Contents

CDS

Clarification call

Documentation issues dampen CCDS up-take

Contingent CDS (CCDS) trading activity appears to be picking up as regulatory support for the product strengthens. However, documentation issues still need to be clarified before broader participation in the market is achieved.

A number of banks are understood to be planning to execute CCDS trades or are currently seeking regulatory approval for capital mitigation for trades they have already executed. ICAP has also reported increased trading activity in the sector. The portfolios being hedged with CCDS are typically concentrated in a few large corporate and sovereign names.

However, one issue that is still being negotiated in the CCDS space is documentation; in particular, what constitutes a credit event under the contract. "If there is an early termination event with respect to the reference derivative transaction, it isn't a credit event as defined under a normal CDS contract (in other words, isn't necessarily a failure to pay or bankruptcy). A way of lining this up is to allow the buyers of protection to convert CCDS into vanilla CDS at a time of their choosing," says Shankar Mukherjee, co-founder of the Novarum Group.

Traditionally banks' internal regulatory capital managers have looked to terminate protection under CCDS if there is a failure to pay under the reference derivative contract. However, by doing so, the exposure to default remains because they can't deliver the derivative obligation but they've terminated the hedges at an unattractive price, since presumably the reference obligations are still trading at par.

Mukherjee suggests that a more favourable outcome would involve giving the bank the right to convert the CCDS to a vanilla CDS hedge (with a notional equal to the current mark-to-market of the reference derivative) at a time of their choosing. "Because they have an ISDA contract, for which the termination events are broader than a regular CDS, banks have a timing/information advantage. Essentially, they can now choose when to crystallise the MTM of the derivative and keep the CDS hedge in place. The bank can now pursue its derivative claim, knowing the correct hedge is intact."

At the same time, the CDS market has moved on, with trades now being settled via a bond auction mechanism. "The use of bond prices in the auction mechanism means that loans are out of the picture. Consequently, insisting on a deliverable obligation under a CCDS is not consistent with the Basel 2 rules and increasingly banks are moving away from that view," Mukherjee observes.

Together with industry debate around documentation issues, the CCDS market is benefiting from increasing regulatory support. Mukherjee points to the Basel Committee's December consultative document entitled 'Strengthening the resilience of the banking sector' (see SCI issue 166).

A section of the document proposes levying a new capital charge for bilaterally cleared derivatives to address the CVA volatility of these positions on top of the existing capital requirements, which are being made more onerous. But it also states that such an incremental capital charge can be mitigated by hedging these exposures with CCDS. The Committee has requested that industry feedback be submitted by 16 April.

CS

Secondary markets

Staying firm

US secondary market CLO activity to 9 February

As with its European counterpart (SCI passim), the secondary US CLO market continues to thrive in its current role as safe-haven for investors. As last week turned into this, BWIC activity maintained its strength and spreads stayed firm.

Yesterday, 9 February, ended positively for the US CLO market, with prices coming down. Equity pieces were seen trading at 40, double-Bs in the 50s and triple-Bs in the mid-50s to low-60s. Meanwhile, single-As were in the mid-60s and double-As around the mid-70s.

Triple-As, on the other hand, were still trading in the in the low-90s. The reason for the discrepancy, according to one US CLO trader, is that it's hard to find triple-A bonds.

"People are just holding onto that paper. So you have corresponding yields for triple-A paper of 250bp over on the one end and on the double-B level you're looking at a 15% yield for the investor," he says.

The trader adds that double-B yields are indicative of a broader change in sentiment. "A few months ago, double-Bs were bringing in close to a 30% yield; now we're at 15, so we're almost back to pre-crisis levels to some degree."

In addition, BWICs continue to generate interest. According to a recent report from structured credit analysts at JPMorgan in the US: "February month-to-date BWIC volume is already at an impressive US$1.7bn, and that CLO spreads have remained firm throughout all of this is testament of the strong demand and inflows."

The trader explains: "There have been a large number of BWICs that are being shown by dealers, who represent a lot of end-user accounts. So we're seeing the bonds being aggressively bid and we think that this is primarily due to dealer buying rather than end account buying."

As was the case last week in Europe (see SCI Breaking News 5 February), much of the aggressive appetite for BWICs is being driven by the quality of the paper on offer. The trader explains that the vast majority of demand remains for high quality triple-A paper: "We have a lot of buyers that are thirsty for triple-A paper, but triple-A is hard to find. Most of the stuff we're seeing is anywhere from equity pieces all the way to double-As."

The JPMorgan analysts agree with this trend, but add that "it is really super-seniors that have attracted a 'flight to quality' bid. We see SS bonds reaching the tighter end of our 100bp-150bp spread target in the coming weeks and months, with banks, insurance companies, asset managers and others attracted to not only the spread pick-up, but also the high subordination - akin to what we might potentially see in primary CLOs in the new regime."

In terms of the primary CLO market, the analysts predict that "the triple-A and mezzanine (double-A, single-A) parts of a new issue CLO could be attractive, considering the higher subordinations and wider spreads/higher current coupons". However, they are quick to emphasise that "primary has yet to be re-started and, unlike some other markets, CLOs still face negative net supply conditions, which cushions any weakness".

In the near-term, JPMorgan believes that the most likely scenario is flat-to-slightly wider spreads rather than a significant correction, with buyers stepping in to take advantage of cheaper offers - especially up the capital structure, as there is a significant premium for minimal risk. In the longer-term, regulation will undoubtedly play a deciding role in CLO pricing, although the impact this is likely to have remains unclear.

As the trader explains, due to regulation "we're seeing a lot of the corporate spreads widen out and we think it'll translate into the CLO market as well. But these talks of regulation have been going on for a year and a half now and, until something actually happens, we'll see spreads widen out - but not to the extent that they could widen out once the regulation is put into place".

The JPMorgan analysts point out that many investors are questioning the benefits of risk retention in future transactions, given that "risk retention was a somewhat common practice in the CDO market's past, but did not prevent high losses; bank-retained subprime mortgage CDOs a case in point". General sentiment towards regulation, they note, is that it could help strengthen the market if handled properly - although the risk of over-regulation remains a concern for many investors (see also Talking Point).

JA

ABS

Hermes flies again

Dutch RMBS remarketed in softening secondary market

SNS Bank has remarketed and placed one tranche of its previously-retained Hermes XIV RMBS against the backdrop of a weakening secondary European ABS market. The three-year €1.4bn class A2 tranche was sold at 115bp after the deal was restructured and the coupon increased from 38bp previously.

"It got a positive response - it is Dutch paper and, generally speaking, Dutch paper is better bid," says one European ABS investor. "But had it come a couple of weeks earlier, it probably would have gotten a lot more excitement." The majority of notes were sold into the UK investor base (58%), with banks the largest subscriber by account type (70%).

The investor does believe, however, that investor interest the deal generated might point to a long-term positive trend. "I think we'll probably start to see people coming back into the RMBS space and starting to support the market as we reach the 150bp mark. At this point, we're heading that way - slowly," he adds.

The European ABS market showed an overall weakness last week, despite there being a recent interest in both credit card and auto ABS paper. One trader notes that while RMBS has fallen off, credit cards and autos have maintained strong levels - although by the end of last week (5 February) the market began to see weakness in those asset classes as well. "We're at the 130bp area for UK prime paper. So we're out 40bp from the tightening of January, but probably back up 20bp on the week," he observes.

The number of retained transactions being restructured and remarketed is expected to increase (see SCI issues 165 and 168), especially in Dutch, Italian and UK RMBS. Indeed, RBS re-sold the class A tranche of Eleven Cities 4 - a Dutch RMBS - late last year. However, securitisation analysts at Deutsche Bank note that the vast majority of retained ABS will be a challenge to place with investors as they stand.

"Of retained senior European ABS issued, only 1% (€8bn) has the selling points of a minimum spread of 100bp and two or more ratings. On top of this, investors have little appetite for certain sectors. While an extra rating or a spread adjustment may be possible in some cases, the fact remains that most of the retained deals look more likely to be unwound at some point than ever placed with investors," they say.

Subsequent to the placing of the restructured Hermes XIV tranche, S&P downgraded its ratings on classes A1, A2, B and C to single-A minus (all had previously been rated triple-A) and removed the ratings at the request of the issuer. The rating agency based its assumption on the fact that there was no swap in the transaction in all rating scenarios above single-A minus, as - under its current counterparty criteria - SNS Bank was no longer considered an eligible swap counterparty. This is because it was downgraded to single-A minus and took no mitigating actions within 60 days.

S&P explains that the swap is key to its analysis, as it covers all basis risk in the transaction as well as providing the transaction with guaranteed excess spread. In the Dutch mortgage market, many borrowers have fixed-rate mortgage loans with a fixed period of five to 10 years.

As such, in the event the swap provider became insolvent, the transaction would struggle in high interest rate scenarios. This has caused the rating agency to weak-link the rating on certain notes to that on SNS Bank.

S&P also rates Hermes Series VIII to XIII, which also have SNS Bank as swap counterparty. The ratings of these transactions will thus presumably require suitable mitigants to be put in place (such as replacement of the swap counterparty) to maintain their current ratings.

JA & AC

CLOs

Mezz CLO hedges recommended

Mark-to-market investors that have already made substantial gains on mezzanine CLO tranche positions may need to start looking to put hedges on to lock in their gains, structured credit strategists at Citi suggest. The strategists continue to believe in the improving economy and falling default story, but say that market sentiment is an entirely different matter.

"While cash is there waiting to be invested, the risk appetite is simply not," they note.

The strategists comment that a "rather half-baked story about a Portuguese bond auction" was enough to spook the market in a big way, while the deficit in Greece and possible impact on European credit flow has been an even bigger story. Even US markets are increasingly reacting to European sovereign headlines (see separate News Round-up stories).

"Through all this, the primary market has remained open to the right issuers. Though there are shorts out there, our sense remains that longs in the Street (cash, as well as structured) and among real money accounts will prevent a rally, unless supported by a strong tailwind," says Michael Hampden-Turner, structured credit strategist at Citi. "On balance, with markets more gripped by fear than greed, we feel the near-term risk/reward remains skewed to the downside."

Despite the negative short-term technicals, Citi says there is ample reason to believe in longer-term positive technicals (not just the credit fundamentals) for the loan market. "Loan supply is down and CLOs need to keep reinvesting. Cash loan prices should be well-supported and are, moreover, sticky, but how about synthetics and their vulnerability to other, say, equity markets," the strategists question.

They note that there is clear correlation between the two and, though cash and synthetic loan prices should not get too far out of sync, one could drag the other with it. "When that happens, the effect will be felt the most by the mezz CLO tranches (triple- and double-Bs) that saw the strongest rally through 2009 as loan prices rose," says Hampden-Turner.

