Contents

CDS

Balancing act

Sovereign/corporate CDS rebalance needed, but unlikely for now

Continued economic concern over Greece, Portugal and Spain's credit quality has resulted in the iTraxx SovX WE index trading wider than the iTraxx Main since 8 January. While the trend is deemed unsustainable in the long-run, it is unlikely that the situation will rectify itself in the near future.

"The relationship between sovereigns and corporates will have to rebalance, but I don't see the current anomaly rectifying itself any time soon," confirms Tim Brunne, senior credit strategist at UniCredit. "But we've now come to the point where sovereigns are going to have to do something: a world in which a multinational corporate is able to access cheaper financing than a similarly-rated sovereign is not sustainable in the long-run."

However, Brunne notes that governments cannot withdraw stimuli suddenly. While many corporates are able to cope without government intervention, other parts of the economy are potentially still dependent on further fiscal stimulus.

He therefore suggests that the year ahead will be characterised by antagonism between the need for further stimulus and aid, and the necessity that sovereigns withdraw their aid measures and impose additional taxes on the corporate sector in order to improve their fiscal situation. Recent examples of this antagonism include the German government's determination to further cut taxes, the additional bonus and income tax in the UK, Obama's levy on financial institutions, last year's spending cuts in Ireland and the IMF's Strauss-Kahn's call to maintain economic stimulus.

"Surely there are more conflicting measures to follow," says Brunne.

The peripheral sovereigns' overrepresentation in the iTraxx SovX compared with iTraxx Main may be exacerbating the differential in spreads, however. Credit analysts at Barclays Capital demonstrate that a re-weighting of the iTraxx SovX according to the prevalence of names in the iTraxx Main in the different countries shows the iTraxx SovX to be trading 10bp below the iTraxx Main.

"The convergence between Main and a re-weighted SovX makes sense in the light of the ballooning deficits of many countries. However, we find it unlikely that Main will trade below a re-weighted SovX index that respects the composition of names in Main," the analysts note. "The overrepresentation of Greece/Spain/Portugal in SovX relative to Main means SovX could once more see trade above Main due to further noise from the usual suspects."

The Barclays Capital analysts also attribute a large part of the tightening in the iTraxx Main - and the subsequent anomaly seen between the two indices - to new-year technicals, with money being put to work in the cash market, in turn causing a tightening in corporate CDS.

Brunne agrees that the widening in the iTraxx SovX is being driven by Greece's weakness to some extent, but he says other countries are also contributing to the widening. As of 19 January, both Ireland and Greece are trading above 150bp, seven countries are trading between 50bp and 130bp, with the remaining countries below 45bp. "The dispersion is quite wide," he observes.

Credit strategists at Citi, meanwhile, believe that a continued widening of sovereign spreads will increase the risk of spillover to corporates. "In a full-blown sovereign crisis all the usual operating parameters go out the window. Be it civil unrest, sudden political change, extortionate taxation or nationalisation, the uncertainty goes up and that should be reflected in credit spreads," they note.

They add: "The wider the sovereign, the more expensive it is to short and the more tempting it will be for market participants to look elsewhere for proxies. Financials are likely to be a first port of call. The nature of their business, their own holdings of government bonds and the fact that many of them have relied on explicit or implicit government support over the last couple of years make them obvious choices. As such, we'd be increasingly wary of going long financials that now trade flat to or inside their sovereigns."

The iTraxx SovX widened beyond iTraxx Main on 8 January and has remained at wider levels since then. In comparison, on 1 December, the iTraxx Main was trading at 85bp, while iTraxx SovX was 63bp; by 23 December, this differential had shrunk to just 6bp, with the iTraxx Main at 74bp and iTraxx SovX at 68bp.

AC

Investors

Alternative product

Negative basis trades to target ABS CDS and LCDS

A structural shift in the basis market has allowed smaller players to begin exploiting distortions in the space, as exemplified by the launch of a new UCITS III fund that targets such trades. However, opportunities remain scarce, leading some investors to look at ABS CDS and LCDS product.

Jochen Felsenheimer, co-head of credit at Assenagon, confirms that basis trade opportunities aren't as obvious as they were 6-9 months ago. While trades in the investment grade sector are hard to find and remain more difficult in Europe than in the US, for example, the high yield space and moving further down the credit curve can provide opportunities.

"Compared to nine months ago, the basis is tighter but less liquid," explains Felsenheimer. "This means you can't buy €100m, for example, in one go; you have to do a number of smaller trades, which fits better with our fund concept."

He adds: "We're also looking at other negative basis opportunities away from corporate bonds, such as loans versus LCDS and ABS versus ABS CDS. The availability of these kinds of positions is growing and, at the same time, the liquidity of LCDS and ABS CDS has improved significantly lately."

Certainly, pricing sheets in these sectors have proliferated since mid-2009, as the number of forced sellers has risen. For example, as central banks move away from supporting the market and begin tightening their repo eligibility requirements, banks that have repoed collateral with them are increasingly looking to unload certain positions.

Felsenheimer points out that this move represents a structural shift in the basis market. "Historically, the primary buyers of net basis were banks and hedge funds," he says. "Banks are now being forced to reduce their exposure because of the new regulatory capital rules, while hedge funds no longer have access to leverage. At the same time, the net basis has moved from around -50 to 10 times that and is now at historically cheap levels. These factors all facilitate access to the market for smaller players - albeit, even then, not everyone can provide a basis fund, especially via a UCITS III structure."

Assenagon last week launched a new UCITS III fund - Assenagon Credit Basis II. Felsenheimer says that the fund is one example of the industry trying to find new concepts with which to exploit market anomalies. "A UCITS III structure is a nice format for providing innovative strategies in the current environment. It is essentially the right answer to what the industry has learnt from the crisis."

The fund's predecessor, Assenagon Credit Basis, has posted a 10% return since launch, with an annualised volatility of 2%. Furthermore, no investor in the first fund has redeemed their holdings as yet. Felsenheimer remarks that the firm's track record with its first fund meant that the second launch went smoothly, with the fund already having attracted €120m in the first few days since launch.

Assenagon Credit Basis II targets a long-term rate of return of 3.5% for institutional investors and 3% for private investors. Potential defaults of bond issuers and all other capital market risks are hedged, and the portfolio is diversified across various issuers and investment instruments, ensuring wide risk dispersion.

CS

RMBS

Falling short

HAMP modifications fail to meet expectations

The US Treasury and the Department of Housing and Urban Development (HUD) report a significant acceleration in the rate at which borrowers are being approved for permanent modifications under the Home Affordable Modification Program (HAMP). However, a new analysis forecasts that only 400,000 to one million loans will be saved from foreclosure by the HAMP - far short of the three to four million loans that the Obama Administration is aiming for.

As of December, more than 110,000 permanent modifications have been approved under the HAMP, including 66,000 that borrowers have accepted and 46,000 awaiting only the borrower's signature. In addition, more than 850,000 homeowners have had a median payment reduction exceeding US$500.

According to the Treasury, several million homeowners are estimated to be eligible for the programme and more than one million have already received modification offers. At this pace, it says, the programme is on track to meet the goals of the Administration's Homeowner Affordability and Stability Plan.

But Moody's recently published an analysis that counters this claim. The rating agency constructed a loan-level data set in partnership with Equifax, which is representative of the entire mortgage market, in order to evaluate the number of loans that would be eligible to receive a modification under the government's plan and estimate the long-term impact of the plan on avoiding foreclosure.

The main criteria for eligibility in the HAMP are: loans must be originated prior to 1 January 2009; mortgaged properties must be owner occupied; outstanding loan balances must be below the expanded conforming limit; and borrowers' front-end debt-to-income ratios must be greater than 31%. In addition, the programme requires that borrowers are either currently delinquent on their payments or otherwise deemed by servicers to be at risk of 'imminent default'. Using Moody's Mortgage Metrics probability of default model, the rating agency in its latest ResiLandscape publication identified roughly 8.2 million loans in the Equifax database that would meet HAMP eligibility criteria.

For the HAMP-eligible population, the mechanics of the programme involve reducing mortgage note rates in 0.125% increments down to a minimum of 2% so as to bring the monthly housing debt-to-income ratio down to 31%. If the reduction in interest rate alone is insufficient to reach the 31% ratio, loans may be re-amortised with a maximum 40-year loan term to reduce the monthly payment further.

Given currently reported income levels and outstanding loan balances in the sample data, an estimated two million loans cannot be modified to reach the DTI target of 31% by both reducing the rate to 2% and extending the term to 480 months. These loans are therefore ineligible for a HAMP modification.

Next, servicers participating in the HAMP programme employ a net present value test to determine the fraction of the resulting HAMP eligible population of loans that would make economic sense to modify. That is, the NPV value after modification exceeds the NPV value without a modification. In order to meet this criterion, modification will have to result in a substantial reduction in the probability of default of the mortgage to justify the loss of income that comes from reducing interest rates.

Regardless of whether the default occurs as a result of a trigger event or as the exercising of a strategic default option, equity is the main driver of the final default decision. As such, Moody's assumes that the 30% of borrowers with negative equity (that is, their combined loan-to-value ratios exceed 100%) will have likelihoods of default that will not be materially impacted by a note rate modification. In other words, they are likely to default regardless of the mortgage rate.

For HAMP-eligible borrowers with equity, the agency assumes that a quarter will either have so much equity that their likelihood of default is low, even if they experience a trigger event, or their probability of default is already so high due to lack of equity, poor credit and/or low income that the NPV of their loans does not turn positive with modification.

Considering all of these factors together, the study identifies 1.7 million loans with positive NPV that servicers should theoretically be willing to modify. However, this estimate needs to be adjusted downwards by 15% to account for servicers that currently are not participating in HAMP, according to the US Treasury Department.

Once a borrower receives an offer to modify their loan's terms, they then need to accept the offer formally, provide additional paperwork to document the income they are currently receiving and make three timely payments on the mortgage under the new terms. Compliance rates may increase in the future as servicers streamline their processes, but at present Moody's assumes that 40% of trial modifications will convert to permanent status.

The estimated number of both trial and permanent modifications is well below the administration's original expectations. However, even these numbers have to be adjusted downwards to account for the actual number of foreclosures avoided. Data on re-defaults for HAMP-modified loans is sparse, given the limited history of the programme, but previous servicer-initiated modification programmes have yielded re-default rates of around 50%.

Assuming that the documentation and trial payment requirements for HAMP are more restrictive than these other plans, the re-default rate may be closer to 30%, Moody's notes. Under this assumption, 400,000 homes would avoid foreclosure under the plan.

But, given the number of assumptions behind this estimate, the actual number of foreclosures avoided could range from hundreds of thousands up to a million. Despite the imprecision, even the high end of this range of estimates is well below the initial expectations for the programme, Moody's notes.

S&P agrees that, thus far, modification programmes do not appear to have yielded the success the market had hoped for. Although many borrowers are on trial modifications, few of these modifications have been made permanent for various reasons.

In some cases, borrowers did not provide complete documentation; in others, borrowers failed to qualify for a modification after a financial review. Some borrowers have also claimed that certain servicers have either lost documentation or were unresponsive.

Although well-intended, it seems that the aggressive focus on loan modification has inhibited servicers' ability to move forward with legal foreclosure proceedings - such as through mandatory mediation programmes or by adding supplemental layers to an already complex process to successfully foreclose on a property. However, S&P believes that 2010 will be as challenging - if not more so - as 2009 for servicers, as the market looks to them to find additional ways to help ease the current mortgage crisis.

With an uncertain unemployment picture for 2010 and questions about what direction home prices will go, residential loan servicers will likely need to hire new staff and ramp-up training efforts to address the possibility that defaults could increase if trends worsen in these two areas, S&P notes. Servicers may find it difficult to find qualified candidates with specialised loss mitigation and foreclosure processing experience.

To date, most servicer loan modifications have primarily reduced interest rates to lower borrowers' monthly payments. However, some servicers have also reduced outstanding principal loan balances. In light of the low percentage of permanent modifications and the glut of homeowners that owe more than their properties are worth, S&P expects more servicers to actively reduce principal loan balances in 2010.

Given that home prices have declined dramatically in several markets, the rating agency also anticipates large write-downs. Consequently, servicers may be forced to communicate more with the appropriate investors (if in a securitisation) for such approval.

