Contents

RMBS

Paragon hits the road

UK BTL originator mulls issuance prospects

Paragon, the UK buy-to-let mortgage specialist, is monitoring developments in the securitisation markets as it looks for appropriate market conditions to support new RMBS issuance. UBS is arranging a roadshow to update investors on Paragon's strategy and talk about its mortgage programme, although the meetings will be on a non-deal specific basis.

"Paragon will commence a non-deal specific UK and European roadshow next week to update investors on what has been happening at the firm over the past couple of years," confirms John Harvey, head of structured finance at Paragon. "We will discuss market concerns and investor preferences in order to continue our growth strategy."

He adds: "We continue to seek options to fund new mortgage lending and hope to be able to make offers to our core BTL customers in 2010. We understand that the market would be receptive to a new BTL RMBS, so are developing our plans in that area."

In Paragon's 2009 annual report issued on Friday (22 January), the firm notes that significant progress has been seen in the securitisation markets in recent months, with credit spreads having tightened to a level where RMBS issuance has once again become a reasonable source of term financing for a number of financial institutions. While the firm admits that current new issuance costs appear expensive compared to the pricing levels prevailing prior to the credit crunch, it says that when compared to current mortgage pricing they now provide a reasonable net margin for the lender.

Existing Paragon RMBS transactions have been trading and performing extremely well, according to Rob Ford, partner and portfolio manager at TwentyFour Asset Management. "At the moment, Paragon deals are trading in the secondary market at approximately double the spread of benchmark prime RMBS names - in the low- to mid-200bp versus the low 100bp (depending on issuer). If a new Paragon deal were to be sold, it would have the added benefit of new collateral, originated under today's stricter guidelines," he comments.

Another European ABS investor comments that UBS' 'non-deal roadshow' for Paragon is a bit like the non-bwic-bwic that circulated the secondary market last week - in other words, there's no such thing. "At a guess, I'd say UBS is looking to gauge investor appetite for a new deal and, if successful, may offer Paragon a short-term originating warehouse facility for a new deal," he says.

In line with other UK prime and BTL RMBS transactions, Paragon's securitisations have shown signs of borrower performance deterioration through 2009 - although not to a level that affects ratings, according to a recent report from Fitch. The rating agency notes that one of the key supporting factors is that BTL lenders have a statutory right to have a receiver of rent appointed to collect rental payments directly from tenants.

"All of the Paragon transactions have seen an increase in the use of receiver of rent cases, and this has helped keep transaction cashflows stable and limit the level of loans in arrears," says Fitch.

The agency also believes that the effect of tighter lending criteria over the last year has helped support the BTL market as people have delayed purchasing their own property, strengthening tenant demand and maintaining upward pressure on rents. The rising rents and shorter void period have helped to ensure that arrears remain low compared to the rest of the mortgage market.

"The Paragon transactions are principally loans to professional landlords and therefore these are the type of borrowers best placed to take advantage of the recent market conditions for rental properties," Fitch says. "In addition to the low arrears levels, until recently, the majority of these transactions had a sequential note pay-down structure, with non-amortising reserve funds. This allowed credit enhancement to build steadily, which supported the affirmations of the current ratings."

Paragon's roadshow will target current Paragon RMBS investors, but not exclusively, given the change in investor base over the past couple of years. Fifteen Paragon RMBS have been issued in the past, the most recent deal being in June 2007.

"Paragon RMBS structures are one of the most transparent in the market: they are very simple, with no DACs or MERCs or other profit extraction mechanisms that have been a cause for concern in some other RMBS deals in recent times," comments Harvey. "I would guess that the structure of a new Paragon RMBS would be similar to existing structures, but will incorporate investor feedback from the roadshow."

AC

CMBS

Holding steady

Peter Cooper/Stuyvesant impact reviewed

Tishman Speyer and Blackrock Realty, sponsors for the US$3bn securitised Peter Cooper Village/ Stuyvesant Town (PCV/ST) loan, have announced their intent to transfer control of the property to CWCapital Asset Management via a deed-in-lieu of foreclosure. As yet investor losses are unclear; however, near-term the development is unlikely to have ramifications for the CMBS market as a whole.

"The situation at present is still very fluid: mezzanine debt owners are involved in the process, trying to use their rights to extract some value out of their investment. That is alongside the senior loan and the CMBS deals that CWCapital is representing," says one CMBS portfolio manager.

He adds: "One thing that this case shows is that the complexity of loans is not helpful when you run into problems. When loan origination starts again, people will likely look at more simple structures."

Fitch says no near-term negative rating actions on CMBS referencing the US$3bn PCV/ST loan are likely, following the latest development. "While it may be the intent of Tishman Speyer and Blackrock Realty to transfer control of the asset, Fitch's analysis of the asset does not change as a result of any near-term transfer of ownership," it says.

Fitch's value estimate of US$1.8bn is based on applying a 7% capitalisation rate to the adjusted Q209 financials.

Prior to the transfer of the loan to special servicing, Fitch downgraded three of the four transactions containing portions of PCV/ST, following continued underperformance of the property and the adverse ruling against the sponsors by the New York State Court of Appeals. Fitch's rating actions to date recognise 50% of the expected loss from PCV/ST.

"It looks like senior investors will take some sort of loss - but exactly how that plays out is not clear: There are several parties angling to put more cash in and take over management. Longer term, it's an iconic property - the local government has reason to stop the situation deteriorating too much," comments the portfolio manager.

"The news has not really affected the CMBS market," he adds. "Away from the Stuy Town and Extended Stay CMBS, CMBS still offers fixed income investors value over corporates. There is good demand for the senior bonds and limited new issuance is supporting spreads in the market. Even when there were three days of sell-off in the equity markets, senior CMBS tranches didn't widen out. This suggests that people are slowly realising that super-senior triple-As are not going to take losses, even with situations such as the Stuy Town default."

PCV/ST comprises 56 multi-story buildings, situated on 80 acres, and includes a total of 11,227 apartments. The loan sponsors acquired the property with the intent of converting rent-stabilised units to market rents as tenants vacated the property; however, the conversion of units has since been determined to be illegal by the New York State Court of Appeals. In addition to the US$3bn securitised balance, there is US$1.5bn of mezzanine debt held outside the trust.

Fitch comments that holders of the US$1.5bn in mezzanine debt, which is secured by ownership interest in the borrowing entity, may have remedies available to them that would delay or prevent a deed-in-lieu. The agency expects that a deed-in-lieu agreement may be a prolonged process, as these agreements are highly negotiated transfers between the borrower and lender.

Malay Bansal, md of portfolio management and advisory for commercial real estate & CMBS at NewOak Capital, says that - although the Stuyvesant Town story has attracted more attention - the Extended Stay bankruptcy story has more unusual elements. "Extended Stay reached a preliminary agreement with Centerbridge Partners and Paulson & Co to provide a US$400m cash infusion to enable the company to emerge from bankruptcy, and judge James Peck gave them a two-month extension of the exclusivity period for filing the restructuring plan. This story includes the original reorganisation plan, which was put together by the borrower and some of the investors throwing out the cash waterfall and procedures specified in deal documents and without consulting the trustee or the servicer, who are normally and legally the sole voices for securitisation," he explains.

"It involves the investors agreeing to pay the borrower for losses from violating the pledge to lenders in loan documents to not file for bankruptcy. It involves a rival group with several current debtors fighting back with an alternate plan. It involves the Federal Reserve as a debtor holding US$900m of debt, which could possibly take a loss," Bansal concludes.

AC

CMBS

A tale of two properties

Investor reports issued this week for the REC 5 and Titan 06-3 transactions illustrate the stark difference in performance that good and poor quality assets can bring to a CMBS. The property backing the former deal has increased in value, while one of the loans backing the latter has plummeted by over 90%.

The latest investor report for REC 5 indicates an increase in the value of the property of 8% in Q409, to £400m. The senior LTV ratio for the transaction is now 102.53%, with the whole LTV ratio 108.67%. The property backing the loan is Plantation Place in the City of London, which is 76% let to Accenture on a long lease.

The rise in value demonstrates the improvement in the investment market for assets with good quality, long-dated income, according to Chalkhill Partners analyst Michael Cox. "The rising market for this type of asset is significantly improving the prospects for full principal recovery to the more junior notes in the deal," he notes. "We think the prospects for the Class A bonds are excellent in terms of likely return of principal, with the only question being when - in our view extension to loan maturity looks quite likely. However, we think there are better returns to be found further down the capital structure."

With the REC 5 LTV still above 100%, the latest update does not seem likely to prompt action on the deal, which has been in a state of limbo since the LTV covenant was breached by the valuation undertaken at the end of March 2008. The loan does not mature until July 2013 and Cox says it is conceivable that the transaction will run until then with no enforcement action being taken.

Meanwhile, Titan 2006-3 has taken over from Windermere VIII (where the Monument loan reported a value fall of 85.4%) as the European CMBS reporting the largest fall in the value of property backing one of its loans, according to Chalkhill records. The issuer has disclosed that the market value of the single property backing the Quelle Nürnburg loan has fallen from €135m to a new valuation as at 1 January 2010 of €12.47m - a fall of 90.8%. The loan accounts for 11% of the Titan 06-3 pool.

The former principal tenant of the property, Quelle, is in liquidation and has exited the property. The property is subject to monumental protection in Germany: it was purpose-built to the requirements of the former tenant and has restrictions on use. The costs of adapting the vacant building to new tenants, limitations on use and challenges in attracting new tenants have resulted in a substantial reduction in value, the servicer notes.

However, Cox says: "We think that for tricky properties like this, valuers have generally been overly pessimistic in their revised valuations - although it is clear that the loss of the tenant will have had a significant adverse impact on the value of the property."

Fitch has placed all of Titan 2006-3's notes on rating watch negative (RWN), except the cash-collateralised Class X notes, which have been affirmed. The rating agency notes that a potential sale of the property at the updated value would result in a write-off of the unrated Class G and H notes, as well as the Class F notes, which are currently rated triple-C. The Class E notes, also rated triple-C, would sustain a loss of approximately 11% of their current balance.

Fitch says it will resolve the RWN after the updated valuation report has been received and analysed and an update is obtained from the special servicer.

CS

Regulation

Political risk rears its head again

President Obama's proposal to curb bank prop trading last week precipitated a significant sell-off in credit, bringing the impact of political risk on financial markets into sharp focus. However, there is optimism that - despite numerous policymaker challenges - securitisation can continue to be a liquidity conduit to consumers.

Obama's proposal aims "to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit". The short announcement on 21 January left many open questions, in particular regarding the definition of allowed prop trading for customers, but speculation is growing that it could lead to a Glass-Steagall Act-like separation of banks.

While the proposal may well be watered down over the coming weeks and much depends on the final details, RBS credit strategists suggest that one option for Goldman Sachs and Morgan Stanley could be to give up their bank holding status, while other US banks - such as Bank of America, JPMorgan and Citigroup - might have to spin-off some of their hedge fund and prop trading operations. The impact on non-US banks with US operations - including Deutsche Bank, HSBC, Credit Suisse, BNP Paribas, Barclays and RBS - will depend on whether it would be possible for them to move their prop trading operations outside of the US.

Richard Reid, director of research at the International Centre for Financial Regulation, indicates that the thrust of the proposal is to prevent institutions that benefit from deposit insurance and other official support measures from becoming exposed to undue risk. "Over the past months some of the plans to change banks capital requirements have similarly taken aim at the riskier part of banking and indeed some academics have suggested that parts of the banking system - the riskier parts - could be treated as the dot-com companies of the 1990s. They can have a high [risk-return] profile (and remuneration policy) but should also bear the ultimate sanction - failure," he says.

Analysts at Credit Derivatives Research note that 21 January was the seventh consecutive day of wider wides and wider tights in credit - the longest run of consecutive wider wides and wider tights since June 2008. The CDX.IG index, for example, reached intraday wides of 12/22 and closing wides of 12/16. "We last saw a run 'like' this into the March 2009 wides," they remark, adding that the current sell-off is one of the steepest they have seen.