In discussing how likely this scenario is, Citi points to a slight pause in CLO buying last week (before it started afresh), with news of Greece and the drop in equity prices. They also note that CLO funds, such as Highland, are liquidating and returning money to investors (see separate News Analysis), which could bring new supply to the market.

"These are bound to introduce flutters in a somewhat nervous market. However, the broad theme of investors chasing yield is likely to dominate, which is why we wouldn't overload our hedges (a suggestion is LCDX and or CDX IG) at this stage," continues Hampden-Turner. "Further diluting the selling forces is the fact that much of the money is now real-money and managed accounts, which are less market-sensitive than hedge funds."

Citi does, however, remain bullish on CLO senior debt. "Bank balance sheets are getting repaired, there are accounts of more total return swap funding for loans and even secured repo financing for CLO debt. Moreover, our investor conversations reveal new sources of real-money liquidity going into secondary senior tranches. Spreads should only tighten," concludes Hampden-Turner.

AC

CMBS

Fleet Street restructuring to set precedent?

The restructuring proposal put forward for Fleet Street Finance Two is the first case in European CMBS that includes an extension of the legal final maturity of the notes by three years (from July 2014 to July 2017). Acceptance of the proposal could lead to other single-loan deals following a similar route.

The restructuring proposal is not a coercive debt exchange (CDE), according to Fitch, especially in the case of the class D notes - which are currently rated triple-C and therefore already have a real possibility of default. The rating agency says that, in the absence of mitigating factors, this maturity extension could be considered as materially impairing the economic position of the noteholders and therefore likely to constitute a CDE.

However, it is of the opinion that other terms of the restructuring proposal sufficiently mitigate the negative impact of the maturity extension. These include the margin increase of approximately 52bp to all note classes (decreasing over time due to amortisation) and the diversion of all excess cash from both the mezzanine debt and the equity, which currently continues to be serviced, to the amortisation of the notes which will now be sequential.

"While the positive impact of these terms is immediately skewed toward the most senior note classes, it still improves the entire capital structure, including the class D notes," says Fitch.

Fleet Street Finance Two is a single-borrower securitisation backed by a portfolio of department stores located throughout Germany, all of which are leased to Arcandor's subsidiaries Karstadt and Quelle. In September 2009 Arcandor and its subsidiaries commenced formal insolvency proceedings. While the outcome of the proceedings regarding Karstadt remains unclear, the insolvency administrator decided to liquidate Quelle.

The circumstances of the proposed restructuring are unusual due to the insolvency of Karstadt Warenhaus (Karstadt accounts for 97.7% of contracted rent), the sole remaining tenant in the transaction. Fitch understands that the insolvency administrator requires evidence of the landlord's lenders' (i.e. the noteholders) approval of the proposal by the end of February at the latest.

This is to demonstrate the financial stability of the landlord (i.e. the borrower) to the creditors' assembly when presenting the insolvency plan. If this approval is not received, there is a significant risk that the insolvency receiver will decide to liquidate Karstadt, in which case it could execute its extraordinary right to withdraw from the master lease agreement.

The restructuring proposal will be put to an extraordinary general meeting on 24 February 2010 and will be approved if at least 75% of each class of noteholders votes in favour. European securitisation analysts at Deutsche Bank suggest that acceptance of the proposal could prompt further deals (most likely of the single loan type) to attempt to take the same route.

"Junior noteholders can be expected to vote in favour of extending, given many such tranches are underwater. Senior bondholders are less incentivised to delay principal recovery, but some holders' unwillingness to take the haircut to par which the valuations imply could trump this," they note.

AC & CS

Indices

CMBX given AM boost

Markit has launched a new set of AM sub-indices for all existing vintages of the CMBX indices, dubbed CMBX.NA.AM.1 to 5 (see SCI issue 169). The move is expected to create a number of new trading and hedging opportunities.

The AM tranche is commonly defined as an originally rated triple-A CMBS tranche that has the second least amount of credit support. The CMBX.NA.AM consequently comes immediately above the CMBX.NA.AJ tranche and below the existing CMBX.NA.AAA tranche in the capital structure.

The aim of the new sub-indices is to create a liquid, tradable index referencing AM securities in order to bring additional transparency to the pricing of the existing CMBX indices, as well as other CMBS securities. As many AM bonds are eligible for inclusion in the TALF programme, Markit says it expects the new indices to be an actively traded tool for investment in CMBS and for managing risk in CMBS portfolios.

CMBS analysts at Barclays Capital agree that the addition of AM tranches rounds out the capital structure and should open up a number of new relative value trading and hedging opportunities. These include: outright directional trades; credit curve steepeners/flatteners intra- or inter-series; credit butterfly trades; for instance, AMs versus AAA/AJ combo; and cross-series relative value trades.

"Based on early indications, we generally see value in most CMBX 1-3 AMs from the long side, even after the impressive debut, but prefer to focus on relative value opportunities at this time," the BarCap analysts observe.

All AM tranches have a fixed coupon of 50bp. Even though the CMBX index trades on price terms, the analysts caution investors not to ignore the fixed coupons, which "may produce seemingly counterintuitive results".

For example, the analysts' fair price estimate (optimistic case) for AJ.2 is higher than that for AM.2, given the 59bp of excess carry for AJs over AMs. This more than offsets a minimal loss expectation for AJ.2 in that state (and no losses for AM.2).

The index will be priced on a daily basis by the licensed market-makers.

Meanwhile, Markit is set to launch its new IOS index - a synthetic total return swap index series referencing the interest component of 30-year fixed-rate Fannie Mae agency pools (see SCI issue 164) - on 24 February. The objective of the index is to serve as a liquid and standardised tool for investors to take long or short positions based on their own assumptions of prepayment and extension of the reference pool interest payments.

Index cashflows, prices and valuation will be independent of the principal component of the mortgage pools. Sub-indices are expected to be created for each coupon.

CS

Insurance-linked securities

Life settlement securitisation debate rages on

The American Council of Life Insurers (ACLI) has called for the securitisation of life settlements to be prohibited in a new statement. Those involved in continuing efforts to launch the new market, which has to date been plagued with difficulties, argue that ACLI's move is self-defeating.

ACLI says: "Securitisation of life insurance settlements exposes senior citizens and investors to increased risk of fraud and the practice should be prohibited by legislation or regulation. Securitisation will lead some settlement promoters to target senior citizens and induce them to commit fraud in connection with illegal stranger-originated life insurance (STOLI) transactions."

In STOLI transactions, investors or middlemen approach seniors and encourage them to purchase life insurance policies they otherwise would not buy solely to sell the policies to investors. STOLI transactions have been outlawed in 28 states and most other states are considering anti-STOLI legislation.

"Because only a limited number of insured individuals are candidates for life settlements, securitisation promoters will have to build their inventories through STOLI," ACLI adds.

Life securitisation structurers say that such arguments directly oppose the methodology that many looking to launch life settlement deals are trying to use. "The difficulty many firms are having is that they are trying to structure high quality deals, which obviously includes strenuously trying to avoid any STOLI transactions in their deal pools. There will always be unscrupulous people, but the aim for the first public life settlement securitisations is to produce transparent structures that will serve as a measuring stick for quality in the market going forward," says one.

The Institutional Life Markets Association (ILMA) has has also joined the debate, with the association'sJack Kelly commenting: "Once again ACLI has chosen to mix apples and oranges when condemning the life settlement market. The recent policy statement issued by ACLI concerning securitisation of life settlements is misplaced and incorrect."

ACLI also says securitisation exposes investors to significant risks. "First, securitisation packages will inevitably become contaminated with STOLI. Second, securitisation promoters have no incentive to properly underwrite the package. Rating agency experts say there is no standard method and no standard set of assumptions used by life settlement providers to predict life expectancies. Without proper underwriting, life settlement securitisations are likely to fail economically," the statement says.

ILMA observes that one of the objections to securitisations raised by the ACLI is that the longevity risk associated with the transactions cannot be underwritten. This risk, however, is the exact same risk that the members of the ACLI underwrite when they issue life insurance policies and annuities. By issuing life insurance policies and annuities, carriers believe that this risk is capable of being adequately underwritten.

Further, a securitisation consultant observes: "Statements like this are so unhelpful and self-defeating - all they are likely to achieve is that they might scare off people who want to do this right, but who understandably are worried about reputational risk. Then it just becomes a self-fulfilling prophecy - you create an environment for poor products to be created, then have the evidence that all securitisation is bad."

The risks associated with life settlement securitisations are under scrutiny by the US SEC, Massachusetts' officials and Congress, ACLI notes.

MP

RMBS

Washington heights

Regulation, RMBS dominate ASF discussions

The location, in Washington DC, of last week's American Securitization Forum (ASF) conference was aimed at bringing the industry closer to the US regulators. Indeed, much of the resulting discussion focused on regulation - in particular the proposed retention requirements - as well as how to kick-start the private label RMBS market.

Hal Scott, Nomura Professor and director, programme on international financial systems at Harvard Law School, set the tone for the conference by identifying what he believes are the impediments to promoting market discipline - lack of disclosure and the 'too big to fail' mentality.

Steven Joachim, evp of transparency services and international affairs and services at FINRA, confirmed that enhanced disclosure is a critical issue. He outlined the Authority's three efforts in this regard: expanding TRACE's coverage to include agency debentures on 1 March; examining whether to expand TRACE to include structured debt; and monitoring the effectiveness of the ASF's Project RESTART.

Scott also pointed to the potential dangers of allowing accounting rules to drive regulatory capital rules. "The two approaches merged during the thrift crisis, but there were negative consequences. The rules serve different purposes: investors need information to judge investments, while regulators need information to judge solvency," he explained.

However, the 5% retention rule (SCI passim) was inevitably the main topic of discussion in the regulatory arena. The proposal was criticised for not differentiating between different risk assets and issuers, as well as failing to motivate issuers enough to strengthen reps and warranties and underwriting practises.

John Kiff, senior economist in the IMF's global financial stability division, noted that the 5% retention requirement is too blunt and its application is too inconsistent. "Will it be applied to the notional or the actual risk exposure? Where will it be applied in the value chain?" he asked.

Further, there appears to be no acknowledgement of the impact that other structural features of securitisations - such as excess spread - could have on performance. "When combined with accounting changes, retention could work against restarting the securitisation market," Kiff added. "I believe the authorities should undertake appropriate impact studies before such a rule is implemented."

According to William Moliski, md at Redwood Trust, it isn't clear whether the 5% is supposed to support a transaction's reps and warranties or its first-loss piece. "If it's targeting reps and warranty violations, it should force issuers to strengthen their due diligence efforts. If it's for the first-loss piece, the concern is that certain borrowers will be shut out of the credit markets."

The other main topic of discussion at the conference was non-agency RMBS, in particular the twin issues of loan modifications and revitalising the new issue market. Paul Colonna, president and cio, fixed income at General Electric Investment Corp, confirmed that loan modifications make it difficult to predict cashflows.