CS

CLOs

Multi-originator microfinance CLO completed

IFMR Capital has closed a multi-originator securitisation of micro-loans originated by four microfinance institutions in India. The Rs308m (US$6.5m) transaction is backed by around 42,000 micro-loans originated by Asirvad Microfinance, Sahayata Microfinance, Satin Creditcare Network and Sonata Finance.

IFMR Capital was the structurer, arranger and an investor in the subordinated strip of the transaction. "Using the multi-originator securitisation structure, we have been able to help a number of MFIs access mainstream capital markets. Given the sizes of the institutions and the limited availability of capital to generate unencumbered portfolios, accessing capital markets on their own is an unviable option for most small and medium MFIs," says Sucharita Mukherjee, ceo of IFMR Capital.

Mukherjee continues: "By pooling together the loan portfolios of these high-quality MFIs, we have demonstrated that these MFIs can access funding at a much lower cost than their average cost of funds. To the best of our knowledge, this is the first multi-originator securitisation of micro-loans in the world".

IFMR Capital Mosec I, the multi-originator SPV, has issued two tranches of securities: a 77% senior-rated tranche, with an expected maturity of six months; and a 23% subordinated strip, with an expected maturity of 11 months. CRISIL has assigned the highest short-term rating of P1+ (so) to the senior tranche, to which Dhanalakshmi Bank subscribed. The closing of this transaction has resulted in the emergence of a new pricing benchmark in the less-than-six-month-maturity asset class.

The IFMR Capital Mosec I securitisation has an average credit enhancement of 13% in the form of cash collateral provided by the four MFIs. The structure has been designed to align the interests of the originator and structurer with the interests of investors.

"This is a landmark transaction for emerging MFIs like Asirvad, as it opens the door to a whole new set of investors and also enables us to leverage our resources in the most efficient way," notes SV Raja Vaidyanathan, chairman of Asirvad Microfinance.

Ajay Verma, ceo of Sahayata Microfinance, adds: "This transaction provides a new source of funding for emerging MFIs. Access to reliable funds from the capital markets will allow Sahayata to achieve their business plan targets and better leverage their balance sheet."

AC

RMBS

Foreclosure paralysis 'not priced in'

US foreclosure-to-REO roll rates (F2R) have trended lower over the past two years, due to servicer capacity constraints, delays from modification programmes and pressure from regulators to keep supply off the market. The trickle in foreclosures has broad implications - not only for loss severities, but also for the bottoming process in home prices - according to RMBS analysts at Barclays Capital.

They suggest that the experience of Countrywide, which experienced a sudden halt in foreclosures well before other servicers when the bank settled with the California attorney general in early October 2008, can shed light on where the market is headed. Countrywide's F2R dropped from 9% to 1% within two months of the settlement, ultimately bottoming at 0.1%. Its foreclosure rates have, however, since normalised and are now only slightly below the aggregate.

The BarCap analysts make several observations based on the Countrywide subprime experience. First is that, by slowing the liquidation process, the foreclosure trickle results in a lower quality severely delinquent pipeline, as is evident from the pipeline LTV.

Second, a combination of adverse selection, servicer advances and reduced short sales could cause Countrywide's severities to rise as much as 10 points as its pipeline reaches the market. And finally, LTV ratios across all subprime collateral continue to rise because of adverse selection - setting the stage for higher future severities.

Foreclosure "paralysis", as exemplified by the Countrywide experience, typically arrests the normal outflow of high loan-to-value loans, resulting in an increase in average LTV in backlogged delinquency buckets. This should, in turn, put upward pressure on loss severities once paralysis ends - thereby impacting aggregate subprime bond valuations.

"Many Countrywide bonds trade 1-2 points behind the market based on high delinquency pipelines, but prospects for rising severities may warrant even larger discounts in some cases," the BarCap analysts explain. "Recent trends suggest that similar concerns could apply to bonds serviced by JPMorgan Chase, although there is no clear reason for Chase F2Rs to fall as much as Countrywide's."

To demonstrate the effect on bond valuations, they price a representative second-pay Countrywide bond - CWL 2006-8 2A3 - using model estimates before and after a 10 point severity increase occurring between years one and three. The effect was worth US$2.26, indicating that a discount of US$1-US$2 for Countrywide bonds is an appropriate discount to add on top of a discount for heavy delinquency pipelines. However, given the risk of substantially higher severities, this may overvalue some Countrywide bonds.

Subprime F2R is now a low 3.4%, implying that the average home will spend 30 months in foreclosure before reaching REO, if rates remain at these levels. The result of this bottleneck has been a build-up of severely delinquent homes: the ratio of severe delinquencies to REO has grown from 3x to 8x in the past year.

Although the BarCap analysts focused on subprime behaviour, they note that these observations should apply to other products as well. "Of course, much could change if modifications are more successful than we expect or if debt forbearance becomes popular," they note. "Paralysis-induced adverse selection is just one factor in determining severities, but it is a risk the market does not seem to have priced in. More generally, the large overhang of severely delinquent loans and low F2R in the general market likely presage higher future severities, in our view."

Meanwhile, variations in servicer performance - as well as changes in transaction cashflows through modifications (see separate News Analysis) - could lead to meaningful tiering opportunities between deals. Such opportunities can be based on modification rates (for instance, higher modification rates can reduce deal CDRs), the share of debt forbearance/forgiveness (greater principal modification will hasten the crossover on subprime), the share of short sales (deals in which servicers more aggressively push short sales could face lower severities on average) and on servicer advances.

For example, the BarCap analysts believe that servicers will reimburse advances from the top of the waterfall once the loan is recapitalised and brought current through modification. A large number of delinquent loans modified in a short period of time could lead to principal payments from the pool being diverted from the front cashflow to pay the servicer, while the corresponding losses hit the subordinate tranches.

This could affect the price of front cashflows negatively in two ways: the bond will become longer as principal payments are reduced; and subordinates will be written down faster, leading to early crossover in subprime. A long ABX 06-2 triple-As/short ABX 06-2 PAAAs trade would capitalise on this opportunity, as the current 30-point spread between the two is unjustifiable and needs to converge, the BarCap analysts conclude.

CS

ABS

Going it alone

The time for government intervention in Euro ABS 'has passed'

The need for government intervention in the European ABS market has passed, according to panellists at a Fitch-hosted conference in London this week. Improving investor appetite, increasing confidence in the performance of existing European transactions and the re-emergence of a primary market were listed as positives for the sector.

"There was a time and a place for government intervention in the European ABS market, but that time has passed," said Robert Liao of Citi's European securitisation market team. "We don't want to create an artificial environment for ABS. If anything, we need constructive statements from governments and consistency between the support they provide to financial products. At the moment, governments are sending mixed messages about the implied quality of an investment by either supporting or not supporting a sector."

This view was shared by Ian Stewart, head of securitisation and mortgage funding at Lloyds Banking Group. He commented that there was a time when more government stimuli would have been helpful, but now that investors are moving back to the market of their own accord, direct government intervention is not necessarily needed.

Graham Page, head of credit at RZB, noted that it would be good, however, to see new ABS deals properly distributed - in other words, without a US bank buying a large proportion of the notes. "If, during 2010, there were around four to five new deals issued a month, I think investor demand could easily meet supply," he said. "However, if that moved to four to five deals per week, I'm not sure that the investor base could swallow it: I'm not entirely sure of what the investor base is."

Notwithstanding the fact that many macroeconomic indicators are pointing to stabilisation in the European structured finance sector, Fitch's structured finance analysts continue to believe that the sector's recovery is fragile and vulnerable to external shocks. "Unemployment is still rising in many European countries and the risk of significant payment shock remains as interest rates begin to increase, particularly as we move into 2011," said Ian Linnel, head of EMEA structured finance at Fitch. "These factors, combined with the fact that many re-financing markets remain illiquid, mean that the scope for further deterioration in European structured finance asset performance remains."

This is reflected in the fact that outlooks for ratings in certain sectors have deteriorated as the effects of the global credit crisis continue to flow through. Fitch says rating changes are likely to still be focused on junior classes, but some criteria changes (for example, in respect of Dutch NHG-backed mortgages) and worst performing deals could mean that ratings further up the curve are affected.

"Prime European consumer ABS and RMBS has performed robustly during the credit crisis, although it is recognised that a major contributing factor to this stable performance has been the very low interest rates, so a sudden rise could have negative consequences," said Page. "Other potential brakes to a recovery in the ABS market could be declining sovereign risk, as exemplified by the recent rating actions on Greek ABS, and it remains to be seen what - if any - affect the various support measures undertaken by some governments (e.g. Italy) will have on the RMBS associated with these regions."

"Governments, regulators and central banks potentially hinder a recovery in the sector due to the lack of clarity in their views," added Liao.

The CRD's 5% ABS retention rule - which is to be applied to all new European primary ABS issuance from 2011 - was also discussed at the conference. Certain panellists expressed their scepticism over the introduction of the rule, suggesting that European regulators were introducing it as a result of European bank losses from recent vintage, 100% originate-to-distribute US subprime RMBS transactions.

Panellists also indicated that the retention rule would not necessarily affect bank business models, but expressed concern over its consequences for non-bank originators. Gerard Breen of the structured finance prudential risk division at the UK FSA argued that the ABS retention rule comes as part of a package of measures, noting that - in and of itself - it will not singlehandedly create alignment of interests between investors and originators.

"We are aware of the retention rule's limitations, such as the fact that 5% retention can, under certain circumstances, be factored into the economics of a transaction by the originator. However, we are also aware of its benefits: as part of a larger package of measures, it discourages the 100% originate to distribute model, helps address the potential misalignment of incentives, and introduces some kind of balance sheet constraint."

He concluded: "The key to its success will be its implementation, and we are currently discussing the details surrounding this."

AC

ABS

Credit card ABS pro recruited

Barclays Capital has recruited Elizabeth Padova Hanson as an md in its asset securitisation origination business in New York. She will lead the bank's coverage of credit card ABS issuers, reporting to Giuseppe Pagano. She was previously an md at RBS Greenwich Capital.

Advisory

UK advisory expands remit with new hires

Structured finance advisory boutique AgFe has acquired Burfield Capital Partners, a specialist commercial real estate debt asset management group. Burfield was founded by Natalie Howard and James Wright after working together in Lehman Brothers' real estate private equity business.

Howard has been a senior banker in the real estate and CMBS sectors for over 20 years, having previously held senior positions at Barclays Capital, Morgan Stanley and Charterhouse. Wright has been working in the real estate and structured finance sectors for over 10 years, having previously worked at Morgan Stanley and PricewaterhouseCoopers.

AgFe has also hired structured finance veteran Steve White, who has worked in the fixed income and structured finance markets for over 20 years, both an investor and a banker. He joins the firm from Cambridge Place Investment Management, where he was the cio in Europe overseeing approximately US$4bn of assets. Prior to CPIM, White spent over 13 years at Morgan Stanley, where he was an md in the securitisation group responsible for capital markets and MBS/ABS origination.

Advisory

Advisory services unit adds Asian md

Houlihan Lokey has hired Bing Chen to join its Hong Kong office as an md, responsible for the growth of the financial advisory services business unit in Asia.

Chen has held leadership positions at global institutions in Asia, the US and Europe. He has experience in the areas of corporate development, restructuring, investment banking and financial advisory services. Prior to joining Houlihan Lokey, Chen served as the ceo of a European specialty financing company.

Earlier in his career, Chen was the cfo of Comdisco Europe, where he restructured businesses in 14 countries with a total value of more than US$1.6bn. Previously, as director of corporate strategy at Deutsche Bank Americas, he directed investment banking strategy, M&A and corporate investments, regulatory compliance, risk and organisational management. He began his career at Arthur Andersen, where he led global projects in several groups, including structured finance and derivatives.

Jack Berka, senior md and global head of financial advisory services at Houlihan Lokey, says: "There is a growing opportunity in Asia for the independent opinions and advisory services that Houlihan Lokey has come to be known for during the past 40 years. The addition of a seasoned professional such as Bing to our Asian team will allow Houlihan Lokey to capitalise on this opportunity and provide Asian clients with the full range of expertise and service that we are recognised for elsewhere in the world."

Chen adds: "Houlihan Lokey has a strong, established reputation as a trusted financial adviser to clients throughout North America and Europe, and this same reputation is rapidly developing in Asia. The convergence of global and local standards for governance and regulation in Asia are creating a healthy demand for quality valuation and advisory services. I look forward to accelerating the growth of our business by providing premier services to existing and new clients in the region."

The firm's financial advisory services business unit provides clients with assessments, advice and opinions on the fairness or solvency of transactions, as well as the valuation of assets, businesses, securities and complex financial instruments.

