Contents

Legislation and litigation

Surveillance step-up

CDS/MBS fraud cases to increase

Government enforcement within the MBS and credit derivative sectors is likely to step up in the coming year. Prosecutors and enforcement lawyers have been increasingly dedicating time and effort to understanding the complexities of these products, but the cases filed so far are unlikely to vary fundamentally from previous US SEC fraud cases.

"We are observing both Department of Justice (DOJ) prosecutors and SEC enforcement lawyers trying to understand the nitty-gritty details of complex financial products, such as CDS and RMBS, in ways that they never have before," says Jonathan Leiken, a former federal prosecutor and partner at Jones Day. "There have been numerous pronouncements from the leadership at the SEC, for example, about the desire to regulate and understand how these products work so there can be enforcement of what the government perceives as a lot of wrong-doing related to these products."

He adds: "When you get down to the actual cases and actual charges brought, really they are the same types of charges that these prosecutors and enforcement attorneys have always brought: someone deceived someone. But what's different now is that the government is really trying to learn the details of the products and how they work to investigate whether any deception occurred."

The SEC announced last year that it had around 50 investigations underway in connection with credit derivatives and MBS, and it is predicted that many of those cases will result in some kind of charges this year.

The first SEC case relating to credit derivatives occurred in May last year when Renato Negrin, a portfolio manager at Millenium Partners, and Jon-Paul Rorech, a salesman at Deutsche Bank, were charged with insider trading related to CDS on media company VNU (see SCI issue 135). According to the SEC's complaint, Rorech tipped Negrin off about a change to the bond offering and Negrin then purchased CDS on the bond for the Millenium hedge fund. When news of the bond amendment broke in July 2006, the price of the CDS rose and Millenium was able to close a profit.

"The DOJ and SEC have demonstrated a new interest in getting into the weeds to understand how these products work and how, if at all, they lend themselves to manipulation or unfair information passing between two parties. But boiled down, the cases brought will be based on theories of fraud, insider trading or other familiar allegations of deception - the same kind of cases that we have seen for decades," says Leiken.

He continues: "At the end of the day, the DOJ's and SEC's job and mission isn't changed, and the kinds of charges they are bringing have not changed. But the amount of scrutiny and the focus on the details of these products has changed a lot."

Leiken also points to the fact that in many current cases prosecutors and regulators cannot help but to rely on 20-20 hindsight. "They are looking back at conduct that occurred at a time when these types of financial products were not strictly regulated, not well understood by regulators and there were far fewer rules as to how these products should be handled, originated or traded. For a prosecutor or an enforcement attorney to now say that people who handled these deals should have acted in a different way may not be fair. As a defence attorney, we frequently make the point that our client acted consistently with the rest of the industry and with the rules as they existed at the time."

One of the most high-profile cases expected to hit the headlines this year is the SEC's complaint against ex-Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin. In November last year a verdict of not guilty was handed down by a federal jury in a DOJ case accusing the pair of securities fraud, wire fraud and conspiracy, with an additional charge of insider trading against Cioffi. The pair was acquitted of all charges (see SCI issue 160).

Despite the DOJ's failure to convict the managers, the SEC has confirmed that it will go ahead with its lawsuit against the pair.

"The Tannin/Cioffi case shows the flip side to this trend - if the government is too aggressive and doesn't have the evidence to back up their allegations, they are going to see an acquittal," concludes Leiken. "This only proves the point about the need to understand the details: after that case in particular, the government will be rightfully gun-shy before bringing a lot of criminal cases without knowing that they have detailed evidence to prove the wrong-doing."

AC

ABS

TALF expiration unlikely to destabilise ABS

The US consumer ABS market is expected to take the expiration of TALF in its stride, with 2010 issuance volumes expected to be in the region of US$120bn-US$135bn, according to Barclays Capital (see also last issue). ABS analysts at the bank suggest that relatively low supply, combined with large amounts of investor cash on the sidelines and the re-emergence of the asset class as a safe haven, should keep the tightening trend intact.

"We believe mezzanine and subordinate credit card ABS offer the best relative value, but we also like recent vintage retail auto lease ABS," the analysts note. "The improving economy in 2010 should help stabilise consumer ABS collateral performance, albeit at still weak levels. We expect credit card charge-offs to peak at 11%-11.5% in Q110, but trend down to 9%-9.5% by year-end. Retail auto delinquencies and losses will likely remain rangebound, but at levels lower than the peaks of 2009."

The US Fed is expected to wind down the consumer-related portions of TALF as scheduled on 31 March (see also separate News story). However, the BarCap analysts believe that the expiration should not be a major destabilising event - although it could have minor implications for volatility near the end of Q110.

Ron Thompson, global head of ABS strategy at Knight Libertas, agrees: "The winding up of TALF in March shouldn't cause too many concerns for the US ABS market as a whole, although I think the first couple of trades after TALF has finished will be tough without the government comfort blanket. I think we'll see less aggressive bidding, at least initially."

New issue volume in 2009 for the primary consumer ABS classes was US$128.1bn - a 2.4% increase over 2008's US$125.1bn, which followed a 44% decline from US$216.7bn in 2007. "Given the expiration of TALF, the various regulatory and legislative headwinds facing consumer ABS issuance (changed accounting regime, loss of regulatory capital relief, uncertainty about risk retention requirements) and the incipient economic recovery, we expect aggregate new issue consumer ABS to be flat to slightly lower in 2010. Specifically, we expect new issue volume of US$65bn-US$70bn for autos, US$35bn-US$40bn for credit cards, US$5bn-US$8bn for equipment and US$15bn-US$20bn for student loans," the BarCap analysts conclude.

AC

CLO Managers

CDO amendment requests evolving

CDO documentation amendment requests are likely to continue to reflect changes in the market, according to a recent report from S&P.

The rating agency, which provided rating confirmations for at least 319 amendments in 2009, says requests by managers to make CDO amendments fell into four categories last year. These were: amendments to address the potential tax consequences of holding workout-related equity securities; amendments to replace the collateral manager of the transaction; amendments to swap agreements; and amendments to alter the calculation of overcollateralisation tests.

However, the number of requests related to discounted assets has seemed to wane with the recent stabilisation in market prices, says S&P, while proposals to add subsidiary SPEs in connection with workout-related equity securities have been trending up in step with rising corporate defaults. "Recently we've been approached with respect to proposed amendments of CDO transaction documents to allow the holding of margin stock - publicly traded securities that would be subject to certain federal regulations when held as collateral," the agency confirms. "We are currently analysing the potential impact of such proposals and the appropriate application of our criteria. We'll continue to keep the market informed of the types of requests we're seeing and our views of their implications for the CDOs we rate."

S&P adds that most collateral managers aren't obtaining noteholder consent for amendments. "CDO transaction documents typically permit the execution of a broad range of amendments without the consent of the noteholders, as long as the collateral manager certifies that there will be no 'material adverse effect' on the noteholders - and most of the proposals we've seen this year haven't sought noteholder consent," it observes. "However, because the transaction documents typically don't define what constitutes a material adverse effect, its meaning is open to interpretation by the collateral managers or their counsel. The sometimes divergent interests within the capital structure of a CDO may further complicate these ambiguities - particularly in cases where the collateral manager or its affiliate holds the subordinate notes or a portion (or all) of the equity in the transaction, or if the collateral manager benefits from subordinate management fees."

AC

CLOs

CDO survey reveals primary market optimism

The results of a recent investor survey confirm industry expectations that a primary market for CLOs will return this year. However, whether the vehicles will re-emerge as a significant funding source for middle market companies remains unclear.

Some 87% of respondents in JPMorgan's latest CDO survey indicated that a primary market for CLOs will return in 2010. But the survey - in which 140 of the bank's clients took part - found mixed views on when the primary market would reopen. Some believe a revival will occur in Q110, some believe Q210 or late 2010 and others think that 2011 is more likely.

Fundamental deterioration appears to be the single biggest risk factor for Q110, trumping market or manager-related risks, according to the survey results. "On a positive note, lack of primary was placed second (vying with market risk) and this suggests most respondents are interested in the future redevelopment of a primary market," note CDO analysts at the bank.

Potential primary CLO triple-As are anticipated to price tighter than 200bp for initial transactions. Most respondents said that pricing should be in the 150bp-200bp range, but a significant minority sees appropriate pricing in a wider range (the tail extends to 250bp).

Respondents also see a global basis with European primary transactions, which are expected to price 25bp-50bp wider than US transactions. Low- to mid-teens best describes respondent expectations for initial primary CLO equity IRR.

"Since we had specified a fairly low degree of leverage (2x-4x), this range of returns suggests investors have markedly increased their expectations for equity risk-adjusted returns, as 'low- to mid- teens' was fairly typical when marketing legacy equity (10x levered) in the old regime," add the analysts.

JPMorgan also asked respondents what improvements or characteristics were most important to the long-term future of the CLO primary market. Structural resilience tops the wish list, trouncing greater transparency, confidence in the rating agencies and improved manager performance disclosure.

In terms of positioning, while nearly half of the survey's respondents envisage little or no trading activity in Q110, within the remaining half, buyers outnumber sellers by a factor of about 2.5 to 1.

But despite the survey's overall positive sentiment, the return of CLOs as a significant funding source for middle market companies remains unclear, according to a recent report from S&P. The rating agency suggests that the consolidation of middle-market lenders and CLO management businesses has likely created an opportunity for other players to step in and fill the void in lending to this segment.

"Until recently, the issuance of CLOs to investors afforded middle-market companies a source of financing," says S&P credit analyst Eric Hudson. "And despite some signs of interest in middle-market securitisations in the past few months, it remains unclear, in our view, whether CLOs will return as a significant funding source for middle-market companies."

Before the credit crunch, a number of banks, specialty finance companies and business development companies (BDCs) were dominant players in middle-market lending. These lenders acquired capital from a variety of sources, including the short-term CP market and lines of credit from banks, and many relied heavily on the issuance of CLOs to provide financing to middle-market companies. As the CLO market dried up, some of these lenders have had to use capital already on hand or turn to alternate sources of funds - such as their revolving credit facilities and the issuance of corporate bonds or loans - which generally had been limited to non-existent for all but the strongest corporate borrowers.

The contraction in funding sources forced many lenders to abandon or significantly reduce their lending activities in order to focus on repairing their own balance sheets. Some major players (including insurer CIT Group) filed for bankruptcy, while others (such as Allied Capital - a BDC) put themselves up for sale. Other market participants (including American Capital - also a BDC) had to restructure their debt due to regulatory and other covenant breaches and many, but not all, banks exited middle-market lending altogether to focus on their mounting loss reserves.

S&P observes that some middle-market lenders seem to have fared better than others. "Lenders that were not as reliant on securitisation and had less leverage, more capital on hand and fewer impaired loans on their books have capitalised on their relative strength by acquiring competitors with less-stable financial positions and purchasing assets from others," it says. Ares Capital, for instance, recently announced the acquisition of Allied Capital, which is expected to close in Q110, as well as agreements to take over some of Allied's CLO management contracts (SCI passim).

S&P suggests that lenders remaining in the market have become much more selective about who they lend to and are employing stricter underwriting standards than in the years leading up to the recession. "Given the current disparity between the supply and demand of middle-market financing, we think these lenders will be in a much better position going forward to dictate the terms and conditions of the financing they extend than they had been in the past, when borrowers appeared to have more of the upper hand," Hudson says.

Indeed, a number of the more stable regional banks are believed to be creating dedicated teams and units to provide debt financing to middle-market companies. "We expect to see other players emerge before the dust settles, but the debt financing they provide may be on a lower scale than in previous years," Hudson concludes.

AC

CMBS

Slow CRE recovery expected in 2011

The pace of US CMBS credit deterioration accelerated in December, with delinquencies topping 6% for the first time in the sector's history. Commercial real estate fundamentals are nevertheless expected to decline more slowly in 2010 than in 2009 and begin a slow recovery in 2011.

According to Grubb & Ellis Company's latest Real Estate Forecast, most commercial property types should reach bottom near the end of this year. "The national economy has begun a slow and cautious recovery, but the labour market - which often lags the broader economy - will turn around only gradually with sustained improvement unlikely before the second half of 2010. Because commercial real estate lags the labour market, it still has a ways to go before reaching its own low point," says Bob Bach, svp and chief economist at Grubb & Ellis.

He adds: "The good news is that the freefall we saw in 2009 is over and the future is more certain, giving owners and users of real estate the confidence to begin making decisions again."

The report notes that the investment market - which experienced artificially low transaction volumes in 2009 as banks, CMBS servicers and other lenders delayed working through distressed assets - will start to see some of these assets finally come to market in 2010, prompting an increase in sales volume of 20% to 30% over 2009 levels. Prices, already down 40% from their peak in October 2007, may decline by another 10% to 20% in order to meet buyers' expectations.

"Many have called commercial real estate 'the next shoe to drop', but that's really an exaggeration," continues Bach. "It implies that commercial real estate could wreak damage on the financial system equivalent to the subprime residential mortgage losses, which is highly unlikely because the value of outstanding commercial mortgages is a fraction of the value of outstanding residential mortgages."