Furthermore, decompression was a strong theme during the day: decompression between the XO-Main indices gained 15bp, HY-IG 30bp, HY-XO 17bp, HY-LCDX 25bp and iTraxx Financials Sen-Sub 6bp.

ABS analysts at JPMorgan observe that the market sell-off highlights a key issue for financial markets - political risk. They point out that challenges - in the form of government policy - remain for the securitisation sector in particular, with a number of laws and bank regulations pending that will impact a broad spectrum of consumer lending and issuance activity.

"Overall, we are cautiously optimistic that government policy will not jeopardise the flow of liquidity to consumers and believe that securitisation - with well thought-out, good regulation - can continue to be that liquidity conduit," they add.

The analysts note that, even as political risk created volatility in the market, fundamental risk is moderating. "Thus far, we have seen mostly positive earnings, with financials and banks generally reporting stability in credit losses rather than increases. The slowly improving economic backdrop and the decreased seller/servicer risk support the performance of ABS."

CS

Regulation

FHA policy changes 'balance opposing forces'

The US Federal Housing Administration (FHA) has unveiled its policy changes designed to strengthen its capital reserves, while enabling the agency to continue to support the nation's housing market recovery. The agency proposes to take the following steps: increase the mortgage insurance premium (MIP) to 2.25%; new borrowers will be required to have a minimum FICO score of 580 to qualify for FHA's 3.5% down payment programme; reduce seller concessions to 3% from 6%; and implement a series of significant measures aimed at increasing lender enforcement.

MBS strategists at Barclays Capital suggest that, in making these changes, the FHA had to balance two opposing forces. On one hand, soaring non-performing loans have crippled the agency's mortgage insurance fund and have called into question whether the government would need to make up any shortfall. On the other hand is the need for the FHA to act in support of the housing market.

Since the collapse of the non-agency market, FHA share of agency purchase originations have increased to nearly 40%-45%. Consequently, a dramatic tightening in underwriting standards risks severely reducing overall mortgage credit availability, putting a nascent housing and economic recovery in jeopardy.

"Overall, the changes announced to FHA underwriting seem to be less restrictive than anticipated and, in our view, reflect the conscious decision of the FHA to support mortgage credit availability and the housing market at the expense of minimising losses to the MI fund," the BarCap strategists note. Furthermore, they don't anticipate a significant reduction in either GNMA prepayments or issuance as a result of the changes.

According to FHA commissioner David Stevens, striking the right balance between managing the agency's risk, continuing to provide access to underserved communities and supporting the nation's economic recovery is critically important. "When combined with the risk management measures announced in September of last year, these changes are among the most significant steps to address risk in the agency's history," he says. "Additionally, by continuing to provide affordable, responsible mortgage products, FHA will support the housing market's recovery. Importantly, FHA will remain the largest source of home purchase financing for underserved communities."

In addition to these changes, the FHA says it will continue to review its overall response to housing market conditions, as well as evaluate its mortgage insurance underwriting standards and measures to help distressed/underwater borrowers through FHA/HAMP and other FHA initiatives.

CS

Secondary markets

New valuation challenges

Andrew Smith, founder and president, and Bruce Lohman, md at Houlihan Smith & Co, discuss the valuation challenges posed by the end of TALF

In December 2009, the Fed reiterated its anticipated expiration dates of the Term Asset-Backed Loan Facility (TALF): June 30 of this year for loans backed by new-issue CMBS and March 31 for loans backed by all other approved types of collateral. The original anticipated date having been 31 December 2009, there is certainly no guarantee that the new dates won't be extended as well.

However, in the fourth quarter of 2009, non-CMBS TALF participation waned as more investors began circumventing the programme and making deals on their own terms. This independent private-sector activity is a strong signal that the Fed has made progress in restoring confidence in an ABS market that was all but frozen in the autumn of 2008.

The purpose of the TALF programme was to increase credit availability and support economic activity by promoting renewed issuance of consumer and business ABS at historically normal spread levels. Fundamentally, the TALF provides balance sheet capacity to the financial system that the private firms have been unable or unwilling to provide in the past year.

Against these goals, the TALF must be considered a measured success. Beginning with consumer ABS in March and with successful auctions each month thereafter, the TALF programme moved onto legacy CMBS in July. While TALF loans for legacy CMBS have been steadily granted, new CMBS issuance has been dormant, aside from US$72m in November. In addition, due to an overall higher demand, spreads on consumer ABS are also down substantially since peaking late in 2008.

The TALF has resulted in increased levels of new issuance for its approved ABS categories. Eligible collateral for non-CMBS TALF loans includes packaged debt within the following sectors: auto, credit card, equipment, floorplan, premium finance, servicing advances, small business and student loans. TALF loans for investment in CMBS weren't introduced until July, three months after the non-CMBS loans.

Although at times overshadowed by the Fed's balance sheet expansion plan and the March PPIP announcement, the TALF serves as an important complement to other measures introduced by various government entities during the crisis.

Many people underestimated the difficulties of establishing TALF funds, as the bureaucracy and reporting requirements are onerous. In fact, these hurdles have encouraged a revival of ABS deals apart from the TALF. Non-CMBS TALF loan requests have been declining steadily since peaking at over US$11bn in June 2009.

The TALF issued but one loan to eligible investors in January, while investors have purchased every ABS from the auto sector in the past two months without TALF assistance. This mixture of investors' new confidence and their aversion to burdensome TALF procedure has precipitated what appears to be a recovering non-CMBS ABS market.

However, comparably encouraging evidence has not been as easily found in support of the CMBS market until recently. Borrowing through the TALF for legacy CMBS has not tapered as much as borrowing for non-CMBS; this indicates that many investors are still not ready to enter the market without the Fed's low rates and non-recourse financing. This tentative behaviour is likely due to disheartening data from the sector.

In December 2009, delinquency rates for loans underlying CMBS exceeded 6% for the first time ever (see SCI issue 167). Jefferies & Co analysts say that rate could climb to between 9% and 14% by the end of 2011.

To add to the stress, US$40bn of CMBS is due to mature this year. That's more than twice the value of new CMBS that Barclays Capital expects to be sold over the same period.

The good news for CMBS is that after 18 months of dormancy, new deals are finally happening. Recently, Goldman Sachs and Developers Diversified Realty Corp arranged a US$400m deal with some TALF assistance. Two fully private CMBS deals have also been executed: JPMorgan-Inland Western Real Estate Trust Inc executed one worth US$500m, and Bank of America and Fortress Investment Group teamed up for a US$460m issuance (SCI passim). It's also been reported that RBS and Deutsche Bank are planning to get into the market.

Structural features impact valuation analysis
As we approach the anticipated date of TALF's termination, the managers of TALF funds are entering a new phase of financial reporting requirements and analysis. While the basic requirements for TALF funds reporting are reasonably straightforward, the programme's terms and conditions present some interesting questions going forward. As with many investment funds, the accounting literature applicable includes recently amended Topic 820, 'Fair Value Measurements and Disclosures'; FAS 157, 'Fair Value Measurements'; and FAS 159, 'The Fair Value Option for Financial Assets and Financial Liabilities'.

The TALF programme provides three essential attributes that the private financing markets have been unable to provide during this period of credit and liquidity stress. First, the TALF programme provides leverage for purchases of highly rated assets in a period of rapid deleveraging. It can provide six- to 20-times leverage, depending on the type of collateral provided.

Second, the TALF programme provides term financing, which allows investors to avoid rollover risk on various asset categories. Lastly, the TALF programme provides protection against negative economic outcomes, making the US federal government the ultimate obligor.

This last important feature of a TALF loan is an implied put option to the Federal Reserve Bank of New York (FRBNY). Under the programme, the FRBNY will provide non-recourse financing to any eligible borrower owning eligible collateral.

If the borrower is unable to repay the TALF loan, the FRBNY will enforce its rights to seize the underlying collateral. In essence, with some minor clarifications for violations of representations and warranties, any TALF fund cannot lose more than its initial collateral posting (i.e., its equity contribution) and administrative fees. The FRBNY does not at any point call for additional collateral or margin posting.

The application of Topic 820 and FAS 159 standards as it applies to assets appears to be relatively straightforward compared to the liabilities evaluation. From a liability perspective, if FAS 159 is elected, the fund may choose to value the debt payable to the FRBNY at fair value.

TALF funds likely will work with outside valuation firms and auditing firms to develop internal models to value debt facilities with little observable market data and substantial restrictions on transferability. As FASB continues to develop guidance on how fair value models apply to liabilities, accountants and financial advisors will need to develop appropriate models to maintain consistency with ever-evolving practice. One possible outcome is the development of methods to limit the reporting of negative equity model solutions, given the inconsistency of such presentation with the non-recourse nature of the FRBNY debt facility.

The TALF expiration dates present unique questions about the valuation of the balance sheet of any TALF fund. While operational, the market reference for TALF liabilities is other TALF fundings. Each month, the programme effectively validates the existing funding level as market-appropriate.

At expiration, however, it is not currently anticipated that privately available funding sources will match the TALF's generous terms, conditions and spread levels. Market reference spreads therefore may be substantially wider, implying that the liability structure may have experienced an implied gain. Again, as the FRBNY develops a withdrawal or programme termination strategy, valuation professionals must be prepared to work with clients on modifications to valuation models to reflect past market inputs.

Conclusion
The TALF programme has been a success to date, as measured against the programme goals of reviving the securitisation markets. However, the extent to which TALF is simply a leveraged bandage in a world of nuclear deleveraging is unclear. As evidenced in the first 11 months of the TALF programme, we anticipate the FRBNY to continue to revise the terms and conditions in order to align incentives that will be necessary to implement an orderly withdrawal from being the world's largest repo desk.

Technology

The right direction

Rohan Douglas, ceo of Quantifi, answers SCI's questions

Q: How and when did Quantifi become involved in the structured credit market?
A: I set Quantifi up in 2002, having previously run the global credit derivative research group at Citi. I saw an opportunity at that time in an environment where the biggest banks had sophisticated internal risk management and pricing systems, but new entrants to the credit market lacked access to such infrastructure. The timing was fortuitous as it allowed us to participate in the subsequent growth of the market.

For our first two years of operation, we worked with a single client to build out our suite of products and then expanded to a broader range of clients. We now have over 120 clients, split fairly evenly between the buy- and sell-side.

Quantifi provides a range of integrated pre-trade and post-trade analysis, pricing, structuring and risk management solutions.

Q: Do you focus on a broad range of asset classes or only one?
A: We aim to be the leading analytics and risk management provider in the broader credit markets. We specialise in cash and synthetic credit products, including sovereign and corporate bonds, loans, CDS, nth-to-default baskets and synthetic CDOs, CLOs, convertibles and interest rate derivatives.

One interesting project we're focusing on at the moment is the area of counterparty credit risk. This follows our recent acquisition of Moment Analytics (see SCI issue 161), whose ceo David Kelly formerly managed counterparty credit risk for Citi.

Counterparty risk touches on a number of asset classes and plays directly to our credit modelling expertise and technology infrastructure: the ability to create fast ad-hoc scenarios is a primary focus for large financial institutions right now. They need to be able to run large-scale Monte Carlo analyses across portfolios.

Because the work is computationally intensive, it is important to be timely. There is a gap in the market for this kind of capability.

The acquisition of Moment Analytics brings a great deal of value to Quantifi and, in particular, David's expertise in counterparty risk will be an important part of our development in this area.

Q: How do you differentiate yourself from your competitors?
A: One differentiating factor is that our technology infrastructure was built from the ground up. Whereas other vendors may offer, for example, add-on scenario analysis functions, we can produce faster results because it has always been an integral part of the risk engine. Equally, our analytics library was built on a .Net platform, so performance has always been a key element of the product.