Alternative assets

SRZ names investment management partner

Schulte Roth & Zabel has elected Daniel Hunter, of its investment management group, as a partner. In addition, the firm has added Michael Brown, also of the investment management group, and Abbey Walsh of its business reorganisation group, as special counsel.

Hunter concentrates his practise on the design, structure and regulation of alternative investment products, including hedge funds, hybrid funds and private equity funds. He regularly advises funds that invest in distressed debt, ABS and bank loans. Hunter also provides day-to-day regulatory, operational, M&A and restructuring advice to fund clients and advises funds regarding the receipt and allocation of seed capital.

CDS

Asian credit opportunity fund minted

Singapore-based 3 Degrees Asset Management has launched 3 Degrees Credit Opportunities Fund (3DCO) with assets of US$27.3m. The fund will invest in the performing debt obligations of Asian borrowers, focusing principally on senior secured bank loans, as well as receivables, private placements, high yield and convertible bonds. 3DCO does not intend to use leverage and will provide a high level of transparency to investors, it says.

"3DCO will capitalise on the systemic inefficiencies endemic to Asian credit markets," says Moe Ibrahim, founder of 3 Degrees and portfolio manager of 3DCO. "With over US$20trn of debt on the balance sheets of Asian commercial banks, the opportunity set is large and growing rapidly. Moreover, with only a handful of secondary market participants, there is no need to crowd into trades. We will cherry-pick opportunities to ensure maximum return, adequate liquidity and downside protection to our investors."

3 Degrees has been operating the strategy via its managed accounts platform since June 2009, returning an annualised 28%, net of fees. 3DCO will target companies that generate enough cashflow to repay maturing debt without dependence on additional fundraising exercises.

Volatility is expected to remain low by keeping the fund's average duration below 24 months and targeting events, such as puts and calls, in addition to working with companies to effect debt buy-backs and tenders. 3DCO seeks an annual net return in excess of 20%.

The fund has been established using a master/feeder structure and is open to US investors, US tax-exempt investors and non-US investors. It has a two-year lock-up and a 1.5%/20% fee structure. Deutsche Bank is the fund administrator and custodian, while BDO is the auditor.

CLO Managers

CDO manager accused of double-crossing

Hildene Capital Management has requested that StoneCastle Advisors be removed as collateral manager for US Capital Funding IV - a Trups CDO - for breaching its fiduciary duties owed to noteholders, breaching the collateral management agreement and for committing other acts in breach of various contractual obligations and extra-contractual duties owed to noteholders and to the transaction.

"It is apparent that StoneCastle has violated several provisions of the collateral management agreement, as well its legal duties under the Investment Advisors Act of 1940, by undertaking several conflicting roles and acting against the interests of investors in US Capital Funding IV," says Hildene. "StoneCastle seems motivated solely to benefit itself, profiting from the fees it earns from numerous roles, despite the conflicting fiduciary responsibilities it has undertaken."

Hildene's complaint goes back to the 2009 case surrounding Tropic CDO IV - a Trups CDO whose equity investors were approached by Friedman, Billings, Ramsey Group (now known as Arlington Asset Investment Corp) - regarding the repurchase of certain trust preferred security obligations for a purchase price of 15% of the original US$10m face amount. At that time, FBR allegedly proposed to circumvent the Tropic IV indenture applicable to all investors and pay directly to equity holders an "illicit" side-payment equal to 5% of the original US$10m face amount of the FBR TRUPS to approve the distressed sale price.

According to Hildene, StoneCastle contacted Hildene concerning the proposal and expressed concerns that a salesperson at JPMorgan - formerly of Bear Stearns - and the same person who had previously sold the original transaction at Bear Stearns, was now assisting FBR in contacting equity holders to solicit their consent to the proposed purchase and to make the payment offers. StoneCastle and Hildene recognised that the FBR proposed transaction would have negatively affected creditors of Tropic IV by causing a substantial loss of US$8.5m to the assets supporting the repayment of the transaction's debt obligations.

Hildene manages a fund that owns debt issued by US Cap IV, a fund managed by StoneCastle, that was a creditor of Tropic IV and which would have been impacted negatively by Tropic IV equity holders approving the improper FBR proposal. Hildene and StoneCastle agreed to work together to prevent the FBR proposal from being accepted.

Hildene also learned that FBR was actively pursuing or had completed several similar proposals to repurchase its obligations with small payments offered to the CDOs holding the securities and also with illicit side-payments offered to equity holders outside of the waterfall provisions of the indentures. Additionally, two other transactions received a similar improper offer from FBR - namely Tropic CDO II and Tropic CDO V.

The Topic CDOs are fixed pools of assets that are not managed like US Cap IV. Accordingly, Hildene considered its options as a direct noteholder to prevent the proposed sales from moving forward, including seeking judicial intervention if equity holders approved the sale of the FBR obligation in exchange for a similar 15% payment amount to Tropic II and Tropic V, in addition to a separate covert side-payment of 5% to the respective equity holders.

As Hildene prepared to take action to stop these pending FBR proposals, they expired without receiving the approval required by respective the equity holders. FBR decided to drop its then outstanding proposals.

On 9 October, Hildene subsequently received a notice from US Bank (the trustee for Tropic V) that a firm it had not previously encountered - Trust Preferred Solutions (TPS) - had submitted a new proposal on Tropic V to acquire US$115m par amount of trust preferred securities issued by the better quality banks in that pool by paying US$5.75m to Tropic V (5% of the face amount) and also paying separately US$5.75m (5% of the face amount) to the equity holders to approve this raid on the CDO's assets (SCI passim). Subsequently, Tropic V experienced an event of default and therefore US Bank properly recognised that the proposed transaction could not proceed on that portfolio.

During this process, Hildene discovered that TPS was affiliated with the private equity firm Texas Pacific Group (TPG) and, concerned that a similar action could be forthcoming on several similar transactions for which Wells Fargo was the trustee, the firm contacted Wells Fargo to inquire if similar offers were pending. Hildene subsequently received notices from Wells Fargo of a similar attempt by TPS to "loot" the assets of six more CDOs with a face amount of an additional US$355.8m - a series of actions to which Hildene and other investors strenuously objected, causing Wells Fargo to file an interpleader action in Federal court.

As part of the interpleader, Wells Fargo named SCP Capital I (SCP I) and SCP Master Fund II (SCP II) as defendants, stating that each was located at 120 West 45th Street in New York City - StoneCastle's address - that each was a holder of preferred shares in Tropic IV and that each had "delivered to Wells Fargo directions to accept the TPS offer" regarding Tropic IV.

"This was the first time we learned that two funds managed by StoneCastle were involved as equity holders in Tropic IV and, when confronted, Mr Siegel [managing principal of StoneCastle] admitted to us that StoneCastle had voted to accept the offer in the TPS proposal in Tropic IV. Hildene also learned that StoneCastle had reversed course and had ultimately voted to accept the improper FBR payment, which permitted FBR to acquire its obligations for a small payment to Tropic IV," says Hildene.

It adds: "Apparently StoneCastle had made this decision notwithstanding our earlier discussions and assurances that it would protect the interests of the US Cap IV transaction by working to prevent the looting of Tropic IV's assets."

Siegel also confirmed that TPG - the parent company of TPS - was also a client of StoneCastle and that StoneCastle had been providing advice to TPG concerning banks and other matters. "Despite StoneCastle denials, Hildene remains unpersuaded that it is a mere coincidence that TPG attempted to raid several portfolios through a newly created subsidiary company only a few months after its advisor, StoneCastle, had taken advantage of an erroneous reading of the underlying transaction documents," says Hildene. "Regardless, the truth will come out during the discovery phase of the TPS litigation and we will uncover the full extent of StoneCastle's involvement."

CLO Managers

High yield CDO manager spun off

GIA Partners has assumed collateral management responsibilities from Reich & Tang Asset Management for the GIA Investment Grade CDO 2001 deal. The noteholders and the swap counterparty have been given notice regarding the agreement, and appropriate consents have been obtained.

The successor collateral manager was formed in October 2009 as a spin-off from the existing collateral manager, whose entire investment team has joined GIA Partners. This team consists of six professionals, five of whom have prior experience managing high yield portfolios. Currently, the successor collateral manager does not have other CDOs under management.

Moody's has concluded that the agreement will not result in a downgrade or withdrawal of the current ratings assigned to the rated notes issued by GIA Investment Grade CDO 2001. The rating agency does not express an opinion as to whether the agreement could have non-credit related effects.

Investors

Senior strategist joins IB solutions provider

Alexander Ineichen has joined Prime Capital, a provider of integrated asset management and investment banking solutions, as senior strategist. In his new role, he will be responsible for the research and product development for satellite investments, focusing on alternative investments and absolute return strategies, as well as on credit.

Ineichen is founder of Ineichen Research and Management, a specialist absolute return and special topic investments company. Until 2009, he worked at UBS Global Asset Management as senior investment officer, alternative investment solutions and as head of industry research for its hedge fund platform. Prior to this, Ineichen worked as research specialist for derivative financial instruments and alternative investments at UBS.

Prime Capital's services comprise balance sheet restructuring and private 'bad bank' solutions for financial institutions, securitisation and structuring of portfolios, including active overlay strategies as well as asset management focused on satellite investments, alpha and absolute return strategies.

Investors

Ex-Merrill Lynch md hired as head of research

Capstone Holdings Group is set to hire Heiko Ebens as global head of research. In this role Ebens is responsible for developing a research framework, tailoring idea generation and structuring products. He will oversee the research platform across Capstone's New York, London and Singapore offices.

Ebens joins Capstone after seven years at Merrill Lynch, where he last served as an md and head of global equity derivatives research, overseeing a 15-member team. This team built the firm's research-driven structured product platform, which raised US$13.6bn in assets.

Paul Britton, ceo and chief risk officer of Capstone, says: "Drastic changes in volatility have brought our expertise to the fore, and the need to produce high quality idea generation and product offerings is paramount. We are very excited to have Heiko join us as it marks a significant step forward in the scope of service that we can provide to clients."

Legislation and litigation

SEC staffs up in enforcement

The US SEC's enforcement division has appointed a number of officials to its national leadership team, as the division undertakes its most significant reorganisation since its establishment in 1972. The division named leaders of national specialised units it has established in five priority areas dedicated to particular highly specialised and complex areas of securities law. It has also created a new Office of Market Intelligence that is responsible for the collection, analysis and monitoring of the hundreds of thousands of tips, complaints and referrals that the SEC receives each year.

The SEC says that these units and the new office will help provide the additional structure, resources and expertise necessary for enforcement staff to keep pace with ever-changing markets and more comprehensively investigate cases involving complex products, markets, regulatory regimes, practices and transactions (see last issue for more).

"Two great challenges face every enforcement authority policing our securities markets - the complexity and high-velocity pace of innovation in financial products, transactions and markets, and the willingness of violators to use every trick to cover their tracks," comments Robert Khuzami, director of the division of enforcement. "These specialised units address both challenges through improved understanding of complex products and markets, earlier and better capability to detect emerging fraud and misconduct, greater capacity to file cases with strike-force speed and an increase in expertise throughout the division. And by making connections between similar tips from different outside sources, our new Office of Market Intelligence will enable the division to better focus resources on those tips and referrals with the greatest potential for uncovering wrongdoing."

The new Office of Market Intelligence will be led by Thomas Sporkin, who assumes the role after serving as deputy chief in the Office of Internet Enforcement at the SEC since 2001. The specialised units encompass asset management, market abuse, structured and new products, foreign corrupt practises, and municipal securities and public pensions.

The asset management unit will be led by co-chiefs Bruce Karpati and Robert Kaplan and will focus on investigations involving investment advisors, investment companies, hedge funds and private equity funds. Karpati was founder and head of the SEC's hedge fund working group, while Kaplan has served as assistant director of the SEC's division of enforcement.

The market abuse unit will be led by Daniel Hawke and will focus on investigations involving large-scale market abuses and complex manipulation schemes by institutional traders, market professionals and others. Hawke is director of the SEC's Philadelphia regional office. His deputy is Sanjay Wadhwa, who was previously assistant regional director for the New York regional office of the SEC.

The structured and new products unit will be led by Kenneth Lench and will focus on complex derivatives and financial products, including credit default swaps, CDOs and securitised products. Lench has served as assistant director, branch chief, assistant chief counsel and senior counsel/staff attorney with the SEC's division of enforcement. His deputy is Reid Muoio, who has been an assistant director, branch chief and staff attorney with the SEC's division of enforcement.