He continued: "There are two factors driving valuations: the macro environment in terms of housing and consumers; and uncertainty regarding loan modifications. I'd like to these removed in order for new issues to return."

Nancy Mueller Handal, md, structured finance at MetLife, suggested that - without principal forgiveness - foreclosure rates will only increase again in the future when mortgage rates rise. "But this is a sensitive issue: there is moral hazard in cutting principal payments, so gates and safety measures need to be built in," she argues. "The strengthening of HAMP documentation is one step, but we should also look at forgiving principal in tandem with a long-term refinancing programme, where borrowers can earn their way into forgiveness. I don't see this occurring any time soon, however."

Laurie Goodman, senior md at Amherst Securities Group, agreed that loan mods will only help at the margin and that principal reduction is key. She observed that negative equity is the single most important driver of homeowner defaults, followed by the existence of second liens.

The US Treasury is believed to be working with servicers around what form any potential principal reductions should take.

Tied in with any discussion about the broader US RMBS market is the future of Fannie Mae and Freddie Mac. James Lockhart, vice-chairman at WL Ross & Co, indicated that there are three potential paths for the GSEs: nationalisation and a merger with the FHA or Ginnie Mae; improvements based on the utility model; or the establishment of a private-sector firm.

Armando Falcon, ceo of Falcon Capital Advisors, said that the solution should be whatever is in the public interest. "The future of the GSEs is premised on their ability to deal with systemic crises and some sort of government mechanism needs to be in place to do this. It makes sense to use the infrastructure that's already there and back out of the market as it recovers and private sector support returns."

However, Annaly Capital Management cio and coo Wellington Denahan-Norris noted the importance of separating out the two GSE missions - affordable housing and promoting stability/liquidity in the mortgage market. "What's good for the public is an interesting concept," she added. "There is agreement that it's great when house prices appreciate and when government entities are receiving lots of tax receipts from the one-way movement in housing. But affordable housing is not the same as giving away credit - you need to be a responsible citizen to qualify."

She continued: "Much more capital would be dedicated to the market if there wasn't so much meddling to facilitate a one-way move in house prices. Lower prices make housing affordable, which in turn would reduce the inventory overhang, but this is being stalled by policy intervention."

Away from the RMBS market, credit card and student loan ABS were identified as providing relative value opportunities. Nichol Merrit, director at TIAA-CREF, noted that there is sharp tiering between on- and off-the-run names and this is likely to become even starker when TALF ends in March.

"Off-the-run names will widen further, but on-the-runs should be OK. The differential between senior and subordinated bonds still has room to compress," she said.

Another area that is likely to provide relative value opportunities is the FDIC's forthcoming securitisation programme, according to Dan Castro, partner at Huxley Capital Management. Issuance from the platform is expected in Q2/Q3, but he recommended that investors get in early and take advantage of any complexity premium associated with it.

In terms of market liquidity, meanwhile, Citi md Ish McLaughlin voiced his concern that the securitisation investor base remains fairly concentrated - with around 80% of volume being purchased by 20% of investors. "It's too narrow a base to build a market on: a number of large investors still haven't come back to the market," he concluded. "TALF ran so quickly that it didn't facilitate a deeper investor base. If investors can't get their arms around the product now, when better quality collateral is being originated and better credit enhancement is available, they probably won't ever get their arms around it."

CS 

Advisory

Illiquid solution

Celestino Amore, md and founder of IlliquidX, answers SCI's questions

Q: How and when did IlliquidX become involved in the structured credit market?
A: IlliquidX is a financial services boutique providing innovative solutions to professional investors that include institutional, corporate and high net worth clients. We enable our clients to effectively price and trade illiquid securities, such as high yield and distressed debt, bankruptcy claims, NPLs, MBS, CLOs, CDOs and CSOs. Our extensive network of contacts and our approach to, and expertise in, trading, settlement and financial restructuring, ensure we can add significant value in resolving liquidity and execution issues within illiquid markets.

We identified a gap in the market to service institutions, corporates and family offices holding illiquid assets and securities. Specifically, from our own histories in the market, we realised there was an opportunity to deliver solutions that would help improve transparency, pricing and access to liquidity. For example, we noted that, in the general downsizing by financial institutions, sales desks in the credit area were becoming understaffed counter to the increasing need to better manage the risks of distressed assets.

Galina Alabatchka (co-founder and md of IlliquidX) and I thrashed out our ideas around using an electronic platform to help deliver transparency and build liquidity, then started operations early in 2009. We assembled a team of product specialists and quickly gained enough experience and critical mass to become a leader in pricing, trading and restructuring the most illiquid and complex fixed income securities and portfolios.

We have grown rapidly from our inception and now boast a client community of over 600. We have recently moved our office to larger premises to further enable our expansion. We have also made some recent key hires to aid our growth: Nagi Kamar joins us from Calyon to advise and execute on synthetic structured credit products such as CSOs; while Nasir Zubairi leverages his experience from RBS and ICAP electronic broking to take the lead on business development, focusing on marketing, alliances and enhancing our service offering.

Q: Which market constituent is your main client base?
A: The spectrum of our clients is very broad: any firm that may be holding an illiquid asset or portfolio of illiquid assets. This could be a corporate creditor to a bankrupt institution, Lehman Brothers being a classic example; money managers holding ABS in their portfolios; professional traders in the credit markets looking for improved market access to buy and sell their positions; pension funds; hedge funds; investment funds; family offices; and high net-worth individuals.

We offer a solid and clear value proposition to both buyers and sellers, so interest in our services has been very strong. Our current geographical focus is Europe, but we are beginning to look at the Middle East and Asia as an area for expansion.

Q: Do you focus on a broad range of asset classes or only one?
A: Right now, we service clients with solutions for four broad asset groups: stressed and/or defaulted debt; high yield debt; illiquid structured products (including MBS, CDOs, CLOs and CSOs); and illiquid equities and equity derivatives.

Q: How do you differentiate yourself from your competitors?
A: We offer a unique combination of services to deliver a total package for consumers who need help in managing their distressed debt and illiquid assets. Our sales and trading team has considerable experience in the securities and assets we cover, gained from within the most prestigious financial institutions around the world. Our incentive model ensures that our people are dedicated to their clients and are looking to add value.

The front office assists in providing valuations and appraisals for structured products, both cash and synthetic, such as ABS, CDOs and CLOs, as well as asset portfolios. Moving down the value chain, we leverage our expertise to provide advisory services in financial restructuring and workouts for corporate debt capital structure and NPL portfolios.

A key differentiator for us is the way we generate liquidity. Our proprietary web-based platform provides our clients with easy access to information on the plethora of securities and assets we have an interest in, which is supplemented by the hard work carried out by our sales people offline. Our team has an in-depth knowledge of our international clients' trading needs, so know who to contact and when.

Finally, we place considerable importance on our company values. Our values help generate the enthusiasm, the collaboration and the motivation to deliver excellent service that forms the basis of our corporate culture. It is our values and dedication to service excellence that have enabled us to build the strong trusting relationships that are fundamental to our business.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: The current market environment - with constant contradictions on economic recovery, critical emphasis and action on banks' operations and credit markets (in particular, the expected lag in bankruptcies and credit actions on businesses and individuals resulting from the harsh environment of the past two years), among other things - all lead to a lot of volatility in the market we are operating in. Volatility in most markets is generally a good thing for traders seeking alpha, but the extent of the volatility benefits in our market are counterbalanced by the complexity of the assets and the degree of illiquidity - prices become hard to determine and there is more uncertainty around the correct timing to trade a position.

In these circumstances, our team has been working diligently to help our clients regain the confidence to trade by ensuring they have as much useful information as possible in their decision-making process. The illiquidity spots followed by liquidity rushes we are witnessing mean we need to move quickly and adapt to different circumstances. Our platform is an efficient way to manage and communicate these ebbs and flows in the market.

Q: What major developments do you need/expect from the market in the future?
A: There are still billions of dollars of assets that will need to be disposed of by banks; institutions are still holding large pools of illiquid structured credit products, and we believe that there is still a bubble in bankruptcies and credit downgrades waiting to happen as firms finally succumb to cashflow issues. This is where the market needs IlliquidX.

By providing an independent, transparent and regulated service for the pricing and trading of distressed and illiquid debt and structured products, we deliver the efficiency and create the environment for best execution that clients desperately need. By working with IlliquidX, market participants also have access to a wide range of opportunities for investment.

Our goal is for an efficient and profitable market to exist for the trading of distressed debt and structured products. We believe this is in the interest of all and that IlliquidX can play a key role in achieving the objective.

We think the continuity of an OTC market in these products and its self-regulation by participants is a market objective. We feel that our services and the transparency they provide can help to ensure that the market structure and its operation align with the wants of its users. IlliquidX is agile enough in its strategy to ensure we can adapt to any developments in market dynamics that may occur in the future and continue to deliver to the needs of our clients.

ABS

French bank expands ABS headcount

BNP Paribas has made a number of hires within its ABS division. Perry Inglis, former head of S&P's CDO business and most recently employed by structured finance advisory boutique AgFe, has joined the bank as head of ABS origination and valuation.

Meanwhile, Giovanni Pini - former ABS research analyst at European Capital Management - is joining BNP Paribas as ABS strategy head and Olivier Morand-Duval, former ABS trader at ICAP, is joining as European head of ABS trading. Inglis reports to Duc Dam Hieu, head of fixed income securitisation and principal finance quantitative structuring, while Pini and Morand-Duval report to Peter Nowell, head of ABS trading and to Pierre Lepinoy, head of portfolio management.

Advisory

Distressed asset advisory group formed

The Corvus Group has formed a Troubled Asset Advisory Group (TAAG) in order to provide specialised staffing and analytical/advisory services to companies involved with troubled and distressed commercial real estate and homebuilder/residential development debt.

Neal Gussis will join TAAG as md of asset management. Gussis comes to Corvus with over 20 years' experience in real estate mortgage, finance and asset management expertise.

Joining him as a Corvus associate is Andrea Lange, previously with Prudential Mortgage Capital Company, where she performed loan origination and portfolio management services.

The new division's services include: loan/REO real estate portfolio due diligence and valuation, workout and disposition services, disposition oversight and management, collateral services oversight and property management, special servicing support and legal coordination.

CDS

Derivatives veteran joins AIG

AIG has hired Peter Hancock as evp of finance, risk and investments. Hancock will oversee finance, risk, audit, investments, strategic planning and AIG Financial Products Corp, reporting to AIG president and ceo Robert Benmosche.

Benmosche says: "I am very pleased that Peter, a recognised expert in risk and finance, will be joining AIG in this important new role. Over the last several weeks, a number of well-respected, seasoned executives have voted with their feet in our team's unwavering commitment to repay taxpayers and create a real future for this great company. Peter's comprehensive experience in financial services will help accelerate our existing team's efforts toward AIG's re-emergence as a strong, independent company."