Nevertheless, he expects losses to mount over the next several years. "If banks aren't lending because they're coping with losses in their real estate portfolios, this could impede the economic recovery," he warns.

Overall, the fact that banks are likely to begin writing off their losses on distressed assets in 2010 means that the capital accumulating on the sidelines will start being deployed and highly leveraged buildings - many without the capital necessary to attract tenants - will transfer to new ownership, removing what was a major impediment to recovery in the investment market.

The 30+ day delinquency rate across the fixed rate US CMBS universe jumped by 59bp to 6.52% in December, versus the trailing three-month average pace of 39bp. "The increase was largely led by loans which were transferred to special servicing in previous months," CMBS analysts at Barclays Capital note. "This is evident by the roll rate, defined as the percentage of loans by balance that changes from one delinquent status to another. The roll rate from special servicing current (SS-Cur) to 30+ days delinquent was 21% in December across CMBX 1-5 deals, versus the trailing three-month average of 15%."

The analysts observe that by vintage cohort, the non-performing loan rate for 2007+ vintage loans rose by 91bp. "Across CMBX, Series 3 was a laggard, with the non-performing loan rate jumping 102bp. This was led by four large loans, totalling US$648m, rolling from SS-Cur to 30 days delinquent status," they add.

CMBX.4 also deteriorated meaningfully with an 84bp increase. CMBX.5, however, remained the worst series on a cumulative basis, with a non-performing rate at just below 7%.

Property-wise, the rotation between multi-family and hotel sectors as the worst-performing sector continued as multi-family worsened the most last month, with a 99bp increase overall.

The number of loans modified or in the process of a workout over the 2009 period increased by 21 to 105 for a total of US$2.9bn by balance at origination. The BarCap analysts believe the actual number of loans that are in the process of a workout is much higher as modifications are not consistently reported. As such, they expect an increase in modifications - including significant rate reductions and/or principal writedowns - to be a major theme in 2010.

Meanwhile, rating agency Realpoint reports that November's delinquent unpaid balance for US CMBS increased substantially to US$37.93bn from US$32.55bn a month prior, driven primarily by the 30-day delinquency status of the US$3.5bn portion of the US$4.1bn Extended Stay Hotel loan from the WBC07ESH transaction. A US$575m portion of the debt related to the A1 note was reported as 90+ days past due, while the remaining US$3.5bn piece of the senior debt was reported as 30 days past due.

Pursuant to an amended cash management agreement, all excess funds are being held in a reserve account while the master servicer is only passing through what is deemed recoverable, as governed by the servicing agreement. Realpoint expects the delinquency reporting for this US$4.1bn specially-serviced loan to continue in the near term.

The overall delinquent unpaid balance is up by 440% from the previous year - when only US$7.03bn of delinquent balance was reported for November 2008 - and is now over 17 times the low point of US$2.21bn in March 2007. An increase in each of the five delinquent loan categories was noted in November, while the distressed 90+ day, foreclosure and REO categories grew in aggregate for the 24th straight month - up by another US$1.47bn (7%) from the previous month and over US$19.97bn (562%) in the past year (up from only US$3.55bn in November 2008).

CS & AC

RMBS

RMBS market bolstered by PSPA amendments

The US Treasury has amended the preferred stock purchase agreements (PSPAs) for Fannie Mae and Freddie Mac to allow the cap on its funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years. At the conclusion of the three-year period, the remaining commitment will then be fully available to be drawn per the terms of the agreements.

There had been growing concern that losses in the GSEs' portfolios would eventually succeed the initial US$200bn cap and thus trigger a receivership (see SCI issue 165). But ABS analysts at Barclays Capital confirm that the amendments mean GSE credit should no longer be a concern for investors for the foreseeable future.

"The larger portfolio caps and change in their definition pushes out the timing of portfolio shrinkage. This should be a positive for MBS investors, as the GSEs can now serve as a backstop for the market once the Fed exits," they say. However, they note that the improvement in the GSEs' fundamental/credit situation should be tempered by increased supply expectations, as delinquency buyouts remain a source of uncertainty in the near term.

The PSPA amendments essentially allow the GSEs to draw a maximum of US$200bn plus the cumulative amount drawn from 2010 through to 2012. Barclays Capital's reading of the move suggests that any surplus at 31 December 2012 will reduce the limit by that amount.

"To give an hypothetical example, suppose FRE draws another cumulative US$50bn during Q110-Q312, but then turns a profit in Q412 such that it has GAAP net assets of +US$5bn as of Q412. Its limit would then become US$245bn: it grows by US$50bn because of the draws, but then reduces by US$5bn due to the surplus in Q412," the analysts explain.

Neither GSE is near the US$200bn per institution limit initially established under the PSPAs: total funding provided under these agreements through to Q309 has been US$51bn to Freddie Mac and US$60bn to Fannie Mae. But the Treasury says the amendments should leave no uncertainty about its commitment to support the agencies as they continue to play a vital role in the housing market during this current crisis.

The PSPAs also cap the size of the two entities' retained mortgage portfolios and require that the portfolios are reduced over time. The Treasury has consequently amended the agreements to provide Fannie Mae and Freddie Mac with some additional flexibility to meet the requirement to reduce their portfolios. The requirement for 2010 and after will be applied to the maximum allowable size of the portfolios - or US$900bn per institution - rather than the actual size of the portfolio at end-2009.

In addition, setting of the periodic commitment fee has been delayed by one year to 31 December 2010. The Treasury has also made technical changes to the definitions of mortgage assets and indebtedness to make compliance with the covenants of the PSPAs less burdensome and more transparent in light of impending accounting changes.

The amendments to the PSPAs has two important consequences for the RMBS market, according to Annaly Capital Management. It will prevent large-scale selling of securities by the GSEs by adjusting the portfolio cap hurdle and enables them to be more aggressive in engineering buyouts of their seriously delinquent loans.

"While this stepped-up activity will have negative prepayment effects (a buyout looks like a refinancing), it should also enable the agencies to better serve the policy objectives of the current administration. This latter point, as well as the virtually unlimited capital backstop, should fundamentally remove any uncertainty about the US government's commitment to support these firms because of their central role in the housing market," officials at Annaly note.

However, credit strategists at BNP Paribas note that the PSPA amendments suggest continued nervousness about the US mortgage market. This is perhaps reflected in the apparent differences of FOMC opinion, as highlighted by the minutes of its December meeting.

The minutes indicate a concern that the recovery in the housing market may still be policy-dependent, and these concerns have likely deepened since the December meeting with the rise in mortgage yields and the drop in pending home sales, according to the BNP Paribas strategists. Indeed, some FOMC members remain uncertain about ending the US Fed's MBS purchase programme, which is due to finish in March (SCI passim).

"With the FOMC so concerned about the impact of its exit from credit easing, it is very unlikely rate hikes are on the horizon," the strategists add. "Overall the minutes paint a constructive economic environment for credit, both in absolute terms (no rate hikes and limited inflation risk in the near term) and relatively to equities and government bonds (more growth is expected, but is likely to remain subdued)."

CS

Ratings

Evaluating credit ratings in structured finance

Simon Collingridge, md, structured finance, at S&P explores the record of credit ratings in structured finance markets and some of the new measures the rating agency is adopting

At the start of the global financial crisis, credit deterioration was generally limited to certain US structured finance assets and global financial institutions. However, the onset of a broader economic recession has meant rising credit risk across most financial asset classes - for example, European residential and commercial mortgages, consumer finance and corporate credit. In certain cases, this deterioration has led S&P to take negative rating actions in the related structured finance sectors.

However, not all structured finance assets have been equally affected. For example, ratings of many European structured finance assets - particularly traditional securitisations, such as RMBS and consumer ABS - have been relatively stable to date, especially at the higher rating levels.

Indeed, S&P's report 'Credit deterioration continued to pressure European structured finance ratings in H1 2009' found that of the 9,293 ratings of European structured securities outstanding at the start of the year, we left unchanged or raised 83% and lowered 17% in the first half of 2009. Importantly, the downgrade rate was lowest in the higher rating categories, with more than 95% of triple-A ratings remaining stable, compared with 73% of double-B ratings.

We believe that it is important that market participants look at the performance of ratings in different areas of the structured finance market, rather than viewing the market as a whole. For example, European CDOs exhibited the highest downgrade rate over this same period with 26.6% of ratings lowered, compared with only 7.3% for ABS.

Furthermore, of the 750 triple-A rated European RMBS outstanding at the outset of the crisis in June 2007, over 98% remain triple-A today and the remainder at double-A or single-A.

Importantly, triple-A rating downgrade rates in Europe remained low in most asset classes, at 0.7% for ABS, 1.9% for RMBS, 2.5% for CMBS and 8.7% for CDOs.

However, it is important to note that a large proportion of CMBS and CDO tranches are currently on credit watch with negative implications and may have their ratings lowered in coming months. Specifically, a number of CDO ratings could be affected by recent revisions to our assumptions and methodologies, while pressure on European CMBS ratings reflects the dramatic deterioration in commercial property values and constricted credit conditions, which we see leading to heightened refinance risk over next few years.

Striving for comparability
While the vast majority of our ratings have performed broadly as anticipated during the crisis, we have acknowledged that the performance of our ratings in certain areas - including US mortgage-related securities - has been out of line with historic norms.

We recognise that a number of the assumptions we used in our analysis of many recent US RMBS and CDO ratings did not hold up. Like many others, we did not fully anticipate the impact of actual home price declines on mortgage loans performance.

We have subsequently made a number of significant changes to our criteria for analysing several asset classes, including CDOs and US RMBS and CMBS. We believe these changes will lead to enhanced rating comparability - across sectors, geographic regions and over time. This, in our view, is key to restoring confidence in ratings

As part of our effort to minimise ratings volatility in the future, we have introduced a measure of stability into investment grade ratings. Under S&P's new criteria, for instance, we may feel that two securities have a similar default risk, but if we believe one is more prone to a sharp downgrade in periods of economic stress, it is likely to be rated lower.

A second initiative concerns our perception that investors prefer ratings to behave as a consistent benchmark of credit risk - meaning that issuers or instruments with similar ratings perform in a broadly comparable way, regardless of asset class, geography or point in time. Accordingly, S&P has published specific economic scenarios for each ratings category that illustrate the level of stress that issuers or obligations rated in that category should, based on our analysis, be able to survive without defaulting.

In the case of triple-A ratings, for example, we are applying a Great Depression-type scenario. Alongside other factors, these stress scenarios are being used to help calibrate ratings criteria and support the ongoing comparability of ratings.

We understand that investors also want to be better placed to analyse and evaluate ratings. We are therefore publishing more information about ratings assumptions, stress tests and 'what if' scenarios, so the market can see more clearly what might cause ratings to change and can take a deeper view of credit risk. If an institution, for example, has different macro assumptions than S&P's, they should be able to determine how that could impact our - and their - view of creditworthiness.

Underlying these and other improvements we are making is an important principle: transparency in what we do and how we do it builds confidence in ratings and helps investors make better informed decisions.

Where now for ratings?
Ratings have been, and we believe will continue to be, an important tool for investors looking for a common and transparent language for evaluating and comparing creditworthiness, across sectors and geographies.

While important changes have been made to governance of the ratings process, ratings transparency and analytic quality, we continue to examine other areas for potential improvement. For instance, there may be further opportunities to continue incorporating experiences over the past two years, as well as enhancing the comparability of ratings across sectors.

We hope that these changes - as well as our ongoing education programme - will leave investors with a better understanding of our ratings, and better equipped to analyse and evaluate them. We also hope it will lead to a healthier and more rational use of ratings by investors, as one of many inputs in their decision-making process. On that basis, we envisage a continued role for S&P in serving the market with ratings, research and data, in which we compete entirely on the quality and value of our product.

ABS

ABS strategy heads switched

Knight Libertas UK has appointed Ronald Thompson as md, global head of ABS strategy. Thompson joins Knight Libertas from RBS, where he spent eight years, most recently as global head of ABS strategy in Stamford and London.

Before RBS, Thompson held research and strategy roles with Citigroup and Salomon Brothers, as well as banking and research roles in several other institutions. He will be based in Knight's London office.

"Ron brings considerable experience to our securitised products effort in the US and Europe, and broadens the services we provide to our institutional structured securities clients," says Ronak Khichadia, md, global head of ABS/MBS sales and trading. "We intend to further leverage our intellectual capital to enhance the products and services we deliver to clients as Ron helps us build out our ABS/MBS strategy and analytics platform to support sales and trading. We are growing our platform globally to meet the opportunities, and strategy will play a key role in helping us expand our franchise across the structured markets."

Meanwhile, Ganesh Rajendra, former head of securitisation research at Deutsche Bank in London and most recently head of advisory and research within the structured products team at Henderson Global Investors, is expected to succeed Thompson at RBS. Rajendra lead securitisation research at Deutsche Bank for eight years before moving to Henderson in Febraury 2009 (SCI passim).

The appointment is, as yet, unconfirmed by RBS.