Another differentiator is that we bring on board experienced people from the industry, so we better understand the nature of our clients' needs. Our infrastructure means we can respond to those needs rapidly; as a result, we've been first to market with a number of products. I think this flexibility will be important in 2010.

Finally, while many vendors are geared towards serving banks, the strength of our risk management system is its scalability. For smaller market participants, we can roll it out in a matter of weeks.

Q: What has been the most significant development in the credit market in recent years?
A: In 2009, the most significant development in the credit market was the introduction of standardised CDS contracts: the downstream effects of this are still being played out. Standardised contracts have changed how risk analysis and processing of credit derivatives are viewed. Essentially, financial institutions have not yet implemented the necessary systems for more detailed analysis.

Certainly the challenge for some institutions is that credit products evolve at a pace that not all existing systems are geared up for. The simplest credit product can be fitted into an interest rate swap system, but more complicated structures need more sophisticated systems.

We've been a believer for a long time in the benefits of the credit markets: it's natural for the market to see a transition in investors from investment banks to broader market participants. The evolution of CDS has followed a similar path to interest rate swaps: most large corporate treasurers use interest rate swaps and some use CDS - this usage will only increase going forward. Although the credit crisis has delayed such broader adoption for a while, the infrastructure changes in the pipeline - if structured correctly - will only accelerate this trend; for example, through better transparency and automation.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: The challenges affecting the OTC derivatives and credit markets more broadly are creating opportunities for Quantifi. In particular, the credit crisis demonstrated that, in certain cases, older legacy risk management models didn't perform as needed or expected. In addition, regulatory changes are having a structural effect on the market.

The overall impact of these challenges will remain uncertain until the final regulatory picture is resolved. However, institutions are already readjusting their priorities in expectation of the need for greater reporting.

The general direction and focus of regulatory efforts is clear: the intention is to introduce CCPs and begin clearing a growing area of the OTC market, as well as increase regulatory reporting. The market is heading in the right direction with regulation, but the slightest change in focus further down the line can have a huge impact. The more complex the regulation, the more likely it is that unintended consequences could occur.

Historically, the CDS market has been dominated by big banks, and it is hard to predict how the opening of the market to new participants will impact the landscape. The concern for some on the buy-side is that the regulatory changes will increase the cost of trading CDS, but I'm not so convinced about this argument. The tying together of all the different pieces involved in using a CCP will be a challenge for most players, especially in an environment where there are cost constraints.

The CDS market has traditionally been quite competitive, with aggressive bid/offer spreads and plenty of liquidity. I'm not sure what the net effect will be if banks are no longer so motivated to provide liquidity. However, if you look at the development of other derivative asset classes, there is a good case to be made around the positive benefits of clearing in terms of liquidity and market size.

Q: What major developments do you need/expect from the market in the future?
A: We talk to many different institutions and there appears to still be wide variety in risk management practices - albeit the average level of sophistication and awareness of industry best-practice has gone up a notch. The experience we've had is that, during times of volatility, firms that don't have the necessary infrastructure end up having difficulties.

There is still work to be done: fundamental changes are taking place in the OTC derivatives trading and processing space that will have a profound impact on infrastructure, but not everyone has bought into this and many are still not prepared. In terms of the independent valuations space, for example, more market participants need to be aware of the benefits of scenario-based analysis.

Traditional static risk management approaches are based on individual sensitivities; thus the danger is that users assume everything stays the same. VaR, another common analysis, involves simplified assumptions about the distribution of market moves. But both approaches miss key elements of risks in more complex markets.

Scenario-based analysis involves analysing specific examples: cases that will realistically capture events that could/have happened to identify the relationships between different moving parts of the market. It also provides the ability to consider arbitrary scenarios on an ad-hoc basis.

CS

ABS

Aladdin appoints key staff

Aladdin Capital Holdings has appointed Sharad Samy as its general counsel and Thomas Donahoe as its global risk officer. In these newly created positions, both Samy and Donahoe will be based in Aladdin's Stamford headquarters and report directly to vice-chairman and cio, Neal Neilinger.

Prior to joining Aladdin, Samy was a partner at Orrick, Herrington and Sutcliffe. His main responsibilities included representing clients in connection with private and public placements of various ABS, including CP transaction and medium-term/long-term debt instruments. He acted as counsel to banks, sponsors, issuers and monoline insurance companies with respect to a number of different funded and synthetic securities, including asset-backed notes and CLNs.

Samy also represented clients in connection with the securitisation of a number of different asset classes including credit card receivables, trade receivables, project finance debt, real estate loans, commercial loans and equipment leases. He has worked extensively in both London and New York and has covered cross-border transactions involving jurisdictions in North America, South America, Europe and Asia for offerings in the US and European capital markets.

Neilinger says: "Sharad has extensive legal experience both in the US and in Europe. His ability to practise law here and in London will serve us extremely well as we continue to develop and grow our investment business in our Stamford and London offices. We are delighted to have him on our team."

Donahoe joins Aladdin from Angelo, Gordon and Co, where he served as chief risk officer. He chaired the market risk and valuation committee, counterparty and disaster recovery committee, and oversaw all aspects of risk across the firm with a focus on distressed debt, bank loans, DIP financing and RMBS strategies.

Previously, Donahoe was with Barclays Capital, where he was director of risk for several fixed income and equity trading desks, and was also promoted to coo of market risk in New York.

Neilinger continues: "Tom is a seasoned risk officer with broad management experience in alternative investments, investment banking, asset management, insurance, trading and regulation. His experience in creating risk infrastructure and building risk teams will be invaluable to the future growth of Aladdin."

Advisory

Credit advisory agreement inked

Christopher Street Capital and Credaris have signed a cooperation agreement to operate in the fixed income advisory space. Under the agreement, Credaris is expected to provide Christopher Street with input in analysing and pricing structured credit products in return for benefiting from any new relationships that Christopher Street can bring.

Andrew Donaldson, head of Credaris, says: "We believe there is a virtuous circle that can be established between the two businesses, which will be of great benefit to our respective clients. While both companies will retain their independence and specialist expertise, we aim to work together where a client needs a more complicated solution involving advisory, management and execution services, particularly of complex portfolios of legacy assets."

Iain Baillie, head of Christopher Street Capital's European fixed income group, comments: "This is a very exciting step forward in the evolution of our business. We are always looking at ways to structure ourselves to better serve our clients."

He adds: "Credaris's reputation for top quality credit analysis and state of the art structured credit pricing technology will be a massive boost to our ability to deliver a first class service to our clients."

The move follows the establishment at Christopher Street of a structured credit team under the leadership of Edward Cahill (see SCI issue 164).

CDS

Bank reorganises fixed income team

UBS Investment Bank has restructured its FICC (fixed income, currencies & commodities) unit with the appointment of Neal Shear as global head of securities. In addition, UBS global head of credit Rajeev Misra and global head of macro Dimitri Psyllidis will take on additional responsibilities as joint global heads of FICC. Jeff Mayer will take on the new role of executive chairman of FICC.

Shear has over 30 years' experience in the industry. He spent most of his career at Morgan Stanley, where he was most recently co-head of sales and trading, with responsibility across equities and fixed income.

Carsten Kengeter, co-ceo of UBS, says: "Neal will be responsible for driving a more aligned approach across equities and FICC, a cornerstone in our strategy for an integrated client-centric investment bank built around flow and advice. He is a real veteran of the securities industry, having spent over 30 years developing world-class businesses. "

UBS has also appointed Roberto Hoornweg as global head of securities distribution, based in London. He joins UBS after 17 years at Morgan Stanley, where he was most recently head of global interest rates, credit & currencies.

Shear, Hoornweg, Misra and Psyllidis will all become members of the investment bank's executive committee.

CDS

New role for ML structured credit pro

Jennifer Meyer, former vp in the global structured credit products group at Merrill Lynch in New York, has joined Rutgers School of Law in Newark as senior associate director of development. In her new role she will increase financial support for student scholarships, faculty research, clinical activities and new initiatives.

At Merrill Lynch, Meyer was responsible for originating, structuring and marketing fixed income derivative transactions. Prior to that, she held positions at Ambac Assurance Corporation and Skadden Arps Slate Meagher & Flom.

CDS

New partner for derivatives team

Berwin Leighton Paisner (BLP) has hired James Duncan, previously with Linklaters, as a partner. He specialises in the derivatives and structured products markets, and joins BLP's derivatives team after having recently advised PwC on the administration of Lehman Brothers and worked with other corporates and investment banks on both securitised and OTC derivative products.

Duncan joins other recent appointments within BLP's finance team, including leveraged finance expert Andrew Bamber, banking and capital markets specialist Richard Hughes and Jayne Black and Eleanor Hunwicks - both of whom are leaders in the advising of servicers of commercial mortgage loans. The hire also complements the establishment of BLP's structured finance team, following the recruitment of Paul Severs, Tamara Box and Tom Church in 2006 and Nick Butler in 2007.

Simon Allan, BLP's head of finance, says: "James's appointment signals a new chapter for the finance team at BLP as we grow and develop to meet the needs of our clients. Notwithstanding the current economic environment, we believe derivatives will continue to be an integral and established feature of financial markets."

He adds: "As a senior structured finance specialist with a wealth of experience, James is well placed to build upon the existing expertise within the firm and create a new centre of excellence. We expect to expand the team in the coming year to include more partners and associates."

Clearing

ICE Clear Europe gains US DCO registration

The Commodity Futures Trading Commission has issued an order granting ICE Clear Europe registration as a derivatives clearing organisation (DCO). Pursuant to an order that the Commission issued on 23 July, ICE Clear Europe had been operating within the US as a multilateral clearing organisation.

ICE Clear Europe clears energy-based contracts and CDS contracts on European reference entities. As a registered DCO, it is authorised to clear futures contracts, options on futures contracts, commodity options and OTC derivative contracts.

CLO Managers

Name change for newly-assumed CDOs

Babson Capital Management has confirmed that is has been selected by the controlling class of investors to serve as successor collateral manager of two CLO-squareds previously managed by Tricadia Loan Management (see SCI issue 164). Under the terms of the amended management agreement, the US$250m Tricadia CDO 2005-4 will be renamed Ashford CDO I and the US$330m Tricadia CDO 2006-6 will be renamed Ashford CDO II.

"We're delighted to have been selected by the investors to assume management of these CDOs," says Matthew Natcharian, md and head of the structured credit team at Babson Capital. "Including the assumption of the Tricadia portfolios, Babson Capital has been named replacement manager for 16 CDOs and CLOs worth more than US$4.7bn since 2003, which speaks to our global leadership in structured credit investing and our track record of success over many market cycles."

Babson Capital was rated No. 1 in the list of top US CLO managers as of 31 December 2009, according to a ranking recently released by S&P. The firm leads the list of the 21 largest CLO managers with 29 CLOs, loan CDO-squareds and CLO market-value transactions.

In total, Babson now manages 55 CDOs worth US$20.4bn in structured credit assets, as of 31 December.

CLO Managers

Callidus CDOs get new manager

GSO/Blackstone Debt Funds Management (DFM) is to take over the collateral management duties for all nine CDO and CLO funds currently managed by Callidus - a portfolio company of Allied Capital. The transactions invest primarily in leveraged loans and high yield bonds. Total assets within the Callidus funds are approximately US$3.2bn.

"This transaction represents the execution of one of our key strategic initiatives to further scale our CLO franchise and capitalise on the strength of our investment process and infrastructure," comments Bennett Goodman, senior managing partner of GSO.

GSO's current assets under management total approximately US$24bn, consisting primarily of leveraged finance investments. Dan Smith, a senior md and head of DFM, says: "The Callidus CDOs fit nicely within our current fund complex. The funds have been well managed in a manner consistent with our style and philosophy such that the assets are very complimentary with our existing portfolios."

