Contents

CLOs

Consolidation continues

CDO manager changes impacting both old and potential new deals

CDO manager consolidation continues apace. However, the trend also has ramifications for CLO new issue market dynamics.

Matt Natcharian, head of structured credit investing for Babson Capital Management, says that lately managers have been replaced on a number of CDOs - including the two Tricadia deals Babson has recently assumed (see last issue) - whose underlying CLOs had been downgraded due to rating agency methodology changes. As a result of the downgrades noteholders are given the opportunity to change managers.

Performance isn't the only driver of recent manager replacements, however. Together with key-man provisions being triggered in a number of deals recently (see separate Job Swaps story), the manager consolidation trend is gathering pace - as exemplified by GSO taking on the Callidus portfolio last week.

"Although in many cases subordinated management fees are being turned back on, the pressure on smaller managers remains. It is hard to maintain a critical mass in an environment where there are few new issues, it is difficult to raise new money and there is pressure to dispose of non-core assets," explains Natcharian.

Indeed, in order for CLO new issuance to become economically viable, further spread tightening on senior tranches needs to occur. "I expect there to be good issuance opportunities later in the year," he adds. "Investors have the appetite, but the question remains economic feasibility for the issuer. Secondary paper is trading with bids and offers in the range of 175bp-200bp over Libor, but this needs to come down to 100bp-150bp."

Natcharian suggests that the first new issues to hit the market this year will be restructurings of CLOs done during even tougher times - essentially refinancings for the lenders who supported the original deal - as opposed to new transactions with new money raised across the capital structure. There is willingness among banks to warehouse assets, but they are likely to demand market value triggers and equity investment in return.

'Real' new issue structures are anticipated to be relatively simple - the key being how much equity is required, a factor that is being driven by the rating agencies. "It will be interesting to see whether some deals will have double-A rated rather than triple-A rated notes. Such a structure would provide a little more leverage, given the new rating methodologies, bringing subordination closer to what used to be triple-A and improving the economics for equity investors. But will senior investors be satisfied with this?" Natcharian asks.

The US CLO secondary market remains buoyant, meanwhile, with a steady supply of bid lists being successfully absorbed. Natcharian notes that, in particular, supply is growing in lower tranches (original ratings of triple-B, but are now single-B or triple-C) - despite the general volatility of the last few weeks. "CLO tranches are cheaper relative to the underlying and investors are finding decent opportunities here."

Sellers increasingly include ratings-sensitive investors wanting to offload some impaired assets to realise gains or losses, but there are also hedge funds flipping positions and banks lightening balance sheets. First priority tranches are currently trading in the 90s and mezz triple-Bs in the 40-60 range.

But Natcharian cautions that buyers still need to remain selective: deals have outperformed and underperformed, depending on their structural features and manager. A manager's understanding of when deferred interest is paid and how to manage triple-C buckets are some of the issues that investors should analyse.

"All CLOs looked pretty similar before the crisis, but now managers have track records of how they dealt with defaults and losses," he says. "While some managers may look like they have the best portfolios, they may have suffered severe losses."

Generally, larger managers appear to have outperformed smaller ones. Whether more managers enter the space going forward depends on how the loan and new issue CLO markets perform, but the number of managers bringing new deals is expected to decrease.

CS

ABS

Euro/US ABS market disparity to continue

European structured finance issuance has yet to recover from the global financial crisis, according to S&P. While the rating agency expects the US structured finance market to maintain its positive momentum and continue to stabilise in 2010 - albeit with less leverage and more modest issuance than before the downturn - future issuance within the European market will be complex and uncertain with mixed collateral performance, the agency predicts.

At a briefing hosted by the rating agency in London this week, S&P commented that government and central bank stimuli and support for financial institutions is one of the key contributing factors to growth within the European sector. This has led to an improving tone in broader credit markets, and lessened the threat of forced sales and mark-to-market volatility among structured finance securities. The agency did not rule out the possibility of further downgrades in the sector, however.

S&P believes that further downgrades for European CLOs are possible in 2010. Around 80% of European CLO tranches were on credit watch negative at the end of 2009 following an update to S&P's methodology for rating CDOs backed by corporate credit. "This methodology change could also contribute to further ratings actions on CLOs in 2010. As in the synthetic CDO sector, leveraged loan CLOs generally exhibit substantial overlap in portfolio composition between different transactions," says S&P. "Once again, our view generally makes overall sector performance highly dependent on idiosyncratic rating or default events among the underlying loans. If a widely held loan experiences credit deterioration then there could be an effect on a large number of CLOs."

In the European CMBS market, downgrades continued to substantially exceed upgrades in 2009. S&P expects this to continue in 2010. Beyond the realised downturn in credit performance, S&P views refinance risks as a major challenge.

In European RMBS, S&P believes that the pace of RMBS downgrades could stabilise in some countries during 2010 given the current low interest rates, though this effect may be affected by continued rising unemployment. "The future trend in arrears will help determine whether the rate of downgrades now slows," says the agency. "One concern is that, even though interest rates are currently low, unemployment is expected to rise in most European countries. Arrears could therefore start to climb again. In the medium term, renewed hikes in interest rates could also reverse the improving arrears trend."

In terms of European ABS, S&P expects the continuing weak macroeconomic landscape to place further pressure of auto loan delinquencies and hence the auto ABS that it rates. S&P's charge-off index for European credit card ABS reached almost 10% in Q309, although delinquencies have leveled off for now. This may be attributable to the one-off effects of the reductions in credit limits, tighter leading criteria, and improvements in collection procedures. However, S&P does not expect this decline to continue, given likely continuing rises in unemployment.

In analysing the performance of the 2009 US structured finance sector, S&P notes that government support increased liquidity and tightened spreads for most structured finance asset classes. However, not every asset class benefited.

The US CMBS market struggled with increasing delinquency rates, maturity defaults, and loss severities last year, and S&P does not expect much improvement in 2010. Therefore, the ratings agency is maintaining its negative outlook on CMBS, with downgrades likely to continue to exceed upgrades. S&P expect the CMBS new issuance market to continue to experience a slower recovery than other structured asset types.

For the US consumer auto loan ABS market, S&P believes that healthier auto sales and renewed investor interest should ramp up issuance as credit quality remains generally strong. Meanwhile, collateral performance for the auto lease ABS market should keep overall ratings outlook on that sector stable to positive. The ratings agency expects issuance volume to remain flat, though a slight uptick is possible.

Credit card ABS issuance might increase by as much as US$10bn in 2010 to US$55bn,the agency predicts, and lenders' tighter underwriting and account management practices since 2007 will likely improve the credit quality of credit card pools in 2010. S&P's ratings on credit card ABS should remain relatively stable in 2010.

The elevated level of the US national unemployment rate continues to weaken student loan collateral performance. S&P is keeping its stable credit outlook on federally reinsured student loan ABS; however, the outlook on private student loan ABS continues to be negative.

With few private label RMBS in 2008 and none in 2009, the ratings agency remains focused on monitoring the performance of the 2007 and earlier vintages of US RMBS. S&P expect to see continued stabilisation of loss severities for the subprime and Alt-A products and possible increases to loss severities for the prime 2006 and 2007 vintages.

In US cash flow CLOs S&P notes that forecasting its new-issuance volume remains difficult given the challenges in the economy and financial markets. The CLO market has generally been negatively impacted by the recent economic downturn, including high levels of defaults and downgrades along with lower market prices on the underlying loans; however, collateral performance has for the most part stabilised in late 2009.

S&P concludes by drawing attention to the effect of evolving regulatory requirements on originators and investors, which remains uncertain. "Until these issues are resolved, the likely configuration of originator motivations, investor base composition, and new standards for securitisation structures will remain unclear," it says.

JA

CLO Managers

Positive outlook for CSO with ineligible assets

UBS - CDS counterparty on Brooklands Euro Referenced Linked Notes 2002-1 - has admitted it included a number of ineligible reference obligations in the deal's portfolio. The transaction is a managed, synthetic CDO referencing a portfolio of investment-grade corporate securities and ABS. Several of these ineligible reference entities and ABS reference securities have suffered credit events that have led to principal write-downs of Brookland's junior notes.

However, Fitch has placed all notes in the transaction on ratings watch positive (RWP) and says the resolution of the RWP will largely depend on the proposed remedy.

On 29 January the swap counterparty informed the issuer that a number of non ABS and ABS reference assets included in the reference pool were ineligible under the exclusion parameters from time to time because they had expected or scheduled maturities falling after the periodic payment date falling in December 2012. This occurred principally because of a misunderstanding on the part of the swap counterparty as to the operation of the substitution provisions under the transaction documentation.

Of the ineligible non ABS reference assets identified, two have experienced a credit event - a Lehman Brothers asset and a Kaupthing asset. A small number of ABS reference assets may also have been included in the reference pool, which were ineligible because their expected maturity at the date of reference fell after the periodic payment date falling in December 2012. Two reference entities within this category have been the subject of a credit event (two Citrine vehicles).

The swap counterparty says it is undertaking an extensive and detailed review of the impact of all the ineligible substitutions for the purpose of determining how best to remedy the situation.