Prior to joining AIG, Hancock spent 20 years at JPMorgan, where he established the global derivatives group, ran the global fixed income business and global credit portfolio, and served as the firm's cfo and chairman of its risk management committee. He later co-founded Integrated Finance, an advisory firm specialising in strategic risk management, asset management and innovative pension solutions. Most recently, he served as vice-chairman of KeyCorp, responsible for Key National Banking.

CDS

Bank hires two in credit research

Nomura has hired Ronan Clarke as head of EMEA high yield credit research and Karine Elias as senior high yield analyst.

Clarke will be based in London and has ten years of experience in high yield research, having held similar management roles at UBS and most recently at Royal Bank of Scotland. Elias has seven years of experience in high yield credit research with Royal Bank of Scotland, UBS and Morgan Stanley.

Both will cover CDS as part of their remit. Elias will focus specifically on retail/consumer and gaming credits.

CDS

ICAP beefs up in post-trade services

ICAP has agreed to acquire all the outstanding share capital (61.78%) of TriOptima that it doesn't already own for an initial €109m in cash, together with a further amount of approximately €12m in respect of working capital. This payment will be financed from ICAP's existing debt facilities.

Following the initial payment, there are two further potential payments based on revenue and profit targets for the period to 31 December 2012. These further payments can be made in cash, ICAP shares or a combination of the two at ICAP's discretion. The agreement is subject to regulatory approval in Sweden.

Michael Spencer, ICAP group ceo, comments: "TriOptima is a highly successful, technology-led business that has performed extremely well since we made our initial investment nine years ago. They are an established market leader in the automation of post-trade and risk management processes in the OTC markets. Post-trade services are an area where risk management, allied with technology innovation is creating exciting new high-growth opportunities for ICAP."

The acquisition is expected to be earnings enhancing from the date of completion.

ICAP originally invested in TriOptima when the business was founded in 2001. The firm now has 102 employees and gross assets of €36.5m. Following the acquisition, the senior management and founders of TriOptima - including ceo Brian Meese - will remain with the business and continue it within the ICAP Group.

Meese comments: "TriOptima and ICAP share a vision of providing comprehensive post-trade services to the OTC markets. By becoming part of ICAP, TriOptima will be able to more rapidly expand the range of post-trade and risk management services we provide. We anticipate significant growth opportunities from working closely with ICAP's other post-trade and risk management businesses to provide a higher level of service to our combined customer base."

CDS

Derivatives documentation committee strengthened

ISDA is broadening the leadership of its Documentation Committee by forming an advisory board that will encompass buy- and sell-side institutions to better represent global documentation needs across constituencies. The board will provide strategic guidance and leadership to the Documentation Committee's work on a range of topics, including new product documentation, resource allocation across projects, legal opinion scope and coverage of Amicus Briefs, and will replace the existing regional chairmanship structure.

"The new advisory board will boost ISDA's legal and documentation efforts across regions and disciplines," says Eraj Shirvani, chairman of ISDA and head of fixed income EMEA at Credit Suisse. "The Board will facilitate a globally consistent approach to documentation development and maintenance, while ensuring appropriate levels of regional expertise on key matters of relevance to both buy- and sell-side."

The advisory board will include the current chairs of the ISDA Documentation Committee: Chip Goodrich (Deutsche Bank), Serge Salabi (BNP Paribas), Teruo Tanaka (Royal Bank of Scotland) and Don Thompson (JPMorgan Chase). The following experienced industry practitioners have also agreed to serve on the board: Tricia Bowden (Goldman Sachs Japan), Sarah Lee (Bank of America Merrill Lynch), Christopher Ramsay (Citadel Investment Group), James Starky (Cairn Capital) and Andrew Wan (Citibank).

The ISDA Documentation Committee provides overall direction for all documentation projects and supervises the Association's respective documentation working groups. The Committee expands and updates the library of ISDA documentation and works to ensure the enforceability of the netting provisions of the Master Agreements.

CLO Managers

Manager suggests itself as replacement on CDO

Hildene Capital Management, a New York-based asset management firm focused on distressed structured finance investments, has renewed its request that investors in US Capital Funding IV - a Trups CDO - oust StoneCastle Partners as collateral manager and appoint it instead.

In January Hildene highlighted that StoneCastle had breached various aspects of its collateral management agreement and accused the manager of acting for its own benefit - to the detriment of investors (see SCI issue 168). Hildene pledges that if appointed replacement collateral manager, management fees will - after reimbursing Hildene for its legal fees associated with this action - "be applied to pay certain legal fees incurred by noteholders currently fighting attempts to loot fund assets that support the repayment of debt held by US Cap IV".

CLO Managers

New manager for three ABS CDOs

Threadneedle International is set to assume the collateral management responsibilities previously performed by Babcock & Brown on the Bernoulli High Grade CDO I and II, and Euler ABS CDO I transactions. S&P says it has issued a preliminary rating confirmation on the assignment agreement.

CLOs

Alcentra takes on affiliate's CLO

BNY Mellon Capital Markets (BNYMCM) has assigned its rights and obligations under the collateral management agreement for the OWS CLO I transaction to its affiliate, Alcentra NY. Both entities are controlled by The Bank of New York Mellon Corporation.

Moody's has been informed by counsel to the collateral manager that the required noteholder consent has been received. The rating agency is of the opinion that the assignment will not affect the current ratings of the notes, as the assignment does not result in inconsistencies with its rating methodology.

CMBS

Advisory service to focus on CMBS loans

Marcus & Millichap Capital Corporation (MMCC) has launched a new division to serve the needs of US CRE borrowers. The Debt Advisory Services (DAS) division will assist borrowers on loan modifications and restructurings, loan maturity extensions, loan assumptions, discounted pay-offs and note purchases. The service will be led by directors Eric Gunderson, Deborah Schiavo and Brian Sullivan.

William Hughes, svp and md of MMCC, explains: "The DAS can assist borrowers with portfolio and securitised commercial mortgage loans to better understand, manage and negotiate the lender and servicer approval process, particularly for CMBS loans. The division has expertise in credit analysis, underwriting, loan closing, securitisation, servicing and asset management. By leveraging our relationship with Marcus & Millichap Real Estate Investment Services and its national network of investment professionals, the DAS division will provide private and institutional clients with solutions for maturing loans, under-performing assets and in facilitating transactions that involve loan assumptions."

Gunderson says: "The DAS understands the assumption process for structured commercial real estate financing. As a buyer's representative, we act as an intermediary to resolve conflicts and enhance the outcome for all parties."

Gunderson brings more than 10 years of experience in the finance industry to his new position as director. Most recently, he was a principal with Highland Advisory Partners.

Schiavo has more than 15 years of experience in commercial real estate finance and securitisation. Prior to co-founding Highland, she was an md with Bear Stearns.

Finally, Sullivan has 10 years of experience in the finance industry, eight of which were spent as a commercial real estate debt provider. He has expertise in originating, underwriting, structuring and funding more than US$5bn in loans. Most recently, he was a vp at Deutsche Bank.

CMBS

Mortgage REIT details TALF purchases

Apollo Commercial Real Estate Finance (ARI) says it has completed investments in CMBS totalling US$349m. These investments involved the deployment of US$127.8m, or approximately 61%, of the equity capital raised in the REIT's initial public offering.

During Q409, the company completed the origination and acquisition of mezzanine loans totalling US$50m and securities totaling US$154.7m. Further, during January 2010, the company completed the origination of a US$32m first mortgage loan and the acquisition of securities totaling US$112.3m. The company's current portfolio comprises: newly-originated first mortgages totalling US$32m; newly-originated mezzanine loans totaling US$50m; and CMBS totalling US$267m.

To date the company has acquired and financed approximately US$267m of triple-A rated legacy CMBS. The securities have been financed through the TALF programme, resulting in loan proceeds of US$221.2m and a net equity investment of US$45.8m.

The securities acquired are comprised of A2 and A3 tranches from nine securitisations with a weighted average coupon of 5.6%. The TALF financing is a mix of three- and five-year non-cross defaulted, non-recourse and non-mark-to-market financing, with a weighted average interest rate of 2.84% - resulting in a levered current cash yield of approximately 18.9%.

Investors

Partnership for specialist credit managers

Ignis Asset Management (formerly Axial Investment Management) has entered into a strategic partnership with Castle Hill Asset Management. Castle Hill is a specialist credit investment manager with more than US$2bn of gross assets under management. These assets include sub-advisory mandates from Ignis Asset Management invested across two leveraged loan portfolios, as well as one long-short credit portfolio.

At the same time, Castle Hill has launched the Castle Hill Total Return Fund, a hedge fund focused on opportunistic credit strategies and capital structure arbitrage. The Total Return Fund has been seeded with approximately US$50m of capital by Castle Hill employees and associates.

Castle Hill, which is majority employee-owned, is a US- and UK-based asset management company consisting of nine founding members. Brian Bassett, chairman, and Jaime Vieser, ceo, are the co-principles of the investment manager. They are joined by Craig Abouchar, Vikram Govindan, Philip Grose, Ross Mandeville, Sven Olson, Sasha Vlahcevic and Fraser Brown.

Ignis will hold a 49% interest in Castle Hill and will have two Ignis executives on the Board: Jonathan Polin and Chris Fellingham.

Prior to becoming chairman and co-principal of Castle Hill, Bassett was cio at Ignis Investment Management. For the three years prior to joining Ignis, Bassett managed the European leveraged finance platform at Deutsche Bank in London, with responsibility for leveraged finance banking, loan capital markets, loan sales/syndicate and investment grade acquisition finance, having run the European high yield capital markets business since moving to London in April 2000.

Vieser was previously a portfolio manager at Ignis. From 2005 to October 2008, he ran a proprietary trading desk for Deutsche Bank in London, having previously been responsible for the bank's high yield sales, trading and research group within the global markets division in London from 1998 to 2006.

Investors

MBIA Asset Management restructured

MBIA has restructured its fixed income asset management subsidiary. The firm, now known as Cutwater Asset Management, will operate under the MBIA corporate umbrella as a separate operating company.

A number of MBIA employees were transferred to Cutwater in order to enhance its in-house IT, legal, marketing and accounting infrastructure. The firm now has turnkey operational capabilities through its own staffing of over 120 employees and maintains separate capitalisation appropriate for its business.

Cutwater will continue to be led by its current management team, including Clifford Corso, who was named president and cio. Corso had been president and cio of MBIA Asset Management and helped establish the asset management platform, building it into one of the largest fixed income managers in the world. He joined MBIA in 1994.

The asset management firm began in 1991 and now manages US$42bn in assets for clients, as well as MBIA's US$16.7bn proprietary portfolio.

Legislation and litigation

State Street faces subprime enforcement action

The US SEC has charged State Street Bank and Trust Company with misleading its investors about their exposure to subprime investments while selectively disclosing more complete information to specific investors. State Street has agreed to settle the SEC's charges by paying more than US$300m that will be distributed to investors who lost money during the subprime market meltdown in 2007. This payment is in addition to nearly US$350m that it previously agreed to pay to investors in State Street funds to settle private claims.