The foreign corrupt practices unit will be led by Cheryl Scarboro and will focus on violations of the Foreign Corrupt Practice Act, which prohibits US companies from bribing foreign officials for government contracts and other business. Scarboro has served as associate director, assistant director, deputy assistant director and staff attorney in the SEC's division of enforcement.

Finally, the municipal securities and public pensions unit will be led by Elaine Greenberg and will focus on misconduct in the municipal securities market and in connection with public pension funds including: offering and disclosure fraud; tax or arbitrage-driven fraud; pay-to-play and public corruption violations; public pension accounting and disclosure violations; and valuation and pricing fraud. Greenberg is the associate regional director of the SEC's Philadelphia regional office and has served as the co-chair of the division's national Municipal Securities Working Group. Her deputy is Mark Zehner, who has served as regional municipal securities counsel in the SEC's Philadelphia regional office and as co-chair of the Municipal Securities Working Group.

Monolines

Monoline closer to recommencing claims payments

Syncora Guarantee is moving closer to recommencing payment of claims, including all suspended payments since 27 April 2009. The monoline says it is currently in advanced negotiations with respect to one transaction within its restructuring and anticipates that it may be able to close the transaction in the near future, subject to obtaining New York State Insurance Department's (NYID) approval and a waiver from certain parties.

However, the firm also says there can be no assurance that the transaction will close in the near future or at all. Furthermore, there can be no assurance that the NYID will accept its submission and lift the claims suspension order, Syncora adds.

In July 2009, the monoline completed all but one of the steps of its comprehensive restructuring, which resulted in the firm's return to compliance with its minimum policyholders' surplus as of 30 September 2009 (SCI passim). When the remaining transaction is ready to close, the monoline expects to make a submission to the NYID requesting that the claims suspension order of 10 April 2009 be lifted (SCI passim).

Meanwhile, Syncora Guarantee expects to record a material decrease in its statutory policyholders' surplus in Q409, principally as a result of an increase of its statutory basis reserves for unpaid losses and loss adjustment expenses on its guarantees of RMBS - partially offset by the ongoing remediation efforts by the monoline. Syncora reported a policyholders' surplus of US$181.7m as of 30 September 2009 and expects that it will remain in compliance with the NYID minimum policyholders' surplus requirement of US$65m.

Operations

ASF and SIFMA part ways

The American Securitization Forum (ASF) has voted to end its administrative affiliation with SIFMA, which in turn is reportedly looking to establish its own securitisation coverage. The ASF is to move into new offices and handle its own technology, human resources and other back office functions, and will also assume complete responsibility for advocacy efforts, including government relations in Washington, DC.

The ASF says it looks forward to serving, in an even more focused fashion, all securitisation market participants. "We believe that operating as a completely independent organisation will allow us to do an even better job of helping to restart our markets and getting affordable credit flowing again to American consumers and businesses," the ASF says.

It adds: "As the only organisation solely focused on the broad securitisation markets and with membership in every part of the markets, the ASF is uniquely positioned to craft and advocate consensus market positions. We look forward to continuing to work on such efforts as ASF Project RESTART, mortgage loan modifications, securities regulation, regulatory capital, accounting standards and the myriad of other issues facing our securitised debt capital markets."

Tom Deutsch has been appointed executive director of the association.

Ratings

Rating agency names ABS svp

DBRS has recruited Rosemary Kelley to its structured finance group as an svp. She will focus her efforts in the ABS group as a lead analyst and will report directly to Claire Mezzanotte, head of the rating agency's ABS/RMBS group.

Prior to DBRS, Kelley spent ten years at MBIA Insurance Corporation, most recently as a director in the structured finance department, where she originated and analysed consumer ABS in the auto finance, student loan, credit card, timeshare loan, unsecured Japanese consumer loan and rental car sectors. She had previously managed MBIA's portfolio management unit, responsible for monitoring consumer ABS.

Prior to MBIA, Kelley worked at several banks, including Citigroup, Deutsche Bank and Morgan Stanley.

Real Estate

Morgan Stanley hires real estate head

Morgan Stanley has appointed John Klopp as head of Americas real estate investing and global real estate debt investing, reporting to Jay Mantz, cio of Morgan Stanley Real Estate Investing.

Klopp has over 30 years of real estate experience and most recently served as ceo of Capital Trust, a publicly traded investment management and real estate finance company. Prior to co-founding Capital Trust with Sam Zell in 1997, he was a founder and managing partner of Victor Capital Group, a private merchant banking boutique that specialised in workouts and distressed debt investing. Klopp also served as md and co-head of Chemical Realty Corporation, Chemical Bank's real estate investment banking unit.

Klopp will start his new role on 1 February.

Real Estate

CRE advisory acquired

BlackRock has acquired substantially all the assets of Helix Financial Group. The transaction closed on 15 January and will see Helix fully integrated into BlackRock Solutions.

Helix provides advisory, risk management and analytical services to commercial banks, investment managers and equity investors in the commercial real estate arena. It also provides other commercial real estate-related outsourcing solutions to institutional financial investors. Since its founding in 2004, Helix has underwritten over US$100bn of commercial real estate loans and in aggregate has served over 80 clients.

Craig Phillips, md and global head of the financial markets advisory group in BlackRock Solutions, says: "We look forward to integrating Helix's professionals into our modelling, advisory, valuation and loan workout practice in order to provide enhanced and superior service to our clients holding complex commercial real estate exposures. In addition to valuable industry relationships and asset class experience, Helix has unique technology, data and intellectual capital that will supplement our present commercial real estate analytics and workout capabilities."

Kevin Donlon, co-founder and managing partner of Helix, adds: "Helix recognised that we needed a partner to accommodate the growing needs of our clients. In addition to facilitating the broader dissemination of our risk technology to clients, our affiliation with BlackRock will allow us to extend underwriting, valuation and asset management services to our clients on a fully integrated basis. At present, the considerable stress in commercial real estate valuations has created substantial client demand for the full range of our services."

Prior to the acquisition, AllBridge Investments was the lead stakeholder in Helix and Helix will continue to provide advisory, credit and underwriting support to AllBridge following the acquisition. Phillips explains: "AllBridge was integral to the repositioning of the Helix platform during a period of unprecedented stress in both the capital and commercial real estate markets. We look forward to providing support to them as an important client relationship."

Real Estate

REIT secures second CRE loan

Inland Western Retail Real Estate Trust has obtained a second commitment for secured loans from JPMorgan. The bank has provided a US$300m non-recourse forward commitment that Inland Western will use to refinance 2010 debt maturities.

"This US$300m commitment, coupled with the US$625m loan we closed in December, demonstrates solid revitalisation signs in the CMBS markets, as well as the existence of attractive credit in the marketplace for quality assets," says Steven Grimes, ceo of Inland Western. "We are appreciative of JPMorgan's continued strong support of Inland Western with this commitment."

During the last twelve months, the REIT has refinanced, including commitments, paid down and extinguished debt totalling US$1.8bn and has reached agreements or is in negotiations to extend another US$396m.

As of 30 September 2009, Inland Western's portfolio under management comprised in excess of 49 million square feet, consisting of 299 wholly owned properties and two consolidated joint venture properties. The REIT also has interests in 12 unconsolidated properties, as well as 14 properties in seven development joint ventures.

Trading

Broker expands in credit sales and trading

Cantor Fitzgerald has added eight experienced professionals to its debt capital markets business, underscoring its commitment to meeting clients' needs. The hires comprise: James Mitchell, md, trading; Ron Consiglio, John Stelwagon and Amil Schiaffino, mds, research; new sales directors Ben Lloyd and Brad Darby; and sales associates Melissa McKenna and Richard Thibeault.

Mitchell was previously at UBS as a senior trader responsible for trading loans, bonds and credit derivatives for European high yield and distressed credits. Earlier, he was at Citi in New York and London responsible for rebuilding the European distressed debt trading business and trading high yield cash and CD books. He will be based in Cantor's London office.

Consiglio joins Cantor Fitzgerald from Akarui Capital Partners, where he focused on undervalued and stressed credits in the North American high yield market for a start-up credit fund. Stelwagon was previously a CLO portfolio manager at Apidos Capital Management and, before that, an md in Babson Capital's leveraged loan group. And Schiaffino has over 20 years of experience in capital markets as head of high yield and investment grade research at Schroders & Co, Scotia Capital Markets, Paine Webber and BMO Capital Markets.

Lloyd began his career at Barclays Capital in the loans group, working in both high grade and high yield sales positions since 1998. Darby was a senior salesperson at Summit Securities, and worked in sales on the high yield/distressed desks at Guggenheim Capital and Miller Tabak Roberts Securities.

Finally, McKenna was most recently at Citigroup as an associate on the FX/corporate sales desk, while Thibeault joins Cantor from Deutsche Bank Securities, where he worked as part of the high yield distressed debt sales team since 2007.

Trading

Senior trader added to global credit team

Thames River Capital has appointed Dahlia Verjee as a senior trader in its 12-strong global credit team. Verjee will report to head of global credit, Stephen Drew, and is responsible for the co-ordination of all trade execution for the team and to manage its sell-side relationships.

Verjee was previously with Deephaven Capital Management, where she was a principal trader working primarily in high yield credit, both cash and CDS, and focusing on identifying catalysts and executing themes in a dislocated market. Prior to this, she worked at D B Zwirn as a trader/analyst in investment grade and high yield credit, and at Close Brothers Corporate Finance as a restructuring analyst.

Drew says: "Thames River is defined by the high calibre of investment professionals working within the company. We are delighted to welcome Dahlia, whose experience will further enhance the global credit team."

He continues: "We have already seen strong inflows into the two new credit funds, having raised over US$220m since launch, and we continue to see a demand from clients for products which offer a good yield, low volatility and enhanced capital preservation through investment in high quality corporate bonds."

Trading

Evolution FI head departs

Guy Cornelius, head of fixed income at Evolution Securities in London, has left the firm. The fixed income department will now be headed up by Mike Hardman, head of credit sales at Evolution, and David Wright, according to a spokesperson for the firm.

ABS

Mixed bankcard ABS performance for December

Securitisation analysts at JPMorgan report that bankcard ABS performance in December was within expectations, although mixed across issuers. The charge-off rate on the bank's aggregate index for the sector decreased by 54bp to 9.34%, but four out of nine issuers reported loss increases.

Three-month average excess spread continued to climb, up 71bp to reach 8.35%. Rising yields, up 80bp to 21.57% in December, have also helped build the excess spread cushion, according to the analysts.

In addition, the index payment rate improved to 19.24% from 17.35% the previous month. 30+ delinquencies declined by 21bp to 5.72%, while 60+ decreased by 8bp to 4.32%.

In the retail card sector, four out of five trusts recorded lower charge-offs in December than in November. HPLCC was the exception, where losses were up a mere 1bp.

"We expect credit performance in 2010 to remain quite well behaved and losses should stay contained below our expected peak of 10.5%-11%," the JPMorgan analysts note. "The recent stabilisation in the unemployment rate, as well as the continued deleveraging by consumers should support credit fundamentals. In addition, ABS credit enhancement levels have increased, with the higher excess spread and subordination via the various steps taken by the ABS sponsors."

They maintain an overweight in credit card ABS, with the top pick being bankcard subordinates, where the spread pick-up in BACCT and DCENT is particularly attractive.

Meanwhile, Discover Bank has increased the credit enhancement on its DCENT and DCMT programmes. Subordination increased by 4% across the capital structure to 23% on Class A notes, 17.5% on Class Bs and 10.5% on Class Cs. The subordination will step up by another 1.5% after the excess spread series (which serves a similar function to the discount option) matures.

According to the 8-K the issuer filed, the actions were "in response to one of the rating agencies adjusting its methodology to give greater consideration to the effect the financial strength of a credit card bank sponsor (Discover Bank is originator of the credit card receivables and master servicer of DCMT and DCENT) may have on the performance of the sponsor's underlying credit card asset-backed securities".

At Baa3/BBB/BBB, Discover is the lowest rated among the top six bankcard ABS issuers, but the analysts point out that the risk of a seller/servicer event remains low. Given the exceptional technicals in the ABS market, they anticipate that credit tiering should compress.