If the CDS counterparty decides to replace all ineligible reference entities and ABS reference securities, Fitch believes this would be beneficial for noteholders. It explains that any credit protection payments made by the issuer for the credit events of the ineligible reference entities and ABS reference securities will be reimbursed, and principal will be reinstated to the junior notes - which have been written down due to prior credit protection payments.

While the resolution of the RWP would most likely lead to an affirmation or upgrade of the notes, the agency notes the uncertainties surrounding any proposed remedies and the potential for legal challenges to any proposed action. Furthermore, the timeframe of the implementation of proposed remedies is also important, especially if the portfolio deteriorated further before the implementation of any proposed remedy.

While the reference pool is under review, the swap counterparty has confirmed to the issuer that it will not call a credit event or partial credit event in respect of any reference asset whose eligibility the swap counterparty believes is questionable and is under review pending satisfactory resolution of these issues.

Fitch says it has contacted the CDS counterparty who has stated that they have "no further comment at this time and are not in a position to speculate about the impact (if any) of any future announcements detailing remedial proposals on the ratings of the notes".

AC

Operations

Comptroller calls for 'skin in the game' alternative

John Dugan, US Comptroller of the Currency, has voiced his concerns over the risk retention or 'skin in the game' proposals being mooted for securitisations. Speaking yesterday, 2 February, at the American Securitization Forum 2010 conference Dugan suggested an alternative solution.

Dugan began by saying: "I certainly agree with the ultimate goal of 'skin in the game' proposals, which is to improve the underwriting quality of the loans being securitised.... But while lax underwriting is plainly a fundamental problem that needs to be addressed, mandatory risk retention for securitisers is an imprecise and indirect way to do that, and is by no means guaranteed to work. How much retained risk is enough? And what type of retained risk would work best - first loss, vertical slice, or some other kind of structure?"

He went on to say: "To the extent that true sale and off-balance sheet treatment really are important factors for re-starting a vibrant securitisation market - and I suspect they are - an on-balance sheet result caused by a mandatory 'skin in the game' requirement would certainly be perverse. That is, a requirement intended to improve the securitisation market by improving the quality and trustworthiness of underwriting could significantly curtail the number of securitisations that are actually done. And that, of course, could materially reduce the amount of credit available for housing or any of the other sectors that have traditionally benefited from securitisation."

Instead Dugan argued for the establishment of minimum underwriting standards. "I think there is a better and more direct way to improve underwriting standards, at least for residential mortgages - and to do so not just for the benefit of securitisation markets, but for all mortgages whether held or sold. Instead of going at the underwriting problem indirectly through 'skin in the game' requirements, why not attack it directly?"

To this end, he suggested the types of minimum standards that should be considered. These would include: effective verification of income and financial information; meaningful down payments; reasonable debt-to-income ratios; and for monthly payments that increase over time, qualifying borrowers based on the higher, later rate, rather than the lower, initial rate.

Dugan did concede, however, that "I do not mean to suggest that minimum underwriting standards are a panacea, or even that they would work as well for other asset classes as I think they would for mortgages. Other measures, including more robust disclosures, credit rating reform, and changes in compensation practices all merit consideration by policymakers, and that process is underway."

Nevertheless, he concluded: "I do think that minimum underwriting standards should be strongly considered as an alternative to rigid 'skin in the game' requirements. Indeed, using such standards as an alternative is expressly contemplated by the 'skin in the game' legislative proposals in the House and Senate. And I want to emphasise that minimum mortgage underwriting standards also accomplish the fundamental consumer protection objective of assuring that borrowers do not take out mortgages that they cannot afford to repay. In sum, I hope this idea is fleshed out in more detail in the days and weeks to come."

MP

RMBS

Northern Rock issues new RMBS

Triple-A ratings have been assigned to four classes of RMBS notes issued by Gosforth Funding. The notes are backed by a pool of prime UK residential mortgages originated by Northern Rock plc and transferred to the newly-created Northern Rock entity as part of the transfer implemented on 1 January 2010 (SCI passim).

This is the first publicly-rated securitisation of the newly-created Northern Rock entity. Northern Rock Asset Management has several UK mortgage-backed transactions outstanding, including the Granite Master Trust.

News of the deal resulted in both brief market confusion and a slight increase in secondary trading in Granite paper. Although Gosforth was subsequently clarified as being a retained transaction, the possibility of a publicly traded deal from Northern Rock garnered investor attention.

One investor explains: "There was a little bit of miscommunication in the market - at first people thought that it was a new public deal coming from Northern Rock. As a result, that kicked off a little bit of activity in Granite's paper been a bit slow this week [ending 29 January]. So we saw those move up about half a point on the back of that and then that all settled down."

Others are surprised that any confusion over the nature of the Northern Rock deal occurred at all. As one trader points out: "There would be a lot more pre-sounding if they were going to do that. Being the biggest profile extension/price fall in the market, you wouldn't just announce a deal out of the blue. It wouldn't work like that. So I'm surprised people are surprised."

Whether or not the market reaction indicates any investor appetite for a Northern Rock deal remains unclear. On the one hand: "Loan markets have a short memory - it's a Northern Rock deal that may have cost investors a fortune two years ago, but they would happily move into a new deal if it was structured correctly. So there would be demand."

The trader adds: "The more people thought about it, the more people would become hesitant. If you're talking about Northern Rock's 'good bank' being the entity to honour the put option in five years' time, if they follow the Lloyds structure, then you would need to start thinking about how well capitalised is that bank; who will own it? Because by the time you come to exercise your put it won't be government ownership. I think investors would be thinking long and hard about it rather than rushing in too fast."

The four classes of Gosforth Funding notes are each sized at £500m. The mortgage portfolio has a weighted average loan-to-value of 68.6% and a weighted average seasoning of 54 months.

Barclays Capital arranged the transaction. Classes A1 to A4 priced at plus 7bp, plus 9bp, plus 11bp and plus 13bp over three-month sterling libor, respectively.

UK RMBS Permanent 2010-1 has, meanwhile, priced in line with guidance - having been upsized from £2.4bn to £2.95bn. The US$1bn class 1As came at 115bp over Libor with a WAL of 2.95 years, the £200m class 2A1s at 130bp with a WAL of 5.19 years, the €750m class 2A2s at 125bp with a 5.19-year WAL and the £600m class 3As notes at 125bp with a 6.95-year WAL.

The class 4A notes, sized at £400m, priced at 130bp but were not offered.

AC & JA

ABS

Securitisation practice expands

Nixon Peabody has expanded its corporate trust and securitisation and structured finance teams, with the addition of William Lasher as senior counsel, based in the firm's New York City office. He joins Nixon Peabody from Dorsey & Whitney.

Lasher focuses his practice in the area of structured finance and corporate trust. He has represented financial institutions in their capacities as trustees, administrators, custodians and agents in domestic and international debt offerings, including those involving CDO and future cashflow securitisations, and under escrow and custody agreements, reinsurance trust agreements and other trust agreements.

Lasher will also be involved with the firm's securitisation and structured finance team, led by Keith Krasney and Peter Morreale. The team covers term and revolving securitisations, sales, purchases and financings of financial assets, and sales, divestitures and purchases of interests in financial institutions. The practice group's clients include investment banks, commercial banks, hedge funds, private equity firms, servicers, third-party credit providers and other financial institutions and investors.

Meanwhile, Robert Coughlin has been named team leader of the firm's corporate trust practice. He succeeds Laura Wheeler, who will retire at the end of January, and is based in the firm's Boston office. He represents institutions involving matters in structured finance, securitisation, municipal finance and corporate finance.

Advisory

New firm to target German mortgage assets

Elystan Capital Advisors - a Munich-based investment firm targeting mortgage-backed assets and the mortgage banking sector in Germany, Austria and Switzerland - has launched, with the backing of private equity house GI Partners.

Following recent developments in the financial markets, the Elystan founders - Keith Fischer, Robert Grassinger and Ulrich Kastner - believe that there is significant pressure on the banking industry to strengthen balance sheets and minimise exposure to certain non-core and non-performing assets. They expect that this pressure will lead to a number of investment opportunities across the mortgage and real estate sector as financial firms look to reduce their exposure to these assets through divestment. The firm's strategy is to acquire these non-performing loan books, as well as MBS and real estate portfolios, which it plans to consolidate and actively manage to improve performance.

Before launching Elystan, Fischer held roles at Citibank, Orion Capital Managers and Lehman Brothers. Grassinger held a number of senior roles within Württemberger Hypo and Hypo Real Estate, while Kastner worked at numerous financial institutions in the UK and Germany, including Deutsche Bank, Dresdner Kleinwort Wasserstein and Lehman Brothers.

GI Partners will provide investment capital from its third fund, GI Partners Fund III, which closed at US$1.9bn in October 2009.

Elystan has been working with GI Partners since June 2009 to pursue the acquisition of a bank to be used as a platform to expand and grow a mortgage lending business that can fill the gap in credit available to German Mittelstand companies.

CDS

Bank hires FI sales head

Guy Cornelius is re-joining UBS as head of sterling credit sales, reporting to Mark Jones, co-head of FICC EMEA distribution. Cornelius recently left Evolution Securities, where he was head of fixed income (see SCI issue 168). He previously worked for UBS from 1990 until December 2006, when he moved to Lehman Brothers.

