represents an important phase of ASF's project on residential securitisation transparency and reporting (Project RESTART), an industry-developed initiative launched in February 2008 aimed at restoring investor confidence in mortgage- and asset-backed securities (SCI passim).

The Model Reps, which are intended to provide substantial enhancements to the traditional representations and warranties provided in RMBS transactions, were developed by a broad-based working group consisting of issuers, originators, credit rating agencies, financial guarantors, primary mortgage insurance companies and institutional investors.

Emerging Markets

Servicing concerns emerge on Kazakh deal

An investor meeting for Kazakh Mortgage Backed Securities 2007-I is scheduled for 18 December 2009, in which critical aspects of the transaction's servicing will be discussed. The transaction is originated by BTA Ipoteka (BTAI), a wholly-owned subsidiary of BTA Bank (which is in restricted default).

During the investor meeting, which has been called by the trustee following the trigger of key servicer termination events, Class A noteholders will be asked to agree to a series of waivers and amendments to the transaction documents. The proposed changes include waivers and amendments to servicer termination events, elimination of the servicer termination events linked to the rating of BTA Bank, an increase in the servicing fee, extension of the time represented by the back-up servicer to take over the servicing operations to six months and an option to extend payment holidays of up to one year to borrowers included in the securitised pool (capped at 10.4% of the outstanding pool).

Fitch says it is concerned that, if most or all waivers and amendments are accepted, the credit risk of the transaction will come to represent more closely that of BTAI. In the absence of a credible servicer replacement mechanism, the servicing operational risk may not be compatible with ratings in the double-B category for any class of notes. As a result, the rating on the Class A notes is likely to be downgraded, even if investors do not agree with the proposed waivers and amendments.

However, the rating agency notes that the extent of the rating action will depend on the decisions to be taken and any alternative actions investors may agree upon.

Fitch understands from the current proposals that the activation of the back-up servicer, Halyk Bank, is not intended. The agency is also concerned that no concrete steps seem to be taken by the back-up servicer to take over the servicing operations.

In particular, Halyk Bank's IT systems are not configured to deal with US dollar-indexed loans, which represent 100% of the loan pool. In a BTAI liquidation scenario, this could leave the transaction without an operational servicer for a long period of time. Consequently, the transaction could be exposed to severe cashflow disruptions and even loss of collections during the transition period from the current servicer to the back-up servicer.

In addition, the proposed payment holidays may negatively impact the transaction's cashflows. However, given the proposed cap on granted holidays and the historical high levels of excess spread (averaging around 8.3% per annum), Fitch regards this amendment as not critical.

The transaction benefits from a liquidity facility which can be used to meet the senior fees and note interest payments if there is a liquidity shortfall. The liquidity facility should cover 15 months of senior fees and note interest payments, assuming that they remain at the current levels.

Investors

Third UCI buyback results in

BNP Paribas has announced the results of its third tender for UCI Class A notes, with €480.5m of original nominal value of notes being accepted from eight transactions. According to RBS data, the prices accepted are: UCI 9 90%-95%, UCI 10 90%-93%, UCI 11 93.5%, UCI 12 87.75%-90%, UCI 14 82.5%-88%, UCI 15 79%-84%, UCI 16 79.5%-80% and UCI 17 Class A2 at 79.5%. This is the last of the programme of tenders originally announced by the French bank in mid-October (SCI passim).

Operations

TARP extended until October

US Treasury secretary Tim Geithner has told Congress that the Administration is extending TARP until 3 October 2010. This extension will enable the Administration to continue to implement programmes that address housing markets and the needs of small businesses, and to maintain the capacity to respond to unforeseen threats to the economy, he noted.

Up to US$550bn of funds will likely be used to expand the Fed's ABS loan facility, facilitate mortgage lending to households and free up credit for small businesses.

According to the SIGTARP, about US$317bn of the original US$700bn raised under TARP is currently available for distribution, following the repayment of capital injected into troubled financial institutions, plus potentially another US$76bn of interest receivables from some of these institutions that are currently in arrears. At about 2.2% of GDP, the remaining TARP money would represent a 40% addition to the US$787bn stimulus package enacted by the Obama administration earlier in the year and would give a sizeable boost to the economy, according to credit strategists at BNP Paribas.

Even with the extension, TARP is expected to cost taxpayers at least US$200bn less than was projected in the August Mid-Session Review of the President's Budget, including US$25bn in potential costs from new TARP commitments in 2010. "We expect that the vast majority of these potential costs would come from mitigating foreclosure for responsible American homeowners, as we take the steps necessary to stabilise our housing market," Geithner explained.