ABS

Reserve draws 'not just weak performance indicator'

Reserve fund draws in ABS and RMBS are not just an indicator of weak performance, according to a report in Moody's latest Credit Insight publication. Although reserve fund draws generally mean that a transaction has exhausted its excess spread availability and has to draw on the next level of credit enhancement, draws can also signal other transaction issues.

There are occasions where reserve fund draws may signal temporary issues not related to asset performance that may not lead to a change in rating assumptions or have a rating impact, observes the rating agency. A recent example includes a sudden and unforeseeable increase in costs that is limited in time, such as a hedging counterparty replacement. This occurred in the BPL Consumer Series 2004 deal in January 2009 when the swap counterparty Lehman Brothers Holding was replaced by Deutsche Bank with a one-off payment of €1.2m covered by cashflows coming from the structure, as well as a reserve fund draw that was expected to be replenished from collections of the following periods.

Another example is an unhedged element of the transaction structure that is limited in time and extent. The impact of this depends on the remedies and their timing. In BPL Consumer Series 2004, the notes remained unhedged against basis risk on their 15 October 2009 payment date when the due amounts on the notes could only be covered with the help of a small cash draw on the reserve fund (€323,109 of the €15m available).

A timing mismatch in payments on the assets and the liabilities is a further example. For instance, if the securitised portfolio mainly comprises semi-annually paying loans that produce income only on every other quarterly payment date (as is typically seen in Asti Finance or Vela Home Series 4).

Asti Finance also exemplifies a situation where previous erroneous calculations need to be remedied at a time when portfolio collections for a given period are insufficient. On the deal's December 2009 payment date, misallocations of cashflows throughout the life of the transaction were corrected with a one-off, 'make-whole' payment of €10.7m funded by the originator (€6.3m) and the cash reserve (€4.4m).

Finally, liquidity problems linked to operational issues - such as weak servicing and a build-up of delinquent loans - is another example. In this instance, however, the lasting nature of the issue may lead to a change in assumptions (for instance, a reduction in expected recovery rates) that will have rating consequences.

ABS

Italian consumer ABS to be repurchased

Fitch says that the ratings of the Nixes 4 notes are unlikely to be adversely affected by the amendment to the transfer agreement between the issuer and the originator, FGA Capital. The amendment enables the originator to repurchase the securitised loans, which have not defaulted, up to 5% of the initial balance of all the notes issued.

At the initial transfer date, the loans were purchased by the issuer at their net present value, computed using a variable discount rate. The calculation of the repurchase price of the loans is defined so that there is no 'principal prepayment loss' as a consequence of the repurchase option's exercise. The principal component of the repurchase price will be considered as part of the principal collections and therefore used to purchase additional loans during the revolving period and amortise the notes thereafter.

Fitch does not expect the amendment to have any detrimental rating effects, as the buyback is capped at a given amount and there will be no prepayment loss as a consequence of the repurchase.

ABS

Performance deterioration for Italian leasing ABS

The performance of the Italian leasing ABS market continued to deteriorate in November 2009, according to Moody's in its latest index report for the sector. Moody's net default index rose to 2.3%, which constitutes an increase of 42% over the past twelve months.

Meanwhile, its delinquency index has increased to 5.9% from 4.4% over the past year. The average CPR trend continued its declining trend and ended the month at 2%.

In November, Moody's commented on the introduction of a payment holiday scheme for Italian small to mid-sized enterprises (SMEs), which account for the majority of lessees in Italy. In the agency's view, there may be overall negative rating implications for certain Italian securitisations with exposure to SMEs. Moody's will assess the scheme's impact on Italian securitisations with exposure to SMEs on a case-by-case basis.

In its view, concern could arise from a large number of securitised borrowers suspending principal payments at the same time, which would leave little excess liquidity to cover any potential spike in cashflows during the 12-month window. Second, defaults might be only back-loaded, which may affect a transaction negatively as available excess spread could decrease with portfolio amortisation.

In addition, the notes would redeem at a slower pace, thus exposing the issuer to greater performance volatility. Finally, there could be additional structural concerns around swaps or triggers.

Italy emerged from recession in Q309, following five consecutive quarters of contraction. Moody'sEconomy.com expects GDP to grow by 1.1% in 2010, driven by exports and modest improvement in domestic demand. The improvement in expectations boosted Italian consumer confidence in December to its highest levels since June 2002.

Additionally, wage growth has accelerated since July and was up by 3.1% in November compared with the same month of 2008. With inflation in November equal to 0.8%, the purchasing power of Italian households has improved.

However, there are some threats to Italy's economic recovery. For one, the main growth driver, external demand, is dependent on the country's key trading partners, which are expected to grow only slightly in 2010.

Additionally, the euro is expected to appreciate against the dollar, which negatively impacts external competitiveness. The other main risk for the Italian economy is weak fiscal discipline, which is magnified by the recessionary effects on government deficits.

Moody's outlook for Italian leasing ABS is negative. Many leasing pools that were originally backed by equipment/auto/real estate leases are now mainly exposed to real estate, which could render this sector more vulnerable to negative pressures.

As of November 2009, the total outstanding pool balance in the Italian leasing ABS market stood at €15.8bn, which constitutes a decline of 27% over the past year.

CDO

CDO investigation targets 06/07 vintages

The US SEC's investigation into CDOs is to focus on deals structured and marketed in late 2006 and early 2007, SEC head Mary Schapiro confirmed in her testimony before the financial crisis inquiry commission. In particular, the Commission is seeking to determine whether investors were provided with accurate, relevant and necessary information, or were misled in some manner.

The number of cases related to RMBS, CDS and CDOs is likely to accelerate in the coming year - see last issue for more.

CDO

... and CRE CDO delinquencies

Delinquencies for US CRE CDOs closed out 2009 with a 2bp increase to 12.3%, according to the latest CREL CDO delinquency index results from Fitch. Accounting for previously delinquent loans written down or disposed of at a loss, the CREL CDO delinquency rate would have neared 15%, in line with Fitch's expectation for year-end 2009.

Fitch senior director Karen Trebach says: "A continued steady increase in delinquencies is likely for 2010. Fitch projects CREL CDO delinquencies to reach 25% by the end of the year."

The removal of 21 delinquent assets last month nearly offset the addition of 26 new delinquent assets, resulting in only a slight increase from the November total of 12.1%. New delinquencies were comprised of nine maturity defaults, four term defaults, five impaired CMBS and eight repurchased assets.

Repurchases consisted of four CRE loans and six CMBS assets. While two assets were repurchased at par, the remaining assets were purchased out of CDOs by asset managers at prices ranging from 88% of par for an A-note interest to 1.4% of par for a credit-impaired CMBS interest.

The extension of 14 matured balloon loans helped keep overall delinquencies in line with last month's total, Fitch notes. While one-third of these loans were granted only short-term extensions to allow time for further negotiation, the majority of these extensions were multi-year, with several loans receiving principal pay-down and/or increased reserve postings among conditions to extension. Overall, there were 51 total extensions reported in December.

Realised losses continue to accumulate, with approximately US$80m noted in the December reporting period. To date, total realised losses to CREL CDOs are approximately 4% of the fully-ramped collateral balance. The largest loss in December was related to the sale of an REO (asset owned by the CDO) hotel property that resulted in only a 21% recovery to the CDO.

All 35 Fitch-rated CREL CDOS reported delinquencies in December, ranging from 1% to 44%. Additionally, a total of 13 Fitch-rated CREL CDOs were failing at least one overcollateralisation (OC) test, which is one transaction less than last month as a CDO was able to cure its failure through the extension of several matured balloon loans. Failure of OC tests leads to the cut-off of interest payments to subordinate classes, including preferred shares, which are typically held by the CDO asset managers.

CDS

Aiful deferred, second Japan determination pending

ISDA's Japan Determinations Committee has deferred Aiful Corporation's auction date to 18 February 2010 to allow for the appropriate compression cycles to be completed and for adherence to the Japan Corporate Calculation Agent City Protocol to be effected. The DC is also deliberating over whether a bankruptcy credit event has occurred in connection with Japan Airlines Corporation, after it filed a petition for a corporate reorganisation with the Tokyo District Court.

CDS

Efforts to improve OTC infrastructure reaffirmed

The Federal Reserve Bank of New York hosted a meeting of major market participants and their domestic and international supervisors to discuss efforts to improve the infrastructure supporting the OTC derivatives market. The meeting is the sixth such meeting with industry participants at the New York Fed (SCI passim).

William Dudley, president of the Federal Reserve Bank of New York, says: "The industry must undertake a major transformation to bring significantly greater levels of transparency to these markets. Increasing the amount and quality of market information available to participants, regulators and the public is critical to the work of shoring up the stability and efficiency of the financial system."

Market participants provided an update on developments in the OTC derivatives market and agreed to further improvements to support the overall goals of reducing risk and increasing transparency. They agreed to detail their next steps and commitments for addressing these priorities in a letter to regulators by 1 March.

In summary, market participants have agreed to:

• Increase central clearing of transactions that are currently eligible to be cleared, as well as to extend the range of products that are eligible for central clearing.
• Provide regulators with enhanced analysis and reporting to help identify and target opportunities for improvements to increase clearing and standardisation.
• Reaffirm their efforts to formalise best practices for managing the risks of non-cleared OTC derivatives, including collateralisation practices.

The New York Fed says it will continue to work with domestic and international regulators to encourage further improvements and transparency in the OTC derivatives infrastructure and market.

CDS

CDS on France up 50%

Sovereign risk moved higher last week after briefly recovering from its spike in December, according to Credit Derivatives Research (CDR). All members of the CDR Government Risk Index (GRI) added risk, as Greece (which is not an index member) continues to make headlines on its debt concerns (see also separate News Analysis). Spain saw its CDS jump by 33% since mid-December and surpassed Italy as the riskiest member of the GRI.

Spain now trades in line with Portugal, while the worst relative performer in the index was France, whose CDS rose by almost 50% over the past month. The USA was the best performer on the month, with its CDS trading just above its December levels. Overall, the GRI moved 20% higher and its current level is just below the highs it hit on 21 December.

"The GRI rose by two-thirds over the past three months and even Germany, the best performing sovereign in the index, jumped higher by over 40%," says Dave Klein, manager of the CDR credit indices. "The index is back to late-December levels, not seen previously since late April 2009. While the deterioration of the GRI has yet to reach early March 2009 levels and may indeed be overdone, current levels indicate increased systemic risk and provide a stark contrast to the corporate CDS and equity markets which continue to improve."

He adds: "As the financial crisis broke in the autumn of 2008, systemic risk was slower to react than corporate risk. With systemic risk now taking the lead, we wonder whether the sovereign CDS market is overreacting or if a correction in corporate credit is overdue."

CDS

US CDS CCP interface debuts

Bloomberg has launched what is believed to be the first interface in the US credit derivatives market that connects both buy- and sell-side firms to the two US-based central clearing counterparties (CCPs). The Bloomberg VCON solution, a confirmation utility for cash and derivative instruments, now allows dealers and their clients to send executed trades to the CME and ICE Trust.

"Bloomberg is uniquely positioned to act as an integrated hub for OTC derivative processing, utilising the network of Bloomberg Professional service to connect trading customers with downstream processing and clearing services like ICE and CME," comments Ben MacDonald, Bloomberg's global head of fixed income trading. "With the data, news and analytics on the all-inclusive Bloomberg Professional service, we can play a key role in assisting our customers with operational efficiency and risk mitigation, and add value for our users."

Ric Okun, evp at PIMCO, notes: "Bloomberg has played an integral role building a robust platform with integrated connectivity that will serve as bridge for PIMCO, the dealer community and the clearing platforms. We are excited about the launch of clearing connectivity and are also looking forward to expanding our CCP capabilities during the course of 2010 with additional products."

CDS

CDS liquidity spike for US financials

According to Fitch Solutions in its latest update on global CDS spreads/liquidity scores, US financial institutions have shown a sudden spike in CDS liquidity, signalling a potential reversal of the previous quarter's stabilising trend. Meanwhile, General Electric continues to outperform other consumer goods companies.

Bank of America, Citigroup, Goldman Sachs and Morgan Stanley are among the 14 US financial firms trading in the CDS market that are scheduled to announce fourth-quarter earnings this week. Fitch Solutions md Jon Di Giambattista says: "CDS spreads on large US financial institutions rose dramatically during the week ended 15 January. The corresponding rise in CDS liquidity for the sector signals a return to market uncertainty over the credit condition of US financial institutions, at least until the regulatory and tax environment for these institutions becomes [clearer]."