GSO currently manages 24 CLOs in the US and Europe. Berkshire Capital served as exclusive advisor to Allied on the transaction.

CLO Managers

Manager gains synthetic mandate

Aladdin Capital Management UK has replaced Solent Capital as portfolio manager delegate with respect to several credit linked notes (CLNs) issued by Iris SPV, according to a statement on the Irish Stock Exchange. The notes include: Series 10/2006 and Series 12/2006 zero coupon CLNs; and series 13/2006, series 14/2006, series 24/2007, series 26/2007, series 27/2007 and series 31/2007 contingent coupon CLNs.

CMBS

MBS strategy head departs

Citigroup Global Markets' md and head of MBS strategy, Rahul Parulekar, is leaving the firm. Parulekar, who has been with Citigroup since March 2004, previously held positions at Bear Stearns, Cygnifi and Lehman Brothers.

Although Citigroup has confirmed Parulekar's departure, a spokesperson declined to comment further.

CMBS

Special servicer solutions provider formed

The Alter Group has unveiled a new affiliate, Alter Asset Recovery, to provide expedited solutions for lenders and special servicers holding distressed properties. Alter Asset Recovery is led by industry veterans James Clark, managing principal of EnTrust Realty Advisors and the former president of the investment services group at Transwestern; Samuel Gould, president of Alter Asset Management; and Ronald Clarkson, president of Alter Construction Management.

Alter Asset Recovery will lead lenders through the financial, operational, asset-management and reporting steps that assure a successful takeover and sale of distressed properties. The affiliate will focus on institutional-calibre office, industrial, medical, mixed-use and corporate real estate assets.

Alter Group president Michael Alter says: "As a developer and owner, we're able to evaluate distress from an operational and underwriting perspective to extract its underlying value."

Clark adds: "This is a critical year for banks, thrifts and special servicers. The FDIC has absorbed US$30bn in debt from failed banks. Some US$40bn in CMBS loans arrive in 2010, straining special servicers to sell assets. Distressed commercial assets can make or break balance sheets this year."

Alter Asset Recovery's services include:

• Cost/benefit analysis of loan modification options
• Implementation of asset recovery plans for a foreclosure or deed-in-lieu transaction
• Forensic analysis of operational efficiency and required property capital investments
• Establishing and repairing tenant relationships, including leasing parameters to fill vacancies
• Re-engineering and resuming stalled construction projects
• Repositioning assets for recovery and a successful sale.

Investors

PE firm hires structured credit pro

Private equity firm Providence Equity Partners has hired Oliver Wriedt as an md in its capital markets group. Wriedt has held senior positions in structured and leveraged finance for the past decade, including as a partner at GoldenTree Asset Management, where he was co-head of marketing and structured products from 2004 to 2008.

From 1998 to 2004, Wriedt was md at Deutsche Bank in London and New York, where he held several sales management positions. These included heading up the structured credit distribution teams in Northern Europe and running the alternative asset solutions effort in North America.

The Providence capital markets group currently invests primarily in the debt of media, entertainment, communications and information companies worldwide - the same sectors in which the firm has made equity investments for nearly 20 years. The team is led by Thomas Gahan, former ceo of Deutsche Bank Securities, and includes Michael Paasche, who spent 13 years at Deutsche Bank in structured and leveraged finance, most recently as global head of leveraged finance.

Legislation and litigation

MBS insider trading charges settled

The insider trading charges levelled against Evergreen chief administrative officer, Charles Marquardt, by the SEC have been settled. Marquardt has agreed to pay approximately US$40,000.

At the time of his trading, Marquardt was the svp and chief administrative officer for operations of Boston-based Evergreen Investment Management Company, the investment adviser to the Evergreen Ultra Short Opportunities Fund. The SEC's complaint alleges that on 11 June 2008 Marquardt learned that the Ultra Fund might soon reduce the value it assigned to several of its MBS holdings and therefore decrease the fund's per-share net asset value (NAV), which might cause the fund to close. The complaint further alleges that, on the next day, Marquardt redeemed all of his Ultra Fund shares and caused a family member to do the same.

Over the next several days, the fund did, in fact, decrease the value it assigned to its holdings, triggering significant reductions of the fund's NAV. On 19 June 2008, Evergreen publicly announced that the Ultra Fund would be liquidated. Marquardt and his family member are believed to have avoided losses of approximately US$4,803 and US$14,304 respectively.

Without admitting or denying the allegations in the Commission's complaint, Marquardt consented to the entry of a final judgment permanently enjoining him from violating Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 there under. Marquardt also agreed to pay US$19,107 in disgorgement (representing the losses that he and his family member avoided), US$1,242 in prejudgment interest and a US$19,107 civil penalty.

Marquardt has also consented to be barred from association with any broker, dealer or investment adviser, with a right to reapply after two years.

The Commission's action against Marquardt follows its enforcement action against Evergreen and an affiliated distributor, filed in June 2009, in which the commission charged Evergreen with violating the federal securities laws in connection with - among other things - overvaluing holdings in the Ultra Fund from February 2007 to June 2008. Evergreen agreed to pay more than US$40m to settle those charges.

The SEC's investigation is ongoing.

Legislation and litigation

Monoline sued for improper CDS termination

Société Générale is suing monoline FGIC in the US District Court Southern District of New York for improperly terminating 22 CDS contracts in which SG is named beneficiary. The contracts' face value exceeds US$2bn.

On 31 December 2009 SG missed two payments totalling US$110,000 relating to two of the 22 CDS contracts, but notified FGIC on 12 January that it would pay the amount in full within the three-day cure period. As the payment had to be denominated in Australian dollars, the transaction went through the Commonwealth Bank of Australia - a payment that was subsequently rejected by FGIC Credit.

On 13 January, FGIC Credit purportedly terminated all 22 transactions under the ISDA Master Agreement, citing as a basis the 31 December non-payment by SG. The bank is therefore accusing FGIC of attempting to clear US$2bn in liabilities from its balance sheet, thereby influencing the ongoing negotiations over its restructuring (SCI passim). SG adds that the termination is part of FGIC's overall strategy to alter its "rapidly deteriorating" financial health.

Operations

Minority stakeholder for Markit

Global growth investor General Atlantic is to make a substantial equity investment in Markit. General Atlantic, as a minority stakeholder, will assist Markit actively in developing its growth strategy further and executing value-creating acquisitions. Under the agreement, GA ceo Bill Ford will become a member of the Markit board of directors.

Lance Uggla, ceo of Markit, says: "We are delighted to welcome General Atlantic as a shareholder in Markit. GA is one of the leading investment firms in financial services and having them as a partner is an affirmation of our business model and enhances the opportunity we have for building long-term value. This significant investment marks an important milestone in Markit's strategy and evolution, and we will benefit immensely from GA's support and Bill Ford's participation on our board."

Ratings

Oversight functions strengthened at Fitch

Fitch has named John Olert chief credit officer. Olert is a 15-year veteran of the rating agency, who was previously responsible for its US ABS and structured credit groups. His new responsibilities will include ratings and criteria oversight, quality assurance, market commentary and research, reporting to Fitch's president.

Separately, Fitch has appointed Mary Griffin Metz to the role of chief compliance officer. During her 20 years with Fitch, Metz has worked on a variety of rating teams, including co-heading US CMBS, and most recently had been the regional credit officer for the Americas.

The compliance group will be responsible for regulatory and professional conduct compliance, including the compliance audit function. Metz will report directly to the ceo and Fitch's board of directors.

"Fitch is constantly enhancing its efforts to provide market participants with credit opinions developed with the highest possible level of transparency, rigor and integrity," says Steve Joynt, ceo of Fitch. "[These] appointments are another important step in that direction."

Real Estate

Merger creates real estate powerhouse

Drivers Jonas is to merge with Deloitte to create one of the largest real estate businesses in Europe, comprising a 'Drivers Jonas Deloitte' group of around 700 partners and staff. The combined real estate group will deliver real estate advisory and transaction expertise to the firm's clients in all markets and industries, the two firms note. It will also form a part of Deloitte's wider real estate industry team, which specialises in providing professional services to real estate clients.

The deal will see over 650 DJ partners and employees join Deloitte. Nick Shepherd, managing partner of Drivers Jonas, will become managing partner of the real estate group, which will trade as Drivers Jonas Deloitte. Shepherd will also join the Deloitte executive.

Shepherd comments: "The merger of our partnership with Deloitte provides a fantastic platform from which to build our advisory and transactions business and further develop our service offering in the capital markets, through greater leverage and a more substantial capital base. Now is the perfect time in the cycle to make this change, and we expect to be very busy hiring and acquiring in the short term."

John Connolly, senior partner and chief executive of Deloitte, adds: "This is a significant step in our ambition to be uniquely positioned as a provider of the broadest range of high value advisory services to support our clients."

The transaction is expected to complete in March 2010.

Real Estate

Promotions made at real estate investment firm

JE Robert Companies (JER) has appointed Devin Chen, Mike Cocanougher, Andy O'Brien and Clyde Robinson as mds in order to strengthen its US fund investment and highly rated special servicing platforms, along with investor-focused capital markets and investor services team.

Chen is based in the firm's headquarters in McLean, Virginia and oversees JER's lodging investment strategy and its US hotel investments. Since joining JER in 1999, Chen has been involved in a variety of real estate investments in the US and Europe across all major property types.

He joined JER as an analyst in its London office, focusing on European real estate investments. Prior to joining JER, Chen held positions in the investment banking division of Banc of America Securities and the sales and trading division of Morgan Stanley, based in Hong Kong.

O'Brien will also be based in McLean, Virginia and oversees all of JER's administrative matters, including facilities, technology and human resources. He has also been appointed to JER's management committee. Prior to joining JER in 2008, O'Brien was an attorney in New York with Simpson Thacher & Bartlett, where his practice focused on executive compensation issues arising in the context of complex private equity transactions.

Robinson has been responsible for capital markets, client relations and communications activities since joining JER in 2000 and will join O'Brien and Chen in McLean, Virginia. Robinson has also been appointed to JER's management committee. During his tenure, he has significantly expanded existing investor relationships and developed new capital sources for JER's private equity funds for North America, Europe and Russia.

Cocanougher is based in the firm's Dallas, Texas office and has been responsible for JER's special servicing operation, a highly rated commercial mortgage servicer, since rejoining JER in 2005. He currently oversees a portfolio of approximately US$4.3bn.

Cocanougher previously worked at JER for eight years from 1992 to 2000, during which time he also directed JER's special servicing business. He rejoined JER from Bank of America, where he was director of special servicing for the bank's CMBS servicing platform.

Barden Gale, JER ceo, comments: "Each of these employees has made significant contributions to JER and deserves recognition of their promotion and accomplishments. These talented individuals bring with them diverse skills and considerable experience, which will further enhance JER's strategic growth in key opportunity sectors as the economy and markets recover."

JER is a fully integrated private real estate investment management company with experience in sourcing, underwriting and managing a broad spectrum of real estate equity investments and debt products in the US and Europe. The firm also invests in CMBS, mezzanine financing and other structured debt products.

Real Estate

Global CRE head appointed

Deutsche Bank has promoted John Nacos to the position of global head of commercial real estate, effective as of 25 January.

Nacos joined Deutsche Bank in 2001 as head of commercial real estate for EMEA and moved to New York in early 2009 to assume the position of head of commercial real estate for the Americas. He will report to Deutsche's head of global banking, Michael Cohrs.

Real Estate

CRE vet added in special servicing

Waterstone Capital Advisors is continuing its push into servicing by hiring Roy Owen to the newly-created role of md of commercial servicing for Waterstone Asset Management, the company's servicing and asset management subsidiary.

Owen has been working as an independent advisor, management consultant, asset manager and litigation support resource since 2002. Prior to 2002, he was a partner in Deloitte's real estate consulting and valuation practice and served as the firm's lead real estate partner in its multi-industry bankruptcy and reorganisation practice.