Ratings

HBOS dips into Perma seller share

HBOS has asked Moody's to assess the impact on the ratings of the notes issued out of the Permanent Master Trust, following a purchase by the seller of a portion of the funding 1 share of the trust property.

Eight tranches of notes from Permanent Financing No. 4-7 were scheduled to pay down part of their outstanding principal balance on 10 December 2009. However, due to prevailing CPR levels the trust did not accumulate sufficient principal to make the payments on this date. Therefore the seller has chosen to purchase approximately £370m of the funding 1 share of the trust property in order to make up for the shortfall and enable the notes to amortise as scheduled.

In Moody's opinion the purchase by the seller of a portion of the funding 1 share is, in this instance, rating neutral since no triggers are breached as a result of the notes not following their scheduled amortisation at this date. The step-up dates for these notes are March, June, September and December 2011. A failure to pay down the notes by these later dates would cause a stop substitution trigger, the rating agency notes.

The legal final maturity dates for the notes are in March 2034, June 2042 and September 2032. Furthermore, the weighted average note margin in funding 1 is only negligibly impacted by the purchase and, although the purchase results in a small increase in the seller share of the trust property (currently 27%), there is already little prospect of a breach in the required minimum seller share (currently 10.63%) in the near term.

Ratings

WBS downgraded on performance

S&P has lowered its credit ratings on the £210m Roadchef Finance's Class A2 and B notes from double-B to single-B and single-B to single-B minus respectively. The rating actions follow its assessment of the estate's performance to date, along with its assessment of the willingness and ability of the parent Delek Real Estate to continue to support the transaction.

Roadchef recently cured a breach of its debt-service coverage ratio (DSCR) covenant after an equity injection cure from the development group following the sale of a motorway service station held outside the securitised estate. This cure comprised an injection of £5m in Q408 and a further injection of £0.9m on 4 November 2009.

Even though technically it remains in compliance with this covenant, in S&P's analysis Roadchef does not generate sufficient cashflow to meet its debt service obligations. The next debt service payment is due in October 2010.

Despite a reported improvement in Q3, EBITDA continues to be down year-on-year, and EBITDA to DSCR and free cashflow (FCF) to DSCR were 0.89x and 0.88x respectively in the 12 months to October 2009, excluding the benefits of the equity cure. In the rating agency's view, this means that Roadchef would have been unlikely to be able to meet its scheduled debt service without the aforementioned injections and without continued support from its parent.

Ratings

High yield default rate to decline in 2010

Fitch projects that the US high yield default rate will continue to decline in 2010 to a range of 6%-7% by year-end, a marked improvement from 2009's results but still above the long-term average annual rate of 4.7%. The pace of US high yield defaults slowed considerably in the second half of 2009, with both the number of issuers defaulting on their debt obligations and the par value of bonds affected by the defaults falling by half, compared with the difficult first six months of the year.

After soaring to 9.5% in June, with 103 issuers defaulting on a combined US$79.7bn in bonds, defaults fell to 42 issuers affecting US$36.8bn in bonds from July to November, resulting in a November year-to-date default rate of 13.6% (on US$116.5bn). Fitch believes that with additional defaults in December, the default rate will end 2009 just shy of the lower end of its full-year forecast of 15%-18%.

"Pressure on corporate credit quality has continued to ease in 2009, with downgrades steadily retreating quarter over quarter," says Mariarosa Verde, md of Fitch Credit Market Research. "While upgrades are still limited, encouraging economic data and a return to more normal credit market activity has caused spreads to tighten to summer 2008 levels, a reflection of the market's improved risk appetite and confidence."

Fitch's data shows that corporate downgrades fell again in October and November, contracting some 35% compared with the third quarter and following a 50% dip in the third quarter. "A concern going into 2010 is not only the risk of new defaults, but also a heightened risk of serial defaults," adds Verde. "If growth proves weak, some of the debt restructuring measures adopted over the past year may have only been successful in helping companies defer rather than avoid bankruptcy."

Ratings

Euro SF CDOs hit by CMBS review

Fitch has downgraded 137 tranches and affirmed 167 tranches from 73 European structured finance CDOs. In addition, the rating agency has revised the outlooks to negative from stable for 23 tranches that have been affirmed.

Fitch recently completed a review of nearly all of its rated European CMBS in two major phases (SCI passim). The first phase, which mainly addressed the UK-based portfolio, was completed in June.