CDS

Ex-CDO underwriter hired

Jas Jalaf has joined Deutsche Bank as vp of the credit solutions group. Until 2008 Jalaf was a director at monoline XL Capital, where he was responsible for originating, underwriting and monitoring European structured credit transactions. Most recently he was corporate advisor at Corporate Risk Associates.

CDS

CCDS working group established

As previously indicated in SCI in October, an ISDA working group on contingent CDS (CCDS) has been established to tackle the lack of understanding around the product (see SCI issue 158). The group is understood to be working on a paper on the effectiveness of CCDS as a counterparty risk mitigant and to create a standard representation of these transactions for a bank's risk and capital metrics.

CLO Managers

Collateral manager resigns on two CDOs

GSC Partners is resigning as collateral manager on two of its European CDOs - GSC European CDO III and GSC European CDO IV. A successor collateral manager will be appointed pursuant to the terms of the collateral management agreement.

GSC is understood to be moving its European portfolio manager back to the US, as part of cost-cutting measures. However, several sources have commented that it is unusual for a manager to resign without finding a replacement manager first.

The firm has a number of CDOs under management. Before indicating its intent to resign on the aforementioned European CDOs, it was managing 11 US and five European transactions.

CLO Managers

German manager seeks CLO transfer

IKB Capital is asking noteholders of Bacchus 2006-1 CLO to consent or object to its proposal to assign collateral management duties to Halcyon Bacchus (US) Management. The deadline to provide objections or consents is 29 March. The CLO is IKB's sole US CLO, which is run out of its New York office. IKB agreed to close its New York office as part of the EC approval for the re-structuring of the bank. As a result, IKB has sold both balance sheet assets and the collateral management agreement.

The Bacchus CLOs in Europe are not affected.

Bank of New York Mellon, the collateral administrator on the Bacchus 2006-1 transaction, informed the issuer earlier this month of certain events that may indicate non-compliance with the terms of the deal's investment management agreement. However, the trustee on the CLO is not expected to conclude that this constitutes an event of default (see SCI issue 167).

CLO Managers

ING Alternative AM wins CLO mandate

ING Alternative Asset Management is set to replace Avenue Capital Management as collateral manager on Avenue CLO IV, V and VI. The move is understood to have been triggered by key-man provisions. S&P has issued preliminary rating confirmation with respect to the proposed assumption agreement.

As of 30 November 2009, Avenue Capital's assets under management allocated to the Avenue CLO strategy were valued at approximately US$2.8bn. The CLOs consist primarily of relatively liquid, large non-investment grade syndicated corporate loans.

CLOs

CLO management team reshuffled

Alcentra has announced several senior management changes. Paul Hatfield, currently cio and head of US operations, is to become global cio, based in London. Hatfield joined Alcentra in 2003 as a portfolio manager for Alcentra's European CLO funds, and became head of US operations in 2008. During this time he has relocated Alcentra's US business to New York and grown the assets under management to approximately US$5bn, taking on management of BNY Mellon Capital Markets' CLO and mezzanine funds, as well as acquiring Rabobank's CLO business in July 2009 (SCI passim). He will start this new role in April 2010.

Julian Colville, head of business development, and Ron Grobeck, senior US portfolio manager, have been appointed co-heads of the US business. Grobeck joined Alcentra as part of the Rabobank CLO acquisition - he was previously head of Rabobank's CLO operations. Colville will relocate to New York from London in March 2010 to focus principally on Alcentra's North American, Japanese and Australian business development efforts.

In Europe, Simon Perry is promoted to head of business development EMEA ex-Japan. Perry joined Alcentra in May 2009 from UBS, where he was head of the bank's European CLO business.

Hatfield, Colville, Perry and Grobeck report to David Forbes-Nixon, chairman and ceo of Alcentra. Paul Echausse will continue to run Alcentra's US mezzanine business, reporting to Hatfield.

Investors

Manager launches global credit boutique

Hermes Fund Managers has formed a global credit asset management capability in partnership with John Lupton and Cian O'Carroll. The new boutique will offer a full range of investment solutions for both BT Pension Scheme (BTPS) and third party clients.

O'Carroll and Lupton were most recently at Fortis Investments, where they built the global credit and hybrids business, as head of global credit and head of market, customised and securitised strategies, respectively.

BTPS will be making an initial cornerstone investment of £400m. The 14-strong boutique, including the existing Hermes credit team, will encompass portfolio management, credit research and quantitative research/risk management.

Secondary markets

Clayton hires ex-MBS trader

Mortgage risk analysis provider Clayton Holdings has hired Raymond Redlingshafer as senior md.

Redlingshafer brings more than 25 years of experience to Clayton, including trading MBS and whole loans, managing a fixed income institutional sales force and founding a mortgage REIT and taking the company public. In his new role, he will focus on expanding Clayton's relationships with all secondary market participants and will focus on business development and promotion of the firm's core products, which include commercial and residential due diligence, surveillance, special servicing and asset pricing. He will report to Tom Donatacci, evp for sales and marketing.

Redlingshafer says: "Although there are tremendous challenges facing the mortgage loan and securitisation market, particularly the secondary market, there are also great opportunities."

Trading

Advisory shop acquires broker-dealer

NewOak Capital has established a fixed income trading desk by absorbing the staff of Vesper Capital, a start-up broker-dealer. The new trading desk is staffed by six Vesper traders and salespeople.

The new recruits are: Tom Caton, who spent more than 20 years at retail investment advisor First Investors; James Colonias, formerly of broker-dealer Fieldstone Capital; Ervin Pilku, who previously worked at bond insurer Ambac; Sean Smith, an alumnus of Merrill Lynch; Bruce Strengberg, formerly of CastleOak Securities; and Ron Yung, who came from specialty-finance shop Cremac. Under the banner 'NewOak Capital Markets', the unit will trade all types of structured products, as well as high yield corporate and emerging market debt.

The team is co-managed by Colonias and Yung, who report to NewOak president James Frischling.

Trading

Bank appoints CDO trading head

Jefferies has appointed Sharif Anbar-Colas as an md and global head of CLO and CDO trading, where he will be responsible for all CLO/CDO trading within the firm's broader MBS/ABS group.

Anbar-Colas joins Jefferies from Cohen & Company, where he was an md and head of European ABS and global CLO trading. Previously, he worked at UBS, where he was executive director and head of global CDO trading. Prior to that, he worked at Bear Stearns and Lehman Brothers in a variety of sales and trading positions.

ABS

Greek bankruptcy law increases ABS rating pressure

A draft Greek law addressing household debt restructuring is likely to reduce recoveries and increase defaults in pools of Greek residential mortgages and consumer credits, potentially leading to negative rating action, according to Fitch.

The proposed law, which is currently under public consultation, seeks to establish a personal bankruptcy framework for private individuals in Greece. The proposed provisions indemnify eligible borrowers up to 90% of the total amount owed after liquidation of all their assets. This excludes the borrowers' main residence, where any outstanding mortgage debt could be re-arranged on favourable terms, with debtors remaining liable only for a maximum 85% of the prevailing market value. As the Greek mortgage market features relatively low LTVs, an 85% loan-to-value (LTV) threshold could prevent losses for the vast majority of mortgage loans, assuming a stable house price environment. However, high-LTV loans are typically more prone to default.

Spyros Michas, associate director in Fitch's structured finance team in London says: "Should Fitch's expectations for a 15-20% peak-to-trough decline in Greek house prices materialise, then an ever-increasing number of mortgage loans could fall under the scope of the draft law. In turn, this would increase loss severities, with direct rating implications for underlying Greek securitisations and covered bonds."

For borrowers found to be only temporarily unable to meet their obligations, a payment holiday of up to two years could instead be granted. Nevertheless, the key question is how a court would assess the actual economic status of the applying borrowers. Considering the weak tax controls, the extent of undeclared income sources in Greece and the possibility of performing debtors taking advantage of the new favorable regime (moral hazard), the draft law poses significant implementation risk.

A similar law dealing with business debt restructuring was recently passed in Greece. Fitch believes the spirit of the new provisions may, overall, encourage bad payment behaviour among Greek borrowers, a trend already evident in worsening loan performance indicators, since the drafts were placed in public consultation in late 2009.

Meanwhile, the introduction of looser credit recording standards in the national credit bureau (Tiresias), primarily by means of reducing adverse data storage timeframes, is likely to exacerbate credit issues.

Cristina Torrella, director in Fitch's financial institutions team, says: "Pushing lenders to extend more credit, while undermining their ability to discern credit risk, is a paradox. It could inadvertently hinder credit penetration and increase its cost to the economy, as Greek banks strive to protect their balance sheets, scaling back lending and re-pricing risk altogether."

In Fitch's view, the negative impact of the lenders' reduced capacity to assess credit risk via Tiresias would more than offset any contemplated benefits from increased liquidity in the economy. At best, the draft law will have no material impact. At worst, it could lead to deterioration in the asset quality of Greek banks, tightening of credit conditions and ultimately contagion to the wider economy.

Following Greece's sovereign downgrade in December, Fitch placed all Greek structured finance transactions and covered bonds programmes on rating watch negative (RWN). While the agency expects to resolve the RWN in the coming weeks, the new law -should it pass in its current form - could exert renewed pressure on the ratings of Greek securitisations and covered bonds.