ABS

Broker hires healthcare structured financier

Cowen Group has hired William Reiland for its broker/dealer subsidiary as an md in the healthcare investment banking group. Reiland will be based in New York and report to co-heads of the firm's investment banking division, Scott Ryles and Don Meltzer. In his new position, Reiland will be responsible for structured and other debt financings, primarily in the health care sector.

Reiland joins Cowen with over 24 years of experience in healthcare as an investment banker, research analyst, investor and consultant. Most recently, he was an md at Leerink Swann, where he was responsible for originating, structuring and marketing royalty monetisations, mezzanine financings and private equity transactions. Previously, he worked at Morgan Stanley for 15 years, where he spent five years in investment banking and eight years on a variety of corporate bond, high yield and distressed trading desks.

ABS

Law firm hires tax counsel

Law firm Nixon Peabody has expanded the firm's securitisation and structured finance team with the appointment of Sarah Nelson. Based in the firm's New York City office, Nelson joins as tax counsel in the global finance practice.

Nelson's practice focuses on representing issuers, underwriters and credit-enhancers as tax counsel with respect to structuring and documenting RMBS, ABS and CMBS. She has represented lenders and borrowers, and advised distressed debt servicers, lenders and trustees.

Advisory

ABN vets launch SF boutique

Ex-ABN/RBS securitsation veterans Mike Nawas and Steve Curry have launched London-based structured finance boutique Bishopsfield Capital Partners. Prior to launching the new firm in the latter part of 2009, Nawas held roles including global head of corporate and structured debt capital markets at RBS and global head of credit markets origination at ABN AMRO.

Curry spent over 20 years as an investment banker at ABN AMRO, specialising in DCM, project finance and structured lending, including eight years in the securitisation business. Most recently he was md at RBS and ran the structured loans and bonds business for CEEMEA.

The firm offers arranging, structuring and advisory services in relation to structured debt transactions, as well as development and arrangement of investment partnerships designed to acquire and manage structured finance assets.

Advisory

Advisory taps Huron valuation pros

Duff & Phelps has added mds Kenneth Evola and Keith Keller, and director Matthew Douthit to its corporate finance consulting segment. All three professionals join Duff & Phelps from Huron Consulting Group.

Douthit joins the Washington DC Metro office to provide deep valuation and risk control skills for complex illiquid investments. At Huron, his responsibilities included providing valuation and due diligence services for structured credit products.

Previously, Douthit led the middle office at Fannie Mae, where he implemented risk controls over valuation and transaction accounting for the investment portfolio. Prior to that, he was a portfolio manager, investing in whole loans and mortgage-related securities.

Evola also joins the Washington office, with experience in accounting advisory and complex financial instruments valuations for illiquid investments. During his tenure at Huron, he served as a co-leader of the financial services practice and provided accounting advisory, valuation and due diligence services for public and private corporations and their external counsel. Previously, Evola led various accounting policy functions at Credit Suisse and Freddie Mac.

In Duff & Phelps' Atlanta office, Keller will serve clients in the areas of governance, risk management and compliance practices, focusing on alternative investments and risk policies. At Huron, he was md, the national leader for corporate governance advisory services and a co-leader of the financial services practice. Keller provided regulatory compliance, operating effectiveness, process improvement and risk management services to large financial service organisations and pension funds.

Alternative assets

Political risk and structured credit practice head hired

Insurance broker Marsh has appointed Julian Macey-Dare as international leader of its political risk and structured credit practice. Based in London, Macey-Dare will drive new business opportunities for Marsh's political risk and structured credit practice globally outside of the US and oversee the strategic development of its existing client base. He will report to Roy White, leader of Marsh's EMEA financial and professional practice.

Macey-Dare returns to Marsh from Willis, where he had executive responsibility for political risks and structured credit in the Americas, as well as co-heading global new business for the past three years. He also worked for Jardine Lloyd Thomson for ten years, latterly as deputy head of the political and credit risks division. Macey-Dare began his career at Marsh and worked for the firm until 1995.

Marsh's political risk and structured credit practice consists of a group of specialists focused on providing clients with advice on the mitigation of emerging market credit default and political risks.

Alternative assets

REIT restructures Trups as part of strategic review

Crystal River Capital is to restructure its outstanding Trups assets, which currently have an aggregate liquidation preference of US$50m. The REIT will exchange certain of its assets for the outstanding preferred beneficial interests of Crystal River Preferred Trust I that are held by a number of CDOs, which would then be cancelled and the trust dissolved.

It has agreed to pay a US$1m exchange fee to the CDOs and a 1% underwriting, legal and due diligence fee (US$500,000) to the collateral manager of the CDOs. The exchange assets include two real estate loans and a CMBS bond, which collectively had an aggregate carrying value for accounting purposes on the REIT's financial statements of approximately US$7.7m as of 30 September 2009. The remainder consists of a portfolio of CDO notes that are not carried as assets on Crystal River's balance sheet due to the effects of consolidation.

The REIT has also agreed to use commercially reasonable efforts to cause its external manager and an affiliated entity to agree to assign to the collateral manager certain rights to act as servicer/collateral manager of the assets to be transferred.

Crystal River previously announced that it had commenced a review of its strategic alternatives. That review remains ongoing, including assessments of possible transactions to sell some or all of its assets or to sell the REIT itself. However, it does not intend to disclose any further developments with respect to that review until a definitive decision has been reached.

CDO

Bank to take CDO hit

Société Générale says it is taking into account the contrasted signals coming from the US residential real estate market in Q409 and will write down its RMBS-backed CDOs. The bank therefore expects to record a total pre-tax negative impact of around €1.4bn. This will essentially include:

• Additional write-downs in NBI on RMBS CDOs classified as 'trading', reflecting in particular the increase in estimated cumulative loss rates (i) on 2005 subprime loans, from 13% to 15% before liquidity discounts and (ii) on all prime loan vintages;
• Provisions for RMBS CDOs classified as 'loans and receivables', reflecting (i) the deterioration of the portfolio over the quarter for an amount of a similar level to the third quarter and (ii) a supplement linked to the downturn in recovery rates from 50% to under 40%.

The group also expects to book around €0.1bn linked to changes in the mark-to-market valuation of CDS and the revaluation of financial liabilities. Overall, however, the bank expects to post a slight profit in terms of estimated net income for the fourth quarter of 2009.

CDS

Management reorganisation at Creditex

ICE has announced changes to the management team within its Creditex business. Grant Biggar has been appointed as president and Sophia Corona as coo of the firm.

Biggar was previously md at Creditex, where he led the European and Asian businesses since joining the company in 2000. He will replace John Grifonetti, the firm's president and coo, who is pursuing other opportunities.

Corona joined Creditex in 2007 as cfo and played a leadership role in realising synergies between Creditex and ICE.

Sunil Hirani, svp and corporate development officer who co-founded Creditex in 2000 and served as its ceo until the firm's sale to ICE in August 2008, is also leaving to pursue other opportunities. Hirani will continue as an advisor to ICE, however. The exchange notes that he was instrumental in the in the integration of the firm into ICE and in the execution of its CDS strategies.

Hirani is expected to pursue other interests with entrepreneurial ventures.

CLO Managers

Manager change for Biltmore CDO

Dock Street Capital Management, an asset manager launched last year specialising in distressed CDOs, is set to become replacement collateral manager for Biltmore CDO 2007-1. If the proposed change is finalised, Dock Street will assume the collateral management responsibilities previously performed by ING Clarion Capital.

Biltmore CDO 2007-1 is a US$1bn high grade structured finance CDO. S&P has released a preliminary rating confirmation in connection with the proposed change.

Dock Street Capital Management has, in recent months, taken on a number of CDO management mandates (SCI passim).

Distressed assets

Ex-MS CMBS banker tapped

A10 Capital, a firm that finances commercial real estate and provides services to resolve troubled assets, has hired Jay Haberman to head up its mid-Atlantic markets business. Haberman will be responsible for sourcing all new business opportunities in Virginia, Washington DC, Maryland and North Carolina, including first mortgage loans, note acquisition financings, mezzanine loans, equity investments, distressed debt financing and troubled asset advisory engagements.

Haberman has been involved with most aspects of commercial real estate financing and investments for the last 20 years, and has closed nearly US$2bn in commercial real estate for a variety of platforms including CMBS, life company balance sheets, Fannie Mae, Freddie Mac and third-party managed accounts. Most recently, he ran lending activities for Morgan Stanley's mid-Atlantic CMBS office. Prior to this, he originated and managed commercial real estate loan portfolios for General American Life, Conning Asset Management, MetLife, Swiss Re and KeyBank Real Estate Capital.

Emerging Markets

DoubleLine builds in emerging markets

Luz Padilla, former lead portfolio manager and md of the TCW emerging markets fixed income group, has joined DoubleLine Capital - the investment manager set up by ex-TCW cio Jeffrey Gundlach (SCI passim). Mark Christensen and Su Fei Koo, the senior-most members of Padilla's previous investment team, have also joined DoubleLine.

Padilla will head investment activities in emerging markets debt at DoubleLine. Christensen and Koo, who report to Padilla, will lead emerging markets research in sovereign and corporate credit.

Under Padilla, the TCW emerging markets fixed income group managed US$1.5bn assets invested in mutual fund, separate account and structured credit vehicles. As co-portfolio manager from December 2001 and then as portfolio manager from October 2006, Padilla ran the TCW emerging markets income fund (TGEIX).

Christensen, a senior research analyst at DoubleLine, previously served for 18 years at TCW - the last 16 in emerging markets fixed income. He was head of emerging markets corporate research at the firm. In addition to credit analysis, he was involved in trading and marketing, with increasing portfolio management duties since December 2006.

Koo, also a senior research analyst at DoubleLine, previously served for 11 years in TCW's emerging markets fixed income group, with her final position there as senior credit analyst. In addition to credit analysis, she was involved in marketing emerging markets fixed income strategies and performed increasing portfolio management duties since December 2006.

Investors

TCW saga continues

The TCW Group has voluntarily withdrawn its UST/TCW Senior Mortgage Securities Fund from the PPIP, following key-man issues raised by the US Treasury (see SCI issue 165). The firm will conduct an orderly liquidation of the fund and distribute capital to the fund's investors.

The UST/TCW Senior Mortgage Securities Fund, which has approximately US$500m in assets under management, completed its initial closing on 30 September 2009. "Given that we are at a very early stage of investment in this particular product and in light of the recent changes in the portfolio management team, we believe this action is appropriate and in-line with TCW's commitment to act in the best interests of our clients," says Marc Stern, TCW Group ceo. "This will also benefit the holders of older TCW vintage funds, as we will be able to dedicate even more resources to those investments."

Meanwhile, ex-TCW cio Jeffrey Gundlach and several other former TCW employees are being sued by their former firm. According to various reports, the ex-TCW employees are accused of breach of fiduciary duty, unfair competition and misappropriation of confidential information.

Gundlach is believed to be countersuing TCW for alleging, as part of its suit, that certain contraband was discovered in his office.

Gundlach was dismissed by TCW in December 2009 following its acquisition of Metropolitan West Asset Management (MetWest). He subsequently founded DoubleLine Capital, along with TCW's MBS head, Philip Barach. A substantial number of TCW employees have since joined the new firm (see also separate Job Swap story).

TCW is reportedly seeking more than US$200m in damages.

Listed products

Mortgage REIT prices IPO

Invesco Mortgage Capital raised US$148.75m via a public offering of seven million shares of its common stock. The company expects to use the net proceeds from this offering to make additional acquisitions of RMBS, CMBS and mortgage loans, on a leveraged basis, and to invest in a public-private investment fund managed by Invesco Advisers.

Monolines

FGIC's surplus restoration plan under review

FGIC has provided the New York State Insurance Department (NYSID) with its proposed surplus restoration plan for review. This follows the NYSID's order to suspend paying claims on 24 November, triggered by the disclosure of the monoline's capital impairment and failure to comply with the applicable minimum surplus to policyholders requirement (see SCI issue 162).

FGIC's surplus was US$932m short of the required level as at 30 September 2009. Kit Evans, a structured finance strategist at Chalkhill Partners, suggests that if the monoline fails to restore its surplus by the deadline of 25 March, then - barring an extension - it is likely to be placed into rehabilitation by the regulator.

"We think most banks have already taken the pain on FGIC by writing down the value of any protection purchased from the monoline, and FGIC only wrapped a handful of public bonds in Europe... Hence, the FGIC story is mainly interesting because it will show the potential path for the likes of Ambac and MBIA, if they were to report a shortfall in their statutory capital," he says.

The CDS payout (see separate News Round-up story) is also expected to facilitate hedged counterparty commutations with the monoline.

Monolines

Proud succeeds Tromp at Assured

Assured Guaranty has promoted Nicholas Proud as senior md, international. He reports directly to Séan McCarthy, coo of Assured Guaranty, and will head the monoline's international credit enhancement business.

"Having headed Assured Guaranty's European structured finance business for the past eight years, we know that Nick is the right person to help us build our international presence in the global structured finance and public infrastructure markets," McCarthy says. "Nick has 18 years of experience in European structured finance, deep market knowledge and strong client relationships. We are confident he will help us to bring best-in-class credit enhancement products to these markets as they recover."