With the addition of Owen, Waterstone is moving to increase its presence in third-party asset management and servicing of distressed and underperforming commercial mortgage loans and commercial real estate equities held by private equity funds, hedge funds, financial institutions and other parties with positions and exposures in the real estate capital markets. Owen and Waterstone will also be combining their respective litigation experience to provide expanded litigation support services to both plaintiffs and defendants in the commercial and residential real estate capital markets.

While working with Waterstone, Owen will continue to provide services as an independent consultant to other clients, including continuing in his current role as senior advisor to Marshall & Stevens.

Waterstone ceo John Church says: "We are very fortunate and excited to have Roy on our team, as he will bring 30 years of workout and litigation experience to our special servicing platform. As we continue to build this business, it is critical to identify and hire professionals with experience through more than one real estate cycle. Successful special servicers will need to be creative in today's environment and be able to draw on years of experience in order to deliver superior returns to investors."

Regulation

NY Fed supports AIG accountability review

The Federal Reserve Bank of New York (FRBNY) has delivered detailed records regarding all aspects of its involvement in AIG's bailout (SCI passim), noting that it welcomes Federal Reserve chairman Ben Bernanke's call for a comprehensive review by the US Government Accountability Office (GAO).

FRBNY president William Dudley says: "We are in favour of a full and objective review of our actions and look forward to the opportunity to document for the public and members of Congress our involvement in AIG. All of the Federal Reserve's actions regarding AIG were undertaken to protect the American people from an even more severe economic downturn and to safeguard US taxpayers' interests in the company."

He continues: "We are confident that a comprehensive GAO review and the documents we have provided to Congress will clarify the government's role in AIG and underscore the importance of the intervention."

The New York Fed has also posted a memorandum on its website regarding its participation in the preparation of securities disclosures by AIG relating to Maiden Lane III, the facility created in November 2008 to address AIG's increasing liquidity strains.

RMBS

Attorney network partners with mortgage servicer

Statebridge Company has partnered with American Legal & Financial Network to form a 50-state network of mortgage banking attorneys to assist with its loan servicing efforts in the US.

Statebridge says its servicing specialists are assigned to a particular loan throughout its lifecycle, resulting in improved loan performance. The firm's clients can speak to their assigned servicing specialists and have an informed conversation about what is happening with their loans. Borrowers can do the same.

William LeRoy, president and ceo of American Legal & Financial Network, says: "By working in concert with the Statebridge team, we can help to raise the mortgage loan servicing industry's bar in risk avoidance, quality legal services and overall excellence."

Secondary markets

Illiquid alternative asset boutique launched

A new boutique has launched to source secondary market transactions on illiquid hedge funds, including credit hedge funds. Gamma Finance was founded by Florian de Sigy, former head of structured equity sales for Europe at Deutsche Bank, and Javier Rodriguez, previously senior strategist and head of strategic accounts at Barclays Global Investors' client solutions group.

"The opportunity is clear: large numbers of funds have been gated and also sidepockets have been created over the last two years," says de Sigy, managing partner at Gamma Finance. "This process has left many investors with the urgency to reorganise their alternative portfolios, creating several disposals that are perceived as long-term investment opportunities by professional investors."

De Sigy confirms that the idea behind the firm is to facilitate liquidity across the hedge fund spectrum. "We act as a solutions intermediary between investors looking to make a position in illiquid hedge fund assets and the hedge fund itself. Some of these hedge funds are inevitably in the credit space," he explains.

This is achieved on a confidential basis among a network of both buyers (asset managers, financial institutions and high net-worth individuals) and sellers that Gamma Finance has established. Investors' appetite and strategy preferences, including the discount they're looking for, are pre-identified.

Opportunities are available at three levels, according to de Sigy. First, there are single hedge funds trading at soft discounts (of around 5%-10%), which have delivered performance already but are gated.

Second, there are fund of funds with discounts of around 10%-20%, depending on the number of single hedge funds within the portfolio that are gated and the quality of their performance. Finally, a number of side-pockets are ripe to be taken over.

"It is estimated that around US$1.4trn of assets are currently allocated to hedge funds, of which US$70bn are gated. So the opportunity is significant and will continue for a number of years," adds de Sigy.

He notes that the confidentiality aspect of Gamma Finance's service differentiates the firm from its competitors, as well as the fact that it is completely independent. Confidentiality is very important to hedge funds at present because they fear that if their name becomes too well-known in the market, it will become associated with a discount.

Secondary markets

Risk and valuation assessment group launched

S&P's Fixed Income Risk Management Services (FIRMS) business has launched a new valuation and risk strategies group. Bringing together independent research and analytics assets from across the business, the new group was formed to provide investors with a robust, cross-market approach to assessing risk and value in portfolios.

The core competencies of the new group include:

• Independent securities evaluations: S&P's securities evaluations provide independent, market-derived price evaluations on approximately three million hard-to-price fixed income and structured finance securities daily.
• Valuation Scenario Services offers transparent assessments of structured finance portfolios under a range of different assumptions and economic scenarios.
• Market, Credit & Risk Strategies provides an independent research team that combines market and credit risk analysis to better understand the relationship between asset price and risk.

Lou Eccleston, FIRMS executive md, says: "There are many ways to measure risk, but if the recent financial crisis has taught us anything, it is that asset price is the great equaliser in the fixed income markets. By combining our market-leading fixed income price evaluation and market research assets into a single unit, we are giving investors an innovative new perspective that will expand the vernacular used to describe credit and fixed income risk. Now, investors will have an independent and transparent assessment of how well they are being compensated by the market for the risk they are exposed to in their portfolios."

Structuring/Primary market

Wealth manager recruits credit structurer

Anthony Valvo has joined Barclays Wealth Americas as head of credit structuring. He was previously credit director at Citi, responsible for providing corporate finance solutions for high net-worth entrepreneurs. He specialises in complex credit structures and remedial loan strategies.

Structuring/Primary market

SF specialist promoted to senior counsel

Allen & Overy has promoted David Lucking to senior counsel in the international capital markets group based in the New York office.

Lucking joined the firm in 2000 and has also worked in its London office. He specialises in OTC derivatives and funded structured finance products, including complex credit-linked structures, longevity and mortality swaps and their related collateral arrangements, as well as both cash and synthetic CDOs, CLNs and ABS.

In addition, Lucking has drafted a number of market standard document templates for ISDA and other industry bodies, including documentation for confirming trades referencing the iTraxx indices, market-standard portfolio CDS templates and, most recently, ISDA's Big Bang and Small Bang Protocols.

Structuring/Primary market

Mortgage servicer ceo replaced

Crown Mortgage Management has appointed Eric Stoclet as its new ceo, effective 1 February, following the departure of Steve Haggerty. Stoclet had previously been advising Crown on the restructuring of its European operations.

Prior to that, he was group executive director at Noor Investment Group in Dubai and, until April 2007, worked for Citigroup for over 25 years, holding a number of senior positions in the US, Europe, North Africa and Latin America. He has experience in commercial and residential financing, loan portfolio purchases and sales, and management of non-performing loans. He also has broad experience in investment banking and all aspects of credit, including origination, workout/restructuring and administration.

Stoclet will be responsible for advising and helping holders of mortgage assets that wish to clean up their balance sheets, facilitating secondary market sales of portfolios, and providing servicing and workout offerings to existing and future clients.

Technology

Vendor adds product management veteran

Sophis has appointed Marc Bothwell to head up product management for the company's iSophis offering.

Bothwell has 17 years of experience in the asset management industry. He joins Sophis from Centre Asset Management, where he was a founding principal. Prior to this, Bothwell worked as a portfolio manager, research analyst and risk manager in a career spanning several financial services companies, including Owenoke Capital, Credit Suisse and Chancellor LGT Asset Management.

Trading

Fixed income strategist added

Jefferies has appointed David Zervos as md and head of global fixed income strategy. He joins Jefferies from the Federal Reserve Board in Washington, DC, where he was a visiting advisor in the division of monetary affairs for most of 2009.

Tim Cronin, global head of fixed income at Jefferies, says: "David Zervos brings tremendous experience, knowledge and relationships to our fixed income platform and will help support Jefferies' ongoing success. As we continue to extend our firm's capabilities, this hire further demonstrates Jefferies' commitment to providing our institutional clients with valuable insight and perspective."

Jefferies' broader fixed income business now has more than 450 professionals globally who are focused on the sales and trading of investment grade corporate bonds, high yield bonds, government and agency securities, repo finance, mortgage- and asset-backed securities, municipal bonds, whole loans, leveraged loans, distressed securities and emerging markets debt.

Before his tenure at the Federal Reserve Board, Zervos spent five years as a portfolio manager at Brevan Howard and UBS O'Connor, specialising in global macro investment strategies. Previously, he directed mortgage and derivative strategy at Greenwich Capital Markets and also worked in international fixed income strategy at Swiss Bank Corporation.

ABS

Bavarian Sky 2 prices tight

The triple-A notes of BMW Leasing's German auto ABS, Bavarian Sky 2, priced at 85bp over one-month Euribor. The coupon matches that of VCL 11 triple-A paper in the secondary market, despite the Bavarian Sky deal's duration being over half a year longer. VCL 11's 1.4-year Class A notes priced at 110bp over one-month Euribor in September 2009.

The €800m Bavarian Sky 2 transaction - of which €742m was rated triple-A - was arranged by WestLB and rated by Fitch and S&P. The remaining notes - comprising single-A rated 3.17-year Class Bs paying a coupon of 105bp over - were retained.

ABS

VW launches revolving ABS platform

HSBC has launched and priced VCL Master Compartment 1 - a new platform for VW Leasing that securitises on a revolving basis German auto lease receivables originated during its ordinary course of business. Four classes of notes have been issued, all of which are rated triple-A by Fitch and carry a coupon of 100bp over one-month Euribor. Three classes of notes were preplaced and one was retained.

The initial revolving period for all series of notes is one year. However, each year investors can choose to prolong their commitment for another year, or to initiate the amortisation of the series. Furthermore, the purchase commitment can be increased or lowered and the margin on the notes may also be changed.

Available credit enhancement consists of a subordinated loan (12.4% of the asset balance), overcollateralisation (1.1% of the asset balance) and the floor amount of the reserve fund (0.7% of the asset balance). During the revolving period, each new lease receivable acquired using collections of the previously sold receivables will be bought subject to an addition purchase price discount of 2.5%. This mechanism will cover ongoing losses in the portfolio and potentially also increase the available enhancement.

The €399m initial portfolio consists of 31,428 vehicle lease contracts with 20,897 lessees. It is highly granular with an average single debtor exposure of 0.0052% and the top 20 lessees contributing 2.32% of the initial outstanding pool balance. Lessees are predominantly enterprises or self-employed individuals.

ABS

Large Euro ABS tender offer launched

UniCredit has launched a cash tender offer for some 26 tranches of 14 deals across its seven securitisation programmes, including Geldilux, Locat and Cordusio bonds. The invitation to tender is subject to a minimum clearing price ranging from 59% to 99.55% and is scheduled to expire on 5 February.

UniCredit says it intends to optimise its balance sheet and to support its main outstanding securitisation programmes by offering investors the possibility to tender these securities. The bank will pay accrued and unpaid interest on the securities accepted for purchase from, and including, the last payment date for the securities falling on or before the settlement date to (but excluding) the settlement date.

European securitisation analysts at Deutsche Bank note that the tender offer, applied in varying degrees across the capital structure, appears to be competitive to secondary levels and "provides further evidence of sponsors seeing value in their own programmes, as well as the often positive knock-on pricing implications for remaining legacy bonds".

In this sense, a further positive backdrop for the market has been provided by Fortis calling DELPH 04-II and GMAC RFC NL providing the servicing advance necessary to facilitate the redemption of the EMAC-NL 03-I tranches (see last week's issue).