ABS

Refinancing to drive S African ABS issuance

Issuance in the South African structured credit market is expected to increase in Q210, according to Moody's. The rating agency expects the significant amount of refinancing requirements to drive issuance in the latter part of the year, however, due to the general state of the economy, the outlook for the South African structured finance market remains negative.

Dion Bate, a Moody's assistant vp/analyst, says: "Issuance in 2010 will largely depend upon the recovery of both the local and international credit markets and particularly the return of investor credit appetite at lower note spread levels. Moody's has already begun to see signs in Europe that the structured finance markets are starting to move away from the European Central Bank repurchase programme as well as the tightening of secondary market spreads. While this is encouraging for the South African securitisation market, Moodys expects any significant recovery of issuance in South African to lag that of Europe."

In its review of 2009, the ratings agency notes that total issuance in the South African structured finance market remained subdued, with both the volume and number of transactions below 2008 levels. Total term issued volumes decreased to ZAR7.87bn (€699m), down 14% from 2008. All asset classes reported a contraction in issuance compared to 2008. The dominant asset class, in terms of both number and volume of transactions was ABS, with five deals valued at ZAR5.98bn (€532m). RMBS saw two existing programmes refinance maturing notes with a total volume of ZAR1.64bn (€145m) and there was one CMBS transaction, with a total volume of ZAR²50m (€22m). There has been no international issuance since 2007.

"While the lowering of interest rates throughout 2009 alleviated debt servicing pressure for many borrowers, the effects of the depressed economy, continued tight credit lending and high consumer indebtedness remained the main drivers behind the weak performance over the year for all securitised asset classes," adds Bate. "Although performance is anticipated to remain under pressure for H110, Moody's expects it will then begin to level off, albeit remaining stressed compared to long-term historical trends."

ABS

Recovery in sight for Asia-Pacific ABS

Issuance in the Asian structured finance market will rise moderately in 2010, as investor interest makes a comeback and the price gap between investors and sponsors narrows, according to Moody's. At the same time S&P says the downward pressure on ratings for the sector will lessen in 2010 as economic recovery in the region gains momentum. However, S&P also notes that liquidity constraints have raised refinancing difficulties for maturing CMBS transactions in the region, particularly in Japan.

"The performance outlook for Korean RMBS and auto loan ABS is stable. Korean residential mortgage loans have a recovery rate of over 99%, while the performance of Korean auto loans has been stable, with no marked deterioration during the credit crisis," says Jerome Cheng, a Moody's vp.

However, Cheng says the performance outlook for Korean credit card ABS and Singaporean CMBS is negative. "The negative outlook on Korean credit card receivables is based on potential deterioration in cardholders' payment ability. Korean household debt is at an all-time high, and a rise in interest rates would hurt cardholders' ability to pay down unsecured credit card receivables. For commercial properties in Singapore, the oversupply of office and industrial space and a weak economy are adding pressure to both vacancy and rental rates," he says.

Moody's expects that Korea - the largest securitisation market in this region - will issue some cross-border ABS, RMBS, and covered bond transactions in the coming year. "Investor interest is evident, given that Korean receivables did not deteriorate much during the crisis. Rather, they have all improved, as Korea's economy started to improve," says the rating agency.

According to Moody's, Korea's domestic and cross-border issuance in 2009 was US$33.0bn, 87.6% of the region's total US$37.7bn issuance. Korea's domestic market was dominated by project finance securitisations and RMBS, while its cross-border market generated all the foreign currency-denominated issuance in the region, including Asia's first covered bond transaction.

In its review of 2009, Moody's notes that the fallout from the credit crunch significantly impacted the issuance from the Asian structured finance market - with the exceptions of the domestic markets in Korea and India. S&P adds that worsening global credit quality has led to a rise in speculative-grade CDO downgrades in 2009, while the ABS sector had a mixed experience resulting in a number of ABS transactions in Australia and Japan downgraded, while ABS ratings in the rest of Asia were robust.

ABS

Mixed outlook for Australian SF performance

The collateral performance for Australian ABS, CMBS, and RMBS for 2010 has a stable outlook, according to Moody's. Moody's rating outlook is also stable due to sound asset quality and robust transaction structures. However, Fitch notes that rising Australian interest rates are expected to result in the deterioration of Australian structured finance asset performance during 2010.

Ryan Lu, a Moody's avp/analyst for the structured finance group in Sydney explains: "The main reason for this neutral view of collateral performance is the improved macro-economic expectations for the Australian economy. For example, in the prime RMBS market, housing delinquency rates have retreated to pre-crisis levels, and we do not expect them to climb back to their record highs in the foreseeable future. Moody's anticipates that ratings will remain stable due to the stable performance of underlying assets and the resilient performance of mortgage insurers".

Moody's explains that the rating outlook for non-conforming RMBS is also stable, as current levels of credit enhancement provide most deals with sufficient buffer to withstand the currently anticipated levels of losses. In the case of ABS, improving conditions in the auto sector will translate into reduced pressure on recovery rates, and, in turn, a stable rating outlook.

Lu goes on to say: "For CMBS, we expect ratings to remain stable, as refinancing risk has decreased, and the decline in property values has stabilised. Furthermore, if defaults were to occur, low initial LTVs would limit the severity of losses. Operating risk remains one of the key factors that could potentially weaken the credit quality of underlying collateral; therefore, Moody's continues to focus on this risk in Australia taking into account market practice."

However, with regards to asset performance David Carroll, director in Fitch's Australian structured finance team says: "The improvement in Australia's structured finance asset performance which was experienced during 2009 thanks to historically low interest rates and a resilient economy, is unlikely to continue during 2010 as the impact of rising rates results in increased delinquencies. However, Australian structured finance ratings are expected to remain largely stable during 2010 as a result of the structural features within existing transactions."

Fitch's Australian structured finance ratings performed well overall during 2009, with rating upgrades comprising 7%, affirmations 79% and downgrades 14% of the 490 rating actions. The majority of rating downgrades which took place in 2009 stemmed from counterparty exposure rating changes brought on by changes in the ratings of the lenders' mortgage insurance (LMI).

It is expected that the three consecutive interest rate rises which took place in Q409, coupled with the prospect of further rises during 2010, will raise the number of delinquencies recorded in Fitch's quarterly Dinkum Index, which tracks the performance of arrears within Australian RMBS transactions. Fitch's 30-plus day conforming Dinkum Index ended Q309 at 1.21%, down from 1.75% at the end of Q408. The effect of rising interest rates will be partly offset by improving economic growth, and Australian residential house prices, which are expected to remain stable or slightly higher during 2010, helping to mitigate losses within RMBS transactions. Rising interest rates are also expected to negatively impact CMBS and ABS asset performance during the year.

Non-conforming RMBS and CMBS are expected to come under the most rating pressure, says Fitch, mainly due to rising interest rates, the continuing rationing of credit by lenders and the ongoing asset performance within certain transactions. While asset performance will come under pressure during 2010, expectations of delinquencies and loss levels remain within rating parameters, which together with the structural features of the transactions, is expected to result in stable outlooks for most asset classes and transactions.

ABS

US auto ABS stable, despite increased loss projections

The US auto ABS market was impacted negatively in 2009, according to Moody's. This was due to increasing unemployment with resultant loss and delinquencies, an initially soft used car market, plummeting vehicle sales and the bankruptcies of GM and Chrysler. However, the outlook for auto ABS - retail loan, retail lease and wholesale - is stable.

For retail auto loan ABS, the turbo-like effect of paying down bonds sequentially and the simultaneous build-up of credit enhancement are expected to further insulate retail auto loan ABS ratings from downgrades, even in the face of performance that deviates for the worse from Moody's base-case loss expectation. For lease ABS, non-declining credit enhancement protects against projected losses generated from highly stressed scenarios involving lease turn-in rates and residual value recoveries. Finally, for floorplan ABS - with the lessons of 2009 informing the agency's view of volatility in this sector, current structures and enhancement levels protect against more remote scenarios of manufacturer bankruptcies that may not proceed according to government mandate.

However, Moody's has revised its loss expectations for the US retail auto loan and lease sector for outstanding 2007 and 2008 vintages by approximately 2-3 times the original loss expectation for prime auto loan pools and 1.5-2 times the original loss expectation for subprime auto loan pools. A forecast of persistent unemployment for 2010 and 2011 has also resulted in expected losses for 2009 and 2010 auto ABS pools.

In 2010, the agency expects to see an almost neutralising effect of stronger credit-quality auto ABS pools on the fragile macroeconomic picture. This neutralising effect can already be seen in the early performance trends of auto loan ABS in 2009, which bear resemblance to the loss rates of the 2008 vintages.

Moody'sEconomy.com currently forecasts new vehicle sales at 11.6 million units - 14% higher than 2009's sales, but far less than the peak standard of 16.9 million units in 2006. Nevertheless, with credit in lower supply for both retail and wholesale lending, and vehicle demand in a state of tenuous recovery, the auto manufacturers have been nimble in calibrating production to the level of demand.

This flexibility has reinforced the stability of the used vehicle market, which returned to its pre-recessionary levels in the second half of 2009. Consequently, Moody's has reported stability within the lease space for realisation on lease residual values. Manufacturers' flexibility has also prevented oversupply on dealers' inventory lots, which in turn helped payment rates on dealer floorplan loans to remain above the triggering thresholds in their related ABS.