The second phase, which mainly addressed continental exposure, was completed in November. Both phases resulted in significant downgrades to outstanding CMBS transactions.

Rodney Pelletier, md and head of the European CMBS team, says: "Because of significant peak to trough declines in European commercial property values and an ongoing concern that there will be downward pressure on occupancy and rental values, significant rating action was taken this year. Furthermore, these concerns will become more acute as maturity dates become significantly more evident in the next two years."

Since November 2008, only one-third of the Fitch rated universe of 170 triple-B European CMBS tranches remained at investment grade - with 37% of the universe downgraded to triple-C or below. As a result, European SF CDO portfolios now have considerable exposure to triple-C and below assets. This increases the credit risk to the rated CDO notes and in many transactions also triggers overcollateralisation (OC) test breaches that redirect cashflow away from subordinate tranches to support more senior tranches.

The vast majority of OC tests with triple-C haircuts are now well below the minimum thresholds, Fitch notes. As a result, many subordinate tranches will be cut off from cashflow for the foreseeable future. In Fitch's view, the excess spread generated and captured through OC tests is not sufficient to mitigate the increase in portfolio credit risk for the downgraded tranches.

The decrease of OC ratios of the senior tranches exposes certain transaction to an event of default (EoD) trigger if the senior tranches become under-collateralised. According to the November 2009 trustee report, Euromax IV MBS only has 4% of OC buffer above the EoD trigger, indicating that this transaction can be subject to an EoD in the near-term if there is further negative migration in the portfolio credit quality.

An EoD is also a real possibility for Pallas CDO II. The agency estimated from the November 2009 report that only 5% of OC buffer above the EoD trigger remained.

Recovery expectations for the underlying structured finance assets are generally poor as most assets are thin mezzanine tranches, which would likely suffer heavy losses upon default. Given the increased default expectations and low recovery expectation of these SF assets, Fitch's outlook for the vast majority of SF CDO tranches is negative. Fitch has withdrawn its current recovery ratings (RR) on European SF CDOs and will review whether to assign RRs to SF CDOs in the future.

In cases where losses associated with synthetic credit events have resulted in write-downs to rated CDO tranches, Fitch considers this a default and has downgraded these tranches to D.

Ratings

NACE mapping explained for SME obligors

Moody's has released a special comment regarding its allocation of industry codes of borrowers/corporate issuers based on the Statistical Classification of Economic Activities in the European Community (NACE) to the 35 Moody's corporate industry category commonly used for quantitative analysis of ABS and some CLO transactions in EMEA.

In the report the rating agency notes that over recent years the volume and number of securitisations backed by loans made to both large corporates and SMEs across EMEA has significantly augmented. Concurrently, the number of low granularity portfolios has substantially increased, leading to a need for quantitative analysis based on Monte Carlo simulation. In its analysis of ABS and SME CLOs, Moody's often relies on CDOROM v2.5, where the updated 35 defined Moody's sectors (industry numbers ranging between 101 and 135) are used.

Monica Curti, a Moody's vp/senior analyst and author of the report, says: "The industry distribution of a portfolio of borrowers is captured under our methodology through Moody's sector classification and has a direct impact on asset correlation amongst borrowers. Asset correlation is a driving parameter affecting the default distribution of a pool. Given that the NACE, or a national version of it, is one of the most widely used industry classifications by European originators, the new report provides a mapping between the NACE Rev.1.1 and the 35 Moody's sector codes."

Ratings

Fitch downgrades Tamweel notes

Fitch has downgraded Tamweel Residential ABS CI (1)'s Class A notes to single-A from double-A and its Class B notes from triple-B plus to triple-B. The rating action is driven by the deterioration of credit fundamentals within the Emirate of Dubai which, in the agency's opinion, increases the uncertainty regarding the transaction's performance (SCI passim).

Tamweel Residential ABS CI (1) is a securitisation of residential property lease receivables due from mainly non-Dubai nationals working in the Emirate. The notes funding the portfolio have already amortised to 32% of their initial balance and credit enhancement has increased accordingly to 42.7% for the Class A notes, 29.1% for the Class B notes and 21.0% for the Class C notes. As such, all tranches of notes are able to withstand a high degree of losses, says Fitch.

Ratings

Agency discontinues rating MLNs

S&P says it will no longer rate obligations with variable principal payments linked to commodity prices, equity prices or indices linked to either commodity or equity prices. These obligations are among the class of obligations sometimes called market-linked notes or MLNs. The rating agency will put the criteria into effect immediately and will withdraw outstanding ratings on these obligations from 31 March 2010.