ABS

US credit card charge-offs show modest decline

Charge-offs on US credit cards declined modestly to 10.32% in December, down from 10.56% in November, says Moody's. Charge-offs finished 2009 more than 250bp higher than they started the year.

The rating agency continues to expect the charge-off rate to peak at 12%-13% during the first half of this year. Moody's svp William Black says: "Our forecast for the charge-off rate is driven mainly by our expectation for the unemployment rate to plateau during the middle of the year in the neighborhood of 10.5%. Unemployment is one of the main drivers of credit card charge-offs."

December's small improvement in charge-offs was the third decline in four months and not unexpected, as holiday shopping swelled credit card receivables, lowering the percent of loans being written off. The charge-off rate measures those credit card account balances written off as uncollectible as an annualised percentage of total outstanding principal balance.

Also in December the delinquency rate index remained essentially unchanged from the month before, slipping to 6.09 from 6.2 in November and ending four months of consecutive increases. Early-stage delinquencies also fell for the second consecutive month, which Moody's describes as an encouraging sign for charge-off rate trends later in the spring.

The payment rate and yield indices also improved in December, with the payment rate advancing above 18% for the first time in 2009 to 18.03%, reversing a seasonal contraction in November. The payment rate measures the average amount of principal that cardholders repay each month, measured as a percentage of total outstanding principal.

Yields on credit cards rose to 22.04% in December, from 21.09% in November. Moody's says that for most of the 'big six' credit card issuers, the discounting of principal receivables continues to be the primary driver of these high yield levels.

Excess spread rose to 8.93% in December, from 7.7% in November. At a three-year high, excess spread has benefited from the higher yields and lower charge-offs.

ABS

Resilient performance for Australian ABS

Australian auto and equipment lease-backed ABS performance has proven resilient, despite the deteriorating macroeconomic conditions experienced in 2009, Moody's says. The rating agency upgraded 15 notes from five deals, primarily due to the combination of collateral out-performance and strong credit support build-up in the case of the 2007 vintage.

Transactions that did not experience any rating action are still performing in line with Moody's expectations. With the economy in recovery mode, the agency expects collateral performance to remain stable over the next 12 to18 months.

CDO

Trups tender offer extended

HomeStreet has extended by a month the expiration date for tender offers that it launched on 18 December for four outstanding Trups that are held in a number of CDOs, for which Bank of New York Mellon is the trustee. The offer involves a payment of an amount equal to US$200 per US$1,000 liquidation amount outstanding, with an aggregate liquidation amount of US$60m. No accrued and unpaid distributions on the Trups will be paid as part of the tender.

HomeStreet is simultaneously soliciting consents from the tendering holders of the securities to amend or remove certain provisions to the declarations of trust.

The tender offers, which were previously scheduled to expire on 20 January, will now expire on 22 February. As of 20 January, there were no tenders of the Trups.

HomeStreet says it has learned that BONY failed to deliver the tender offer documents to the CDO beneficial holders, whose votes determine whether the trustee will tender the trust preferred securities in the tender offers. As a result, it has designated Hexagon Securities, the dealer manager in the tender offers, as the recipient of the voting instructions from the CDO holders. If Hexagon has received the requisite number of voting instructions from the holders, it will deliver those voting instructions to BONY, which should implement those instructions in accordance with its governing indentures.

The tender offers are conditioned on 100% of the aggregate liquidation amount outstanding of each Trups being tendered and are subject to the other conditions, including the completion of a financing transaction by HomeStreet sufficient both to purchase the securities that are validly tendered and to satisfy its other regulatory capital requirements. The bank says it is conducting the tender offers in order to reduce the amount of its outstanding indebtedness.

CDS

Two Japanese credit events confirmed

ISDA's Japan Determinations Committee has resolved that a bankruptcy credit event occurred in respect of Japan Airlines Corporation (JAL). The committee also voted to hold an auction for JAL.

The Japan Determinations Committee separately voted that a bankruptcy credit event occurred with respect to Japan Airlines International Company Limited, but that no auction would be held for CDS referencing this entity.

CDS

SD sees little demand for exotic CDS

The use of OTC derivatives to manage risk and hedge is increasing, according to SuperDerivatives (SD). Figures cover both vanilla and complex derivatives across interest rates, FX, credit, commodities and equity derivatives, and reflect derivatives pricing activity by banks, corporates and funds across the globe.

However, SD says demand for exotic credit derivatives remains very low - a pattern SD expects to continue for some time, with the likelihood of a longer-term resurgence.

According to BIS figures, the outstanding values of CDS shrank by 14% to US$36tn in H109 as confidence began to return to markets, pushing down the costs of taking insurance against default (see SCI issue 161). SD also notes that notional amounts outstanding of CDS fell for the second half-year period in succession, but far more slowly than in the second half of 2008. According to SD, the gross market value of CDS contracts fell 42% due to declines in inter-dealer business and contracts with other financial institutions.

CLOs

'Virtuous cycle' influencing US CLO fundamentals

CDO analysts at JPMorgan estimate that US CLO overcollateralisation ratios have gained 100bp-200bp since June, as transitions have improved and asset prices have risen. In a sample of 376 transactions, they determine that current O/C cushions are around -0.03% for double-B rated tranches, 1% for triple-Bs, 3.5% for single-As and 6.7% for senior tranches on average.

Only one default occurred in the US high yield market in December and the pace of defaults is slowing: there were five defaults on average in the last four months of 2009 versus 15 per month in the first four months of the year. "On potential future losses, recovering primary issuance in the leveraged loan and high yield bond markets mitigates refinancing risks and is also positive for CLOs to maintain reinvestment and build back excess spread," the analysts note. "Based on S&P LCD data, weekly institutional loan pricings have averaged about US$5bn in January, maintaining the October to December 2009 pace. M&A and buyout activity is picking up and essentially there is a 'virtuous cycle' of technicals influencing fundamentals - the opposite of 2007-2009."

CLOs

Moody's concludes global CLO review

Moody's has completed its review of all European CLOs and has now officially concluded its global CLO review initiated in March 2009. For US and European CLO transactions combined, Moody's conducted rating reviews on 4,713 tranches from 739 transactions totalling US$346bn (at closing). The review resulted in downgrades affecting 4,038 tranches from 713 transactions, or roughly 86% by tranche count, 96% by deal count, and 73% by deal volume.

According to Moody's, 1347 tranches from 197 European CLO transactions were analysed during the two-stage review, resulting in downgrades to 1129 tranches from 183 European CLO transactions originally totalling €50.4bn (at today's exchange rates). The ratings on 213 tranches from 107 transactions totalling €24.9bn were unchanged, while a small number of tranches were upgraded.

Of the 395 triple A-rated CLO tranches in Europe (as at the start of 2009), 184 or approximately 47% retained their triple-A ratings, while 211 tranches were downgraded by an average of two notches. Out of the 211 downgraded triple-A tranches, 172 or 82% were downgraded to the double-A range, 37 or 17% were downgraded to the A range, and two or 1% were downgraded to Baa1 or below.

Moody's explains that the CLO tranches that retained their ratings were usually part of transactions which had a combination of higher than average par coverage, better than average collateral credit quality, low Caa exposure, and lower than average exposure to non-first lien loans and/or high-yield bonds. The small number of combination notes backed by triple A-rated securities (such as French OAT strips) also retained their triple-A ratings.

Moody's also observed that certain managers strategies appear to support the stability of triple-A ratings throughout their transactions. These transactions consistently showed strong collateral performance through the economic downturn, coinciding with a propensity of the manager to select lower-risk assets in defensive industries. Additionally, these managers largely avoided investing in risky mezzanine and junior CLO tranches.

According to Moody's, the downgrade actions were largely the result of credit deterioration in the underlying portfolios combined with Moody's revised modelling assumptions, which together reflect the unprecedented credit stress experienced in the corporate sector. CLOs that incurred rating downgrades were typically found to report: i) a decrease in the portfolio performing par amount, fuelled by distressed sales or asset defaults, and/or, ii) a deterioration of the credit quality of their assets, as demonstrated through a fall in the average rating of the portfolios, an increase in holdings of securities rated Caa1 and below, or concentrated exposure to higher risk assets such as structured finance securities and mezzanine loans.

The current CLO ratings incorporate the updated assumptions announced on 4 February 2009. These assumptions together were designed to be forward-looking, covering a full credit cycle including the recovery phase. Consequently, with the completion of its sweep for global CLOs, Moody's expects CLO tranche ratings to generally remain stable in the near to medium term subject to ongoing credit changes in the underlying portfolios. Moody's continues to monitor the performance of all CLOs and will identify deals for further review if required by changes in their pool performance and structural strength.

Moody's notes that the global corporate credit environment has shown signs of stabilisation or improvement, with certain sectors outperforming others. This trend towards stabilisation and improvement is also visible in key CLO portfolio metrics. However, Moody's believes that a sluggish recovery is the most likely global macro-economic scenario for 2010. This hook-shaped recovery scenario assumes that the crisis will leave enduring scars and that many economies will not return to their previous output paths. In addition, most loans in CLO portfolios will mature in the next few years, and the uncertainty around companies' ability to refinance without reducing current high leverage remains a major risk factor in future CLO portfolio performance.

CMBS

CMBX to get a new tranche

An AM tranche is scheduled to be added to the CMBX indices on 9 February, following a request from index market-makers. The associated documentation is currently being prepared, according to a spokesperson from Markit.

CMBS

US CRE appraisals decline by 50%

CMBS strategists at Barclays Capital report two indications of an uptick in the pace of credit deterioration in the US market. First, they estimate that across the fixed rate conduit universe the percentage of loans in special servicing has surpassed 10%, with little sign of abating. Second, while liquidation volumes remain relatively low, new appraisals suggest significant declines in property values.

The strategists point to a decline from the original appraisal of on average 50% for US transactions. Focusing on recent vintages, they identify interest shortfalls in nearly half of 2005+ vintage bonds, rising steadily into the investment grade portion of the capital structure.

One recent example of a loan that is likely to contribute a significant interest shortfall is the US$105m One Pacific Plaza loan in the MLCFC 07-7 transaction - the largest loan, at 3.8% of the deal. This loan is backed by a mixed use/office property in Huntington Beach, CA and had an original appraised value of US$139m (or US$325 per square foot).

The property first went delinquent in December 2009, given cashflow declines associated with the third largest tenant vacating their space and higher expenses attributed to an increase in real estate taxes. An updated appraisal has just been received, valuing the property at only US$65mn (or US$152/sf) - a 53% decline from origination. The BarCap strategists estimate that this loan will cause interest shortfalls to rise to the Class F notes, originally rated triple-B plus.

The borrower group is reportedly attempting to negotiate a modification with the special servicer, Midland.

CMBS

Bank consortium refinances UK CMBS

A consortium of seven banks has advanced a seven-year £525m loan facility to refinance the Lakeside Shopping Centre in Thurrock, Essex. Lakeside is owned and managed by Capital Shopping Centres - a UK prime regional shopping centre owner, manager and developer owned by Liberty International.

The proceeds of the loan are being used together with the group's cash resources to redeem in full the current total outstanding loans of £545.8m secured on Lakeside otherwise repayable in July 2011, including the redemption at par of the £445.8m of Opera Finance CMBS notes. Liberty International's finance director, Ian Durant, comments: "This seven-year loan substantially improves the group's overall debt maturity profile and refinances one of the group's largest debt maturities, leaving 2015 as the next significant date for repayment of CMBS-related debt."

The existing loan has a current funding cost of about 5.5%. The hedging arrangements of the new loan require progressively greater levels of interest rate protection over time. Based on the current yield curve, Capital Shopping Centres should see some interest savings during the initial years of the new loan, according to Liberty International.

The news is obviously positive for holders of the Opera deal, but is also of wider interest to the market as an example of a very large refinancing, according to Chalkhill Partners analyst Michael Cox. However, he cautions that Lakeside is a very high quality asset owned by a high quality sponsor, and the new facility still has a relatively modest LTV of less than 60%.