ABS

US credit card ABS methodology updated

S&P has refined its methodology and assumptions for rating US credit card ABS. The revised criteria are part of the ratings agency's objective to make ratings comparable across sectors, geographic regions and over time. For each rating symbol, S&P intends to connote a comparable overall view of creditworthiness wherever and whenever it appears.

To help enhance ratings comparability, the rating agency has recently embraced the use of specific economic stress scenarios to calibrate the criteria. For a triple-A stress scenario, S&P uses the Great Depression. Accordingly, it is intend for triple-A rated credit card ABS securities under the revised criteria to be able to withstand that level of economic stress without defaulting.

Under the update, S&P will supplement its established criteria methodology by comparing all US credit card master trust portfolios with its US Bankcard Credit Card Quality Index (CCQI). The CCQI will serve as an industry average benchmark and will be used to compare and measure all rated pools when portfolio-specific stressed charge-off rates are forecast and when the adequacy of provided credit support is evaluated.

S&P has also established a triple-A peak charge-off rate of 33% for the benchmark pool that will be operative, provided the historical relationship between unemployment rates and industry charge-off rates continues to hold, when expected charge-off rates for the benchmark pool are within a range of about 5% to 10%. By holding the triple-A stressed peak charge-off rate constant during normal economic cycles, S&P effectively increases the loss coverage multiple when charge-off rates are lower during more benign economic environments.

The rating agency will evaluate the credit risk of an actual pool relative to that of the benchmark pool, as well as its peer group. During the evaluation, S&P will review originator-specific data on historical performance, pool-specific loan and borrower characteristics, and its forward-looking base-case performance.

Finally, after S&P compares an actual pool with the benchmark pool and peer group, it will adjust the actual pool's specific triple-A stressed charge-off rates to the extent there are deviations in originators' historic and expected performance relative to the benchmark pool and peer group or current loan and obligor characteristics relative to the peer group. If a pool's expected charge-offs are higher than what the agency would expect for the benchmark pool in the base-case scenario, then the pool-specific triple-A stressed peak charge-off will likely be above 33%. Triple-A stressed peak charge-off rates that are lower than 33% could also be applied in its cashflow analysis to the extent there are pools with higher credit quality assessments relative to the benchmark pool.

These criteria are effective immediately for all new and outstanding US credit card ABS transactions. At this time, the criteria changes will not in and of themselves have an impact on S&P's outstanding US credit card ABS ratings.

CDS

January's cash/CDS schism explained

Credit markets underwent two distinct phases in January: the first half dominated by consistent tightening; the second by widening. While CDS widening has taken the indices above 1 January levels, many bonds remain tighter on the month.

Credit strategists at Citi observe that synthetics - proving more vulnerable to concerns about sovereign risk - have borne the brunt of the recent softness. "What's striking about spread movements this month is the schism between cash and CDS," they note. "All CDS indices are wider, with the nascent iTraxx SovX underperforming the most on a relative basis. CDS have also been the instrument of choice for hedging; activity in the cash market has been quiet in comparison."

On an absolute basis, meanwhile, synthetic high yield has been the main underperformer, with the CDX HY index wider than the iTraxx Crossover. The Citi strategists suggest that much of this movement reflects a squaring of long positions, which had built up in recent weeks.

"Another feature of January's movements is the geographical disparity of current market drivers," they add. "Clearly, sovereign concerns are weighing on CDS spreads in Europe, yet in the US credit is more preoccupied with uncertainty surrounding the direction of future financial regulation."

However, the strategists point to an additional explanation for the recent weakness is market technicals. "A strong consensus developed about the economic recovery, with investor longs (especially in high yield) reaching new records on the back of it. The Street, in particular, seems to have scrambled in early January to get long, both in equities and in credit."

"This helps explain why the US market has reacted similarly, yet for very different reasons. Negative headlines - whatever their origin - proved much scarier to exposed longs than the reassurance provided by small positive surprises on earnings," they conclude.

CDS

DTCC CDS data trends analysed

Credit derivative strategists at Barclays Capital have undertaken an analysis of the CDS data published by the DTCC since late-2008, with the aim of providing an overall picture of market positioning since Lehman's bankruptcy.

The analysis notes that gross credit derivative notionals continued their decreasing trend, driven largely by compression and clearing, facilitated by the market standardisation that occurred with the Big Bang and Small Bang protocols. Net notionals are also decreasing, although the decrease is predominantly in single names, partly reflecting rebalancing of CSO hedges and CSO unwinds.

CDS liquidity is shown to have been resilient in the aftermath of the Lehman bankruptcy, with volumes picking up markedly since early 2009. Index rolls created visible volume spikes, as old trades are terminated and rolled into the new series.

Corporate end-users have predominantly been buyers of single name CDS protection from dealers. An exception to this is in the utility sector, where they have been net sellers of protection over most of 2009 - presumably seeing utilities as a safe haven. As markets stabilised, the Street gradually became net sellers of protection in utilities, in line with other corporate sectors.

"Generally, client buying of protection intensified into year-end as investors looked to protect gains from a strong 2009. In spite of recent market weakness, this trend has generally not continued in January," the BarCap strategists observe.

Throughout most of the crisis, end-users also appear to have been net buyers of sovereign protection from dealers, adding US$10bn in shorts on an aggregate basis between November 2008 and June 2009. As markets calmed down, investors went flat into August, shedding US$20bn of shorts. Since then, more relative-value views have been expressed on sovereigns - a transition from trading beta to trading alpha, the strategists conclude.

CDS

Survey highlights lack of CPR hedging

A recent survey of counterparty risk managers (CRMs) shows that most buyside firms do not hedge counterparty risk. Of the 85 managers surveyed by Fitch Solutions, in conjunction with Credit magazine, the majority cited hedging as too expensive and said they 'manage' counterparty risk rather than hedging it.

The survey also showed that 63% of respondents deal with fewer counterparties today than before Lehman defaulted. Respondents did not see the benefit of counterparty diversification due to the nature of derivatives, the correlation of derivatives and fixed income credit risks. Some 75% of respondents said they are not set-up to trade on CCPs.

"I believe [the lack of hedging] is partly a result of the implicit guarantees that the governments have put in place on a lot of the larger financial institutions," comments Pawan Malik, md at Navigant Capital Advisors. "What you will find is a lot of these firms manage counterparty risk in a different way - they will spread the risk out among banks, they'll have limits on how much they can, for example, trade with Goldman Sachs or JPMorgan."

He adds: "But the world in which they operate has become narrower. Whereas price drove a lot of their swap counterparties before 2008, I think they will be now more reliant on facing the bigger counterparties - if the counterparties face them. But generally speaking the cost of hedging is very expensive as the contingent risk has gone up."

The survey also highlighted that CRMs are dissatisfied with their ability to access and integrate counterparty credit risk signals. CRMs indicated they have significant informational needs around current risk levels and the potential for credit risk migration. Areas in which managers sought more clarity include: anticipating changes to internal risk assessments, full transparency into central risk methodologies and policies and access to relevant data.

CDS

Telecom sector drives Euro CDS liquidity surge

22Fitch Solutions' European CDS liquidity index has now exceeded levels seen during the week of the Lehman Brothers failure, with the telecom sector driving this renewed surge in liquidity. The European index closed at 9.29 on 22 January 2010 versus a peak of 9.38 during the week of 15 September 2008 (the lower the liquidity score the greater the increase in CDS liquidity).

Jonathan Di Giambattista, md of Fitch Solutions, says: "With European telecom companies due to report earnings at the month end, the CDS market is signalling increased uncertainty on the outlook for the sector, driven partly by the impact of heightened competition on companies' profits."

Average CDS spreads on European telecom companies widened by nearly 9% since the fourth week of December 2009, whereas the overall credit market widened by less than 1%. Similarly, average CDS liquidity for the telecom sector moved up eight global percentiles during the same period.

The top-five most liquid CDS corporate names in Europe are now all telecom-related companies: Telecom Italia, British Telecommunications, Kabel Deutschland, Virgin Media Finance and Portugal Telecom International Finance.

In the past two weeks to 22 January, all of Fitch's regional CDS liquidity indices became more liquid, although the increase was most pronounced in Europe. Average global CDS liquidity closed at 10.07 versus 10.34 on 8 January.

CDS

CESR launches OTC reporting consultation

The Committee of European Securities Regulators (CESR) has published a consultation paper giving guidance on how to report transactions on OTC derivative instruments. Market participant views are being sought on the proposed guidance. The publication is accompanied by a feedback statement on the consultation on "classification and identification of OTC derivative instruments for the purpose of the exchange of transaction reports amongst CESR members" and a second paper summarising the decision on the technical standards by CESR members.

CLOs

Retranched 2009 CLO tweaked

Blue Wing Asset Vehicle (BWAV) Series 2009-1 - a CLO repack - has amended its documentation to allow noteholders of class A1 callable certificates, class A2 certificates and class A3 certificates to simultaneously unwind their certificates proportionally in exchange for a proportional notional of the underlying securities, under certain conditions.