Mark Adelson, S&P's chief credit officer, says: "With today's decision to stop rating obligations with principal payments linked to equities, commodities or indices linked to either, we are highlighting the primarily non-credit nature of such structures."

He continues: "However, we are not discontinuing our issuer credit ratings for entities that issue obligations with variable principal payments linked to equity prices, commodity prices, or indices based on equity or commodity prices. Accordingly, investors in such obligations can continue to know our view of the issuing entity's ability to honour the terms of such an obligation by looking to the ICR of the issuer."

Regulation

FDIC approves safe harbour ANPR

The FDIC has approved an Advance Notice of Proposed Rulemaking (ANPR) regarding safe harbour protection for treatment by the FDIC as conservator or receiver of financial assets transferred by an insured depository institution in connection with a securitisation or participation.

On 12 November the FDIC Board approved a transitional safe harbour that permanently grandfathered securitisation or participations in process through to 31 March 2010 (SCI passim). The ANPR will seek public comment on what standards should be applied to safe harbour treatment for transactions created after 31 March.

Since 2000 and the adoption of 12 C.F.R. Part 360.6, the FDIC has provided important safe harbour protections to securitisations by confirming that in the event of a bank failure it would not try to reclaim loans transferred into a securitisation so long as an accounting sale had occurred. However, with the June 2009 changes in FAS 166 and 167, most securitisations will no longer meet the off-balance sheet standards for sale treatment when they take effect on 1 January 2010.

FDIC chairman Bair says: "Today's ANPR will move the discussion forward to achieving a broad agreement on securitisation reforms that can be implemented by all the regulatory agencies. As deposit insurer and receiver for failed insured banks and thrifts, the FDIC has a unique responsibility to control the risks to the Deposit Insurance Fund. The misalignment of incentives in securitisations has contributed to massive losses to insured institutions, to the DIF and to our financial system."

She adds: "Fostering a sustainable securitisation market that emphasises transparency, loan quality, risk retention and appropriate incentives and authorities for restructuring troubled loans will restore investor confidence and help banks diversify their funding sources while managing interest rate risk for longer-dated assets. The sample regulatory text for conditions to a FDIC safe harbour would, I believe, go far towards correcting the weaknesses in securitisation that contributed to the crisis and is very consistent with the direction of legislation in the House and Senate."

The sample regulatory text for conditions to a FDIC safe harbour is included in the ANPR. The ANPR will be open to public comment for 45 days following publication in the Federal Register.

Regulation

Constructive criticism for US reform bill

The CMSA and SIFMA have both released statements following the passage of H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009, in the US House of Representatives. While both associations welcome the move, they highlight a number of the bill's shortcomings.

The CMSA praises the legislation for including language that it strongly supports and tailoring financial reforms that would facilitate a recovery in the commercial real estate finance market. Specifically, the bill grants regulators the flexibility to allow a third-party investor - or B-piece buyer - to satisfy the new retention requirements. The Association believes that recognising the role of these third-party investors who purchase the first-loss position and re-underwrite all loans during the pre-issuance period is critically important.

H.R. 4173 also includes a measure that would require the Federal Reserve and financial regulators to examine the combined impact of new retention requirements and new accounting standards (FAS 166 and 167) on credit availability, and to report to Congress with specific recommendations prior to any rulemaking on the retention.
"A risk retention provision that gives market and financial regulators flexibility in overseeing diverse asset types and structures is essential to support an overall recovery in commercial real estate," says Patrick Sargent, CMSA president. "Passage of this language by the full House today is a tremendous step toward restoring access to credit in this market."

Meanwhile, SIFMA says it applauds the House for its "thorough and serious" approach to developing this legislation, but continues to believe that certain provisions in the legislation will undermine the shared goal of market stability and reducing systemic risk. In particular, the bill's framework for resolving failing non-bank institutions contains too much uncertainty for investors and creditors. Furthermore, the adoption of the so-called Miller-Moore amendment authorising the FDIC to impose a 10% hair cut on secured creditors will undermine the credit markets and would increase systemic risk, according to SIFMA.

"While we may disagree on certain policy details, there is no doubt that the industry shares the same goal of reforming our financial system as President Obama and the Congress. We stand committed to further constructive engagement on these issues as the legislative process moves forward," comments SIFMA president and ceo Timothy Ryan.

RMBS

Westpac returns to RMBS market

Westpac is returning to the Australian securitisation market with its first public RMBS since 2007. S&P has assigned preliminary ratings to two of the three classes of the A$1bn Series 2009-1 WST Trust.