"State Street led investors to believe that their investments were more diversified than a typical money market portfolio, when instead they were invested almost entirely in subprime investments that ultimately caused hundreds of millions of dollars in losses," comments Robert Khuzami, director of the SEC's Division of Enforcement. "Investigating potential securities law violations arising out of the credit crisis remains a high priority for the SEC Enforcement Division."

The enforcement action is the result of joint efforts by the SEC with the Massachusetts Securities Division and the Massachusetts Attorney General's office, which both announced related charges against State Street.

According to the SEC's complaint filed in federal court in Boston and a related administrative order issued by the Commission, State Street established its Limited Duration Bond Fund in 2002 and marketed it as an "enhanced cash" investment strategy that was an alternative to a money market fund for certain types of investors. By 2007, however, the fund was almost entirely invested in subprime RMBS and derivatives that magnified its exposure to subprime securities. But State Street continued to describe the fund to prospective and current investors as having better sector diversification than a typical money market fund and failed to disclose the extent of the fund's concentration in subprime investments.

According to the SEC's complaint and order, the bank sent investors a series of misleading communications beginning in July 2007 concerning the effect of the turmoil in the subprime market on the Limited Duration Bond Fund and other State Street funds that invested in it. At the same time, however, it provided particular investors with more complete information about the fund's subprime concentration and other problems with the fund. These other investors included clients of State Street's internal advisory groups, which provided advisory services to some investors in this fund and related funds.

The SEC alleges that, based on this more complete information, State Street's internal advisory groups subsequently decided to recommend that all of their clients - including the pension plan of State Street's publicly-traded parent company (State Street Corporation) - redeem their investments from the fund and the related funds. Further, it is alleged that State Street sold the fund's most liquid holdings and used the cash it received from these sales to meet the redemption demands of better informed investors, leaving the fund and its remaining investors with largely illiquid holdings.

Under the terms of the settlement, State Street agreed to pay a US$50m penalty, more than US$8.3m in disgorgement and prejudgment interest, and more than US$255m in additional payments to compensate investors. Combined with nearly US$350m that it has already paid or agreed to pay some investors through settlements of private lawsuits, the total compensation to harmed State Street investors is approximately US$663m.

State Street was also ordered to cease and desist from any further violations of certain securities laws. The SEC's enforcement action took into account the company's remediation and its cooperation, including: replacement of key senior personnel and portfolio managers, conducting a review of its procedures and revised its risk controls, entering into private settlements with harmed investors and a recent agreement to provide information it was not otherwise obligated to provide to enable the SEC to assess the potential liability of individuals with respect to certain investor communications.

Separately, the SEC has filed a motion seeking court approval of a proposed settlement whereby Bank of America will pay US$150m and strengthen its corporate governance and disclosure practices to settle SEC charges that the company failed to properly disclose employee bonuses and financial losses at Merrill Lynch before shareholders approved the merger of the companies in December 2008.

Legislation and litigation

FSA bans EM fund manager

The UK's Financial Services Authority (FSA) has banned a London-based hedge fund manager and fined him £140,000 for deceiving investors by mismarking funds he managed and misleading the FSA during the investigation.

Simon Treacher was portfolio manager on the BlueBay Emerging Market Total Return Fund - a fund that has now been wound down. From August to October 2008, he cut and pasted different figures onto seven original broker quotes used in the valuation process of assets in the funds he managed. The deliberately altered quotes led to an uplift in the independent valuation of the funds of approximately US$27m over three months.

This resulted in investors being financially disadvantaged by approximately US$650,000, for which BlueBay has fully compensated them. Treacher then provided misleading information to the FSA about his conduct during its investigation.

Treacher is no longer employed at BlueBay and the FSA says it makes no criticism of BlueBay in connection with this investigation.

Treacher agreed to settle at an early stage of the FSA's investigation and qualified for a 30% reduction in the financial penalty. Were it not for this discount, the FSA would have sought to impose on him a financial penalty of £200,000.

Legislation and litigation

Wisconsin school districts to pursue CDO claims

Law firm Shepherd, Smith, Edwards & Kantas and its Milwaukee, Wisconsin-based co-counsel Kravit, Hovel & Krawczyk have defeated motions to dismiss filed by the Royal Bank of Canada and Stifel Nicolaus & Co. A Milwaukee judge has ruled that claims filed by five Wisconsin school districts and their Other Post Employment Benefits (OPEB) Trusts can go forward against the investment banks that district officials say misled them to invest US$200m in risky investments using mostly borrowed money.

The ruling, delivered by Milwaukee County Circuit Court Judge William Brash, denied all motions to dismiss claims in the lawsuit filed against Stifel, Nicolaus & Co, Royal Bank of Canada Capital Markets and RBC Europe. The judge also rejected an argument by RBC Holdings that claims against it should be dismissed because it did not have "control" over the other RBC entities.

The Kenosha, Kimberly, Waukesha, West Allis-West Milwaukee and Whitefish Bay School Districts and those districts' OPEB Trusts sued these banks in September 2008, asserting legal claims that include violation of state securities law, fraud, misrepresentation and breach of contract. Stifel Nicolaus and Royal Bank of Canada filed motions to dismiss every claim in the lawsuit, arguing, for example, that the districts hadn't provided enough specifics to support their claims of fraud; that they had been warned about the potential risks of the investments; and/or that the banks could not be held liable for the losses.

At hearings last November on these motions, an attorney for the Royal Bank of Canada claimed the lawsuit was a way to cast blame for potential losses and that what happened was a once-in-a-lifetime economic meltdown no-one saw coming. That argument and others advanced by the defendants failed to persuade the Court to dismiss the lawsuit at this stage of the proceedings.

"The lawsuit alleges that the plaintiffs were led to believe that they were investing in a portfolio of AA/AAA bonds that would be used to help fund their OPEB liabilities," comments William Shepherd, managing partner of the lead law firm representing the plaintiffs. "Instead, what was sold were synthetic collateralised debt obligations, which are in essence credit default swaps - the same type of highly complex and risky investment that caused the collapse of Lehman Brothers."

Those investments are now virtually worthless, the law firm says.

Legislation and litigation

SF partner joins Canadian firm

Canadian law firm Blake, Cassels & Graydon has hired Michael McIntosh as a partner in its Calgary office. McIntosh's practice focuses on banking, acquisition finance, structured finance and project finance.

He also has considerable experience in all phases of corporate and commercial acquisitions and regularly advises on cross-border financings. Recent transactions have included major acquisition financings, private placements, major construction financings and cross-border structured financings.

Legislation and litigation

New phase for Ocala Funding suit

The Ocala Funding ABCP programme dispute entered a new phase last week when Bank of America (BoA) filed a court document countering investors' allegations that it breeched its contractual duties. The two sole ABCP investors, Deutsche Bank and BNP Paribas Mortgage Corporation, claim that BoA's failure to safeguard the Ocala collateral and to certify and test the borrowing base caused them to suffer losses (see SCI issue 164).

In its defense, BoA principally argues that it was never Ocala's guardian, despite its various transaction roles (BoA served as Ocala's indenture trustee, depositary, collateral agent and custodian). The bank also asserts that the two ABCP investors were not without fault, having been Ocala's swap providers and note dealers.

In its filing to the court, BoA describes Ocala as an instrument of Taylor, Bean & Whitaker Mortgage Corp (TBW) and downplays its own roles. It portrays its investors as active sophisticated parties with rights to control Ocala and who had better access to information than BoA itself did, according to the latest Moody's Weekly Credit Outlook.

Further, BoA asserts that governance over the programme resided with TBW and Ocala and that it was obligated to follow their instructions. The bank also contends that TBW controlled Ocala, as TBW picked the mortgages that were sold to Ocala, serviced the loans and decided when the loans should be sold by Ocala, to whom and at what price. BoA states that TBW's dominion over Ocala was evidenced by back-to-back swap agreements between TBW and the two swap providers.

Moody's points out that the ultimate payment on the ABCP is uncertain. BoA asserts that it is "widely-understood" that TBW engaged in a "complex fraudulent scheme" to delay its financial demise, including the use of multiple pledged mortgages or stolen assets as Ocala collateral.

If these allegations are true, then even if BoA recovers the Ocala assets from the FDIC, the assets could be insufficient to pay off the ABCP. Investors will suffer a loss unless they win their suits against BoA, Moody's says.

"BoA's contentions highlight a dilemma in certain structured finance transactions," notes Sally Acevedo, vp - senior analyst at the rating agency. "Swap providers are typically closely involved in structuring of mortgage warehouse programmes because they are at risk of loss. If a swap provider is also an investor, should that affect the investor's rights?"

Real Estate

US real estate head appointed

Deloitte has appointed Robert O'Brien to lead its US real estate practice as a vice-chairman, effective immediately. O'Brien succeeds practice leader, Dorothy Alpert, who has assumed the role of northeast deputy regional managing partner at the firm.

O'Brien is responsible for the real estate practice's overall strategy and execution across tax, audit, enterprise risk, consulting and financial advisory services in the real estate, homebuilding, engineering and construction industries. He will be based in Chicago.

Most recently, O'Brien served as the US audit and enterprise risk management leader for the real estate practice, as well as Deloitte's global real estate funds initiative leader. From 2003 to 2008, he led one of Deloitte's Chicago audit practice groups.

From 1999 to 2003, O'Brien served as a transaction services partner in Deloitte's M&A practice. He was promoted to partner in 1995.

Bill Freda, Deloitte's vice-chairman and US managing partner for clients and markets, says: "Bob's broad background and global relationships position him well to execute for our clients. His more than 25 years of public accounting and transaction experience in the real estate and hospitality industries will prove to be an invaluable asset to Deloitte and to our clients in meeting the challenges of the current market dislocation."

O'Brien comments: "As the global economy recovers, two trends are becoming apparent: the next generation of real estate investors is emerging in the form of distressed asset funds, and REIT activity is heating up via IPOs and M&A. Success through the downturn in real estate and into the next cycle will require overcoming challenges and excellent execution. Whether it's enhanced financial reporting to investors and the capital markets, efficient entity and investment structuring, valuation insights, strategy and operations, or technology, these new and evolving industry players will need the assistance of a professional advisor with broad and deep real estate expertise."

Technology

Software firm strengthens South Asia coverage

Sophis has hired Jean-Sébastien Py to take on the role of general manager for South Asia, based in Singapore. Py joined Sophis in 2004, first as a front office consultant and then as senior business consultant, before heading up the business consulting team for Asia.

In his new role, Py will be responsible for consulting, support and implementations for new and existing clients in South Asia. In addition, he will be exploring new markets, such as India and Vietnam.