BWAV is a retranching of Westchester CLO's US$570.5m class A1-A floating-rate senior secured extendable notes due 2022. Westchester CLO is a cashflow CLO backed by corporate loans and managed by Highland Capital Management (SCI passim).

According to Moody's, the changes will not in and of themselves and at this time cause the current Moody's rating of the class A1 callable certificates to be reduced or withdrawn. Moody's does not express an opinion as to whether the amended agreement could have non-credit-related effects.

CMBS

White Tower intercreditor clarified

An amendment agreement clarifying the application of available funds under the terms of the intercreditor agreement has been executed on the White Tower 2006-3 transaction. The move follows the resignation of auditor Ernst & Young in December, which sparked concern over the potential for an issuer event of default on the deal (see SCI issue 164).

Under the agreement, available funds will be applied first in meeting items (i) to (ix) of the pre-enforcement interest priority of payments, including interest due on all classes of notes, with any excess being used to repay the most senior outstanding note principal. S&P has consequently removed from credit watch negative and affirmed its credit ratings on all of the White Tower 06-3 notes.

The notes were placed on watch negative in November due to uncertainty over transaction cashflows which, in S&P's view, increased the possibility of a note interest payment default. But the amendment agreement now clarifies the way the issuer applies available funds.

However, the agency warns that the timing and amount of proceeds from any property disposal programme is likely to be a material consideration that could trigger further rating actions. The special servicer on the deal published its strategy for the disposal of the properties that secure the loan in November.

CMBS

US CMBS delinquencies at all time high

January CMBS delinquencies are at an all time high, according to the latest Trepp delinquency report. The percentage of loans 30 or more days delinquent are now at 6.49% - up from 6.07% in December and 1.48% in January 2009. Trepp points out that this is the highest rate in the history of the CMBS industry.

Hotel loan delinquencies soared past 15% in January, as multi-family delinquencies reached 9.71%. However, the Stuy Town delinquency was not included in the January totals and would push the multi-family delinquency rate to about 13%. Retail, industrial and office delinquencies also rose during the month, notes Trepp.

Meanwhile, the strong secondary CMBS performance observed at the beginning of the year was offset by heavy selling at the close of the month. Average recent-vintage super senior spreads finished January at 476bp over swaps.

CMBS

Upcoming CRE loan maturity volumes 'relatively low'

The Mortgage Bankers Association's (MBA) 2009 commercial real estate/multifamily survey of loan maturity volumes indicates that the volume of commercial and multifamily mortgage debt maturing in 2010 and 2011 is relatively low. Of the US$1.45trn balance of outstanding mortgages held by non-bank investors, only 13% of the total (US$183.9bn) will mature in 2010 and 7% (US$99.8bn) in 2011.

MBA's 2009 survey collected information directly from servicers on the maturity years of more than US$1.5trn in outstanding mortgages, including US$1.45trn of non-bank commercial/multifamily holdings. Only small shares of the commercial and multifamily mortgage debt held by life insurance companies, Fannie Mae, Freddie Mac or FHA, or in fixed-rate CMBS will be coming due in 2010 or 2011. Greater shares of mortgages held in short-term and floating-rate CMBS and by credit companies, warehouse facilities and other investors will mature in 2010 and 2011.

Commercial/multifamily mortgage maturities vary significantly by investor group, notes the MBA. Just 2% (US$4bn) of the outstanding balance of multifamily mortgages held or guaranteed by Fannie Mae, Freddie Mac, FHA and Ginnie Mae will mature in 2010. Life insurance companies will see 7% (US$17.5bn) of their outstanding mortgage balances mature in 2010. Among loans held in CMBS, 12% will come due in 2010, including 7% of the US$650bn of loans in fixed-rate conduit CMBS and 72% of the US$54bn of loans in floating rate and large-borrower CMBS. 32% (US$69bn) of commercial mortgages held by credit companies and other investors will mature in 2010.

"Commercial and multifamily mortgages tend to be long-term loans, often for ten years or more," says Jamie Woodwell, MBA's vp of commercial real estate research. "The fact that a disproportionate share of commercial and multifamily mortgages were made in 2005, 2006 and 2007 means that for most investor groups, only a fraction of the balance will be maturing in the next couple of years."

He adds: "Investor groups' maturity schedules are generally designed to match their liabilities. Many maturing mortgages have built-in extension options, and most investor groups and servicers have considerable discretion in how they deal with loans that may not be able to immediately refinance at maturity."

CMBS

Fitch launches CMBS loan maturity bulletin

Fitch has launched its European CMBS Loan Maturity Bulletin as a supplement to its ongoing ratings analysis and surveillence services. The monthly report provides data and commentary on the loans backing European CMBS that are due to mature in the next month and comments on what happened to loans that have recently matured.

The bulletin sets out the factors that influence whether the upcoming balloon payments are likely to be made and provides Fitch's opinion on what is likely to happen to each loan.

Gioia Dominedo, senior director in Fitch's CMBS team says: "The number and volume of loans scheduled to mature ticks up in 2010 and accelerates thereafter. Fitch expects detailed information and commentary on each of them to become increasingly valuable to investors."

Charlotte Eady, director in the CMBS team adds: "The imminence of any loan maturity alone will not be sufficient cause for rating action. Our assessments of credit strength for CMBS are more forward-looking than the Bulletins, which instead provide a summary of what we expect to happen to individual loans in the short-term."

Indices

Further improvement for troubled company index

The Kamakura index of troubled public companies improved in January for the ninth time in the last ten months. The index declined from 11.07% in December to 10.23% in January. Kamakura's index had reached a peak of 24.3% in March, 2009. Kamakura defines a troubled company as a company whose short term default probability is in excess of 1%.

Credit conditions are now better than credit conditions in 68.2% of the months since the index's initiation in January 1990, and the index is 3.5% better than the index's historical average of 13.73%. The all-time low in the index was 5.40%, recorded on 11 May, 2006, while the all-time high in the index was 28.0%, recorded on 28 September, 2001. The index is based on default probabilities for almost 27,000 companies in 30 countries.

Kamakura's president, Warren Sherman, says: "The rated firms showing the largest increase in one- month default risk in January included Blockbuster, UBS, and Petroplus Holdings. Japan Airlines, which was one of the companies showing the largest default probability increase in December, filed for bankruptcy on January 18."

Investors

Initial PPIF performance stats released

Cumulative net performance data related to the nine Public-Private Investment Programme funds (PPIF) shows that five funds have, so far, made a net gain on their investments. These are: AG GECC PPIF Master Fund (3.9%); Blackrock PPIF (1.0%); Invesco Legacy Securities Master Fund (2.8%); RLJ Western Asset Public/Private Master Fund (3 3%) and UST/TCW Senior Mortgage Securities Fund (0.7%).

Three funds have made a net loss: AllianceBernstein Legacy Securities Master Fund (‐0.6%); Marathon Legacy Securities Public‐Private Investment Partnership (‐1.4%) and Wellington Management Legacy Securities PPIF Master Fund (‐1.2%).

One fund - Oaktree PPIP Fund - had not drawn down capital as of 31 December.

The Treasury stresses that the PPIFs are in the early stages of their three-year investment periods and early performance may be disproportionately impacted by structuring and transaction costs and the pace of capital deployment by each PPIF. Because of this, it says any performance analysis done on these funds would not generate meaningful results and it would be premature to draw any long-term conclusions about the performance of individual PPIFs or PPIP in general from the data reported.

The US Treasury's initial quarterly report on the PPIP shows that, as of 31 December 2009, the PPIFs had completed initial and subsequent closings on approximately US$6.2bn of private sector equity capital, which was matched 100% by Treasury, representing US$12.4bn of total equity capital. The Treasury also provided US$12.4bn of debt capital, representing US$24.8bn of total purchasing power. As of 31 December 2009, PPIFs had drawn down approximately US$4.3bn of total capital which has been invested in eligible assets and cash equivalents pending investment.

Legislation and litigation

Trustee to appeal Dante ruling

The Bank of New York Mellon has, in its role as trustee, announced it is to appeal the US ruling on the Dante CDO (see news analysis). "As a result of the conflicting court decisions in the US and UK regarding the Lehman-sponsored Dante bond programme, BNY Mellon, in its role as trustee, will appeal the recent ruling by US Bankruptcy Court," the firm says. "The US court's ruling is likely to have implications beyond this specific case and we are hopeful the appeal will help clarify the issue."

Ratings

K2 senior debt fully repaid

Moody's has withdrawn its ratings on the senior debt programmes issued by Dresdner Kleinwort's SIV, K2 Corporation and K2 (USA) LLC. These withdrawals follow the repayment in full of the senior debt.

Ratings

LatAm SF markets to recover gradually in 2010

The domestic securitisation markets of Mexico, Brazil and Argentina should gradually recover in 2010, according to Moody's in its annual review and outlook report on structured finance in the region. The rating agency does not expect a significant change in the level of cross-border issuance in Latin America in 2010, however, after volumes dropped by 81% in 2009 to become only 4% of the Latin American structured finance total.

In 2009, Latin American mortgage-backed and asset-backed issuance decreased by an unprecedented 31% to approximately US$13.5bn from US$19.5bn a year earlier. Moody's says, however, that securitsation volumes are already showing signs of recovery.