The new RMBS has been structured with 92% triple-A notes and a weighted average LTV of 58%. Structured finance strategists at Chalkhill Partners expect this level of credit enhancement at the triple-A level (50% all-in) would imply pricing well inside secondary levels.

"This deal will hopefully go a long way in supporting global RMBS issuance," they note.

The capital structure comprises a A$920m triple-A tranche, a A$55m double-A tranche and a A$25m unrated tranche. According to reports, the deal is due to price by 18 December.

RMBS

Mexican RMBS delinquencies, defaults to rise

Rising delinquencies and defaults within Mexico's RMBS market over the first ten months of 2009 are due to the country's weak economic fundamentals and decreasing prepayments, according to S&P's recently published Mexican RMBS index. Defaults for the aggregated RMBS market rose to 5.65% as of 31 October 2009 from 3.76% at year-end 2008, reflecting a more-than-50% increase due primarily to non-bank financial institutions (NBFIs).

S&P credit analyst Maria del Sol Gonzalez de Cossio says: "We expect that this challenging environment will continue to test Mexican RMBS transactions in 2010 as a result of the decrease in the average Mexican household's disposable income, which is a consequence of the country's contracting GDP, growing unemployment and weak growth prospects for 2010."

The rating agency believes Mexican RMBS delinquency and default levels will continue to increase in 2010. The extent to which they may rise will depend on the following factors:

• The servicers' collection efforts and the effectiveness of their restructuring programmes in reducing loss severity;
• Inflation, which diminishes borrowers' purchasing power;
• Current unemployment levels;
• The overall leverage levels for Mexican households, which have been high -primarily as a result of credit card bills and auto loans;
• The servicers' ability to foreclose and liquidate properties from defaulted loans, coupled with the homes' sale values; and
• The continued decline in foreign remittances flowing into the country, which in some cases represent a high percentage of household income.

Some of the mortgage loan performance trends in the 10 months ended 31 October 2009 include:

• The 2004 and 2005 vintages continued to have lower default and delinquency levels than the rest of the vintages due to the more-seasoned portfolios in the first securitisations that closed between 2003-2005;
• Northern states showed higher default and delinquency levels compared with other regions in the country because their local economies are more closely tied to the US economy and, therefore, are suffering from industry slowdowns; and
• From 1 January 2009 through to 31 October 2009, the loans originated by commercial banks and NBFIs showed significantly higher default levels, increasing to 2.18% from 0.97% and to 14.83% from 7.34% respectively.

RMBS

UK NC RMBS performance stabilising

The performance of the UK non-conforming RMBS market remained stable in October 2009, according to Moody's.

The weighted-average delinquency trend for the sector was 19.9%, which constitutes an increase of 8% during the past year, but is still 0.6% below the level observed in September. The repossessions trend stood at 2.1% in October, which is 1.5% below its all-time high of 3.6% that was observed in February 2009.

The total redemption rate remained low and stood at 10.6%, which is less than half the level it had one year ago. The weighted-average cumulative loss trend remained at the September level of 1.3%.

The elevated delinquency levels are likely to result in further repossessions and losses, according to Moody's. Although the market is showing some signs of stabilisation, credit conditions are tight and refinancing opportunities for non-conforming borrowers remain rare. As of October 2009, 43 transactions have drawn on their reserve funds and 11 have fully depleted their reserve funds and recorded a principal deficiency.

Meanwhile, UK house prices have been increasing for the past six months. Moody's economist Nitesh Shah says: "The current increases in house prices are a product of a tight supply of houses for sale. However, the number of houses for sale is starting to increase once again and this will temper the growth in prices and could lead to them falling once more."

While low interest rates are helping to contain the number of home repossessions, rising unemployment and tight credit conditions will continue to place downward pressure on house prices.

Moody's outlook for the UK non-conforming RMBS market is negative. Although recent forecasts indicate that the leading economic indicators may improve in the near future, conditions are likely to remain unfavourable for non-conforming borrowers. Approximately one in five borrowers is currently more than 90 days delinquent.

A total of 127 UK non-conforming RMBS transactions have been launched and rated by Moody's since 2001. As of October 2009, a total balance of £26.5bn was outstanding in this market which constitutes a year-on-year decline of 14%.

RMBS

Continued deterioration for Italian RMBS

The performance of the Italian RMBS market continued to deteriorate during October 2009, according to the latest indices for the sector published by Moody's. The rating agency's cumulative default trend reached 1.5% in October, the highest level since Moody's began measuring it in 2004.