Py comments: "Asia is a large and varied region that offers a multitude of opportunities for Sophis. By expanding our footprint in South Asia, we will be able to deliver service excellence to our clients from our Singapore hub and create a strong and trusted brand that will enable us to leverage new opportunities and gain a foothold in new markets."

Trading

Broker expands distressed, EM coverage

BTIG's fixed income group has hired seven senior professionals in the areas of high yield/distressed, emerging markets and capital markets. The new recruits include: Chris Majak, Kerry Stein and Michael Satzberg in fixed income high yield/distressed; Tim Goodell, Diogenes Vazquez and Antonio Lopez-Torrero in fixed income emerging markets; and Peter Burton in fixed income capital markets.

The addition of these industry veterans further enhances BTIG's capabilities in fixed income sales and trading. The firm has hired more than 75 fixed income professionals since the group was launched in February of last year.

Jon Bass, co-head of global fixed income at BTIG, says: "Our clients are responding to the growing breadth of our team, finding them liquidity for their positions and giving them high quality ideas and guidance from our respected desk analysts. These hires represent our continued efforts to rapidly build-out our global fixed income capability."

Burton joins BTIG from Emporia Capital Management, a middle market CLO with approximately US$1.5bn in assets under management. While at Emporia, he was responsible for sourcing, screening, investing and managing a portfolio of middle-market leveraged loan investments. Burton will be part of the fixed income capital markets group.

Goodell joins BTIG in fixed income emerging market sales, joining the firm from Ropemaker Capital, a New York-based broker-dealer where he was co-founder and co-president. Prior to Ropemaker Capital, Goodell spent nine years at UBS Investment Bank as head trader for Latin American structured credit and later as an executive director in structured credit sales.

Majak joins BTIG in fixed income high yield sales. He was previously at Polygon Investments, where he traded high yield and distressed credit. Prior to Polygon, he spent nine years (six in the US and three in Europe) as a high yield/distressed salesperson at Miler Tabak, KBC and Barclays.

Stein comes to BTIG from Jones Trading, where he was the head of fixed income and bank debt trading. He is joining BTIG as a credit salesman focusing on high yield and special situations. Over his 25 year career, Stein has traded high grade, emerging market and high yield debt at Drexel Burnham, Kidder Peabody/Paine Webber and Morgan Joseph.

Satzberg joins BTIG's Los Angeles office in fixed income high yield/distressed trading. He previously worked at Sun Capital Partners, where he was responsible for the development and management of the distressed debt and private corporate loan portfolio in the Sun Capital Securities Fund. Prior to joining Sun Capital Partners, Satzberg was a svp with Jefferies & Company, where he was responsible for trading and principal debt investments in several industry sectors.

Vazquez comes to BTIG from ACMV Capital, a private equity/venture capital fund with investments in Argentina and Chile. He previously spent five years at Santander Investments in New York, executing both debt and equity capital markets transactions. He joins BTIG's fixed income emerging market sales team.

Finally, Lopez-Torrero joins BTIG in fixed income emerging market sales, coming from G-O Holdings, where he traded emerging markets corporate bonds. Prior to that, he was at Marathon Asset Management, where he co-managed its global emerging markets local currency portfolio.

BTIG's fixed income group focuses on sales and trading of credit products, which cover the full credit spectrum from investment grade to distressed debt.

Trading

Ex-TCW manager hired as CRO

Allan Toole, former portfolio manager at TCW and head of its portfolio analytics group, has assumed the positions of chief risk officer of DoubleLine Capital and head of product development at the firm.

As chief risk officer, Toole is responsible for coordinating the firm's programmes for detection and measurement of material risks to investment portfolios, enabling the firm to maintain accounts in accordance with strategy guidelines and client risk profiles. He will play a key role in the development of internal risk systems and processes for the analysis of the firm's workflows, operations and systems, and the establishment of mitigating controls for material operations risks.

As head of product development and analytics at DoubleLine, he will review new products and structures to identify material market risks and establish effective risk-management controls over their life-cycle. Other responsibilities include performance measurement/analytics and compliance with GIPS, and assistance in marketing/client relations. He will also chair the DoubleLine risk management committee, which meets to review account performance and performance attribution, yield, duration and other risk metrics.

Prior to joining DoubleLine, Toole served 15 years at TCW until December 2009. At TCW, he was an md and served as head of the portfolio analytics group, chairman of the portfolio analytics committee and chairman of the market and product development committee. In addition, Toole was a portfolio manager of the TCW asset allocation funds and the TCW Alpha Series market-neutral strategy.

Jeffrey Gundlach, ceo of DoubleLine Capital, says: "Allan and I have worked with each other professionally for 15 years and I place implicit trust in his level judgment as well as his analytical acumen. His contributions will form a keystone to the fulfilment of DoubleLine's foremost objective: the delivery of superior risk-adjusted returns to our clients."

ABS

Monoline anticipates Euro ABS opportunities

Assured Guaranty indicates it is seeing signs of support in the European structured finance market for wrapped products and anticipates writing new business in certain ABS sectors - such as consumer, auto loan and trade receivables - in the near future.

According to Nick Proud, recently-promoted senior md, international, at the monoline (see SCI 167), as structured financings outside of the ECB repo facility increase, the firm expects to have opportunities to provide insurance to the market. "In 2009, our activities in structured finance were primarily limited to secondary market transactions where we could help investors with risk management as well as capital optimisation - we expect this activity to continue in 2010 and beyond," he says.

He adds: "We believe there is support in the market for financial guaranty products and would anticipate adding value to financings backed by granular assets, such as consumer assets, auto loans and trade receivables, as well as public infrastructure financings."

ABS

UniCredit tender 'oversubscribed'

UniCredit has released the results from its tender offer to repurchase notes from 26 tranches of 14 ABS deals (see SCI issue 169), which saw €2.1bn in original notional being accepted. According to ABS analysts at RBS, the tender for the A1 tranche of Capital Mortgage was oversubscribed, with €173.25m original notional being accepted and 65.8% allocations. All other tenders were accepted in full and prices varied between 78% (for Locat 2005-3 B) and 99.5% (for Geldilux 2007-B).

ABS

Decline in ABS new issuance underlined

Fixed income new issuance was valued at US$3.7trn for 2009, representing an 8.2% (US$280bn) rise on 2008 figures, according to Xtrakter. Asset-backed new issuance accounted for 12.6% (US$469bn) of this total, with the size of the international capital market rising by 14.8% (US$2trn) to a total of US$14.7trn during the same period.

In 2009 asset-backed new issuance declined by 46.9% (US$414bn) to US$469bn, with large decreases recorded in Q2 (-54.1%), Q3 (-39.9%) and Q4 (-60.3%) when compared with 2008 data.

Yannic Weber, Xtrakter ceo, comments: "In line with market expectations, 2009 saw a rise in sovereign new issuance; this demand was primarily driven by the need to support differing liquidity schemes and stimulate the financial markets. As related economies start to recover, it is likely such liquidity measures will dry up and we will see an increase in corporate new issuance."

The euro was the preferred currency in 2009, capturing 48.8% (US$1.8trn) of total fixed income new issuance. US dollar was selected for 37.9% (US$1.4trn) and Sterling was chosen for 6.6% (US$246bn).

The top-10 issuers in 2009 (excluding government domestic issues) were: Freddie Mac (US$143bn), Fannie Mae (US$105bn), KfW (US$100bn), Federal Home Loan Banks (US$98bn), European Investment Bank (US$94bn), Lloyds Banking Group (US$94bn), SFEF (US$89bn), Barclays Bank (US$68bn), Royal Bank of Scotland (US$63bn) and Rabobank Nederland (US$51bn).

ABS

Criteria for Greek SF transactions reviewed

Following Moody's downgrade of Greece's government bond rating, the rating agency is reviewing its criteria that enable Greek structured finance transactions to achieve triple-A ratings.

The ceiling for bond ratings in local currency in Greece is triple-A, along with the other members of the Eurozone. A key reason for the ceiling being set at triple-A is that being part of the monetary union removes the risk - generally one of the most perilous risks for creditors - of a devastating disruption to a national payment system. Moody's believes the risk of a disorderly exit of Greece from the Eurozone is negligible.

At the same time, as the public finance situation has markedly deteriorated and is bound to remain highly challenging in the country, Moody's downgraded the government bond rating to A2 from A1 last December and the gap between this rating and the ceiling has widened. As a result, triple-A ratings for structured finance securities appear high compared to the government's own A2 rating. The type of economic and financial stress that would be associated with government debt problems would somewhat weaken the credit fundamentals of even highly enhanced structured transactions.

Moody's is currently reviewing the potential implications of the changing situation in Greek public finances for structured finance and covered bond ratings. While the risk of a government default is very low, as reflected in its A2 bond rating, the resiliency of private sector ratings - especially those higher than the government - to the stress associated with government financial difficulties must be thoroughly assessed.

Until Moody's concludes its review, it will not issue any new triple-A ratings to Greek structured finance transactions or covered bonds. Upon completion of the review, existing and future ratings will be assessed using the new criteria.

CDO

CRE CDO asset re-hedged

A recently-proposed re-hedging of one of the euro-denominated portfolio assets of CRE CDO Glastonbury Finance 2007-1 will not in itself impact the ratings of the transaction's notes, according to Fitch. The related FX option of the CMBS asset expired earlier this month, with Glastonbury now expected to receive the settlement proceeds.

Fitch notes the FX option's expiry date approximately matched the expected maturity of the asset. The underlying loan of this asset is now not expected to repay on its expected maturity and may well extend through to its final legal maturity in February 2012. The manager thus proposed to use the expired FX option's settlement proceeds to enter into an FX option for the asset through to the asset's final legal maturity.

The expired FX option's settlement proceeds are expected to be sufficient to hedge only around 22% of the asset's current principal amount, which has amortised to 78.2% of its original balance. This is in contradiction to the transaction documents, which state that 25% of the principal amount at the time of acquisition should be hedged for euro-denominated portfolio assets. But, in Fitch's view, the increased risk to the transaction from the FX option not meeting 25% of the asset's original principal amount is not significant enough to impact the ratings of Glastonbury's notes.

Glastonbury Finance was launched in March 2007 by Eurohypo Asset Management. It was the first sterling-denominated CRE CDO and is backed by European CMBS - two thirds of which are UK deals and one third of which are European deals.

CDS

Sovereign concerns raise systemic risk floors

Sovereign risk rose over 12% this week led by the European majors, according to Credit Derivatives Research, reaching levels not seen since March/April 2009. The CDR Government Risk Index (GRI) traded back up to 90bp as of 4 February - its highest level since April 2009 - and is now over 130% above its August 2009 lows.

"The GRI (created based on the volume of outstanding debt and CDS liquidity) has underperformed the less-developed-countries (LDC) so far, but a vicious circle of voluntary austerity leading to lower growth, driving Europe weakness and a flight-to-safety bid in the US dollar, is raising systemic risk floors across financial and corporate spreads as we have seen the CDR Counterparty Risk Index (CRI) rise more than 33% in the last three weeks," says Tim Backshall, CDR's chief strategist.