"In European CMBS, there are few loans that could be refinanced with a 60% LTV loan and only a handful of assets of comparable quality," he observes.

The financing was arranged by WestImmo and Eurohypo and the lenders are DekaBank, Eurohypo, Helaba, Lloyds, Pfandbriefbank, Santander and WestImmo. Eurohypo is facility agent and WestImmo was documentation agent on the refinancing.

CMBS

Full payout achieved on defaulted CMBS loan

Hatfield Philips says it has successfully negotiated the resolution of the loan secured against the £30m Anchor office development with the borrower, achieving a full par payout for the noteholders of the Feronia (ELOC 11) CMBS. The Manchester-based office block had fallen into default and, after numerous negotiations with the borrower, Hatfield Philips arranged for the appointment of a receiver. The property was sold when the borrower finally agreed to pay off the loan in full.

Philip Byun, associate director at Hatfield Philips, comments: "There's been a lot of negotiation and, by achieving a full market value, we can ensure that the Feronia noteholders achieve a full payout. The successful resolution of the defaulted CMBS loan in such a tight timeframe and bringing together the cooperation of noteholders, legal adviser (Rosling King), primary servicer (Morgan Stanley Mortgage Servicer) and receiver (Knight Frank) is testament to us having a strategically aligned and focused approach to maximise return to the noteholders."

CMBS

EOD for Euro CMBS

Moody's has placed the Windermere VIII Class A2 notes on review for possible downgrade, following a recent valuation of the property securing the AMG Portfolio Mortgage Loan (accounting for 25% of the pool), which matures in April 2010. The updated valuation showed a 43% decline in market value from April 2006, suggesting an updated LTV of 133%, which breaches the 90% covenant and will result in an event of default under the loan agreement.

Two loans accounting for 7.4% of the portfolio (the Amadeus Portfolio Mortgage Loan and Monument Mortgage Loan) are currently in special servicing, with the former experiencing shortfalls in interest payment and a full non-payment of interest on the last IPD.

CMBS

2010 recovery 'unlikely' for EMEA CMBS

A robust recovery of the CMBS market in EMEA is unlikely in 2010, according to Moody's in its 2009 review & 2010 outlook report for the asset class. The rating agency predicts that throughout 2010 there will be only sporadic issuance in the market, estimated to be around €15bn. Moody's outlook for the sector remains negative.

In the report, Moody's notes that primary issuance increased in 2009 compared to 2008, although it remained low overall. Raphael Smadja, a Moody's associate analyst and co-author of the report, explains: "Most of the issuance in 2009 stemmed from retained transactions. However, three credit-tenant-lease transactions were sold to investors with considerable success."

The performance of outstanding EMEA CMBS is likely to continue to face pressure in 2010, the agency notes - with downgrades continuing to outweigh upgrades, although the total number of rating actions is likely to be considerably smaller than in 2009 and mainly driven by idiosyncratic loan and transaction performance. Moody's does not expect systemic rating actions in 2010, as witnessed in 2009.

Although the outlook for EMEA CRE improved overall towards the end of 2009, the rating agency still believes that CRE loans securitised in CMBS bonds will perform poorly in 2010 and beyond. Jeroen Heijdeman, a Moody's analyst and co-author of the report, notes: "There are some signs of stabilisation in property values and even some evidence of value increases in the UK prime segment [see separate News story]. However, Moody's remains sceptical about a sustainable CRE recovery in the short- to medium-term, especially taking into account the only sluggish economic recovery and its impact on occupational markets."

The poor performance of loans in EMEA CMBS is expected to continue, in particular because of refinancing risk. Even with a moderate CRE value recovery, CMBS loans will still feature very high loan-to-value ratios at maturity and will therefore be difficult to refinance, Moody's adds.

The rating agency believes the capital markets will still play an important role in the financing of commercial real estate, however. Oliver Schmitt, a Moody's avp, analyst and co-author of the report, says: "Beyond 2010, it is possible that a new generation of CMBS deals will emerge in EMEA. They will likely contain lower leverage loans and will try to avoid the shortcomings that have been revealed in outstanding transactions."

Moody's notes that although covered bonds are often discussed as an option for funding commercial real estate loans, they are only limited to the senior portion of CRE loans and to low leverage CRE loans. Banks issuing them also retain the risk on their balance sheet. Some form of CMBS will still be needed by banks to fully transfer the risk to the capital markets.

Emerging Markets

Global sukuk sector paused in 2009

The global market for Islamic financial services is estimated to have risen by 25% to reach US$951bn by end-2008, according to International Financial Services London (IFSL). The report notes that the Islamic finance sector is feeling the influence of the downturn in the global economy, with asset growth likely to have paused for breath in 2009.

Parts of the Islamic finance market face particular challenges: some Islamic banks are exposed to the downturn due to the falling real estate market and to liquidity constraints. The sukuk market, despite a 30% recovery in issuance from a low of US$15bn in 2008 to US$20bn in 2009, is being tested by its ability to deal with several defaults. However, quality sukuk issuers continue to attract demand from investors, the report notes.

Reflecting the economic downturn, there was less activity in London in 2009: two sukuk were listed on the London Stock Exchange, following three in 2008 and 12 in 2007. There were three fund launches in 2009, compared with six the previous year. No further licences to Sharia-compliant banks were sought to add to the five established since 2004, while the one independent takaful operator in the UK ceased to take new business in 2009.

IFSL's report indicates, however, that the UK's position as the key Western hub for Islamic finance remains strong. London's total of 22 banks offering Islamic finance products is greater than that of any other Western country. This is buttressed by the UK's uniquely strong infrastructure of professional support for Islamic finance deals and transactions, including 20 major law firms and the 'big four' accounting firms.

The LSE's 20 sukuk listings worth US$11bn is second only to Dubai. This position has yet to be seriously rivalled in Europe, although both Paris and Frankfurt are gradually developing capabilities.

Duncan McKenzie, IFSL's director of economics, says: "The UK is the only western country to feature prominently in provision of Islamic finance and remains in eighth position, with assets of US$19bn in a global ranking of Sharia-compliant assets by country."

Operations

FDIC securitisation plans supported by SIFMA

SIFMA has responded to reports that the FDIC is working on a plan to package failed bank assets into securities in an attempt to restart the stalled securitisation markets.

SIFMA president and ceo Tim Ryan says: "The FDIC's move to package and sell loans through securitisation is a positive step for the securitisation markets and our economy. These deals will provide a model for future private market issuances, could help kick-start non-conforming loan securitisations and secondary markets, tighten pricing for securities and strengthen the interests of real money investors. We look forward to continuing to work with the FDIC to ensure vibrant and stable securitisation markets that help expand credit and lending to businesses and families during America's economic recovery."

Ratings

Revised supplemental risk measures for CFOs

Moody's is applying revised supplemental risk measures to collateralised fund obligations (CFO) that it rates. The overall V Score - intended to rank transactions by the potential for significant rating changes owing to uncertainty around the assumptions - as well as the assessments of the components and subcomponents are represented on a five-point scale, from low assumption variability to high assumption variability.

Moody's expects V Scores for the typical transaction in this sector to reflect high assumption variability.

The second supplemental measure being applied by Moody's in this sector is a parameter sensitivity analysis, which provides a quantitative calculation of how the initial, model-indicated rating of a structured finance security could vary if key assumptions were changed.

In addition to these parameters, the annual NAV trend may also have an impact on ratings of hedge fund CFOs. A separate analysis is therefore included to address the potential impact of a change in the value initially assumed for this third key parameter.

Ratings

Negative performance outlook for Euro ABS/RMBS

Performance outlooks for ABS and RMBS in EMEA are negative, says Moody's in its 2009 Review & 2010 Outlook report for the two asset classes. The negative outlooks are based on rising unemployment rates and insolvency rates, which will likely remain at high levels over 2010.

In its review of the year, Moody's notes that the fall-out from the credit crunch continued to severely impact the securitisation sector throughout 2009. The number of downgrades of ABS and RMBS ratings increased to 741 in 2009 compared with 408 in 2008, largely as a result of poor collateral performance.

Mehdi Ababou, a Moody's vp-senior analyst, explains: "Over two-thirds of the downgrades for RMBS were in Spain and the UK non-conforming sectors, while over 50% of the ABS downgrades were linked to the ABS of SME sector and largely due to the update of the ABS SME methodology."

Meanwhile, total ABS and RMBS issuance volume for the year fell back sharply to €351.5bn from €732.8bn in 2008. RMBS issuance fell sharply, while ABS was in line with that of 2008.

Volumes of issuance were once again dominated by collateral intended to be used for central bank repo transactions. The rating agency notes, however, that there are some positive signs emerging, including the placement of a few transactions in Q409.

Moody's believes that rating pressure will continue in 2010, emanating not only from performance concerns but also from operational and sovereign risks. Ababou cautions: "Rating migrations are still expected, especially on the 492 tranches currently on review for downgrade and which include significant exposures to Spanish and UK non-conforming RMBS, ABS of SME and Spanish consumer loans."

However, Moody's noted in most recent performance indices some early signs of performance stabilisation in certain consumer asset sectors. The agency says it will continue to assess the degree of performance volatility for unsecured consumer loans, servicer practices in the asset recovery process and the level of disclosure in monitoring reports.

Real Estate

CRE index positive in November

After 13 consecutive months of declining property values, the Moody's/REAL Commercial Property Price Index (CPPI) measured a 1% increase in November. The commercial real estate sector had, until then, seen values fall 43.7% from their peak in October 2007. With this uptick, aggregate prices now stand at 43% below the peak.

Moody's expects commercial real estate prices to decline further in the months ahead, however. While prices for properties with short-term lease structures, such as multifamily, could show signs of a sustainable recovery later this year, most other property types will likely need longer to turn the corner.

The rating agency expects prices to remain well below peak values, with no sustained upturn for several quarters. The CPPI may exhibit some choppiness as transaction volume picks up and a bottom begins to form, but the overall price trend will continue downward over the near term.

Further deterioration in property fundamentals and increases in cap rates are anticipated. On a more positive note, Moody's predicts that the price declines from here on will almost certainly be milder than the large monthly price drops seen in the middle of 2009.

The Case Shiller Index shows that home prices peaked in August of 2006, more than one year before the peak in commercial real estate. Home prices then fell for more than two and a half years, hitting the lowest value thus far in April 2009, with nearly a one-third value loss. Since April, prices have rebounded slightly but have seen no significant growth in the last two months' returns.

In contrast, commercial property prices fell further in a shorter amount of time. After two years of value declines, commercial real estate reached its lowest value yet in October 2009 - nearly 44% below the peak level. Prices in the commercial sector will rebound off the bottom (yet to come) as markets recover, but it is expected that commercial property prices will ultimately flatten out for the longer term at levels of 30% to 40% below the peak.

Regulation

Final risk-based cap rule for FAS 166/167 issued

The US federal banking and thrift regulatory agencies have announced the final risk-based capital rule related to FASB's adoption of FAS 166 and 167. These new accounting standards make substantive changes to how banking organisations account for many items, including securitised assets, that had been previously excluded from their balance sheets (SCI passim).

Banking organisations affected by the new accounting standards generally will be subject to higher risk-based regulatory capital requirements. The rule aims to better align risk-based capital requirements with the actual risks of certain exposures. It also provides an optional phase-in for four quarters of the impact on risk-weighted assets and tier 2 capital resulting from a banking organisation's implementation of the new accounting standards.

The final rule - issued by the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation and Office of Thrift Supervision - will take effect 60 days after publication in the Federal Register, which is expected shortly. Banking organisations may choose to comply with the final rule as of the beginning of their first annual reporting period after 15 November 2009.

Regulation

Basel releases compensation methodology

The Basel Committee on Banking Supervision has issued a new methodology report entitled, 'Compensation Principles and Standards Assessment Methodology'. The methodology aims to foster supervisory approaches that are effective in promoting sound compensation practices at banks and help support a level playing field.