Meanwhile, Moody's 90-days plus delinquency trend also continued its rising trend and was at 2.1% in October 2009. Moody's constant prepayment rate (CPR) trend maintained a decreasing trend line and now stands at 9%.

In October 2009 there were 28 Italian RMBS transactions not at the target reserve fund level. Three recently closed transactions are technically below the target due to reserve fund build up.

The remaining 25 transactions have drawn the reserve fund as a result of increasing delinquencies and defaults. Five transactions have fully drawn the reserve fund, of which four now record an unpaid PDL.

Moody's assigned definitive ratings to the RMBS notes issued by Mercurio MF in November 2009. The transaction represents the sixth securitisation of Italian residential mortgage loans originated by Barclays Bank. The assets supporting the notes, which amount to around €2.3bn, are prime mortgage loans secured on residential properties located in Italy.

In October 2009, the Italian Banking Association 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, mainly due to an increased risk of back-loaded defaults. However, the payment holiday may also have a positive impact as it could reduce arrears and defaults in the affected pools.

Moody's has taken few rating actions on Italian RMBS in November. The Class B notes in both Casa D'Este Finance and Casa D'Este Finance II were downgraded to Baa3 from Baa2. The downgrades were prompted by the downgrade of Cassa di Risparmio di Ferrara, which is the originator of the assets and acts as financial guarantor of the rated notes.

In the past month, the agency has also placed the Class C notes issued by Argo Mortgage 2 on review for possible downgrade due to the worse-than-expected collateral performance of the underlying portfolio.

The Italian economy resumed growth in Q309, expanding 0.6% over the previous quarter. However, for full-year 2009, Moody's expects gross domestic product to have contracted by 4.8%.

While the export sector will likely lead a recovery, the nature of Italian exports tends to be very cyclical and therefore highly dependent on the economic recovery elsewhere. The unemployment rate is expected to peak at 9.7% by the middle of 2010 from its current 9.0%. Although consumer confidence has been improving in recent quarters, the level remains weak and indicative of caution held by consumers.

Moody's outlook for Italian RMBS is negative as borrowers will continue to be under stress for a while and are particularly exposed to interest rate volatility, given the floating rate nature of this market.

As of October 2009, the total outstanding pool balance in the Italian RMBS market was €87.2bn, which constitutes a year-on-year change of over 50% in the past year. Since May 2009, a total of €14bn of mortgage loans was securitised in the Italian RMBS market. This increased market activity has been driven by the strong ECB investment programme that was implemented this year.

Structuring/Primary market

BTL deal restructured on basis risk concerns

UK buy-to-let RMBS Hawthorn Finance Series 2008-A has been restructured to minimise basis risk and terminate the existing swap arrangements.

Prior to the restructuring, West Bromwich Building Society was the basis swap provider to the issuer, hedging the fixed and floating rates and the three-month Libor-Bank of England Base Rate (BBR) risk. Most of the loans in the outstanding pool are linked to the BBR, although a small proportion of loans - less than 1.5% - which are still in their initial fixed period will revert to a BBR variable rate over a period of time.

Following a breach of rating triggers in the swap documents, West Brom was obliged to find a suitably rated replacement swap provider or a guarantor to hedge the basis risk. It has instead decided to restructure the transaction. No swap termination payment will be made to the swap provider.

The key elements of the restructuring include: termination of fixed and floating rate and three-month Libor-BBR swaps at no cost to the issuer; the note index will change from three-month Libor to BBR, calculated on a monthly basis; and no fixed rate loan or Libor variable loans will be eligible to be purchased by the issuer. The note interest payment dates have also been changed to 1 March, June, September and December.

Post-restructuring, around 98.5% of the loans in the pool are paying a rate linked to BBR (increasing to 100% of the loans over time) and the notes also pay a rate of interest linked to BBR, thereby minimising the basis risk substantially. Most loans in the pool presently pay BBR+0.99%, which is currently 1.49%.

Fitch has affirmed the ratings of the Class A notes at triple-A, outlook stable, and assigned loss severity rating of 'LS-1'. The agency notes that despite the UK economic downturn of the past two years and a general deterioration in mortgage arrears levels, the performance of the pool has remained strong.

As of the last interest payment date, loans more than three-months in arrears were 0.44%, which is below the average for the UK prime and UK BTL sectors. There have also been no losses since closing and no loans are currently in repossession.

Structuring/Primary market

Alternative SF counterparty proposals reviewed

Fitch is reviewing new and revised derivative structure proposals for structured finance transactions. The rating agency is determining how these structures might be considered from a ratings perspective in the event that they were incorporated into a securitisation.