Greece, for example, has seen its CDS curve invert with the short-end now trading above 650bp compared to five-year at around 405bp (implying investor expectations of an event much sooner than later). Greek government bonds (GGBs) trade uniquely among sovereigns for now, wide of CDS, offering a considerable negative basis package where protection can be bought along with the bonds and a relatively risk-free differential locked in.

"The uniqueness of this situation suggests that the selling pressure in GGBs is far more aggressive than in CDS and that real money investors are pulling away from peripheral European nations' debt, as opposed to the more speculative attack that some have suggested," comments Backshall.

Meanwhile, the outperformance of the LDCs over the major sovereigns is extremely notable, adds CDR. While LDCs from emerging markets and CEEMEA have seen some decompression, they have remained relatively stable through this last four months as investor angst has focused on the nations with the largest deficits, highest short-term refinancing needs and most prone to 'stimulate' their way out of this crisis.

"The EM nations, with lower average debt/GDP, have survived well, based (we believe) on their reliance on commodity performance," says Backshall. "Many of these nations are natural resource providers and - as such - a weak dollar, China stockpiling (the marginal bid on any and everything physical) and hope for a V-shaped recovery have driven commodity prices considerably higher [and] have enabled money to keep rolling in."

CDR also points out that dependence between LDC sovereign risk and commodity prices is unnervingly close. Given the weakness of the euro (due to the contagious pain being felt among the sovereigns) and a general sense of uncertainty, investors have fled back to the US dollar - whether by unwinding carry trades, which seems likely as Japanese Yen has weakened notably - or more simply a flight-to-quality that has also seen gold relatively outperform the dollar in this last rally.

CDS

'Valid reasons' for sovereign/corporate CDS inversion

Despite the counterintuitive price levels, Fitch Solutions believes that there are valid reasons for corporate CDS to be pricing at narrower spreads than sovereign CDS (SCI passim) and, conversely, for sovereign bond yields to be lower than corporate bond yields.

In its most recent report, Fitch Solutions uses the UK and Greece as two case study examples, illustrating that BP and Hellenic Telecom both trade at significantly narrower CDS spreads to the respective sovereign CDS of UK and Greece. However, when assessing bond yields, it highlights that there are valid reasons why the UK sovereign bond yield is lower than BP's bond yield - contradicting the CDS market - whereas the relationship between corporate and sovereign bond yields in Greece is in fact consistent with the CDS market.

In terms of UK CDS, by calculating the risk premium for the UK sovereign and BP, Fitch Solutions found that it is much higher for the UK than for BP (135bp versus 74bp respectively). This confirms that CDS investor perception of UK CDS as riskier than BP's is not attributable to economic fundamentals. But it also highlights valid reasons why the CDS market believes corporates might have lower risk premiums than for sovereigns; i.e., the risk premium for BP is more closely linked to the price of oil than to the health of the UK economy.

However, when doing a similar calculation for the bonds, the opposite result occurred (75bp for the UK versus 123bp for BP) - showing that bond market investor perception of the risk for the bonds on these entities is quite different from the risk premium perceived for the corresponding CDS. Evidence of the divergence between the CDS and bond risk premium can be explained by the current low level of government bond yields partially due to the effects of quantitative easing (QE), in conjunction with the need for investors to hold triple-A rated paper to be compliant with their investment mandates.

Moreover, the bulk of government bond investors are not major players in the CDS market, which remains a more specialised asset class. In essence, one way of looking at the CDS market is that it is characterised by a group of investors who believe that the current low level of UK government bond yields is not sustainable and will rise to attract new investors once QE finishes.

On a related point, Fitch Solutions notes that when UK government bond yields started to rise last October, the CDS market initially lagged behind due to the higher liquidity premium of the CDS compared to the underlying liquid government debt. This created a potential arbitrage opportunity, bringing active investors into the market, which in turn drove CDS spreads significantly wider due to the continued market uncertainty on both the prospects for the UK economy and government bond yields. Spreads are unlikely to narrow until this market uncertainty improves, the firm notes.

For the Greece case, Fitch Solutions found that the bond yields are consistent with the CDS spreads partly because, unlike for the UK, there has been no QE policy artificially lowering bond yields, nor any flight to quality that would also drive sovereign bond yields down, given that Greece is not triple-A rated.

The report notes that other factors also play a role in the way in which bond markets and CDS markets price assets - principally market liquidity. As an example, through its CDS liquidity scores Fitch Solutions estimates that the liquidity premium for the UK sovereign is 5bp, whereas for BP it is only 2bp. However, this only explains a small part of the differential in pricing between the CDS and bond markets (SCI passim).

Meanwhile, growing market concerns about both the sustainability of sovereign debt levels, particularly in Europe, and the interdependency of European banks and sovereigns has driven a surge in global CDS market liquidity over the past two weeks. Jonathan Di Giambattista, md of Fitch Solutions in New York, says: "The CDS market appears to have reached a consensus that the risk premium for some European financial institutions now needs to be priced higher. This has resulted in several big moves in CDS spreads and liquidity scores since the start of the year."

The biggest European banking movers, according to the monthly increase in Fitch Solution's global CDS percentile ranking, are (in descending order): BBVA, Intesa Sanpaolo, UBS, BNP Paribas, Banco Comercial Portugues, Credit Suisse, Commerzbank, Societe Generale, Banco Espirito Santo and Banco Santander.

Di Giambattista adds: "The fact that the CDS market is now scrutinising some better known European banking names is reflective of the degree to which the market considers government support when assessing a bank's risk of potential default."

More generally, North American CDS are now following the trend set in Europe two weeks previously, with Fitch Solution's North American CDS liquidity index also now more liquid than levels seen during the week of the Lehman Brothers failure.

CDS

Euro sovereign CDS-implied spreads analysed

Credit and equity markets are sending somewhat different signals on the outlook for credit risk, according to the first edition of Moody's Analytics European Risk Report.

David Munves of Moody's Analytics Capital Markets Research Group (CMRG) says: "Until last month's check following the spike in sovereign risk, spreads had tightened at a rapid rate, but the European EDF Index - which captures default risk signals from the equity market - has declined more slowly. It's quite possible that the credit markets got ahead of themselves. This isn't surprising, given the momentum behind the furious rally that started in March of last year. However, the more stable behaviour of the EDF Index signals that CDS high yield spreads are most likely to trend sideways in the coming months."

The average CDS spread on Portugal, Spain, Italy, Ireland and Greece has risen sharply since September. While the countries vary considerably, their average CDS-implied spread now stands at Ba1, meaning that it is in line with the median spread for issuers rated in that category. This is down from the Baa1 level in December.

Munves adds: "It's typical to see such rapid changes with names that are much in the headlines. Bond spreads are usually less volatile and the five countries' average bond-implied rating is much higher, at A2. This is closer to Moody's Aa2 average rating for the group."

The drop in the countries' average CDS-implied rating represents a significant underperformance of their spreads compared to those of other entities. Munves explains: "When comparing the Greece versus Germany yield differential, we note that this is the second time that the yield differential has peaked in the last year. The first was March 2009, during the post-Lehman crisis. However, unlike recent events, then the move was part of a general spread widening."

Moody's ratings analysts are well aware of the countries' trading levels, according to Pierre Cailleteau, head of the agency's sovereign ratings group: "For these countries, our view is that this is the story of a long-term erosion of creditworthiness, and that short-term liquidity problems are overly exaggerated."

Moody's Risk Report is published monthly by the CRMG, which analyses and interprets signals from the credit and equity markets using a variety of Moody's credit risk metrics.

CLOs

Mezz fund to have limited effect on German SME CLOs

Deutsche Bank's mezzanine capital fund will have a positive but limited impact on German SME CLOs, according to Moody's. Last week, Deutsche Bank announced it would provide €300m to seed a mezzanine capital fund that will make equity-like contributions to German SMEs in all industries except finance and real estate. The fund is intended to reduce refinancing risks among German SMEs and therefore mitigate one credit risk in German SME CLOs.

However, Moody's believes that the stressed economic environment will still lead to a high default rate in 2010, as the fund will only support companies with promising long-term prospects. In recent months, industry officials have expressed concerns about the impact the credit crunch is having on German SMEs.

In response, Deutsche Bank's fund will provide capital in the form of profit-sharing rights to medium-sized companies, with an annual turnover of up to €100m. Companies across all industries except finance and real estate can apply for capital contributions between €2 and €10m with a maturity of seven years.

However, SMEs may still have adequate access to bank lending. "We see this initiative as a positive measure to support German SMEs financing, but wonder if a high level of demand for these funds actually exists," says Armin Krapf, avp - analyst at Moody's.

Recent data published by the German Central Bank shows stable outstanding credit volumes and a bank survey on planned changes in lending requirements suggests an easing of the credit crunch. According to the survey, the German Central Bank believes that a lack of tightening of lending criteria in Q409 was a turning point in the credit cycle. Banks anticipate stable total credit volumes in 2010 and small increases in new loans driven by demand.

While the outlook has improved, volatility remains. "Our expectation for high SME loan defaults is based on the fallout and anticipated slow recovery from the credit crunch," notes Krapf.

Moody's view is reflected in a February 2010 survey by Ernst & Young, which - in a survey of 3,000 medium-sized German companies - suggests a positive trend in companies' self-assessment of their current and future financial situation compared with the previous year. However, around 10% of the companies expect to encounter serious financial difficulties unless a period of significant recovery is experienced shortly.

Only half of the surveyed companies see themselves in a strong position and immune against the negative impacts of the current crisis. Moody's therefore sees signs of stabilisation, but expects high default rates for German SMEs in 2010.

CMBS

New US CMBS rated

Ratings have been assigned to two classes of notes from GTP Global Tower Series 2010-1 - a US cell tower-backed CMBS arranged by Barclays Capital and Deutsche Bank. Fitch has assigned a single-A minus rating to the US$200m class C notes and a double-B minus rating to the US$50m class F notes.

The transaction is backed by mortgages representing no less than 80% of the annualised run rate net cashflow (NCF) and is guaranteed by the direct parent of the borrower. Those guarantees are secured by a pledge and first priority perfected security interest in 100% of the equity interest of the borrower, which owns or leases 1,351 wireless communication sites, and of its direct parent respectively. Both the direct and indirect parents of the borrower are special purpose entities.

According to Fitch, Global Tower Partners has outstanding debt of US$480m in the Global Tower Series 2007-1 transaction and after the closing of this transaction will have approximately US$35m outstanding under a new senior credit facility. The Series 2007-1 transaction is secured by 2,074 wireless sites and includes its own SPEs.

None of the securitised debt has cross-default provisions among the two CMBS transactions or any other corporate debt.

Citi and RBS are also understood to be preparing new CMBS transactions.