Moody's vp and senior analyst Victoria Moreno, says: "Even with the high degree of uncertainty, we expect that more transactions will come to market based on the need for financing and investor appetite for traditional asset classes and robust structures - although the rate for growth in the local Latin American markets observed in prior years will be curtailed."

Given the demand for housing, especially in Mexico, Colombia and Chile, and industry's need for financing, mortgage securitisations should remain a pillar of securitisation activity in Latin America, says Moody's. Transactions backed by mortgages in the region totalled approximately US$4.6bn in 2009.

Mexico witnessed a strong decrease in total domestic issuance in 2009 of approximately MXP44.752m - a 31% decline in comparison to 2008's MXP64.955m.

Moody's continues to have a negative credit outlook for both RMBS and construction loan ABS in Mexico in 2010, despite expecting a stronger economy. Performance in the Mexican RMBS sector, which has been under stress - especially in the low income space - should continue to deteriorate before stabilising by the end of 2010, as the economy and unemployment levels gradually recover.

In Argentina, the credit outlook for the securitisation market is stable, following a year of moderate-to-low delinquencies and strong credit enhancement levels. Moody's expects credit performance of securitised assets to improve in Argentina in 2010, especially the performance of loans granted by financial companies and also retailers.

Argentine securitisation market volumes decreased by a modest 1% in 2009, despite several changes in the regulatory framework and general concerns in the market about servicing risk. Total issuance volume was approximately ARS9.83bn.

Overall, the outlook for the securitisation markets in Brazil remains stable, continuing the steady performance observed in 2009 in light of the economic crisis. Deterioration in the consigned loan sector has been moderate on account of the job stability enjoyed by public civil servants, however. But a slight increase in delinquencies in these transactions has not had a significant impact on the credit quality of the securitisations.

The Brazilian securitisation market saw a moderate decrease in issuance in 2009. Issuance volume for the year was BRL9.4bn, compared to BRL11.1bn in 2008 - a 16% decrease year-over-year.

Credit resilience was tested across Latin America in 2009 as international conditions deteriorated. Moody's says that, compared with other regions, Latin America was able to handle the shocks from the global economic and financial crisis with relative ease - leading to a better-than-expected overall economic performance during the year.

Ratings

Japan SF sectors upgraded to stable

The sector performance outlooks for three key asset classes in Japan's structured finance market have been changed to stable from negative, according to Moody's.

Mitsuteru Masuoka, a Moody's senior credit officer, explains: "Moody's has revised its outlooks to stable from negative for ABS backed by SME leases, CDOs backed by SMEs and balance sheet CDOs (large corporates), given Moody's improving macroeconomic assumptions for Japan, as well as its revised view on the credit fundamentals of each asset." The outlooks for other asset classes remain the same.

First, Moody's examined the semi-annual updates of its asset performance outlooks. Of a total of 11 asset classes, the performance outlooks for eight are now stable and negative for three others - indicating that the asset performance of Japanese structured finance deals is stabilising. The eight stable asset classes comprise five types of ABS (autos, installment sales loans, credit card purchases, card cash advances and SME leases); SME CDOs; balance sheet CDOs (large corporates); and RMBS (conforming). The three negative classes are consumer finance loan ABS; CMBS; and RMBS (other).

Second, the rating agency reviewed 2009 and examined the outlook for 2010, with its credit analysis covering asset performances and rating implications for each asset type, specifically ABS, CDO, CMBS and RMBS. Moody's believes that asset performance in 2010 will stabilise as a whole, compared to the prior year, and should help strengthen investor confidence.

Looking back at 2009, some ABS backed by real estate-backed SME loans and consumer finance loan receivables were downgraded, due to the deteriorating real estate market, high level of claims for refunds of overpaid interest and declining pool performance. However, transactions backed by credit card receivables were upgraded due to increased credit enhancement.

Previously, Moody's had updated its key assumptions for rating and monitoring corporate and structured finance CDOs, as the recession and tightening credit conditions resulted in an increase in default rates. The number of downgrades of CDO transactions rose significantly because of the deteriorating credit quality of the reference portfolios or due to Moody's own updated assumptions. In 2010, although there are factors over which Moody's remains cautious - such as the transition of default rates of SMEs - Moody's expects the asset performance and ratings of Japanese SME CDOs and of balance sheet CDOs referencing Japanese large corporates to remain stable in 2010.

A number of CMBS saw negative rating actions in 2009, based on Moody's view that defaults at loan maturity would rise. However, following the rating agency taking into account the stressed financial conditions of the real estate finance market in its 2009 reviews, the number of rating actions is expected to decline in 2010. CMBS asset performance in 2010 will depend largely on two factors: delinquencies at maturity and the recovery of specially serviced loans.

Meanwhile, the performance of RMBS pools has been stable as a whole, even though the unemployment rate and other economic indicators have deteriorated markedly. In fact, no transaction was downgraded due to deterioration in asset performance. Despite the severe employment and income environment, pool performance in 2010 should be stable overall, except for pools with loans to obligors of lower credit quality or loans approved only by pro-forma criteria in the screening process.

Regulation

FSA and SEC confer on capital market strategy

FSA chairman Lord Turner, chief executive Hector Sants, and SEC chairman Mary Schapiro have held a meeting to discuss current matters affecting the US and UK capital markets and areas of future collaboration.

Some of the areas discussed included: corporate governance and executive compensation; regulation of hedge funds and investment advisors and the protection of customer assets; disclosure regimes around client asset risks; market infrastructure, particularly relating to central counterparties for OTC derivatives; market supervision and cooperation on cross-border supervision.

At the meeting, Schapiro, Turner, and Sants agreed that, given the linkages between the US and UK markets, enhanced supervisory cooperation is critical to market integrity. Cooperative efforts between the staffs of the two agencies are increasing in areas such as oversight of credit rating agencies, hedge fund advisers and the clearing of OTC derivatives.

The two agencies plan to review the existing memorandum of understanding concerning consultation, cooperation and the exchange of information related to the supervision of financial services firms and market oversight, entered into by the SEC and the FSA in 2006. This memorandum of understanding is designed to promote the coordination of robust and sound supervision of cross-border financial institutions and markets.

The dialogue also provided the opportunity for the SEC and the FSA to continue discussions in the areas of corporate governance, particularly board risk oversight, and executive compensation. Consistent with the emerging international consensus, both agencies' current efforts seek to address, among other things, the intrinsic links between the types and degree of risks regulated entities/registrants assume and their corporate governance and compensation policies.

FSA chief executive Hector Sants says: "Global cooperation between regulators is central to tackling the reform agenda and the relationship between the FSA and the SEC is key for international markets. Our ongoing dialogue gives us the opportunity to widen the areas of cooperation between the FSA and the SEC, in particular progressing our collaborative work on hedge funds and credit rating agencies."

SEC chairman Schapiro adds: "This dialogue has proven its utility again in allowing the SEC and FSA to share expertise and experiences regarding the rapid changes occurring in our capital markets. As regulatory reform advances on both sides of the Atlantic, we can feed this combined body of knowledge into the development of high-quality regulatory systems that take into account both national and international market dynamics."

RMBS

AOFM picks five for serial investment

The Australian Office of Financial Management (AOFM) has received investment proposals to invest in a series of separate RMBS, whose issuers have been largely or wholly reliant on securitisation markets to fund mortgage lending. Following the closing date on 15 January, five of the six received proposals were accepted.

The proposed issues will be invested under a serial investment arrangement. The total amount to be invested by the AOFM is up to A$3.4bn.

The five participating parties are: AMP Bank; Firstmac; Liberty Financial; Members Equity Bank; and Resimac.

Each serial investment will end at the earlier of 15 December 2010 or upon the relevant party providing written notice to the AOFM. The terms of each serial investment arrangement have been agreed with each successful applicant.

Confirmation of the AOFM's investment in each proposed RMBS issue under a serial investment arrangement is subject to a number of conditions, including the issuer meeting its undertakings in relation to new mortgage lending, finalisation of acceptable documentation and agreement on pricing.

RMBS

No sign of RMBS 'default burnout' yet

US non-agency RMBS data still isn't showing much evidence of a 'default burnout' in underlying mortgage pools, according to RMBS analysts at JPMorgan.

"In our view, the most important performance metric across non-agency RMBS is the transition rate of current loans into delinquent status, with other metrics (e.g., liquidation timing, loan modifications) having second-order importance," they note. "While we continue to look for signs of 'default burnout' in pools and ultimately expect this can occur, the data does not show much evidence of this yet."

JPMorgan's transition matrices for each non-agency RMBS product shows the transition rate from current to delinquent has not increased in recent months. In November, this rate was 5.6% for subprime, 3.9% in option ARMs, 2.8% in Alt-A ARMs and 0.9% for prime ARMs.

"Until investors/dealers see clear signs of a slow-down in early stage delinquencies, market convention will remain the same: run aggressive tail CDR assumptions that default a very large percentage of the remaining loan balance," the analysts add.

They remain neutral on subprime in both cash and synthetics, and overweight on Alt-A and prime jumbos. "The year-end price rally was most pronounced for the lowest credit quality portion of the non-agency space (e.g., subprime, option ARMs). While technicals remain supportive across the mortgage space (PPIP demand, repo leverage returning, run-off in existing securitisations), we anticipate stronger demand for better quality sectors in the near term."