Fitch says that it remains open to reviewing any such future proposals that are presented to it in order to provide feedback regarding their rating impact. The agency published its revised counterparty criteria for SF transactions on 23 October 2009, which incorporated some changes to its previous criteria, including revised collateral posting expectations in the event that counterparties become ineligible following minimum rating thresholds being breached (SCI passim).

One of the most notable changes in the revised rating criteria was the extent of collateral posting expectations regarding currency hedging derivatives in the event of loss of eligibility. This was in light of recent market experiences, in particular the potential for considerable volatility in exchange rates over a lengthy replacement period that could occur if the counterparty needed to be replaced.

Following the bankruptcy of Lehman Brothers, some transactions where Lehman acted as currency swap provider saw the ratings of the senior tranches downgraded precipitously from triple-A to distressed rating categories, largely due to the loss of currency hedging. This underlines the importance of adequate protection to transactions that incorporate a currency swap.

The SF market is now tentatively reopening to investors in Europe, with a handful of transactions in 2009 being placed with third-party buyers. While none have yet issued in a currency other than that of the underlying assets, it is likely that issuers will want to access overseas markets and may therefore wish to structure transactions incorporating currency hedging derivatives.

Since the agency published its revised counterparty criteria, alternative derivative structures - most notably in the currency swap area - have been proposed. Fitch is currently reviewing these proposals to determine if they appropriately address the risks highlighted in the revised criteria.

Fitch's counterparty rating criteria largely reflect the type of derivative structures that have existed historically in structured finance transactions. The agency emphasises, however, that this does not preclude providing rating feedback to market participants who might choose to structure SF derivatives differently.

Such proposals may include new or revised structural features that address risks in a different way and which prove adequate mitigants, from a ratings perspective, in addressing those risks. In such circumstances, it is possible that certain aspects of rating criteria might not apply or will be revised with respect to new or revised structures.

Fitch says that in the event that new transactions are rated that incorporate derivatives with revised structural mitigants - such that elements of published criteria are not applied - it will disclose this in its rating communications. Disclosures will include a description of the nature of the structural mitigants incorporated, how these mitigants have been taken into account in Fitch's rating analysis, which elements of published criteria have not been applied as a result and why.

Technology

Risk measurement, reporting platform launched

Risk Integrated, a consultancy and software firm specialising in risk measurement and reporting, has launched its Generalised Finance System (GFS) - a web-based risk measurement and reporting platform. The system helps risk and portfolio managers calculate and report on capital and stress tests for mixed asset types, including ABS, by enabling risk analysts to immediately convert spreadsheet analyses in a robust enterprise-level system.

"Given the very tight deadlines, many institutions have been forced to develop their analyses using spreadsheets, with the inherent problems of scalability, robustness and auditability. Spreadsheets are an excellent tool for rapidly prototyping new analytics, but not viable as an enterprise-level application," says Chris Marrison, founder and ceo at Risk Integrated.

In order to fully explain the results of the stress, an audit trail shows all the data, assumptions and models that were used in creating that set of results. As a result, this enables reliable and timely stress test reporting, the firm notes.

Outputs from GFS include stressed probabilities of default, expected loss and stress capital requirements. The analytics can also be directly linked to a Monte Carlo evaluation engine to provide fully correlated loss distributions for the portfolio. These can then be dissected into the contribution of individual assets and sub-portfolios.

Technology

Platform enhanced for data standardisation

Principia Partners has enhanced its platform to help investors standardise the ongoing integration of structured finance bond trustee data. As a result, investment managers can better define, analyse and report on bond-level information for RMBS and other structured credit asset classes, supporting market standards being proposed by the American Securitization Forum (ASF) and the European Securitisation Forum (ESF), it says.

The interface includes a standard set of bond issuance data descriptors that enables investors to map trustee data directly into their systems. Within Principia SFP, tranches can be evaluated in the context of the original securitisation or across all the deals being managed in a portfolio. The platform also allows this data to be analysed alongside collateral pool performance data from any given source.

"Expanding pool and loan-level disclosure to investors, both pre- and post-issuance, is critical to restoring confidence in securitisation transactions," says Tom Deutsch, deputy executive director, ASF. "This new raw data in standard formats, as well as the tools to analyse it, gives investors the ability to better compare transactions, apples to apples."

Structured credit investors can select and monitor standard bond characteristics, such as those being recommended by the ASF and ESF for RMBS, as well as the issuance data for all other structured finance assets. Custom fields can also be specified to address individual requirements.