Bank of America, Citigroup, Goldman Sachs and Wells Fargo are all among the top 5% of the most liquid CDS names globally. Wells Fargo, which has replaced Citigroup as the most liquid North American bank, is the only financial firm reporting earnings this week to see its CDS spread widen over the past three months.

Notably, American Express Company, reporting on Thursday, has substantially outperformed the US market, tightening 42% over the last three months while seeing its liquidity rank rise nine percentiles on a regional basis. Among all North American firms, liquidity on Goldman Sachs Group has increased from trading in the 20th percentile to trading in the 7th percentile over the past three months. Although performing in line with the broader financials sector over the previous three months, CDS on Goldman have recently widened.

Among consumer goods companies, meanwhile, General Electric and Johnson Controls have both outperformed the sector over the past three months, with their CDS tightening 23% and 35% respectively. Despite this improvement, GE's CDS spreads are significantly wider than pre-crisis levels, pricing in line with triple-B negative spread levels, as opposed to the triple-A levels the firm priced at pre-crisis. GE subsidiary, GE Capital, remains a prominent concern for credit markets as CDS spreads on GE's financial arm remain in a non-investment grade trading pattern.

Di Giambattista notes: "The fact that GE Capital remains among the most liquid names in the CDS market signals ongoing market uncertainty towards its business at a time when the CDS market is signalling stability for its parent company. GE Capital is among the top five most liquid US financial names in the CDS market, which continues to cloud the outlook for General Electric Corporation."

Other notable announcements this week are due from the airline industry. Although the price of credit protection on AMR Corporation, Delta Airlines and Continental Airlines has been falling steadily, CDS spreads remain at distressed levels. Southwest Airlines, however, continues to outperform the sector, pricing in the investment grade space.

On average, CDS on North American Oil & Gas companies tightened by 27% over the last three months, more than any other sector. Kinder Morgan Energy Partners has outperformed the sector, tightening 42% in that time period - reflecting an improvement in the CDS market's outlook for the energy company.

After outperforming credit markets throughout the crisis, technology firms, including IBM, represent the only sector to see spreads widen over the past quarter. Notable exceptions are Advanced Micro Devices (AMD) and Xerox.

AMD's CDS spreads have significantly tightened over the past quarter and the corresponding drop in CDS liquidity indicates the CDS market anticipates a more stable outlook for the chip maker. Xerox's 34% spread tightening and corresponding drop in CDS liquidity signals that the market uncertainty surrounding the imaging company's outlook has abated somewhat over the past quarter.

CDS

CDS compression continues apace

TriOptima reports that its triReduce multilateral termination service significantly reduced outstanding notionals between dealers in credit default swap outstandings during 2009.

With 68 CDS portfolio compression cycles globally, triReduce eliminated US$14.5trn in CDS notionals, US$12trn in credit index transactions and an additional US$2.5trn in European, Asian and Japanese single name and credit tranche transactions during the year. This also included the Thomson index and single name portfolio compression cycles, which were the first to be initiated after implementation of the ISDA 'small bang protocol.

CLO Managers

Euro mezz ABS CDO completes tender

€27.5m of Faxtor ABS 2004-1Class A-1 notes have been repurchased by the issuer at an aggregate price of €22.4m, leaving €236.5m notional outstanding. The repurchase has been effected using principal proceeds in the principal account of the issuer received from amortising portfolio assets and occurs in connection with a tender offer announced on 15 December 2009.

The transaction is a mezzanine ABS CDO related to a €349m portfolio comprised primarily of European assets, whose reinvestment period ended in July 2009. The portfolio is dynamic and managed by IMC Asset Management.

Moody's has determined that the repurchase will not cause its current ratings on the deal to be reduced or withdrawn.

CLOs

Balance sheet CLO restructured

Moody's has withdrawn its ratings and assigned new ones to notes issued by SOLON 2009-1. The action affects €201.8m of debt securities.

The rating action follows the restructuring of the transaction, which involved the originator - Sal. Oppenheim - repurchasing leveraged loans with a principal amount equal to €302m (including €2.6m accrued interest) from the issuer. All the notes issued at launch in September 2009 have been repurchased and cancelled, and three new classes of notes have been issued.

All payment obligations arising from the above restructuring have been netted such that ultimately the issuance of the new notes relates to a total portfolio size of €405.9m (compared to €731m prior to the restructuring). All of the new notes have been acquired by Sal. Oppenheim at closing.

The underlying portfolio post-restructuring consists of bilateral loans (around 98.4%) to mostly small and medium-sized enterprises and a few syndicated leveraged loans (1.6%) originated by Sal. Oppenheim. The obligors are either incorporated in Germany or are subsidiaries of German companies.

The major industry sectors of the underlying loan portfolio are beverage, food & tobacco (20.0%), high tech industries (16.9%), automotive (16.3%) and retail (13.3%). The portfolio weighted average life is 2.35 years.

This balance sheet CLO is mainly static, with the exception of a 26.1% bucket of revolving loans. These exposures can only be replenished from the same loan agreement up to the initial revolving loan drawing amounts assigned to Solon at closing.

CLOs

Euro CLOs subject to further downgrades

S&P has downgraded 102 tranches in 21 European CLOs. Excluding combination notes, the affected tranches represent a current combined notional amount of US$12.53bn (€8.65bn).

The downgrades reflect two primary factors: the application of S&P's new corporate CDO criteria; and, for some of the transactions, the rating agency's assessment of the deterioration in the credit quality of the collateral supporting the CLO tranches due to increased exposure to obligors that have either defaulted or been downgraded into the triple-C category. Downgrades occurred across all rating classes.

CMBS

Rising trend for US CMBS loan ...

Delinquencies on US CMBS loans in conduit/fusion deals increased five-fold during last year, as measured by the Moody's Delinquency Tracker (DQT): they began 2009 at 0.95% and ended it at 4.9%. The rating agency expects loan performance to deteriorate further in 2010 and projects that the DQT will reach 8%-9% by the end of the year.

Moody's md Nick Levidy says: "2009 saw delinquencies on all property types and in all regions surpass previous highs seen in the history of the DQT. The delinquency rate will continue to climb in 2010 to a rate that we project will be between 8% and 9% by year-end." Delinquencies reached a low of 0.22% in July 2007 and have been climbing since.

The DQT rose by 43bp in December, marginally less than November's 46bp rise - the biggest increase of the year. The first six months of the year saw monthly increases average 29bp, while the most recent six-month span averaged a 37bp increase per month.

Of the five core property types tracked by Moody's DQT, the hotel sector saw the greatest increase in delinquency rate during the month. In December, the delinquency rate on loans backed by hotel properties rose by 127bp to 9.07%.

More multifamily loans moved into delinquency during December than for any other property type, with 113 new loans totalling US$1.1bn becoming delinquent. The current delinquency rate for multifamily loans is 8.14%, a 74bp increase over November.

Similar to their performances in November, the remaining three major property types saw moderate increases relative to hotel and multifamily. The retail delinquency rate currently stands at 4.52%, a 28bp increase over November, while the delinquency rate on loans backed by industrial properties increased by 31bp in December to 3.42%. The office sector, which maintained the lowest delinquency rate of the five property types throughout 2009, continued that trend in December - posting a 24bp increase during the month to end the year at 3.19%.

By region, the South saw a 73bp increase in delinquency in December - the largest increase in the history of the southern index - and remains the worst performing region in the US, with a current delinquency rate of 7%.

The Midwest had a 46bp increase in December, bringing its delinquency rate to 5.62%. Michigan continues to exhibit poor performance, with more than 25% of newly delinquent loans by balance backed by properties in the state, although the state makes up just 15% of all outstanding Midwestern loans.

Delinquencies on loans backed by properties in the West rose 51bp in December, bringing the total rate to 5.28%. Loans in Arizona account for 10% of all outstanding loans in the West, but made up more than 25% of newly delinquent loans in December.

The East continues to be the best performing region, according to Moody's. Delinquencies rose 17bp in December and the rate for the East currently stands at 3.12%.

Massachusetts was the poorest performer in the East in December. Loans backed by properties in this state make up just 6.5% of the outstanding balance in the region, but accounted for 20% of the newly delinquent loans.

In December, Nevada became the first state to have a delinquency rate greater than 12%. Nevada, however, represents less than 2% of all tracked loans. The four states with a delinquency rate greater than 10% - Nevada, Arizona, Michigan and Rhode Island - are relatively small and combined represent a total 6.49% of all outstanding loans.

Emerging Markets

Taiwanese structured credit activity to remain slow

Fitch expects Taiwan's quiet domestic structured credit market to continue with limited origination and investment activity in the short-run.

Jackie Lee, director in Fitch's structured credit team, says: "Given the excess liquidity within the island's financial system, together with stagnant loan growth and low corporate impairment losses, there have been limited incentives for local financial originators to securitise their existing credit books. In particular, under Taiwan's interpretation of Basel 2, securitisation of corporate loan portfolios is not an effective approach to managing banking capital efficiency."

April Chen, associate director in Fitch's structured credit team, adds: "From the investment community's perspective, the losses suffered by Taiwan's major financial institutions from their investments in global synthetic CDOs and US subprime-related securities made before 2008 have significantly curbed their appetite for complex credit instruments. At this moment, they are completely averse to instruments involving foreign structured exposures, but have generally retained their appetite for domestic corporate structured credit paper."

In 2009, Fitch affirmed all ratings of the notes issued by the existing six domestic securities-backed ABCP programmes and two CBO term deals. The liabilities of the existing transactions will continue to amortise as the underlying securities become due over time. The credit prospects for the underlying assets in these transactions are expected to be stable in the coming year, the rating agency notes.

Indices

US housing market 'recovering well'

The LoanPerformance US home price index declined by -3.1% (annualised) in November, while the October reading was revised downwards from -1.9% to -5.6%. However, ABS analysts at JPMorgan report that the seasonally adjusted one-month HPA has been positive for six consecutive months, with November at 1.6%, October at 0.1% and September at 1.6%.

Year-over-year price declines (12-month HPA) appear to be recovering, reaching -4.9% in November, compared to -6.3% in October and -7.4% in September. The other main home price indices, FHFA Purchase Only and Case-Shiller 20-city composite, have also improved significantly and are at -1.9% and -7.3% respectively.

The JPMorgan HPI model projects that home prices will bottom in the second half of 2010, with peak to trough HPA at -15% and -34.7% for the FHFA and Case-Shiller national indices respectively. "Overall, the housing market has been recovering well so far and we expect early 2010 to be strong as well, supported by the tax credit programmes," the analysts note. "Although a tight lending environment and a weak labour market continue to threaten housing demand, and the recovery story remains challenged by the highly uncertain release timeline of a massive amount of shadow inventory, we believe that the majority of the price correction has already been seen."

Operations

Challenges of unwinding TARP examined

The US Congressional Oversight Panel (COP) has released its January oversight report, entitled 'Exiting TARP and Unwinding Its Impact on the Financial Markets'. The report finds that the repayment of TARP assistance represents only the first stage of exiting the programme: even after repayments are complete, the US Treasury will hold a significant pool of assets, worth hundreds of billions of dollars, for several years to come. Managing these assets will present extraordinary challenges, the COP says.

The Treasury department has articulated three principles guiding its strategy to unwind TARP: maintaining a stable financial system, preserving individual institutions and maximising the return on taxpayers' investments. The Panel found that these principles will sometimes be at odds with one another. For example, the most profitable moment to sell a TARP asset may not be the moment that best promotes systemic stability or the moment that best serves a particular institution.

Furthermore, these three principles are so broad and subjective that the Treasury could justify almost any divestment decision using this approach, effectively giving no metric to determine whether its actions met its stated goals. These concerns are compounded because the Treasury is a unique market participant: TARP investments are so large that the decision to hold or sell has the potential to impact the financial markets.

The Treasury is also urged to learn from the mistakes made in the past and demand greater disclosure in funds spent this year. In announcing his decision to extend TARP through to October, Secretary Geithner said that TARP funds would be used, for example, to provide capital to small banks to increase lending to small businesses.

But the Treasury failed to require the recipients of the first infusions of TARP funds to account adequately for how they put taxpayer dollars to work. The Panel recommends the Treasury require that future recipients provide much greater disclosure of their use of TARP dollars.

Finally, even after every TARP asset is sold, unwinding the implicit guarantee created by the programme will remain a serious challenge for policymakers, according to the COP. The financial rescue created a moral hazard that distorts pricing and infects calculations of risk. The Panel notes the broad agreement that a new approach to systemic risk regulation is necessary, so that businesses are not insulated from the effects of their own bad decisions.