Fernando Vargas, chairman of the Basel Committee's task force on remuneration and associate director general of banking supervision at the Bank of Spain, explains: "The methodology provides a comprehensive set of tools for supervisors to assess compensation practices in an effective and consistent manner."

The methodology will help supervisors assess a firm's compliance with the Financial Stability Board's 'Principles for sound compensation practices' and related implementation standards, the Committee says. This will contribute to ongoing implementation of the principles and standards, including the FSB's current thematic review of national and firm implementation.

The methodology is structured around the following themes: effective governance of compensation; effective alignment of compensation with prudent risk taking; and effective supervisory oversight and engagement by stakeholders.

Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank, states: "Use of the methodology will promote appropriate compensation practices that create the right incentives for effective risk management and avoiding excessive risk-taking. The Basel Committee's work on compensation issues is ongoing. It is likely that the methodology will expand and change over time as more practical experience is gained."

RMBS

First UK RMBS of 2010 to offer US notes

Permanent 2010-1 is set to become the first UK RMBS of the year. Five classes of triple-A notes will be issued: three will be sterling-denominated, one US dollar-denominated and one euro-denominated.

Tranche WALs range from 2.95 years to 6.95 years. The size of the transaction is yet to be confirmed.

Lloyds TSB arranged the transaction, while JPMorgan, Lloyds TSB and Bank of America are leading it.

To the extent there are insufficient funds to redeem each of the 2010-1 notes in full on their step-up dates, Lloyds TSB has agreed to purchase the notes in an amount equal to the principal outstanding balance minus amounts recorded on the relevant principal deficiency ledger (PDL), at the request of the 2010-1 noteholders. But Fitch says it has not given credit to this mechanism within its cashflow analysis and the notes are rated for payment by their legal final maturity.

According to a UK-based RMBS investor, Nationwide may be next in line to issue an RMBS, having successfully placed Silverstone 2009-1 in October last year (see SCI issue 158). "I would not be surprised if Nationwide issued a deal next, but I imagine they will give the Perma deal some breathing space - maybe a week or two," he says.

RMBS

Non-agency remits remain 'benign'

Non-agency remit reports remain benign, according to RMBS analysts at JPMorgan, with no major signs of improvement. As in the previous few months, the market reaction to this month's remits was muted, with all ABX tranche prices roughly unchanged.

Delinquencies in the January remits rose at a slightly slower pace than in the December remits. 60+ delinquencies increased by 52bp across JPMorgan's prime indices (versus 55bp last month), 47bp in Alt-A (versus 70bp), 34bp in option ARMs (versus 113bp) and 33bp in subprime (versus 89bp).

The ABX delinquency increase of 35bp-67bp was driven by large increases in the 90+ bucket. All other delinquency buckets, including foreclosure and REO inventory, exhibited modest declines.

Meanwhile, voluntary prepayments picked up for prime collateral, with speeds across JPMorgan's indices rising by 2-3 CPR to a low- to mid-teens range. Changes in speeds were more mixed further down in credit, however, with option ARM and ABX hovering in the 1-2 CPR range.

Liquidations were slightly lower in prime RMBS, with a 0.6 CDR drop to 3.4 CDR. Involuntary speeds were more range-bound on other collateral, with liquidations in the 10-15 CDR range.

Finally, cumulative losses continued to rise at a steady pace to reach 10.6% for the ABX 06-1 index and 15%-16.5% for the remaining indices. 07-2 losses continue to rise at a significantly faster pace than the others, the JPMorgan analysts note. "Month over month, loss severities declined by 3%-8% across ABX series and are now very similar across series (68%-69%); it is still too early to view the severity decline as a trend."

RMBS

Russian MBS note currency switched

Noteholders of Russian RMBS Gazprombank Mortgage Funding 2 (Gazprombank 2007-1) have voted in favour of converting the class A1 notes of the deal from euros to roubles at an exchange rate of €1 to Rbs34.7. This corresponds to the exchange rate at the transaction's close and is significantly more favourable than the current prevailing foreign exchange spot rate, according to Moody's.

Lehman Brothers Holding Inc. (LBHI) was the guarantor for both the swap provider and the liquidity facility provider in the transaction when issued in June 2007, meaning it is fully exposed to foreign exchange and interest rate risk and does not benefit from any liquidity source other than the cash reserve fund. In March 2009, Moody's downgraded all classes of notes, assuming that the issuer would not find a replacement swap, exposing the deal to foreign exchange spot rates until maturity.

Moody's indicated that should the extraordinary resolution pass, the class A1 notes would be subject to downgrade but at the same time, classes A2, B and C would be subject to upgrades. The rating agency explains that if the note denomination is switched from euros to roubles, the class A1 notes will crystallise a principal loss of approximately 14% due to the local currency depreciation from closing. However, the transaction will no longer be exposed to currency risk and therefore the other classes of notes will benefit from the redenomination of the class A1 notes - hence the upgrade review.

RMBS

RMBS loan-level database launched

A team of mortgage finance and investment management veterans has launched BlackBox Logic - a comprehensive database of loan-level collateral underlying non-agency RMBS for investors, broker/dealers and researchers.

The company has also made its loan-level data aggregation service, BBx Data, available, covering the jumbo A, subprime and Alt-A mortgage markets. It includes more than 7,200 RMBS, 21 million loans and nearly 600 million remittance records, dating back to 1999.

Founded in 2007, the team spent more than two years designing and testing a beta version of BBx Data with RMBS researchers, investors and broker/dealers. The BlackBox Logic management team has more than 50 years of experience in designing, building and managing information technology systems for the securitised mortgage market. The team is led by Larry Barnett, ceo; Wyck Brown, director of marketing and new business development; Bill Pugh, chief technology officer; Marty Schwartz, lead data modeler; and Dmitri Raskes, director of e-commerce solutions.

The company is majority-owned by Braddock Holdings, the private equity affiliate of Denver-based Braddock Financial Corp.

Structuring/Primary market

Hedge fund CFO platform gains flexibility

A number of modifications have been made to the Amathea Funding CFO issuance programme. The amendments occur in conjunction with the issuance of US$107m Amathea Jan 2010-1 variable funding notes, which have been rated Aa1 by Moody's.

The first modification involves the removal of certain portfolio management criteria that were not considered in Moody's rating analysis. Second, both investments and senior debt instruments can now potentially mature on the legal maturity of the programme in 2018, whereas previously they were limited to one-year maturity assets.

Third, the issuer can now draw on the senior variable funding notes to pay the quarterly junior collateral management fee. This is, however, limited to cases where all the management tests are satisfied and the drawn amount is not larger than the excess spread accrued but unpaid on the underlying assets.

Finally, the voting rights of affiliates of the collateral manager have been expanded. But Moody's believes that the voting rights are extended to situations where the manager's interests and those of the noteholders are well aligned from a rating perspective.

The rating agency notes that these amendments and performance of the activities contemplated therein will not cause the existing ratings of the debt instruments issued to be reduced or withdrawn.

Amathea is a refinancing platform for loans to funds of hedge funds. It is managed by Demeter Holdings, a member of the Citco group.

The issuer's rated variable funding notes are ultimately backed by low LTV loans to 15 funds of hedge funds. The overall underlying portfolio comprises 233 eligible hedge funds covering 28 strategies among the 33 sectors in Moody's classification. The strategies representing more than 5% of the portfolio are: long/short hedged (19%), emerging markets (15%), opportunistic (12%), macro (10%), event driven (9%), country specific (7%) and CTA (6%).

Trading

Considerable two-way flow for SovX CEEMEA

The iTraxx SovX CEEMEA Series 3 index saw considerable two-way flow on its first day of trading (20 January). The index is composed of the 15 most liquid sovereign entities from Central & Eastern European, Middle Eastern and African countries that trade on emerging markets documentation.

The constituents comprise Abu Dhabi, Bahrain, Bulgaria, Croatia, Czech Republic, Dubai, Estonia, Hungary, Israel, Kazakhstan, Latvia, Lebanon, Lithuania, Morocco, Poland, Qatar, Romania, Russian Federation, Saudi Arabia, Serbia and Montenegro, Slovakia, Slovenia, South Africa, Tunisia, Turkey and Ukraine. The number of constituents may be changed from time to time at an index roll.

Russia and Turkey constitute 30% of the index by weighting. The Ukraine and Latvia are by far the poorest quality credits in the index, according to Markit, though their contribution to index volatility will be limited by their relatively small weighting.

Markit credit analyst Gavin Nolan notes that the difference between the Markit iTraxx SovX Western Europe index and the Markit iTraxx SovX CEEMEA index is now at its tightest since Markit records began for the two indices (1 January 2009). "Investors looking at the ballooning fiscal deficits in Western Europe can buy the SovX WE and sell the new SovX CEEMEA, particularly if they think emerging markets will continue to drive growth. Bearish investors fearful of a contagion effect across the CEEMEA region can buy protection on the index," Nolan says.

Meanwhile, Greece's successful placing of €8bn in five-year bonds this week resulted in a rally in Greek sovereign CDS, which in turn brought the iTraxx SovX WE level below that of the iTraxx Main (as of Tuesday 26 January). This is the first time that the iTraxx SovX WE has traded below the iTraxx Main since 8 January (see last week's issue for more).

Trading

Trading ideas: sealed tight

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright long on Sealed Air Corp

Sealed Air Corp delivered solid, consistent results during the most difficult economic time period of recent memory. Its management's ability to keep costs down while still increasing margins give us reason to get long the company's credit.

Relative to comparable issuers, Sealed Air's fundamentals leave its CDS spread undervalued as our MFCI credit model recently turned positive. We recommend selling protection on the company.

Sealed Air generated amazingly consistent earnings during the recession. Not surprisingly, the bottom line took a small hit; however, the company increased its earnings margins throughout 2009, which led to a quick reversal back to trend of its quarterly EBITDA.

Exhibit 1 illustrates this best, as it shows that the company produced quarterly EBITDA numbers in a fairly tight range between US$150m and US$175m. This consistency led to LTM interest coverage that essentially flat-lines right below 5x. Though the absolute level is not terribly impressive, the volatility of the ratio is.

 
Taking this a step further, we look at the company's total expenses (interest expense combined with dividends and capex). Through enforcement of an austere, cost-reducing plan, management kept its bottom line healthy.

As Exhibit 2 demonstrates, Sealed Air's total expense level decreased while cashflow from operations increased. So, not only did the company generate solid earnings; but Sealed Air's free cashflow shot up this past year. Through the first three quarters of 2009, it produced US$339m in free cash compared to only US$75m in 2008.

One final point, the company's liquidity positioning remains positive. It signed a new €170m senior unsecured revolver back in November to replace a maturing loan, while also holding US$487m in cash and equivalents against total debt of only US$1.6bn. We foresee little chance of a liquidity crisis for Sealed Air.

We expect its spread to drop below 80bp. The expectation is based upon our quantitative credit model due to Sealed Air's equity-implied, change in leverage, liquidity and free cashflow factors.

Over the past year, our model correctly forecast a massive rally in Sealed Air's credit spread (Exhibit 3). After the rally (its spread collapsed from 580bp down to 100bp), there was little deviation between its market and fair spread levels until late 2009. Since then, its fair spread tightened by 30bp.

 
The differential is currently at its widest level since the end of its 2009 rally. We believe its CDS will revert back to fair over the coming months and therefore recommend selling protection. That said, our biggest concern is that Sealed Air's CDS sits at its tightest level of the past two years.

Though we do expect its CDS to trade through the established floor, we will keep a tight stop-loss on the trade at 130bp. The company reported fourth-quarter earnings on the 25 January, which could swing its credit either way.

Position
Sell US$10m notional Sealed Air Corp 5 Year CDS at 110bp.

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

Copyright © 2010 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).