Investors can then consistently monitor and react to changing deal information throughout the lifecycle of a security. Organisations can set limits, flag deals and monitor triggers that have been established within the indenture of a securitisation, to track and maintain compliance over time.

"The ASF and ESF's efforts are playing a major role in ensuring that best practices are in place for the return of a stable and functioning securitisation market," says Douglas Long, evp business strategy, Principia. "The developments to Principia SFP aim to help market participants adapt to changing standards as they are introduced and ensure clients have the operational infrastructure they require to consistently understand their structured finance investments over time."

Technology

Risk management software enhanced

Kamakura's Risk Manager (KRM) Version 7.1 has launched with significant advances in speed, accuracy and product coverage, the firm says.

Kamakura Corp president Warren Sherman comments: "Version 7.1 of KRM is a huge step forward in integrated risk technology. In combination with our clients' advice, the Kamakura research and development team in Honolulu has brought the best of breed simulation technology from astrophysics and physics to apply state of the art risk management and finance to portfolios of unprecedented size."

He continues: "New Version 7.1 offers unparalleled integration between formerly separate disciplines: market risk, interest rate risk, credit portfolio management, economic capital, funds transfer pricing, Basel I and II capital calculations, and operational risk. Our clients have been very impressed with the increased understanding of risk and return and the huge cost reduction they can achieve by replacing multiple silo-oriented legacy risk systems with the integrated risk capabilities of Kamakura Risk Manager. Moreover, clients have been quick to point out to us that KRM users have navigated the 2007-2009 credit crisis with great skill, while legacy risk technology has been called into question."

Among the new features in KRM Version 7.1 are enhanced capabilities in credit risk management, interest rate risk management and funds transfer pricing, as well as valuation and market risk.

Trading

Trading ideas: metal test

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

Incredible year-long rallies in base metals helped erase old memories of the massive declines they endured throughout the recession. Even though copper is now up over 100% since last December, it still remains far below peak levels set back in 2008.

Commercial Metals' credit spread benefited from both the recent dramatic rise in commodity prices as well as the market's shift into risky assets. Its spread does not appropriately compensate investors for default risk and we recommend buying credit protection on the company.

As aluminium and copper rose to meteoric levels back in 2008, Commercial Metals took the opportunity to load the boat with a substantial amount of debt. Unfortunately for the company, this coincided with its peak revenues and serious declines in commodity prices (Exhibit 1).

Though base metals regained much of their lost ground (copper up 118% and aluminium up 32% since last December), Commercial Metals' fundamentals remain weak and at risk. Its interest coverage levels dropped from over 20x down to less than 4x.

Debt to EBITDA for the last quarter came in at a high 15x (up from recent LTM of 5x) and earnings margins dropped to just over 1% for the last quarter. Risk is heavily tilted to the downside.

Our hybrid structural model implies credit spreads derived from balance sheet variables and current equity data. Due to the risk inherent in Commercial Metals increased leverage and high equity-implied volatility (at 51%, it's the second highest of all metals & mining companies behind AK Steel), its implied spread is significantly wider than its five-year CDS level (122bp).

Though we tend not to use the absolute results of the model, we do prefer to compare implied levels of several companies within the same industry to one another. For instance, Alcoa's CDS trades almost double that of Commercial Metals'; however, its equity-implied spread recently tightened below Commercial Metals' (Exhibit 2).

On the tighter side, Freeport McMoRan's credit spread trades only 10bp tighter than Commercial's; however, Freeport's implied credit spread is more than five times tighter than Commercial's. We take this as an indication that Commercial Metals' spread will eventually trade more in line with Alcoa's than Freeport-McMoRan's.

We see a 'fair spread' above 250bp for Commercial Metals based upon our quantitative credit model due to its equity-implied factors, margins, change in leverage, interest coverage and accruals factors. Over the past year or so, our model's expected spread anticipated large shifts in Commercial's actual credit spread - both wider and tighter. Back in October, the model quickly changed course again due to a deterioration of the company's fundamental and market-based factors (Exhibit 3).

We find this change in the model's valuation to be another indicator to short Commercials' credit. We are aware of strong forces in the market keeping a lid on spreads (large fund flows into corporate debt funds and the government's attempt to re-inflate the market) that can keep valuations disjointed from fundamentals. We will maintain a stop loss at 100bp and only hold the position for three months.

Position

Buy US$10m notional Commercial Metals 5 Year CDS at 122bp.

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).