RMBS

Granite CPR spike clarified

The latest Granite Master Trust report has clarified why the CPR spike in December 2009 occurred (see SCI issue 168). The key reason was a cumulative £280m correction to principal receipts to adjust for the fact that redraw requests had incorrectly been netted against principal receipts since the non-asset trigger was hit in November 2008. A second factor was an increase in mortgage refinancing and, therefore, removal of loans from the trust.

But, as Northern Rock (Asset Management) will not be offering further lending, this effect is unlikely to continue, according to ABS analysts at RBS. "This points to the December CPR being a one-off event, although the end of netting redraw amounts should increase principal receipts by circa £20m per month," they note.

RMBS

HAMP documentation requirements strengthened

The US Treasury and the Department of Housing and Urban Development (HUD) have updated guidance for servicers participating in the mortgage modification programme. This guidance refines the documentation requirements in order to expedite conversions of current trial modifications to permanent ones.

HUD senior advisor for housing finance, William Apgar, explains: "Increasing the number of borrowers receiving permanent modifications under HAMP is critical to our efforts to preserve affordable and sustainable homeownership. While we continue to meet our goals to provide immediate assistance, the updates ... should enable servicers to transition borrowers more quickly and easily from trial to permanent modification."

On 23 December 2009, the Obama Administration required most trial modifications to be placed in a temporary review period to ensure that all borrowers are being fairly evaluated for the programme. During this temporary review period, servicers were not permitted to cancel an active HAMP trial modification for any reason other than failure to meet the HAMP property eligibility requirements.

This allowed servicers to convert a significant number of trial modifications to permanent ones. In fact, the total number of conversions more than doubled in December.

The updated process requires that key documents, including proof of income, be obtained from the borrower before a borrower evaluation can begin. This more robust requirement of upfront documentation will make it easier and quicker to convert trial modifications to permanent modifications and enable servicers to use their resources more effectively, the HUD says.

Supplemental Directive 10-01 provides guidance on two major issues. First is that documentation be provided before trial modification begins.

A simple, standard package of documents will be required prior to the servicer's evaluation of the borrower for a trial modification. This process will be required for all new HAMP modifications that became effective after 1 June, although mortgage servicers may implement it sooner.

Second is converting borrowers in the temporary review period to permanent modifications. This clarifies for servicers the proper procedures for conversion of those borrowers, who are current on their monthly payments to permanent modifications.

Technology

Technology round-up

RMBS third-party review solution launched
Allonhill has released what it describes as a complete securitisation solution for issuers and underwriters of RMBS. The new approach offers issuers a turn-key solution by meeting the requirements of all four major credit rating agencies for third-party review firms.

The certification means the company is an approved contractor to perform due diligence on publicly traded RMBS. The programme was designed by S&P to help companies identify third-party review firms that meet the highest standards of accuracy, accountability, transparency and independence.

Allonhill's approach incorporates:
• New requirements of major credit rating agencies
• Scientific sampling methodologies and practices that are documented and incorporated into the system
• Tracking and reporting of loan errors, exceptions and their resolution
• A signed attestation of Allonhill's review procedures, findings and their disclosure.

The new approach includes presale due diligence, transaction preparation and rating agency compliance, as well as post-securitisation risk monitoring. Allonhill has also adopted the ASF's new universal mortgage loan identification code, ASF LINC.

The offering includes a desk reference manual for clients detailing rating agency requirements and the firm's sampling methodology.

Saudi Hiri calendar included in analytics update
Kamakura Corporation has incorporated what it believes is the most accurate version of the Saudi civil Umm al-Qura calendar into Kamakura Risk Manager version 7.1.2, which will be shipped to clients in February.

Kamakura has used advanced tools from the US National Aeronautics and Space Administration (NASA) to project the exact timing of the new moon, sunset and moonset in Mecca to ensure the accuracy of Umm al-Qura dates from 1937 to 2200. This is 123 years farther into the future than the best previously available projections of the Umm al-Qura calendar, the firm says. Alternatively, a user-specified Hijri calendar can be used.

Ardi Tavakol, md for client services at Kamakura, explains: "To an increasing degree, financial contracts in Saudi Arabia and other countries in the region have payment dates specified according to the local variation of the Hijri calendar. Beginning in February, Kamakura Risk Manager will automatically produce scheduled cashflows based on the Umm al-Qura calendar without any need for the client to make a conversion from the Umm al-Qura calendar to the Gregorian calendar first."

The current astronomical rules are determined at the Institute of Astronomical & Geophysical Research of the King Abdulaziz City for Science and Technology in Riyadh.

CDS trading simulator adds Markit data
Traccr has incorporated Markit's index and single-name CDS pricing data within its online CDS Trading Simulator. Traccr's CDS Trading Simulator will allow traders, investors, regulators, educational institutions and other interested parties to interact with and trade single-name CDS and, in particular the iTraxx and CDX, in a virtual environment from any location with internet access.

Farooq Jaffrey, ceo of Traccr, says: "We believe the merits of credit derivatives have been overshadowed by the recent credit crisis and we aim to improve understanding of how CDS can be used to enhance and/or protect an investor's investment portfolio. I believe Traccr's alliance partnership with Markit is an important step in developing our business model to serve as a universal portal for furthering knowledge about CDS trading."

CMA enhances pricing data
CME Group's OTC CDS clearing service, CMA, will use DataVision to support the pricing and intra-day risk management services in the clearing and settlement of CDS trades. DataVision is based on prices observed by leading credit derivatives trading desks ensuring CMA provides accurate and comprehensive market price data.

Equifax enhances MBS data solution
Equifax has enhanced its data solution for the MBS industry. Equifax ABS Credit Risk Insight (CRI) now includes the FICO credit score and several new data variables - an enhancement that will allow investors to better predict loan default and prepayment loan performance and value securities using extensive borrower credit data and highly accurate risk models, it says.

By providing both the FICO and VantageScore risk models, ABS CRI allows investors to select the score that best addresses their business needs and link mortgage loan-level data on the entire universe of non-agency mortgage securities to up-to-date borrower credit data. The solution gives investors data on leading indicators of mortgage default such as updated credit scores, balances and utilisation, delinquencies and defaults, monthly payments, credit inquiries and length of credit history.

Among other solution enhancements, Equifax has added multiple data variables that provide additional detail on all mortgage and home equity payments, owner-occupancy, bankruptcies and performance on past mortgages.

Trading

Trading ideas: inflating differential

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at a long Cooper, short Goodyear pairs trade

The fragile recovery has not treated all companies equally. At the close of last year's third quarter, reported earnings showed Cooper Tire & Rubber made drastic improvements to its bottom line. In contrast, Goodyear Tire & Rubber failed to produce such dramatic growth.

Since the earnings announcement, Cooper's CDS started to trade tight to Goodyear's; however, we believe the differential has much further to go. We recommend a long Cooper, short Goodyear pairs trade.

The key driver to today's pair is the relative difference of the changing momentum of the two companies' fundamentals. The recession following the credit crisis wreaked havoc on both issuers' credit profiles. The two suffered several successive quarters of negative EBITDA leading to rather scary coverage levels. As Exhibit 1 demonstrates, Cooper's interest coverage came narrowly close to zero back in 2008. Interestingly, after hitting its nadir, Cooper managed to generate significantly more solid and consistent earnings than Goodyear.

Exhibit 2 shows both companies' quarterly EBITDA numbers divided by Total Assets. Cooper's EBITDA's shot upwards in late 2009, nearing five percent of total assets; however, Goodyear's rebound was notably more tepid hitting a recent high of 2.5%. Cooper's recovery of its bottom line, not surprisingly, also led to a strong recovery in its coverage level which now sits just below 4x. Goodyear's weaker recovery in earnings leaves its coverage level depressed below 2x. It is both the difference of their rates of change combined with the resulting absolute levels that provide the underpinning for the pairs trade.

A quick comment on both issuers' balance sheets is worth making as the differences are striking. Goodyear and Cooper hold relatively sizeable debt, cash, and pension obligations on their books. At first take, ignoring pensions, Goodyear's net debt sits at US$3.3bn against a current market cap of US$3.2bn resulting in a leverage of 1.03x. Cooper, on the hand, holds net debt of only US$180m (total debt US$581m with cash of US$401m) against a market cap of US$1.1bn resulting in a leverage several factors less than Goodyear's. If we treat pension obligations as debt (Goodyear's of US$3.4bn, Cooper's of US$470m), then both leverages notably increase with Goodyear's doubling to 2x and Coopers jumping to 0.6x. The point of this quick analysis is that, regardless of which measure we use, Goodyear's balance sheet is several times riskier than Coopers and investors need to be compensated for this.

Based on the output of our quantitative credit model, we expect the differential of the two credits' spreads to trade more than 500bp. Up until late 2009, the fair value spread levels for both issuers tracked one another closely; however, after the release of Q309 earnings data, the fair spreads quickly diverged. Though the market spreads also started to trade with Goodyear wide to Cooper, we believe there is plenty more room to go.

Position
Sell $10mm notional Cooper Tire & Rubber 5Y CDS at 370bp

Buy $10mm notional Goodyear Tire & Rubber 5Y CDS at 510bp

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).