Operations

Wall Street responsibility fee in the works

President Obama has confirmed his intention to propose a Financial Crisis Responsibility Fee that would require the largest and most highly levered Wall Street firms to pay taxpayers back, so that the TARP programme does not add to the deficit. The fee - which would go into effect on 30 June 2010 - would last at least 10 years. If the costs have not been recouped after 10 years, the fee would remain in place until they are paid back in full.

The proposed fee is expected to raise US$117bn over about 12 years and US$90bn over the next 10 years. As a result of prudent management and the stabilisation of the financial system, the expected cost of the TARP programme has dropped dramatically. While the Administration projected a cost of US$341bn as recently as August, it now estimates - under very conservative assumptions - that the cost will be US$117bn.

The fee the President is proposing would be levied on the debts of financial firms with more than US$50bn in consolidated assets, which the Administration says will provide a deterrent against excessive leverage for the largest financial firms. By levying a fee on the liabilities of the largest firms - excluding FDIC-assessed deposits and insurance policy reserves, as appropriate - the Financial Crisis Responsibility Fee will place its heaviest burden on the largest firms that have taken on the most debt. Over 60% of revenues will most likely be paid by the 10 largest financial institutions.

The fee would be assessed at approximately 15bp of covered liabilities per year.

Under the proposal, the Treasury department would be asked to report after five years on the effectiveness of the fee, as well as its progress in repaying projected TARP losses.

Ratings

Turbo O/C tests delay sequential O/C breaches

Turbo overcollateralisation (O/C) tests may delay the breach of sequential O/C tests, according to a report from S&P. The rating agency observes that credit deterioration over the past two years has resulted in many CLO transactions breaching their junior O/C tests and, although many transactions have diverted interest to pay down their senior notes, several of the transactions with turbo o/c tests have started to pay down their junior notes.

"The range of junior note pay-downs due to turbo O/C tests has ranged from 1% to 50%, depending on the effect of the credit markets on other O/C tests," says S&P credit analyst Sarah Sachse.

Turbo O/C tests differ from standard o/c tests in the way they pay down the notes. CLO underwriters often employ them because they generally reduce funding costs in a moderately stressed corporate debt market by using excess interest proceeds to pay down a transaction's highest-yielding liability.

"This feature may help junior notes, but may produce less-favourable results for senior noteholders," notes the rating agency. "While these junior securities carry higher risk than those with higher ratings, the presence of turbo O/C tests can increase their appeal to investors."

Ratings

Equity investment for mezzanine fund

The recently proposed equity investment in one of GS Mezzanine Partners III's portfolio companies will not in itself impact the rating of the deal's US$148.5m and €492.1m multi-currency revolving loan agreement, according to Fitch. The transaction is currently rated triple-B minus, with a stable outlook.

The proposed equity investment of up to US$15m will be funded using cash available in the collection account. The credit enhancement will decrease by less than 1% if no credit is given to the equity investment. Furthermore, proceeds available for immediate distribution to the lender will be reduced by this amount.

However, the increased risk to the transaction is partially mitigated by the repayments made to the lender since the last rating action in December 2008 and resulting increased credit enhancement. In the rating agency's view, the increased risk to the transaction will not impact the rating of the loan agreement.

RMBS

AMP RMBS to benefit from AOFM support

Ratings have been assigned to Australian RMBS Progress 2010-1 Trust - a securitisation of prime residential mortgages originated by AMP Bank. The transaction is the first to benefit from the Australian Office of Financial Management's (AOFM) recently-revised RMBS investment programme (SCI passim).

Fitch and S&P have assigned ratings to three classes of notes: triple-A to the A$500m Class A notes, triple-A to the A$30m Class AB notes and double-A minus (S&P only) to the A$13m Class B notes. The notes will be issued by Perpetual Trustee Company in its capacity as trustee of Progress 2010-1 Trust. Mortgage insurance is provided by Genworth Financial Mortgage Insurance and QBE Lenders Mortgage Insurance.

The collateral for the transaction comprises 2,986 full and low documentation mortgage loans originated by AMP Bank and other related parties. The portfolio's weighted average loan-to-value ratio is 66.2%.

Fitch notes that 13.8% of the pool is comprised of fixed rate loans, 44.7% of the loan pool bears interest-only repayment terms of one to ten years, with the remaining 30.5% being comprised of investment properties. The pool has a weighted average seasoning of 26.2 months.

RMBS

US subprime loss projections revised

Moody's has revised its loss projections for US subprime RMBS issued between 2005 and 2007. On average, the rating agency is now projecting cumulative losses of 18.7% for 2005 securitisations, 38.4% for 2006 securitisations and 48.1% for 2007 securitisations, reported as a percentage of original balance. As a result of the revision, it has placed 5,698 tranches of subprime RMBS with an original balance of US$584bn and outstanding balance of US$319bn on review for possible downgrade.

On 29 October 2009, Moody's announced that it would update certain assumptions underlying loss projections for each of the major RMBS sectors. Since March 2009, when it last announced a revision to its subprime loss projections, serious delinquencies (loans that are 60 or more days delinquent, including loans in foreclosure and homes that are held for sale) in subprime pools from 2005, 2006 and 2007 have increased to 48% from 43%, 56% from 51% and 55% from 47% respectively (reported as a percentage of outstanding pool balance).

Even though the Case-Shiller index in recent months has reported very modest home price gains, Moody's believes the overhang of impending foreclosures will impact home prices negatively in the coming months. Moody's Economy.com (MEDC) expects home prices to fall by an additional 11% to reach a peak-to-trough decline of approximately 37%.

Adding to borrowers' financial pressure, unemployment is now projected to peak at around 10.5%. Both measures are expected to reach their peaks sometime in the second half of 2010, after which recovery is expected to be slow.

To estimate losses, Moody's first projected delinquencies through to the second half of 2010. It estimated that the proportion of contractually current or 30-day delinquent loans that will become seriously delinquent by the second half of 2010 will be 23%, 35% and 35% for the 2005, 2006 and 2007 vintages respectively.

Growth in new delinquency levels beyond the second half of 2010 is expected to decline with improving economic and housing conditions, however. To estimate delinquencies beyond 2010, Moody's applied a reduction to the new delinquency rate of 25% for 2011, 40% for 2012, 50% for 2013 and 50% for 2014 and beyond. This deceleration reflects home price and unemployment projections by MEDC for years beyond 2010.

To calculate the default rate on the projected delinquencies, Moody's assumed an average roll rate (probability of transition from delinquency into default) of 95%. The loss on the loan upon default (severity of loss) is expected to be around 70% on average.

In addition, the US government's effort to curb loan defaults and foreclosures through loan modification has failed to gain traction - prompting Moody's to reduce the average modification benefit to projected losses across vintages from 15% in March to less than 5% going forward.

RMBS

Eurosail deals face liquidity facility difficulties

Noteholder meetings have been held in connection with the Eurosail Prime-UK 2007-A, Eurosail-UK 2007-5NP and Eurosail-UK 2007-6NC transactions to consider resolutions to not pursue Danske Bank for the stand-by drawings under the liquidity facility agreement, following the bank's decision not to renew the liquidity facilities on the deals. The resolution was passed - for Eurosail Prime-UK 2007-A by the Class A noteholders, Eurosail-UK 2007-5NP by Class A1a noteholders and for Eurosail-UK 2007-6NC by Class A1a, A2a and A3a noteholders. The remaining classes of notes failed to reach a quorum at these meetings and a second round of meetings will be convened on 1 February 2010.

RMBS

Spanish RMBS defaults decrease

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

Moody's cumulative defaults trend decreased to 1.3% from 1.4% one month previously. At the same time, its 90 days plus delinquency trend decreased to 1.8% from its October level of 2%, a level that was maintained for three consecutive months. Moody's annualised constant prepayment rate (CPR) trend remained stable in November and ended at 6.5%.

Spanish RMBS transactions have suffered significant negative rating migration over the past months due to the country's deteriorating macro-economic environment. To a large extent, the weaker performance of Spanish RMBS has been driven by rising unemployment and dropping residential real estate prices, as well as highly levered loan features, geographical concentration to the coastal areas and the high number of new resident borrowers affected by unemployment.

All of the affected transactions closed between 2005 and early 2008. In some of the most recent RMBS vintages, cumulative defaults have more than doubled since the beginning of 2009. During December, Moody's downgraded notes from the following transactions: Hipocat 10, Hipocat 11, Hipocat 12, TDA CAM 5, TDA CAM 6, TDA CAM 7, TDA CAM 8, TDA CAM 9 and TDA CAM 10.

The Spanish economy is expected to remain in recession until Q210 - one of the longest in the Eurozone. For 2010 as a whole, Moody'sEconomy.com expects gross domestic product (GDP) to grow by a moderate 0.2%, while unemployment is expected to exceed 19%.

Weak economic activity, soaring unemployment and slowing income growth will continue to depress the residential property market, where prices have fallen by 9.5% since the peak in 2008. Excess housing supply, with an estimated 1.5 million vacant houses at present in Spain, will lead to a long adjustment process for the housing market. A low interest rate environment has helped many obligors deal with the turbulent economic conditions, but as other parts of the Eurozone recover at a faster speed, interest rates could rise towards the end of 2010, which could be premature for Spanish obligors, according to Moody's.

The rating agency's outlook for Spanish RMBS remains negative.

RMBS

UK non-conforming RMBS steadies

The performance of the UK non-conforming RMBS market continued to hold steady in November 2009, according to Moody's. The weighted-average delinquency trend reached 19.7%, which constitutes a decrease of 0.2% from one month previously.

Moody's reports that the repossessions trend continued the declining trend line that commenced in February 2009 and in November was equal to 2%. The total redemption rate remained unchanged from one month previously at 10.6%, which is less than half the level it was one year ago. The weighted-average cumulative loss trend remained at 1.3% for the third consecutive month.

As the performance of UK non-conforming transactions further stabilised in November 2009, 21 transactions have replenished their reserve funds and the number of transactions with a reserve fund below target level decreased to 36 from 42. However, 13 transactions have further drawn on the reserve fund and ten transactions have fully depleted the reserve fund.

The rating actions taken since November 2009 were mainly driven by weaker-than-expected performance of the collateral. Furthermore, Moody's notes that most of the recently downgraded transactions are exposed to rising costs due to stand-by drawings of the liquidity facilities, which cannot amortise following performance trigger breaches. The liquidity stand-by drawings represent, in certain cases, up to 47% of the current balance of the transactions.

The recovery in the UK economy is lagging other key western economies. GDP contracted a further 0.2% quarter-on-quarter in Q309 and Moody'sEconomy.com expects the UK economy to grow by a sluggish 1.1% in 2010. The unemployment rate is expected to continue to increase in 2010, peaking at 8.8% in Q210.

Weak economic activity will keep inflationary pressures under control. The continuation of low interest rates for most of 2010 will support households and help to contain the number of home repossessions. The UK property market is expected to resume falling in coming months and continue doing so until late 2010. The overhang from the property market may subsequently take some time to heal.

A total of 127 UK non-conforming RMBS transactions have been launched and rated by Moody's since 2001. As of November 2009, a total balance of £26.5bn was outstanding in this market, compared to £30.8bn one year previously. Since January 2009, no new transactions have been issued in the UK non-conforming market.

RMBS

Italian RMBS stabilises

The performance of the Italian RMBS market stabilised during November 2009, according to the latest indices for the sector published by Moody's. The rating agency's cumulative default trend declined to 1.2% in November from 1.5% in October (albeit the cumulative default trend may decline due to the inclusion of less seasoned transactions with lower cumulative default levels).

Meanwhile, Moody's 90-days plus delinquency trend also displayed a decreasing trend and ended November at 1.7%. Its constant prepayment rate (CPR) trend maintained a decreasing trend line and now stands at 8.4%. However, the stabilisation in performance trend lines needs to be considered with caution as the development is partially due to the inclusion of more recent transactions in the index, the agency notes.

As of January 2010, the 'Piano Famiglie' came into effect. This was approved by the Italian Banking Association to allow borrowers who meet a set of criteria to enjoy a maximum 12-month payment holiday. In Moody's view, the impact of this scheme on Italian RMBS will depend on the number of banks that participate, the portion of their securitised pools that relates to borrowers that are both eligible for the scheme and apply for a payment holiday under it, and the specific structure of each securitisation transaction.