Proud succeeds Philippe Tromp, who headed Assured Guaranty (Europe) - formerly Financial Security Assurance (UK) - for over 15 years and assisted in the integration of the company's London-based subsidiaries. Senior managers on the monoline's international team are Dominic Nathan, md European infrastructure, and Craig Lee, md head of Asia-Pacific.

Proud joined Assured Guaranty (UK) in January 2001 from QBE Insurance & Reinsurance (Europe), where he was a director and senior underwriter in its financial risks operations. Prior to that, he was executive director of the structured financial risks division of Special Risk Services, a financial products reinsurance broker. Earlier positions included credit underwriting of facultative and treaty reinsurance of monoline financial guaranty companies.

Operations

Mortgage servicing vet returns to Franklin

Franklin Credit Management Corporation (FCMC), the mortgage servicing subsidiary of Franklin Credit Holding Corporation, has recruited Jimmy Yan as evp and md of its servicing and asset recovery operations. Yan was most recently employed by Deutsche Bank Securities as vp, a position he held for over four years, during which time he was responsible for managing a dozen mortgage servicers and the servicing and recovery of over 100,000 mortgage assets. Prior to his position with Deutsche Bank Securities, he had been employed by FCMC as manager of the default operations of its servicing department.

"We are very pleased that Jimmy Yan has returned to Franklin, where his expertise in managing recovery operations will be instrumental in Franklin Credit's efforts to attract new clients and to introduce a variety of innovative collection and loss mitigation strategies and services related to re-establishing and maintaining contact with borrowers in a difficult economy," says Thomas Axon, chairman and president of Franklin Credit Holding Corporation and FCMC.

Operations

Gandy appointed ESF chairman

Steve Gandy, head of securitisation at Santander Global Banking and Markets, has been elected AFME/ESF chairman. Mark Lewis, global head of structured capital markets at UniCredit Group, has been appointed vice-chairman. Caroline Muste from ING Investment Management is to join the association's board of directors.

The ESF's previous chairman was Mark Hickey - former md and head of financial institution debt capital markets at RBS.

Real Estate

CRE firm makes key hire

Clayton Holdings has hired Edward Robertson as md in charge of its commercial real estate services, focusing on due diligence, asset management and advisory practices. Prior to joining Clayton, Robertson was cfo of Washington Mutual's commercial group and Barclays Group's Latin American business. At Clayton, he will report to Conrad Vasquez, evp of operations.

"There is approximately US$3.5trn in commercial real estate debt outstanding and, over the next three years, some US$1.5trn will be coming due," says Paul Bossidy, Clayton's ceo. "Bankers and institutional investors will need teams of seasoned professionals to help them assess their exposure and identify opportunities that will arise. While Clayton has always had a presence in the commercial real estate market, we are investing in a seasoned banking executive, like Ed, to accelerate the growth of this critical practice area."

"The state of the economy, the turmoil in the secondary markets and the volume of debt coming due mean that commercial real estate will be the next big challenge for the recovering banking industry," says Robertson. "Lenders and investors will need help in analysing and valuing CMBS, portfolios and properties, as well as sizing their default risk and determining their ongoing asset management strategies."

Regulation

Joint Forum names new chair

The Joint Forum's parent organisations - the Basel Committee on Banking Supervision (BCBS), the International Organization of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS) - have appointed Tony D'Aloisio as its new chairman. This two-year appointment is effective from 1 January 2010. D'Aloisio, who succeeds John Dugan of the US Office of the Comptroller of the Currency in this role, is the chairman of the Australian Securities and Investments Commission (ASIC).

The Joint Forum was established in 1996 under the aegis of the BCBS, IOSCO and the IAIS to deal with issues common to the banking, securities and insurance sectors, including the supervision of financial conglomerates.

RMBS

Asia-Pacific RMBS head appointed

Deutsche Bank has appointed Sal Mirran as md and head of RMBS for Asia Pacific. Mirran joins the firm from Fannie Mae and is based in Hong Kong. He reports regionally to David Lynne, head of global rates Asia, and globally to Doug Naidus, global head of RMBS.

In this new role, Mirran is responsible for building a local mortgage origination and risk management platform across Asia, Japan and Australia, which completes strategic touch-points across the world, as well as providing key clients in the region with access to Deutsche Bank's US RMBS platform.

"Expanding our Asia Pacific RMBS platform is a key focus for the coming year and Sal's long experience in all aspects of mortgage origination, distribution and investment make him an ideal candidate to steward this growth," comments Lynne.

Mirran most recently ran corporate strategy at Fannie Mae in Washington, where from 2008 he led strategy and policymaker engagements, providing solutions and research related to volatility in the US mortgage market. This included deliberations with the US Treasury, as well as engagements with Congressional staff, representatives and the incoming administration regarding mortgage market conditions, corrective efforts and new approaches.

For the 16 years prior to this, he was involved in many aspects of corporate, structured and consumer finance. He built and managed businesses for First Union Securities, Wachovia Securities' predecessor, and restructured and managed mortgage capital markets for Bank of America's consumer real estate business.

RMBS

Conyers adds to structured finance team

Law firm Conyers Dill & Pearman has hired Tara Rivers as attorney-at-law, as the firm continues to expand its corporate and investment funds presence in the Cayman Islands. Rivers will practice corporate and commercial law, specialising in investment funds, securitisation and structured finance matters.

Prior to joining Conyers, Rivers was an international capital markets associate at Allen & Overy in London. During her time at the firm, she helped structure and execute a number of 'firsts', including establishing the first UK building society RMBS master trust programme and the first CMBS covered bond programme.

Trading

Broker hires US credit sales co-head

Knight Libertas has appointed Sean Dowd as md, co-head of US credit sales. In his role at Knight Libertas, Dowd is responsible for US credit sales to increase client growth among mutual funds, insurance companies, pension funds, hedge funds and commercial banks.

Dowd joins Knight Libertas from UBS, where he has worked for the past 12 years, most recently as head of credit trading and research in the US. Previously, he was co-head of investment grade sales and trading at the bank.

Dowd began his career at ScotiaMcLeod in fixed income sales, covering US and Canadian clients for Canadian and US dollar corporate and provincial products.

ABCP

European ABCP conduit structures simplified

Sponsors of European asset-backed commercial paper (EABCP) conduits are restructuring their programmes to be simpler and returning to more traditional multi-seller structures that offer the greatest diversification, according to a recent report from Fitch.

Having peaked at US$296.90bn of issuance in July 2007, the EABCP market has since struggled to return to these historical volumes, hovering at approximately US$50bn since January 2009. While the market for ABCP has not completely disappeared, some EABCP programmes are still unable to issue or are issuing outside Europe, primarily in the US.

In light of the difficult operating environment, sponsors of ABCP vehicles in Fitch's rating universe have undergone significant restructuring of their programmes over the past two years. A review of all Fitch-rated EABCP conduits has revealed sponsors implementing such structural features as fully supporting liquidity facilities or full insurance wraps at the underlying transaction level. They are also reducing the programmes' overall exposure to assets and jurisdictions that they deem to be the worst affected by the global economic downturn, gravitating towards simpler and more transparent structures such as the more traditional, flexible, multi-seller programmes in order to allay investor concerns and prompt a return to normality in the ABCP market.

ABCP

Credit arbitrage ABCP approach enhanced

Moody's is supplementing its existing approach to monitoring credit arbitrage ABCP programmes by using the latest version of CDOROM. This is a change to the rating agency's current approach for determining the adequacy of credit enhancement, which mainly relies on a dynamic credit enhancement matrix.

Credit arbitrage conduits, also called securities arbitrage programmes, fund portfolios of highly rated securities, most of which are structured finance securities with initial ratings in the Aaa or Aa range. They benefit from a liquidity facility that is equal to the face value of the outstanding ABCP. The liquidity facility funds the conduit's book value of non-defaulted assets.

For structured finance securities default is defined by a rating standard, typically rated Caa1 or below. In order to cover non-defaulted assets, credit enhancement is provided at the programme level and is dynamic, meaning it increases as the credit quality of the assets migrates to Aa3 or lower.

The primary risk to investors in credit arbitrage programmes is that a highly-rated security goes directly to default in a very short period of time, before a cure can be effected by increasing enhancement or selling assets. The cure period varies by programme.

While Moody's still believes in the benefits of the dynamic credit enhancement adjusting to the migration of the securities' credit quality, it also sees some limitations in the current approach, which could be mitigated by the use of CDOROM as a surveillance tool. In particular, the previous methodology is based on corporate rating migrations, which did not differentiate rating transition by asset types or geography.

It is also not easily updated for changes in correlation assumptions. The main advantage of CDOROM as a surveillance tool is that it allows the latest assumptions on correlations among asset types as regularly updated by Moody's to be taken into account.

It is expected that all of the partially supported credit arbitrage conduits currently rated by Moody's will pass the test with the current stressed migration assumptions on the basis of the actual amount of credit enhancement. However, in many cases, the required credit enhancement as per the grid would not be sufficient. In addition, concentrated exposure on certain asset classes for certain programmes could lead to pressure on the rating, should those asset classes show further rating volatility.

ABS

Renewed interest in negative basis trades

If US corporate bond yields exceed swap spreads for a sufficient period of time in the future, market conditions for negative basis trades may arise once again, according to a recent report from S&P. In the first half of 2009, conditions in the US corporate bond markets generally appeared to provide a favourable environment for negative basis trades on many corporate names. These trades could effectively result in 'free' default protection for the bondholders, says the rating agency.

"When these conditions occurred earlier [last] year, we received several proposals for securitising these trades," says S&P credit analyst John McCarthy. "Should the US corporate bond markets return to a position where negative basis trades are possible, in our opinion, we may see originators again consider securitisation as an option."

Among some of the risks that S&P has found in the course of its review of such proposals, two specific ones were identified in the particular structure of the negative basis trade itself - prepayment risk and succession event risk. The rating agency has thus far seen proposals for two types of negative basis trade securitisations: single name transactions, where the issuer would hold one corporate bond and enter into a corresponding CDS; and portfolio transactions with a pool of bonds, where the issuer would enter into corresponding CDS for each bond, in many cases with the same counterparty.

ABS

Safe harbour ANPR unclear on repudiation risk

Moody's notes in a new report that although the FDIC effectively waives its right to delay payments under its stay powers under its December Advance Notice of Proposed Rulemaking (SCI passim), it does not explicitly and clearly waive its repudiation power to reclaim assets transferred to bank-sponsored securitised vehicles.

"This is important because upon repudiation, the FDIC would only have to pay ABS investors damages limited to the market value of the underlying assets, which may be less than the par value of the ABS, thereby introducing market value risk to the ABS," the rating agency notes.

"Our ABS ratings typically address credit losses on the underlying assets in a scenario where the assets are held to maturity pursuant to the promise made by the issuer," it adds. "Adding exposure to market value risk would dramatically alter the credit analysis, since - in addition to credit losses - the asset pool would be subject to being valued under potentially harsh or illiquid market conditions following the sponsor's failure. This risk becomes more likely to materialise the weaker the credit strength of the sponsor bank."

Moody's says that if the FDIC's repudiation power is not waived or otherwise mitigated in the final version of the rule, the credit quality of bank sponsored ABS issued after the rule's effective date will be more highly linked to the credit quality of its bank sponsor than is the case at the moment. "Bank sponsors rated below Aa would be unlikely to achieve Aaa ratings for their ABS if this risk isn't mitigated," the agency warns.

ABS

Timeshare ABS issuance defies recession

Timeshare ABS was one of the few asset classes in 2009 that demonstrated strong investor demand and resilient credit performance without the support of the TALF programme. According to a recent report from S&P, issuance of ABS based on timeshares passed the US$1bn mark in 2009, with developers such as Marriot, Wyndham, Diamond Resorts and Starwood issuing new term securitisations. Timeshare ABS issuance in 2008 issuance was just more than US$600m.

The healthy issuance volumes defied the recession and its impact on consumers, who were expected to shy away from timeshares. "The comeback in volume is even more remarkable because it is happening amid declining sales, diminished property values and higher consumer delinquencies for timeshares. Compared with historical levels, the 30% year-over-year decline in timeshare sales in 2009 is the highest since the sector's inception in the 1970s," says the rating agency.

According to S&P, timeshare developers who securitised were able to achieve investor demand by increased credit enhancement and pricing reflective of the current market environment. "Typical US consumers view a timeshare purchase as a discretionary item in their budgets. One could assume that, under financial stress, payments on a timeshare loan might be among the first items to get cut," it says.

The agency continues: "To be sure, timeshare loans have not escaped the deteriorating performance experienced by all consumer credit assets. However, the increase in delinquencies and defaults in the sector since September 2008 has been relatively modest, and we believe preliminary signs indicate that the worst may be over."

Timeshare ABS ratings performance has held up, in part because the deals typically have sufficient credit enhancement, in S&P's opinion, to absorb multiples of the historical default levels. "Perhaps as a result, timeshare ABS investors are demanding new issuance in the face of lower timeshare sales and slowed developments," says the rating agency.

ABS

Dealer floorplan moratorium lifted, criteria revised

Fitch has lifted its moratorium on rating auto dealer floorplan transactions and published a revised global dealer floorplan (DFP) ABS criteria report. The document supersedes the reports entitled, 'Rating Criteria for US Dealer Floorplan ABS' (dated 14 May 2008) and 'European Auto Dealer Floorplan ABS Criteria' (dated 6 February 2008).

The orderliness of the bankruptcy process has been a key assumption in Fitch's prior criteria, particularly for non-diversified DFP, such as those issued by auto-related captive finance companies. As a significant departure from former criteria, the rating agency now assumes the likelihood of catastrophic dealer failures and highly disorganised collateral liquidations upon a rapid and disorderly bankruptcy of the manufacturer/lender.

Fitch's new approach for non-diversified platforms assumes high dealer default rates (up to 100% of the dealer network), adjusted based on an assessment of dealer network strength and its ability to survive independently of manufacturer support (e.g. based on concentration of multi-franchised dealers). Absent relevant dealer network data, it will not make adjustments (or accord any credit) to dealer default frequency estimates.

The new approach also assumes high severity of collateral losses due to disorderly unwinding and liquidation of failed dealers.

By assuming a high dealer default frequency regardless of the issuer default rating (IDR) of the manufacturer/lender, Fitch effectively de-links the DFP ABS rating from the financial strength/IDR of the manufacturer/lender. Additionally, the revised criteria places a notable emphasis on analysing operational risks inherent in DFP platforms by focusing on the logistical feasibility of repossessing, transporting and disposing repossessed inventory under a liquidation scenario, and capacity/depth of the secondary market to absorb large potential increases in auction volumes. Fitch will cap ratings for DFP ABS platforms that lack infrastructure to support such operational risks.

The criteria report is intended to encompass both diversified and non-diversified (including auto captives) DFP platforms. Although the key analytical considerations of Fitch's rating methodology for diversified DFP ABS remain largely unchanged from former criteria, under the revised criteria its expectations for credit enhancement (CE) levels for both diversified and non-diversified platforms will be higher than they have been in the past at all rating categories.

Fitch expects to conclude its review of the existing portfolio by the first quarter of 2010. Rating actions and their magnitude will depend on the degree to which available CE deviates from expected coverage levels under the revised methodology. Potential rating actions are expected to be within one rating category.

Alternative assets

New fund launched in film finance segment

P&C Arcade Fund Management has launched a new fund that provides short-term asset-backed liquidity to TV and film producers. Dubbed Grand Arcade Film Fund, the offering is listed in the Cayman Islands and is expected to deliver an annual return of 12% after all fees and expenses, while operating within a conservatively managed risk environment.

The launch follows the successful first-year performance of its sister fund, P&C Arcade Film Fund, which is incorporated in the British Virgin Islands.

The funds essentially take security via SPVs over all available assets of each film financed. Types of financings typically include secure bridging and government credit discounting.

Arcade investment manager Christopher McGinty says: "We are replacing the banks who have all withdrawn from this market due to their lack of liquidity, by offering secure lending in first position to the global media and entertainment industry. We are delighted that the year-one performance of our fund has netted investors an 11.24% return after costs."

Film producers typically pay interest rates of 500bp over Libor for secured loans and arrangement fees of 5%-10% of the amount loaned. For short-term bridging loans, monthly interest rates of 2%-3% are not uncommon.

McGinty adds: "Our investment objective is to secure a high level of accumulated interest income from investing in specially structured short-term loans made to film, TV and entertainment production companies and re-investing the investment proceeds on a continuous basis in a portfolio of new productions."

McGinty is an investment professional with more than 20 years of experience in fixed income. He is investment director of investment manager Kreis Consulting and also serves as director of P&C Arcade Fund Management.

Asia

Survey finds appetite for non-Japan Asian ABS

Fitch's inaugural investor sentiment survey of non-Japan Asian structured finance (NJA SF) investors has found a reduced but still-existing appetite for structured products at higher spreads than pre-crisis levels.

The survey found that investors in NJA SF expect asset performance of underlying structured finance assets in the region to remain generally stable in the next six months. Some 38% of respondents do not expect to invest in any NJA SF transactions within the next 18 months, while 30% of respondents are either acquiring structured finance assets or expecting to do so in the next six months. The rest of the respondents expect to invest in structured finance transactions in the next six to 18 months.

Respondents primarily hold Korea ABS, Korea RMBS, Singapore CMBS, CDOs and other structured products in their current portfolio.

"NJA SF investors are still reluctant to invest in most structured finance debt at pre-crisis pricing levels. This is in contrast with the tightening spreads seen in the other major markets after the announcement of the TALF programme in the US," says Peeyush Pallav, director in Fitch's non-Japan Asia structured finance team.

Expectations are that asset performance in the non-Japan Asia region will remain largely stable, with none of the survey respondents expecting asset performance to either worsen drastically or improve significantly over the next six months.

Asia

CMBS downgrades hit Asia-Pacific performance

Fitch reports that a total of 93 Asia Pacific structured finance or structured credit tranches (including public, private, international and national ratings) were downgraded during the fourth quarter of 2009, while 30 were upgraded. Additionally, 337 tranches were affirmed, accounting for over a quarter of all outstanding tranches rated by the agency in the region.

"The most significant rating actions in Q409 were the downgrades of over 80 Japanese CMBS classes. These followed the implementation of the Japanese CMBS surveillance criteria in September 2009. Reviews were conducted and rating actions had been taken since the implementation of the criteria and this process continued into Q409," explains Helen Wong, director in Fitch's Asia Pacific structured finance performance analytics team.

She adds: "A few downgrades were related to New Zealand non-conforming RMBS transactions as a result of deteriorating performance of the underlying portfolios." Despite these downgrades, the majority of tranches rated in Asia Pacific continue to perform in line with Fitch's expectations, as evidenced by the fact that most rating actions in the quarter were affirmations.

Over 20 publicly rated Australian ABS/RMBS tranches were upgraded due to increases in credit enhancement levels and sufficient excess spreads to cover losses incurred to date. Five publicly rated New Zealand RMBS tranches were also upgraded due to the build-up in credit enhancements. And two tranches from a Hong Kong CMBS transaction were upgraded on account of strong cashflows of the underlying properties and the mitigation of the refinancing risk, given that financing is already secured by the originator.

Over 20 Japanese CMBS tranches remain on rating watch negative. The agency aims to review these over the coming months, upon the realisation of expected dispositions of the underlying properties of loans that have defaulted or are expected to default, or other events expected to trigger a review.

At the end of December 2009, the number of tranches with negative outlooks in Asia Pacific increased to 220 from 193 at the end of Q309, according to Fitch. Japanese CMBS accounted for the majority of the negative outlooks, reflecting the agency's negative view of the Japanese commercial real estate market and the real estate finance environment.

CDO

CSOs tipped for 2010 comeback

The strengthening corporate credit markets could spark a renewed interest in corporate synthetic CDOs in 2010, according to a new report from S&P. 2009 was a record year of issuance for the corporate bond market and the rating agency believes this trend may eventually lead to a rebound of certain structured products - but only if investors have interest and market conditions continue to improve.

"Synthetic CDO issuance mostly dropped off in 2009, in large part, we believe, because deal managers focused primarily on unwinding their existing transactions. However, the significant infusion of capital and risk protection from various government and regulatory bodies was likely a catalyst for the record US$1trn in annual corporate bond issuance through August," S&P explains.

It adds: "We believe that investors seeking yield in the fixed income markets may ultimately migrate to certain structured products as well, especially those that are associated with debt types with which they are already comfortable. Given the composite nature of synthetic CDOs and their recent performance history, it is our view that it will likely take a mixture of corporate stability, investor confidence and ratings transparency for this sector of the market to regain some of its former volume."

Meanwhile, S&P's corporate default projections are substantially better now than they were just four months ago. The US investment grade default rate was at 0.30% in early December, with the agency revising its 12-month-forward baseline aggregate default rate for US speculative grade obligors on 4 December to 6.9% from 10.8% in September.

"Combined, corporate credit trends, rising liquidity, low interest rates, tightening spreads and declining corporate default rates all appear to be creating possible opportunities in areas that were mostly inactive for the past 12-16 months," S&P concludes.

CDS

Aiful credit event among new determinations made

ISDA's Japan Determinations Committee has resolved that a restructuring credit event has occurred in respect of Aiful Corporation, a Japan-based financial services provider. The Committee also voted to hold an auction to settle CDS on the company.

The move follows the establishment last month of an ISDA subcommittee to rule on whether entering into Japan's alternative dispute resolution process could constitute a CDS trigger (see SCI issue 165). Aiful Corp protection holders have attempted to trigger CDS contracts on the company three times in the recent past (see SCI issue 161 for more).

Separately, ISDA's ANZ Determinations Committee has determined that a bankruptcy credit event occurred with respect to The Griffin Coal Mining Company in Western Australia. However, it voted against holding an auction to settle CDS on the name. The coal mining company entered into administration on 3 January, with debts of A$700m - US$475m of which is blieved to be owed to US bondholders.

Meanwhile, a final price of 26 was reached on 7 January for the FGIC CDS auction. Twelve dealers took part, with deliverable obligations denominated in US dollars.

CDS

End-2009 decline in CDS liquidity less pronounced

Fitch Solutions reports that the year-end seasonal decline in global CDS liquidity was far less pronounced this year than in previous years, suggesting signs of recovery in the credit markets.

"The fact that CDS liquidity did not dry up to levels tested during the end of 2008 is a positive sign," explains Jonathan Di Giambattista, md at Fitch Solutions in New York.

At its most illiquid point during the year-end period, Fitch's global liquidity index dropped to only 10.4 versus 11.4 a year earlier (the lower the liquidity score the greater the increase in CDS liquidity).

One notable trend already appearing in 2010 is for global sovereigns, where average liquidity on emerging market economies' sovereign CDS has once again overtaken that for developed market economies. This reverses the convergence seen during most of 2009, which eventually saw developed market sovereigns become, on average, more liquid than emerging market sovereigns.

CDS

Japan calculation agent city protocol launched

ISDA has launched the 2010 Japan corporate calculation agent city protocol. The purpose of the protocol is to enable parties to update the provisions of legacy single name Japan corporate CDS transactions to match current trades. With the implementation of this protocol, the definition of 'calculation agent city' for these legacy trades, dated before December 2007, will be amended by deleting reference to London or any other city (which is not Tokyo) and replacing the reference with 'Tokyo'.

The protocol is open to ISDA members and non-members alike. The adherence period runs until 22 January 2010.

CDS

Voltaire CLNs redeemed

€12m notional of the Series 43/2005 Voltaire CLNs, issued via the Claris vehicle, have been repurchased in accordance with the terms of a partial redemption deed between the issuer and SG. Under the deed, the underlying deal collateral has been liquidated to pay the termination costs of the CDS, the interest rate swap and to redeem the notes for a face amount of €12m. The remaining noteholders' exposure to the credit default swap and the IRS has remained unaffected.

Moody's has determined that the repurchase will not cause the ratings of the notes to be reduced or withdrawn. The rating agency does not express an opinion as to whether the amendment could have other, non credit-related effects.

Clearing

CME seeks FCM CDS clearing change

The Commodity Futures Trading Commission has issued a request for comment on a revised petition submitted by the CME in connection with credit default swaps cleared by the exchange. Specifically, CME is requesting that the Commission issue an order under Section 4d of the Commodity Exchange Act that would permit futures commission merchants clearing through CME to commingle customer funds used to margin, secure or guarantee cleared CDS with other funds held in the segregated account.

The Commission says it posted CME's original petition for a 30-day comment period on 14 August 2009 and received four comment letters. The exchange submitted a revised petition on 21 December that includes changes to its CDS clearing plans. Comments regarding the revised exemption request should be submitted before 5 February 2010.

CLOs

CLO eligibility criteria questioned

Bank of New York Mellon, the collateral administrator on the Bacchus 2006-1 transaction, has informed the issuer of certain events that may indicate non-compliance with the terms of the deal's investment management agreement. However, the trustee on the CLO is not expected to conclude that this constitutes an event of default.

First, in respect of certain CDOs purchased by the investment manager (IKB Fund Management), neither acquisition proposals nor notices of acquisition were sent to the issuer, as required pursuant to Clauses 18.1(a)(i) and 18.1(b)(ii) of the investment management agreement. The second event is in connection with the deal's eligibility criteria, which require that each CDO - at the time of the investment manager's entry into a binding commitment to acquire such collateral - must have a purchase price (excluding accrued interest) of not less than 90% of the principal amount.

According to BNYM, it appears that the purchase price of the majority of CDOs bought in the secondary market by IKB was stated to be 100% of the principal amount in all cases, even where the market value of the relevant collateral was less than 100% of the principal amount. However, where the market value was less than 100% of the principal amount, the investment manager and the seller of the asset agreed to document an amount owed by the seller to the issuer, described as an "upfront fee".