In December, the agency downgraded several notes issued by Sestante Finance Series 2004, Sestante Finance Series 2005 and Sestante Finance Series 2006 due to worse-than-expected performance. All notes had been placed on review in July. In November, Moody's also downgraded notes issued by Casa D'Este Finance and Casa D'Este Finance II.

The downgrades were prompted by the downgrade of Cassa di Risparmio di Ferrara, which is the originator of the assets and acts as financial guarantor of the rated notes. Additionally, in November Moody's placed the Class C notes issued by Argo Mortgage 2 on review for possible downgrade due to the worse-than-expected collateral performance.

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

Italy emerged from recession in Q309, following five consecutive quarters of contraction. Moody'sEconomy.com expects GDP to grow by 1.1% in 2010 driven by exports and modest improvement in domestic demand.

However, there are some threats to Italy's economic recovery. For one, the main growth driver - external demand - is dependent on Italy's key trading partners, which are expected to grow only slightly in 2010.

Additionally, the euro is expected to appreciate against the dollar, which will negatively impact external competitiveness. Also unemployment is expected to continue to rise to an average of 9.4% in 2010 from 8.5% in 2009, which will continue to place pressure on household obligors

As of November 2009, the total outstanding pool balance in the Italian RMBS market was €93bn, which compares to €80.8bn one year previously. In 2009, a total of €24.2bn of mortgage loans was securitised in the Italian RMBS market. This increased market activity has been driven by the strong ECB investment programme, which was implemented this year.

RMBS

Irish prime RMBS continues to deteriorate

Delinquencies in the Irish prime RMBS market increased again in November, according to Moody's latest index report for the sector. The weighted-average 90+ days delinquency trend exceeded 3% for the first time since the agency began measuring the series in 2004, ending the month at 3.3%.

The weighted-average total redemption rate (TRR) continued to decline and ended November at 6.1%, which compares to 11.5% one year previously and is substantially below the all-time high of 25.3% observed in 2005. The weighted-average 360+ days delinquency trend continued to increase and stood at 0.8% in November, which is more than triple the level observed 12 months ago.

In December, it was announced that the government intends to extend the existing six-month moratorium for commencing legal proceedings on owner-occupied mortgages to 12 months, which could potentially further delay the repossession process.

The Irish economy has been acutely impacted by the recession and Moody's believes that that there has been damage to the country's growth engine to the extent that growth potential has been impaired. Sustained growth is not expected to return before H210 and Moody'sEconomy.com expects GDP to contract by 1.5% in 2010 overall.

Weak demand and oversupply of property in many areas suggest house prices will continue to fall during 2010. Around 80% of mortgages carry variable rates, which will rise when the ECB starts to tighten monetary policy, likely late in 2010. The unemployment rate is expected to continue to increase in 2010 to 13.8% and consequently mortgage arrears are expected to increase.

Moody's outlook for the Irish RMBS market is negative. As of November 2009, €40.3bn was outstanding in the Irish prime RMBS market, which compares to €39.9bn 12 months ago. In December 2009, one new transaction closed - Wolfhound Funding 2 - which was placed with the ECB.

RMBS

Managing extension risk with PAC structures

Glenn Schultz, senior analyst at Wells Fargo Securities, LLC, argues that investors seeking to maintain portfolio yield while at the same time limiting extension risk should consider five-year average life PAC bonds collateralised by high-balance agency MBS

The mortgage basis for both agency MBS as well as loan origination spreads is at or near historic tight levels. The relatively 'rich' mortgage basis poses a conundrum for many MBS investors (Exhibit 1). While the yield carry of agency MBS remains attractive, the likelihood that mortgage rates may rise over the year, thereby subjecting investors to extension risk, remains in the market.

We believe that investors seeking to maintain portfolio yield while at the same time limiting extension risk should consider five-year average life planned amortisation class (PAC) bonds collateralised by high balance agency MBS. Five-year average life PACs collateralised by high balance pools offer investors the following:

• Comparable yield and average life versus conforming collateral on our base case scenario.
• Extension protection in a rising mortgage rate environment.

Prepayment analysis
In response to the housing market, distress agency loan balance limits were increased beyond the US$417,000 balance. In certain high-cost areas, loan limits were increased to more than US$600,000, effectively creating a jumbo agency sector.

The relationship between loan balance and refinancing is well understood. Prime jumbo borrowers tend to exhibit both higher turnover rates as well as greater sensitivity to refinancing incentives.

This results in a more negatively convex mortgage pool. Exhibit 2 illustrates the difference in seasoning by loan balance.

Generally speaking, agency MBS exhibit a seasoning ramp that begins at 0.0% CPR and increases over 14 months to a peak around 12% CPR. The noticeable differences are the US$100,000-US$150,000, the US$150,000-US$200,000 and the US$200,000-US$250,000 loan balance cohorts.

We believe that the higher base turnover rate of these cohorts is largely attributable to the timeframe used to construct the baseline seasoning ramp. Our seasoning ramps cover the 2000 through 2009 time period, so our analysis covers the housing bubble and thus likely exhibits a 'speculative' turnover component.

To estimate the turnover component of the agency jumbo cohort (US$400,000-US$625,000), we used loan level data covering prime jumbo loans originated and securitised over the same period (2000-2009). Our analysis suggests that agency jumbo loans may exhibit a more aggressive seasoning ramp (Exhibit 3). Our expected seasoning ramp begins at 0.0% CPR and increases 2% CPR per month, reaching a maximum of 22% CPR in month 12.

Given the current economic environment and the potential 'lock in' effect with respect to the high-balance pool, we expect current origination high balance pools to season to between 10% and 15% CPR.

Refinancing response
Higher-balance loans typically exhibit greater responsiveness to refinancing incentives than lower-balance loans. Two reasons are given for this.

First, it is assumed that borrowers with higher loan balances tend to be more financially sophisticated than those with lower balances and thus exercise their refinancing option with greater efficiency. Second, the costs associated with refinancing are, for the most part, fixed and, as a result, higher-balance loans enjoy a shorter 'break-even' horizon for a given refinancing incentive versus lower-balance loans.

Exhibit 4 illustrates agency refinancing response by loan balance. The exhibit shows that as a general rule higher-balance loans exhibit higher prepayment rates for a given refinancing incentive than lower-balance loans. Again, our response functions cover the 2000 though 2009 experience; the higher response rate of the US$150,000-US$200,000 may be due to a 'speculative' component.

The expected refinancing response for the higher-balance loans is drawn from our loan level database and suggests that the US$400,000-US$625,000 loan balance cohort may exhibit prepayment rate around 55% CPR, given a 100bp refinancing incentive. For borrowers that are 'out of the money', prepayment rates are likely to be comparable to those of conforming agency loans around 5% CPR.

Collateral analysis
High-balance agency 5% collateral trades to a concession of 18/32nds versus conventional balance pools. The concession of the higher balance pool reflects the 'convexity cost' of the higher balance pool. Exhibit 5 compares the relative performance of a high-balance pool for a yield shift of +/- 100bp.

Under our base-case prepayment assumption, the average life of the high-balance pool is 2.7 years shorter than the conventional balance pool. Our analysis suggests that in the case of a 100bp rally in the mortgage rates, high-balance prepayment rates will likely be around 55% CPR.

In the case of a rising rate environment, we believe that high-balance loans will slow to around 3% CPR. The yield and average life analysis supports the market's concession and highlights both the greater extension and call risk of high-balance agency MBS.

PAC bonds provide extension protection
We examined the relative performance of a five-year PAC bond collateralised by a high-balance agency pool with a 5.45% gross WAC (Exhibit 6). In our base-case no-change scenario and using our high-balance ramp, the PAC bond's average life is 5.77 years - just modestly shorter than that of the high-balance collateral - and the PAC bond offers a 1bp yield advantage.

A down 100bp scenario causes the PAC bond's yield to underperform the collateral. This is due to both the higher dollar price and call risk profile that is similar to that of the high-balance collateral.

In a rising rate scenario, we expect prepayment rates to decline as low as 3% CPR. At that prepayment speed, the collateral average life extends to 13.5 years and the collateral's spread to the curve declines 76bp from +150/curve to +74/curve. Conversely, the PAC bond's average life extends to 8.03 years and the spread to the curve declines 45bp from +125/curve to +80/curve.

The five-year PAC bond offers investors a comparable average life and yield profile to high-balance collateral. In a falling mortgage rate environment, both the PAC and the collateral exhibit similar call risk. However, the PAC structure provides investors with superior extension protection vis-à-vis collateral in a rising mortgage rate scenario (Exhibit 6).

© 2010 Wells Fargo Securities, LLC. All rights reserved. This Research Note, entitled 'Relative Value Concept: Managing Extension Risk with PAC Structures', was first published by Wells Fargo Securities on 12 January 2010.

About Wells Fargo Securities, LLC
Wells Fargo Securities, LLC is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. Wells Fargo Securities International Limited is a U.K. incorporated investment firm authorized and regulated by the Financial Services Authority.
This report is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments named or described in this report. Interested parties are advised to contact the entity with which they deal, or the entity that provided this report to them, if they desire further information. The information in this report has been obtained or derived from sources believed by Wells Fargo Securities, LLC, to be reliable, but Wells Fargo Securities, LLC does not represent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgment of Wells Fargo Securities, LLC, at this time, and are subject to change without notice. For the purposes of the U.K. Financial Services Authority's rules, this report constitutes impartial investment research. Each of Wells Fargo Securities, LLC, and Wells Fargo Securities International Limited is a separate legal entity and distinct from affiliated banks. Copyright © 2010 Wells Fargo Securities, LLC.

Trading

Trading ideas: play time

Byron Douglass, senior research analyst, looks at an outright long bond trade on Hasbro Inc

The reach for yield continues. Comments from clients make it evident that investors are in need of cash bonds offering decent returns and backed by solid companies. Given the massive rally in corporates, finding such securities remains elusive though not impossible.

Our recently established bond MFCI model highlighted Hasbro as a company whose bonds trade cheap to its fundamentals. Hasbro is a solid company that generates plenty of free cash and maintains fairly low leverage. We recommend buying its 6 1/8s of May 2014 at a price of US$110.50.

Hasbro increased net earnings year-on-year during the third quarter of 2009, which bodes well heading into the fourth-quarter announcements. The recession has certainly been tough on consumer-focused companies, such as Hasbro, which is evident from its drop in interest coverage and cashflow from operations (albeit from fairly high levels). However, Hasbro's positioning as the second largest toy maker, with extremely solid margins, allowed it to plow through the tough times with limited damage.

The company's interest coverage remains at a healthy 11.6x - one of the best amongst triple-B rated consumer non-cyclicals (Exhibit 1). Hasbro's low total expense level (with LTM dividends, interest expense and capex totalling only US$273m) leaves it with plenty of free cashflow.

Exhibit 2 shows the time series for LTM CFO versus LTM expenses. Hasbro never comes close to generating a deficit, even during the difficult times. The company's strong cash generation, coupled with low expenses, position it well for the future (whatever may come).

At a price of US$110.50, the bond's z-spread is 108bp. We see a 'fair spread' of roughly 37bp for Hasbro's 6 1/8 bond based upon our quantitative bond model, due to its strong equity-implied factors, margins, leverage, free cashflow and interest coverage factors.

The MFCI bond model quantifies debt-issuer risk factors for which we, as investors, demand compensation when taking on credit risk. Its output is an expected five-year equivalent spread level for roughly 250 non-financial issuers based on a non-linear cross-sectional regression of the companies' credit scores and spreads. The equivalent spread of the model is then re-adjusted for each bond based on our curve model and the bond's maturity.

While our expectation for Hasbro's bond spreads is similar to CDS, we forecast a more substantial rally in the company's bonds and therefore prefer to take a long position in the cash market. That said, the model is closely aligned with our long-standing CDS MFCI model, which turned positive on Hasbro's CDS in late summer.

Though the gap between fair and market spreads narrowed in past weeks, the opportunity is still sizeable. As Exhibit 3 demonstrates, we expect the rally to continue and close the gap between the market and fair five-year CDS levels. Ahead of its scheduled fourth-quarter earnings announcement on 8 February, we recommend buying Hasbro's 6 1/8s of May 2014 bond when liquidity arises.

Position

Buy US$10m notional Hasbro Inc's 6 1/8s of May 2014 Bond at US$110.50 (Z-spread 108bp).

The appropriate interest rate hedge is available upon request.

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

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

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