The upfront fee in all cases was structured so as to equal 100% of the principal amount, minus the agreed market value. The actual amount paid from the issuer's account to the seller was the stated purchase price (100%), minus the upfront fee. This net amount was thus equal to the agreed market value, yet the stated purchase price remained 100%.

BNYM says that the issuer was not aware that this practice was being followed. However, it notes that there is no suggestion that the upfront fees were applied for the benefit of the investment manager. Based on the information provided to the issuer, the fees were applied for the benefit of the issuer, in order to reduce the net purchase price payable by the issuer to the seller.

In the case of certain CDOs, the upfront fee was greater than 10%, meaning that the net amount paid from the issuer's account was less than 90% of the principal amount of the relevant asset. This raises the question of whether the purchase price of each such asset should be deemed to be the stated purchase price or the net amount paid. If the former, the obligations would be compliant with eligibility criterion; if the latter, they would be non-compliant.

The potential breach of eligibility criterion relates to CDOs where the upfront fees exceeded 10% of the principal amount. The issuer understands that the aggregate par value of these assets was €9.9m and that the aggregate upfront amount was €2.1m.

IKB has informed the issuer that in these cases it believes that the purchase price should be deemed to be the stated purchase price and that the eligibility criterion has not been breached. Further, it says that these structured price arrangements were disclosed in investor reports. Nonetheless, for the avoidance of doubt going forward, the purchase price will be stated net of any upfront fees.

If the eligibility criterion have been breached, it is possible that Clause 11.3 of the trust deed has inadvertently been breached. If so, and if the trustee were to determine that any such breach was materially prejudicial to the interests of the noteholders, then a potential event of default on the notes could occur.

CLOs

MV CLO reduces funding costs

The Avoca Credit Opportunities market value CLO has issued an unrated €30m Class E-7 subordinated note, due 2086. The E-7 notes were issued in order to simultaneously redeem in full the Class I-1 intervening notes.

The I-1 notes were originally issued to provide additional subordination to the transaction. By replacing the I-1 notes with the E-7 notes, the issuer maintains the same level of subordination while reducing its cost of financing. There was no effect on the overcollateralisation tests of this transaction, according to Moody's.

The rating agency has determined that the issuance will not cause the current ratings of the notes to be reduced or withdrawn. It does not express an opinion as to whether the Class E-7 issuance could have non-credit related effects.

CLOs

CLO Class Bs cancelled

Moody's has determined that the purchase and cancelation of €2m notional of Egret Funding CLO I Class B notes at a price of 72.5% of par will not cause the current ratings of the notes to be reduced or withdrawn. The purchase is being financed from section Y of the deal's interest waterfall, which is junior to all Class A, B, C, D and E coupon payments, but senior to equity distributions. It is expected that this purchase will occur on 31 December 2009.

CLOs

Dutch CLO notes repurchased

The issuer of Scute Bali has bought back €205.8m of the Class A notes. Scute Bali is a €1.51bn NIBC-managed balance sheet CLO that launched in June 2008. The single-A minus rated Class A notes were issued at 50bp over six-month Euribor.

CMBS

Fed rectifies TALF CMBS error

The New York Fed says one legacy CMBS - CUSIP 059497AX5 — was accepted as TALF collateral that would not have been accepted using the current methodology. Upon reviewing its stress value estimates, the Fed recently identified and corrected the methodological error that allowed the bond to be accepted.

However, it expects no losses on the loans backed by this CMBS because the stress value is based on extremely unlikely economic circumstances and because the market value of this CMBS is well above the TALF loan amounts.

The Fed says it will not accept CMBS CUSIP 059497AX5 as collateral for new TALF loans at or around its current market price, and states that it continues to reserve the right to reject any legacy CMBS in the future, whether or not the legacy CMBS was previously accepted.

As part of the process for reviewing requests for TALF loans to be collateralised by legacy CMBS, the Fed conducts a risk assessment of the proposed collateral. The assessment considers whether the estimated value of the CMBS would fall below the loan amount, should economic conditions turn out to be much worse than expected. The Fed currently obtains these 'stress value' estimates from two separate vendors.

Distressed assets

Troubled public companies index improves

The Kamakura index of troubled public companies improved in December for the eighth time in the last nine months. The index declined from 11.45% in November to 11.07% in December, a total decline of 12.93% for 2009. Kamakura's index had reached a peak of 24.3% in March.

Kamakura defines a troubled company as a company whose short-term default probability is in excess of 1%. Credit conditions are now better than credit conditions in 63.6% of the months since the index's initiation in January 1990, and the index is 2.63% better than the index's historical average of 13.7%.

The all-time low in the index was 5.40%, recorded on 11 May 2006, while the all-time high in the index was 28.0%, recorded on 28 September 2001. The index is based on default probabilities for almost 27,000 companies in 30 countries.

Emerging Markets

Record Lebanese auto ABS closed

Bemo Securitisation (BSEC) in late December completed the second revolving auto securitisation for Bassoul & Heneiné, the exclusive distributor in Lebanon of BMW, Renault, Mini Cooper, Alfa Romeo and Dacia brands. The deal is a US$14.4m securitisation of the company's portfolio of auto loans and constitutes the largest asset-backed issuance in the local market.

Cylinder II is a structured investment fund, established under the Lebanese Securitisation Law 705 pursuant to Banque du Liban approval. On the closing date, the fund issued two classes of notes, class A and class B, which are backed by a diversified portfolio of auto loans purchased by the fund from Bassoul & Heneiné. The class A notes have an expected weighted average life of 3.9 years and a yearly fixed coupon of 7.25%, while the class B note was retained by Bassoul & Heneiné. Investors from the first Bassoul & Heneiné transaction - launched in 2005 - subscribed to the new deal.

The structure provides for a revolving period, during which additional loans may be sold to the fund by Bassoul & Heneiné and the financing can be increased by up to US$44m. Different types of credit enhancements are embedded in the structure to ensure the maximum protection to noteholders; these being first-loss protection, a cash reserve fully funded on closing and an excess spread trapping mechanism. These credit enhancements come in addition to other structural enhancements, such as portfolio eligibility criteria and conditions precedent to purchase, amortisation and accelerated amortisation triggers.

The deal is structured, arranged and lead managed by BSEC, and the deal was underwritten by Banque BEMO, BEMO Europe Banque Privée, Medgulf, Fransa Invest Bank and Federal Bank of Lebanon.

Indices

iTraxx SovX CEEMEA due next week

The iTraxx SovX CEEMEA index will start trading on 20 January. Markit says that the index will provide market participants with a standardised tool to hedge or gain exposure to the risk of 15 countries across the CEEMEA region.

The 15 countries represented in the index have a combined total outstanding CDS notional of US$530bn. The new index will replace the existing theoretical index and start trading as Version 2 of Series 2 with more than ten market makers.

Markit launched the Markit iTraxx SovX indices in July 2009. The first of these indices to be traded was the Markit iTraxx SovX Western Europe index.

Indices

Trend continues in ABX remittances

Remittance reports for the December ABX.HE distribution date show a continuation in the trend of moderating defaults and build up of the 60+ delinquency bucket, according to ABS analysts at Barclays Capital.

Default rates declined by an unusually large 2.4 CDR in aggregate (falling by 2.98, 2.29, 1.97 and 2.45 across the 06-1 to 07-2 series), the fifth straight monthly drop. "This suggests a further drop in REO liquidation rates as servicers await the results of modification trials. We expect CDRs to remain low over the next few months as servicer foreclosure paralysis continues to shrink REO buckets," the analysts note.

Severities changed by -1.69, 2.77, -1.31 and -1.08 points for the 06-1, 06-2, 07-1 and 07-2 series respectively. While the lengthening time in foreclosure is expected to increase severities over the medium term, the loans being liquidating at present are generally not subject to foreclosure bottlenecks.

The flipside of foreclosure paralysis is a slow build-up in the seriously delinquent and foreclosure categories, the analysts point out. Aggregate 60+ delinquencies (including foreclosure and REO) grew by 74bp, 89bp, 113bp and 108bp across series 06-1 to 07-2, roughly in line with increases since September. However, the backlog of 60+ loans is expected to continue to rise during the winter.

Indices

Homebuilders CDS index prepped

S&P is preparing a new CDS index, the US Homebuilders Sector Index. The index provides exposure to US-based companies from the consumer discretionary and industrials GICS sector, as well as the home building, home improvement retail, home furnishings and building products industry groups.

As with S&P's other CDS index offerings, the new product focuses on liquidity with the goal of supporting investment products, such as index funds, index portfolios, and index futures and options. Index levels are published daily for three types of sub-indices: base, event inclusive and rolling.

Indices

2004/2007 subprime RMBS prices buck trend

While US subprime RMBS prices on the whole continue to stabilise, 2004 and 2007 vintages showed notable declines, according to Fitch Solutions in its latest RMBS CDS indices results.

Fitch Solutions' US Subprime RMBS Price Index increased by just over 5% month-on-month to 7.62 as of 1 January - up from 7.25 a month previously. The 2005 vintage was the main driver of the positive trend, showing strong growth of 4.7% to reach 8.42. The 2006 vintage also showed marginal improvement by rising to 2.81.

The 2004 and 2007 vintages, however, showed respective declines of 7% and 11%.

Recent loan-level analysis conducted by Fitch Solutions of the indices' constituents found an increase in the six-month constant default rate (CDR) as a primary driver behind the underperformance. "Higher quality borrowers' ability to refinance this past summer resulted in higher prepayment rates, but left 2004 vintage pools on average with lower credit quality borrowers," says Fitch Solutions md Thomas Aubrey. The 2004 CDR rose to 18.6% from 17.6% month-on-month.

Historical 90-day plus delinquencies in the 2007 vintage jumped significantly to 14.6% from 14%, which according to Aubrey suggests that default rates may begin increasing within the 2007 vintage.

Operations

Accounting issues continue to dominate

The dual issues of global convergence and accounting for financial instruments are set to dominate the accounting landscape in 2010, Fitch notes, following the financial crisis that challenged accounting policymakers and aggravated the implementation and interpretation of key accounting issues.

A number of countries are gearing up to fully adopt IFRS in the next two years, including Brazil, Japan and Canada. Meanwhile, the US still awaits the US SEC's plan to announce a decision on the adoption of IFRS by all public companies. The initial SEC 'roadmap', which requested comments from market participants in 2008, is now viewed by some participants to be overly ambitious - particularly the option to allow some companies in the US to adopt IFRS at the end of 2010.

"In spite of many perceived setbacks, including political and regulatory pressures, resulting in divergent FASB and IASB proposals on financial instruments, it is highly unlikely that the US would completely withdraw from the ultimate goal of a single set of global accounting standards," comments Olu Sonola, director at Fitch. "The more likely scenario is for the SEC to amend the current timetable while establishing more milestones to lay the path to the eventual adoption of IFRS by all US public companies as advocated by G20 leaders."

In the US the expected consolidation of many former off-balance sheet structured entities, such as securitisations, in the first quarter of 2010 will likely produce pockets of unexpected announcements by non-financial companies. Most of the effects will likely be on the balance sheets of financial institutions - in fact many banks have already disclosed the expected impact on capital and their balance sheet.

From a longer-term perspective, Fitch notes that analysts and investors should be aware of several other accounting changes that standard setters will continue to debate in 2010 - including financial statement presentation, lease accounting and revenue recognition.

Real Estate

Non-bank CRE origination gathers pace

Another non-bank lender has announced its successful origination of new commercial real estate loans, following the recovery seen in the CMBS market last year (see SCI issue 165). Mortgage REIT Starwood Property Trust has closed three first mortgage loans for US$107.8m, with an expected unlevered return of approximately 11.3% inclusive of fees and a weighted average LTV of approximately 61.5%.

The originations comprise: a US$73.8m loan on a portfolio of 17 extended stay hotels located in Florida, Virginia, Maryland, North Carolina and Georgia; a US$18m loan on a beachfront hotel located in Laguna Beach, CA; a US$16m loan on a retail centre located in Orland Park, IL.

Starwood reports that it has also recently invested approximately US$32m in single-borrower CMBS, which were acquired at a blended purchase price of approximately 79% of face value with an expected unlevered return of 12%.

Real Estate

Prime US CRE collateral on offer

The Carlton Group has been retained on behalf of a number of CMBS trusts on the sale of approximately US$307m of non-performing loan and REO assets located throughout the US. The portfolio consists of prime office, industrial, retail, multi-family, assisted-living facility and self-storage assets.

While most recent commercial real estate loan sales have been characterised by land lots and other partially completed assets, Carlton says that this asset sale provides exposure to well-capitalised local and regional investors, as well as national players with domain expertise, the ability to acquire loans and REO secured by high quality and, in most instances, cash-flowing collateral.

The assets are being offered on a competitive sealed-bid basis, with bids due by 25 February. Prospective bidders may bid on an individual asset, on any number of assets or the entire portfolio.

Regulation

Supervisors target 'regulatory gaps' ...

The Joint Forum has published a report that seeks to address regulatory issues in connection with certain unregulated or lightly regulated entities. The document, entitled 'Review of the Differentiated Nature and Scope of Financial Regulation - Key Issues and Recommendations', was prepared for the G20 to help identify potential areas where systemic risks may not be fully captured in the current regulatory framework.

John Dugan, chair of the Joint Forum until the end of 2009 (see separate Job Swaps story) and US Comptroller of the Currency, says: "This paper takes a focused look at certain regulatory gaps that became apparent during the crisis. There are some key recommendations in this report that, once implemented, will reduce those gaps and strengthen regulation of the financial system."

He adds: "Consistency in regulation and similar supervision for similar activities are key principles for effective oversight of systemic risks. This report sets the stage for additional important work that will lead to greater convergence of the supervision of financial activities and firms."

Findings and recommendations are presented in five key issue areas: issues arising from regulatory differences across sectors; supervision of financial groups, focusing on unregulated entities within those groups; residential mortgage origination, focusing on minimum underwriting standards consistently implemented by different types of mortgage providers; hedge funds, especially those that present systemic risk; and credit risk transfer, focusing on credit default swaps and financial guarantee (FG) insurance.

Specifically regarding CDS and FG insurance products, the Joint Forum's analysis identifies five issues as being common to both, with each contributing to the recent crisis or posing cross-sectoral systemic risk. First is inadequate risk governance: sellers of credit protection did not - and often could not (given their existing risk management infrastructure) - adequately measure the potential losses on their credit risk transfer activities. Buyers of protection did not properly assess sellers' ability to perform under the contracts and they permitted imprudent concentrations of credit exposures to uncollateralised counterparties, according to the report.

The second issue highlighted is inadequate risk management practices: poor management of large counterparty credit risk exposures contributed to financial instability and eroded market confidence. Some CDS dealers are said to have ramped up their portfolios beyond the capacity of their operational infrastructures.

Third is insufficient use of collateral: the absence of collateral posting requirements for highly rated protection sellers allowed firms to amass portfolios of OTC derivatives and FG insurance contracts - thus creating "excessive" credit exposures for their counterparties - that were far larger and riskier than would have been the case had they been subject to normal market standards that require collateral posting. Fourth is an apparent lack of transparency, which made it difficult for supervisors to understand the extent to which credit risk was concentrated at individual firms and across the financial system.

Vulnerable market infrastructure is the final issue to be highlighted. The concentration of credit risk transfer products in a small number of market participants created a situation in which the failure of one systemically important firm raised the probability of the failure of others, the report says.

The Joint Forum consequently offers five recommendations in connection with the CDS and FG insurance sectors, including encouraging/requiring greater transparency for both markets. Under the recommendations, firms should disclose risk characteristics of instruments, risk exposures of market participants, valuation methods and outcomes, and off-balance sheet exposures (including investments with unregulated entities and contractual triggers that may lead to the posting of collateral, claims payment or contract dissolution).

Supervisors should also promote the appropriate and timely disclosure of CDS data relating to price, volume and open interest by market participants, electronic trading platforms, exchanges, data providers and data warehouses. With this greater transparency, they should monitor concentrations that could pose systemic risks and develop tools to conduct enhanced surveillance of CDS markets to detect and deter market misconduct.

The other recommendations encourage supervisors to: continue to work together to foster information-sharing regarding CDS market information and regulatory issues; continue to review prudential requirements for CDS and FG insurance (and take action where needed, including setting appropriate regulatory capital requirements for CDS transactions and establishing minimum capital, solvency, reserving and liquidity requirements for FG insurers); continue to promote current international and domestic efforts to strengthen market infrastructure, such as supervised/regulated CCPs and/or exchanges; and clarify the position of FG insurance in insurance regulation.

In addition, the report highlights a number of other options that could also be explored. One is to ring-fence the potential losses of other business lines from the traditional business underwritten by FG insurers, so it is separately reserved and capitalised. Others include prohibiting/limiting exposure by FG insurers to pools of ABS that are partly or wholly composed of other pools and requiring FG insurers to set maximum limits for exposure to any one risk or group of risks.

Regulation

... as Basel Committee reform package is reinforced

The oversight body of the Basel Committee on Banking Supervision has welcomed the substantial progress made towards translating the group's September 2009 agreements into a concrete package of measures, as elaborated in its December 2009 consultative proposals (see last issue). These proposals are designed to strengthen the resilience of the banking sector and the international framework for liquidity risk measurement, standards and monitoring. The Committee aims to deliver a fully calibrated and finalised package of reforms by the end of this year.

ECB president Jean-Claude Trichet, who chairs the group, emphasises that timely completion of the Basel Committee reform programme is critical to achieving a more resilient banking system that can support sound economic growth over the long term. In particular, the group welcomes the Basel Committee's focus on both micro-prudential reforms to strengthen the level and quality of international capital and liquidity standards, as well as the introduction of a macro-prudential overlay to address pro-cyclicality and systemic risk.

It has also provided guidance and noted the importance of making progress in the following key areas: provisioning, introducing a framework of countercyclical capital buffers, addressing the risk of systemic banking institutions, contingent capital and liquidity. According to the group, it is essential that accounting standards setters and supervisors develop a truly robust provisioning approach based on expected losses (EL).

Building on the Basel Committee's August 2009 Guiding Principles for the replacement of IAS 39, a sound EL provisioning approach should achieve the following key objectives: address the deficiencies of the incurred loss approach without introducing an expansion of fair value accounting; promote adequate and more forward-looking provisioning through early identification and recognition of credit losses in a consistent and robust manner; address concerns about pro-cyclicality under the current incurred loss provisioning model; incorporate a broader range of credit information, both quantitative and qualitative; draw from banks' risk management and capital adequacy systems; and be transparent and subject to appropriate internal and external validation by auditors, supervisors and other constituents.

So-called 'through-the-cycle' approaches that are consistent with these principles and which promote the build-up of provisions when credit exposures are taken on in good times that can be used in a downturn would be recognised. The Basel Committee is expected to translate these principles into a practical proposal by its March 2010 meeting for subsequent consideration by both supervisors and accounting standards setters.

With regards to introducing a framework of countercyclical capital buffers, it should contain two key elements that are complementary. First, it is intended to promote the build-up of appropriate buffers at individual banks and the banking sector that can be used in periods of stress. Second, it would achieve the broader macro-prudential goal of protecting the banking sector from periods of excess credit growth through a countercyclical capital buffer linked to one or more credit variables.

Meanwhile, supervisors are working to develop proposals to address the risk of systemically important banks (SIBs). To this end, the Basel Committee has established a Macro-prudential Group.

The Committee says it has been encouraged to develop a menu of approaches using continuous measures of systemic importance to address the risk for the financial system and the broader economy. This includes evaluating the pros and cons of a capital and liquidity surcharge and other supervisory tools as additional possible policy options, such as resolution mechanisms and structural adjustments. This forms a key input to the Financial Stability Board's initiatives to address the 'too-big-to-fail' problem.

In addition, based on information collected through the quantitative impact assessment, the Committee is required to flesh out the details of a global minimum liquidity standard - including both the 30-day liquidity coverage ratio and the longer-term structural liquidity ratio.

The aim of the new global standards should be to achieve a better balance between banking sector stability and sustainable credit growth. Trichet explains that the Basel Committee's oversight group will provide strong oversight of the work of the Basel Committee during this phase, including both the completion and calibration of the reforms.

The fully calibrated set of standards will be developed by the end of 2010 to be phased in as financial conditions improve and the economic recovery is assured, with the objective of implementation by the end of 2012. This includes appropriate phase-in measures and grandfathering arrangements for a sufficiently long period to ensure a smooth transition to the new standards.

Regulation

Euro ABS retention impact remains uncertain

The impact of the forthcoming risk retention requirement for European securitisations under the EU capital requirements directive (CRD) is uncertain and highly dependent on the specifics of each securitisation and on the economic environment through the life of the securitisation, according to Fitch. In particular, it may not consistently align the interests of investors and originators across structured finance - a key objective of the European regulatory community.

The retention rule stipulates that European banks must retain 5% of securitisations that they originate and place with investors (SCI passim). The rule becomes effective in Europe in 2011.

In a new report, Fitch finds that the effects are likely to be muted for typical securitisations from established bank balance sheets. The changes may, however, reduce the attractiveness of the originate-to-distribute model - especially for lightly capitalised originators - due to the requirement for ongoing originator 'skin in the game', which may help avoid some of the worst excesses of the subprime crisis.

"Regulators are struggling with competing objectives. In some cases, the option under the retention rule that best achieves the stated objective of aligning originator and investor incentives may also remove the economic incentive to securitise, undermining broader regulatory and policy efforts to restore effective securitisation markets," says Ian Linnell, group md in Fitch's European structured finance group.

Fitch says that, in practical terms, increased disclosure will be just as important to the success of restoring confidence to the securitisation markets.

RMBS

Doubt over servicing advance for Dutch RMBS

E-MAC NL 2003-1 has issued a notice stating that two stages of the deal's put option process - the rating agency confirmation and the determination of the extension margins - have been unsuccessful. As a result, the notes are due to be redeemed in full on 25 January (their put date).

However, the redemption is believed to require a servicing advance from GMAC RFC NL of €111m to the issuer. If, in turn, the redemption of the notes is unsuccessful, this would amount to an event of default.

Moody's downgraded the ratings of all the E-MAC NL 2003-I notes following the publication of the notice. The rating agency believes that the transaction is now more likely to experience an enforcement event, given the uncertainties surrounding the ability of GMAC RFC NL to provide funds for the notes to be redeemed. GMAC RFC NL is an indirect wholly-owned subsidiary of ResidentialCapital, which Moody's rates at its lowest rating of C, with a stable outlook.

European securitisation analysts at Deutsche Bank point out that the documentation does not clarify what coupon should be paid in case of the issuer being unable to determine the extension margins. "While just last July GMAC provided the advance for the redemption of EMAC NL 02-I following a similar non-confirmation of ratings, we note the 02-I deal had structural issues not present in 03-I and that the subsidiary of a C/CCC/C rated entity is likely to find the funding of such a redemption onerous," they note.

RMBS

Over US$47bn prime/Alt-A IOs to recast

Many US prime and Alt-A mortgage borrowers that are making interest-only (IO) monthly payments will experience a payment shock over the next year due to a recasting of these IO loans to full principal and interest payments, according to Fitch.

Over US$47bn of prime and Alt-A RMBS collateral is due to recast over the next 12 months from an IO payment to a fully amortising payment. This recast exposes borrowers to an average payment increase of 15% and possibly higher if interest rates increase. Over the next two years, a total of US$80bn of prime and Alt-A loans, and a total of US$50bn subprime loans are due to recast.

This payment shock will have a substantial effect on the recasting population, according to Fitch md Roelof Slump. "60-day delinquency rates have risen over 250% in the 12 months following previous recasts for prime and Alt-A loans," he says. "Even though Fitch's current ratings consider the risks of upcoming IO recasts, mortgage pools with significant interest-only loan concentrations may be downgraded if performance is worse than anticipated."

Recasts typically have a significant impact on loan performance. While only 3.3% of prime loans are 60 or more days delinquent prior to recast, delinquencies the year after recast increased to 9.3%. Similar effects have been seen in Alt-A and subprime, with delinquencies increasing from 12% to 29% for Alt-A and from 20% to 58% for subprime.

"Furthermore, declining borrower equity is still eroding refinancing opportunities and incentives to continue payment," says Slump. "On average, current loan-to-value (LTV) ratios for prime and Alt-A loans are 118%, with 64% of borrowers having negative equity."

Fitch expects the effect of higher expected defaults on IO loans figures to be relatively small on the overall market since these loans account for only 8% of the securitised non-agency market. However, there is significant performance risk in RMBS transactions with high concentration of IOs, particularly if a large portion of loans recast around the same time.

According to the agency, it was not uncommon to see IO concentrations of greater than 50% in certain securitisations. Performance on these pools will be particularly hard-hit by recasts.

"If observed IO performance results in higher than expected loss estimates for Fitch-rated RMBS, this may result in further negative pressure on long-term ratings and/or recovery ratings (RRs)," says Fitch.

RMBS

Underwater prime borrowers on the rise

More US prime jumbo borrowers are falling and staying behind on their monthly mortgage payments, with states such as California and Florida driving the elevated underperformance, according to Fitch in the latest edition of its US RMBS delinquency updates.

Overall, prime RMBS 60+ days delinquencies rose to 9.2% for December 2009, up almost three times compared to the same period last year (3.2% in December 2008). The 2006/2007 vintages combined rose to 12.7% from 4.3%.

The five states with the highest volume of prime jumbo loans outstanding (California, New York, Florida, Virginia and New Jersey) comprise approximately two-thirds of the loans in question. Prime jumbo RMBS 60+ days delinquencies for these states at December 2009 compared to December 2008, and their approximate share of the US$388bn market, are: California - 10.8%, up from 3.5% (44% share); New York - 5.8%, up from 1.8% (7% share); Florida - 16%, up from 7.3% (6% share); Virginia - 5.4%, up from 2.3% (5% share); and New Jersey - 7.1%, up from 2.3% (4% share).

Prime jumbo borrowers that were current on their mortgage the previous month but missed a payment the following month (roll rates) averaged about 1% a month for the last 12 months, reaching a seasonal high of 1.3% in December 2009. "While some of these borrowers caught up, many either remained a payment late or became more delinquent in the succeeding months," comments Fitch md Vincent Barberio.

Despite some improvement in home prices and a slowdown in employment loss, roll rates have not improved, primarily due to the number of prime jumbo borrowers who owe more on their mortgages than their home is worth. "Over one-third of prime jumbo borrowers that are current on their mortgages also are 'underwater' on their mortgages," adds Barberio.

RMBS

Solid performance for Indian RMBS

The performance of Indian RMBS remained stable throughout 2009 due to low levels of default and high amortisation, according to Fitch's latest Indian RMBS report.

According to Jatin Nanaware, associate director in Fitch's structured finance team, well-seasoned transactions have experienced substantial credit enhancement build-up, which on average increased to 4.13x as of September 2009 from 3.16x in September 2008.

Fitch has also introduced the Fitch Indian Residential Mortgage (FIRM) delinquency index. This tracks the 90+ days past due (dpd) principal as a percentage of initial principal outstanding for residential mortgage loans in Indian RMBS transactions that are publicly rated by the agency.

"The index will be a useful benchmark for investors to compare the trends in credit performance across different RMBS transactions in India over time," says Dipesh Patel, senior director in Fitch's structured finance team.

During 2009, the agency affirmed nine publicly rated RMBS transactions and all 13 series have a stable outlook. In its opinion, low delinquency trends in these transactions can be attributed to factors such as high borrower equity, low instalment-to-income ratio and revisions to loan payment schedules.

In addition, Fitch has performed a loan-by-loan analysis on 25,800 outstanding loans backing Fitch-rated RMBS transactions in order to study the key drivers of collateral performance. The analysis confirms its assumption of delinquency behaviour with respect to key collateral characteristics, such as original loan-to-value, sources of income and geographical location.

RMBS

Fitch warns on ABI loan modification scheme

The mortgage loan modification scheme launched on 18 December 2009 by the Italian Banking Association (ABI) could have a negative impact on Italian RMBS ratings if issuers implement it without correcting for potential distortions that could affect standard RMBS structural features, says Fitch. The scheme consists of a 12-month mortgage loan payment holiday, either on principal payments only or principal and interest payments, for financially distressed borrowers that satisfy certain eligibility criteria. If a mortgage loan is in arrears at the start of the payment holiday, the arrears period is counted as part of the 12-month payment holiday.

Fitch notes that Italian RMBS loans are normally classified as delinquent or in default, for the purpose of the transaction, depending on the number of instalments in arrears. Delinquent and defaulted loan statistics are used in Italian RMBS to regulate a series of structural features. Fitch takes these features into account in its rating analysis of Italian RMBS and they are considered, in some instances, as crucial for the rating performance of such notes, including the excess-spread provisioning mechanism to cover for defaulted loans.

If the new scheme is implemented by an RMBS issuer, borrowers entering the payment holiday would theoretically be classified as performing, as they would 'freeze' their arrears status until the end of the payment holiday window. Therefore, should an RMBS issuer implement the scheme without adjusting the delinquent and defaulted loan definitions to take payment holidays into account, the loan modification scheme could result in a weakening of the transaction's structural features and potentially have a negative impact on note ratings.

In addition, the payment holiday scheme could impact the swap payments of certain transactions, resulting in a potential weakening of swap coverage and/or a change in swap payments. This in turn could result in an issuer's swap counterparty requesting a termination of the swap agreement.

As the borrowers benefiting from the payment holiday are distressed borrowers, Fitch would expect RMBS issuers that implement the scheme to improve their portfolio reporting and to provide enhanced disclosure about the number of loans that are subject to a payment holiday. Such additional reporting would enable the agency to adequately assess the quality of the pool and whether the payment holiday had resulted in a distortion of pool performance.

The agency would also expect originators that decide to implement the scheme through a bilateral agreement with a borrower (i.e. a personal loan to the borrower to help the borrower repay the securitised mortgage), without involving the RMBS issuer, to show that any agreements contained an explicit acknowledgment by the borrower that the loan has been securitised and that the agreement with the originator is not binding for the RMBS issuer.

SIVs

Sedna SPS notes default

Fitch has downgraded the second priority senior (SPS) notes issued from the MTN programmes of Sedna Finance to D from single-C. Following the June 2009 payment date, the SIV's first priority notes were paid in full; however, there are no more assets in the portfolio and no remaining funds to pay the outstanding balance of the SPS notes.

Technology

Managing valuations process set to become costlier

With OTC derivative end-users asking for more information and increased access, the cost of managing the valuations process is on the rise. This is according to a new report - entitled 'Shifting Gears to Navigate the New World of Valuations: Pressures, Priorities, Practices and Prospects - published by consulting firm Celent.

With respect to IT spending for pricing and valuations, Celent estimates that front office intraday pricing IT spending will grow at a compound annual growth rate of 4.6% to US$1.1bn in 2013. This is primarily driven by a moderate growth in the number of traders and quants (between 2% and 5%).

Middle/back office IT spending for recurring valuation services will grow at a CAGR of 1.6% to almost US$550m in 2013. This will be driven by reasonable growth in CDS positions (15%-20%), single-digit growth in bonds and moderate recovery in structured credit positions in 2011 and beyond.

For recurring valuation services, spending has come from a demand spike in 2007-2008 and so Celent expects IT spending to moderate, growing at 1.6% to nearly US$550m in 2013. Despite this relatively low headline growth figure, the demand for data in different asset classes varies significantly for pricing and valuation services. For example, in the credit derivatives sector, the industry is expected to grow in excess of 10%.

The report also finds that in terms of supply side dynamics the valuation vendor ecosystem is highly fragmented, with a lot of small players occupying niche segments. The provision of valuation solutions is broadly divided along three lines: front office intraday price discovery mechanisms; post-trade/recurring valuation; and agents that repackage/redistribute price and valuation data.

When selecting valuation service providers, customers adopt a best-in-class approach. They mix and match vendor data down to the field level, often because of the wide-ranging complexity that exists across asset classes. Generally, Celent has identified that customer buying dynamics are triangulated along three factors: size of the firm, front office versus back office dynamics and asset class complexity.

In the long run, firms are anticipated to reduce the number of suppliers they engage for valuation requirements. Thus, the market is ripe for valuation vendors, OTC/structuring application firms, pricing model providers, data vendors and risk system suppliers to form tighter ecosystem partnerships to deliver end-to-end solutions and to facilitate greater convergence in the two areas.

Looking ahead, Celent expects these themes and practices to shape future asset valuation activities: aligned price methodologies; data 'connectedness'; transparency and model risks; operational efficiency for valuation control activities; and systematic assessment of third-party valuation providers.

Technology

Basel 2 capital charges tool debuts

Fitch has launched its Basel 2 supervisory formula approach (SFA) tool, which calculates capital charges on a set of unrated tranches of standard securitisations. The tool, which is aimed at banks that use an internal ratings-based (IRB) approach to credit risk, covers the most common asset types (RMBS, ABS, CMBS and CDOs of corporates and structured finance) with loan assets where all relevant IRB risk parameters are available - such as probability of default, loss-given default, maturity adjustment factor and potentially SME turnover adjustment - and where there is a clear seniority structure of the liabilities.

The SFA Tool comprises two Excel sheets - one for data input and the second for the calculation output - and a user guide. Users are required to input details, including covering the portfolio type, collateral pool that underlies the securitisation and also the capital structure of the securitisation. The tool can be used for securitisations of one single type of assets only.

The SFA Tool calculations are primarily based on a credit loss distribution model set out in the Basel 2 document, entitled 'International Convergence of Capital Measurement and Capital Standards'.

Technology

Technology briefs

Vendor signs up for ASF LINC
Clear Capital has updated its systems to accept the American Securitization Forum Loan Identification Number Code (ASF LINC) - the standardised universal code intended to create greater data transparency at the collateral level across the ABS and MBS segments.

"We are eager to work with the industry to help facilitate a new generation of more transparent reference data for origination and securitisation models," says Kevin Marshall, Clear Capital president.

The sixteen-digit ASF LINC captures the loan type, origination date and country of origin, as well as randomised alphanumeric data, to create a unique ID for a wide range of loans that may be pooled and sold into the capital markets.

New ABS valuation tools unveiled
Pricing Partners has released several new tools for ABS valuation. Within the new framework, users can take into account both prepayment risk and default risk of structured credit products, with the ability to mark their own assumptions and use market data from traditional platforms like Intex or Bloomberg.

Marian Ciucă, head of quantitative research at Pricing Partners, says: "The chosen amortisation profile is calibrated in order to match the observed average life of the ABS bond. Then, using the ABS bond price, we bootstrap the default intensity of the underlying and imply the survival probabilities."

Pricing Partners is also offering clients access to the latest, publicly available model used by Fitch for its ABS CDOs. Several other Factor Copula models can, however, be used to evaluate the products.

Quantifi upgrades risk analysis software
Quantifi has released Version 9.3 (V9.3) of its pricing, hedging and risk analysis software. V9.3 provides more robust risk reporting, streamlined operations, expanded product support and improved performance and scalability, the firm says.

Rohan Douglas, ceo of Quantifi, says: "2009 was a challenging year for market participants and, as we embark upon a new year, the pending 'regulatory tsunami' which will impact the OTC markets is just beginning to be felt. We are finding that our clients need to overcome a number of crucial challenges: improving risk analysis, while increasing performance and improving operations. In light of this, we have released V9.3 to ensure our clients have a competitive advantage by being well-prepared and strategically positioned for future change."

The release introduces several new features, including: improved reporting with Risk Navigator, an aggregation and reporting application that allows users to build interactive composite reports; simplified operations with Credit Event Manager, an application that automates and simplifies workflow processing of corporate events; and expanded product support with Quantifi RISK for synthetic CLOs and CDS options.

Pricing/risk analytics platform enhanced
Numerix has released the latest versions of its pricing and risk analytics software - Numerix CrossAsset and Numerix Portfolio.

Numerix CrossAsset (Version 8.0) users now have access to enhanced pricing models, methods and risk management functionality designed to navigate in the current fast-changing global markets and unprecedented volatility. In addition to advancements in modelling, Numerix has also introduced refined protocol enhancements for the market standard pricing of simpler more fungible instruments pertaining to the global standardisation of derivatives pricing.

The enhancements to Numerix CrossAsset include additional support for trading and risk management of "big bang" standard North American CDS (SNAC) contracts. In particular, they allow the conversion of conventional spread quotes to upfront payments for investment grade CDS and the ability to import the SNAC LIBOR curve needed for these calculations.

Trading

Trading ideas: Donnie's sister

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright short on Anadarko Petroleum Corp

Investment grade energy credits have been on an absolute tear over the past month, with the average spread tighter by 30%. They are now some of the richest amongst all non-financials.

We recommend buying protection on Anadarko Petroleum as a way to play the eventual reversion back to fair value. Anadarko's spread is less than half of what it was a few months prior and has been further held down recently by Exxon Mobil's purchase of XTO. Anadarko is not in a position to be acquired and, given its high debt load, extensive capital expenditures and declining interest coverage, buying protection is a solid trade with limited downside.

Declining interest coverage, massive capital expenditures, large debt load and negative free cashflow - what is there not to like? All jokes aside, Anadarko is not the first company we think of as likely to get into trouble servicing its debt (which stands at around US$12bn). However, for a company whose credit spread trades at a mere 50bp, it deserves serious consideration as a short candidate.

Anadarko's high interest expense, capex and dividends do not give the company much breathing room with regards to its cash flow. Its quarterly capex bill increased to above US$1.4bn at the end of 2008, before being reduced to its latest of US$800m (Exhibit 1). Such high levels provide a substantial drag on cash flow.

Also, as Exhibit 2 demonstrates, declining revenues led to its most recent LTM interest coverage to drop below 5x. The company's leverage (LTM debt to EBITDA) now stands at just over 4x, which is one of the highest amongst high quality E&P credits. Though rising natural gas prices will certainly help the company recover on the revenue side, a repricing of its credit spread is still necessary.

We see a 'fair spread' of above 120bp for Anadarko based upon our quantitative credit model, due to its equity-implied factors, change in leverage, interest coverage and free cashflow factors. Over the past year, our model's expected spread anticipated several shifts in Anadarko's actual credit spread - both wider and tighter.

Back in August, the model and market spread levels notably diverged, leaving the differential at one of its widest points in recent history (Exhibit 3). Since then, Anadarko's spread has been cut in half and now trades near 50bp. Most recently, its spread rallied on the back of Exxon's takeover of XTO.

As shown by Anadarko's recent purchase of TXCO's assets, the company is more in a position to acquire rather than be acquired, thus limiting the possibility of a takeover leading to a tighter credit spread. Given the dramatic drop in spread and reduced takeover risk, the downside to a short position is limited. We will maintain the position for up to six months before stopping out to limit the drag of negative carry.

Position

Buy US$10m notional Anadarko Petroleum 5 Year CDS at 51bp.

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).