CMBS

GAO foresees CMBS risks

The US Government Accountability Office (GAO) has issued a report to Congressional committees highlighting that the Treasury needs to strengthen its decision-making process on the TALF programme. The report also notes that although TALF contains a number of risk management features that reduce the risk of loss to TARP funds, risks - particularly related to CMBS - remain.

According to the report, Treasury and Federal Reserve Bank of New York (FRBNY) analyses project minimal, if any, use of TARP funds for TALF-related losses, and the Treasury currently anticipates a profit. GAO says that the overall risks TALF poses to TARP funds are likely minimal, but its analyses show that CMBS potentially pose higher risk of loss than ABS. GAO has requested that the Treasury give increased attention to reviewing risks posed by CMBS, strengthen its TALF decision-making process and determine which data are needed to track the management and sale of assets that TALF borrowers might surrender.

"Ongoing uncertainty in the commercial real estate market and TALF exposure to legacy CMBS warrant ongoing monitoring," says GAO. "TALF may present risks beyond the potential risks to TARP, such as the risk that FRBNY might fail to identify material non-compliance with programme requirements by TALF participants."

To enable a more effective review of TARP, GAO asked Congress to grant it authority to audit Federal Reserve TALF operational and administrative activities. However, the Treasury, while appreciative of GAO's recommendations, said GAO understated the TALF's success and overstated the risk of CMBS.

GAO continues to believe that its depiction of TALF is accurate and its recommended actions are necessary to strengthen the oversight and operations of TALF.

CMBS

Failure-to-pays rising in Euro CMBS

Fitch says in a performance update that although the majority of CMBS loan defaults currently stem from missed interest payments or covenant breaches, it expects loans failing to repay at their scheduled maturity dates to account for an increasingly large proportion of defaulted loans.

The number of defaults in European CMBS continued to increase in the second half of 2009. Signs of recovery in prime commercial property values in many markets across the continent provided little benefit to the credit position of the majority of borrowers in European CMBS. Such loans are generally secured against lower quality properties, which have not yet seen value appreciation, while the borrowers continue to face tough occupational market conditions following the economic downturn.

"Over 7% of all Fitch-rated European CMBS loans were in some form of default at end-2009, with three-quarters of the defaults caused by missed payments or covenant breaches," says Mario Schmidt, associate director in Fitch's European CMBS team.

Fitch continues to believe that the largest credit risk facing European CMBS is that the underlying loans will not make their balloon repayments as scheduled. "While less than 10% of the loan defaults as at Q409 were due to the loans having failed to repay at their maturity dates, this is only because few loans matured in 2009," says Schmidt.

Of the 20 loans that were scheduled to mature in 2009 that had not previously prepaid, four repaid either at or shortly after maturity, eight have been extended and the rest remain outstanding and, therefore, in default. As the number of CMBS loans maturing in 2010 significantly increases on that maturing in 2009 and the trend for such loans failing to repay as scheduled appears set to continue, Fitch expects failed repayment to account for a higher share of defaulted loans in the coming months.

CMBS

Special servicer replaced on four CMBS

Citibank International has terminated its appointment as special servicer with respect to loans securitised in four EMEA CMBS transactions. The servicing agreements for the affected loans and transactions have been novated to the new special servicers, Capita Asset Services (UK) and Deutsche Bank.

Capita replaces Citibank on Victoria Funding (EMC V) and for all the loans except for the Sunrise II Loan in EuroProp (EMC VI), with Deutsche Bank the new special servicer on the Sunrise II Loan. Deutsche Bank also replaces Citibank as special servicer on the Treveria Loans I and II in DECO 9 Pan Europe 3 and DECO 9 Pan Europe 4 respectively.

According to Moody's, these terminations took place according to the 'termination on notice' clauses in the respective servicing agreements but with the three months' notice period being waived by all the relevant parties. The rating agency understands that there will be no changes to the terms of the servicing agreements for the affected loans and that the special servicing fee will remain unchanged. Based on the latest available information, none of the loans for which the special servicer has changed are in special servicing.

In Moody's opinion, based on the capability of Capita and Deutsche Bank to perform the role as a special servicer, the replacements will not negatively impact the current ratings of the notes in the four transactions.

CMBS

Performance pressure continues for EMEA CMBS

Moody's reports that continued adverse performance and the expectation of further deterioration in the performance of the CRE loans backing CMBS drove further negative rating actions in Q409.

In its latest report for EMEA CMBS, the rating agency notes that market sentiment for the CRE markets improved during H209 as some recovery in property values, occupational markets and CRE lending and investment markets was evidenced. However, this was limited to certain sub-markets and with a positive impact almost exclusively for prime properties.

Viola Karoly, a Moody's analyst and co-author of the report, says: "The broader CRE property, occupational, investment and lending markets remain under pressure, which resulted in continued performance deterioration for EMEA CMBS loans and transactions in the past quarter."

Thomas Babin, a Moody's associate analyst and co-author of the report, adds: "Given the negative outlook for EMEA CRE markets and 2010 and beyond refinancing exposures within EMEA CMBS, Moody's expects this performance deterioration to continue over the coming quarters."

By the end of Q409, Moody's had completed its broad-based review of EMEA CMBS transactions, taking into account its adjusted central scenarios. The rating agency believes that ratings will remain under pressure going forward and the negative ratings drift is expected to continue throughout 2010, albeit mainly driven by loan- and transaction-specific factors.

The report provides an analysis of Moody's rating actions in the CMBS sector since October 2008. Between October 2008 and December 2009, it took current and expected performance-related rating action on 108 transactions.

Of the 340 Moody's-rated tranches in these transactions, three tranches were upgraded, 121 (36%) tranches were confirmed or affirmed and the remaining 216 (63%) tranches were downgraded. 2006 and 2007 vintage transactions have been affected by downgrades to a greater extent than earlier vintages.

The largest average notch downgrade has been for the 2007 vintage transactions, which closed near or at the peak of the market. The 2007 vintage transactions are also the largest contributors to loans in default and in special servicing in the large multi-borrower transaction category.

Manuel Rollmann, a Moody's associate analyst and co-author of the report, says: "In Moody's view, due to the significant realised value declines and the expectation that values will not significantly recover in the short- to medium-term, principal losses on defaulted loans and ultimately on EMEA CMBS seem inevitable."

The agency expects first losses to be allocated to some transactions over the course of the next few quarters, starting in most cases with the write-down of junior notes. These losses will relate to troubled loans, for which the servicer and/or other relevant parties have seen limited scope for property management and pursued a sale of the mortgaged properties.

LCDS

Lafarge credit event determined

Markit iTraxx LevX index market-makers have voted to run a restructuring credit event auction to facilitate settlement of LCDS trades referencing a credit agreement entered into by Lafarge Roofing/Monier, a constituent of the LevX Senior Series 2 index. The credit agreement is a €2.07bn senior secured credit facility. Auction terms, including the auction date, will be published by ISDA in due course.

Meanwhile, the proposed settlement auction for CDS referencing Aiful has been postponed for a month until 18 March. An auction for Cemex is scheduled to take place on 18 February instead.

Ratings

Transparency for valuation assumptions

S&P's Fixed Income Risk Management Services (FIRMS) has launched a transparency initiative through its valuation & risk strategies group, which involves releasing the assumptions used in the creation of prices on a wide range of structured finance securities. When appropriate, these assumptions can include the default probability, loss severity and prepayment speed used in the calculation process.

This increased level of transparency will give investors, risk managers and accounting personnel an added perspective on the element components of portfolio valuation, the firm says. In today's marketplace, this additional perspective is essential to helping market participants maintain a balance between mark-to-market pricing and other market pressures that impact the valuation process.

"One of the most critical issues confronting fixed income investors in the current market is price defensibility; any evaluation of an asset's price must be able to stand up to rigorous analysis by risk managers, compliance officers and boards of directors," explains Frank Ciccotto, svp, S&P's valuation & risk strategies. "Openly publishing the assumptions that go into our independent pricing analysis makes it possible for market participants to engage much more deeply in the evaluation process by understanding not just the market-derived opinion of price, but also the significant individual variables that help to form that opinion of price."

Initially disseminated to valuation & risk strategies customers through a data feed, the valuation assumption data will soon be incorporated into a web-based solution that allows users access to current and historical data through a search engine or one-by-one lookup. The web portal launch is slated for the first quarter of 2010.

Ratings

EMEA auto lease residual values re-evaluated

Moody's is set to re-evaluate the assumptions it uses to rate auto lease ABS transactions exposed to residual value (RV) risk in EMEA.

RV risk is the risk that a vehicle's realised market value at the end of its lease term differs from its book value. This difference could arise from adverse movements in used car prices or the RV policy pursued by the originator. RV losses on a transaction are a function of the number of lessees exercising their option at the contract maturity date to return the vehicle (the turn-in rate) and the severity of loss on the contractual residual value (the loss on turn-in).

Moody's re-evaluation has been driven by the volatility in the used car markets across Europe over the past two years. In several sectors, declines of up to 30% in value were observed over 2008 and - although values have since recovered - the observed volatility significantly exceeds expectations.

To date, when rating such transactions in EMEA, the agency has primarily relied on the historical performance data provided by originators. However, this data is influenced by changes in RV policies and/or does not adequately capture sudden shifts in the used car market.

In forming its revised assessment, Moody's will place more emphasis on the current market values of vehicles in the securitised pool, as well as taking into account third-party forecasts of residual values. Until recently, this data was unavailable to the agency in Europe. To enhance its analysis, Moody's has acquired a large data set of historic and current market values in the UK, and is in the process of acquiring similar data sets for key European jurisdictions as well as contract level data received by originators.

Preliminary analysis of the data set implies that haircuts of approximately 50% would be appropriate on reforecast residual values at the triple-A level. Given the RV setting strategy of many originators (who typically set RV levels at 5% to 10% below the break-even value), a 50% haircut on reforecast RV would translate into a loss assumption of 45% to 40% on the residual value of the securitised portfolio in a triple-A scenario, the agency says. The haircuts would be lower for lower rating levels.

Moody's is concluding its analysis of the data set, including determining appropriate haircuts at each rating level. Its next steps will be to assess the rating impact on all EMEA auto ABS transactions exposed to RV risk and it will provide an update of the findings of this analysis over the coming weeks.

Ratings

Deterioration in Japanese SF to slow

Negative rating actions in 2010 are expected to slow in the Japanese CMBS sector, according to Fitch. The agency points out that this sector comprised more than 80% of all downgrades in 2009.

Fitch notes that underlying asset performance needs more time to improve, given the weak pace of domestic economic recovery, although its sovereign analysts predict GDP growth for 2010 calendar year at 1% (versus a forecast of -5.4% for 2009). However, the expected rating performance of Japanese securitisation products in 2010 continues to be a mix of stable and negative.

The agency explains that CMBS was directly affected by the deterioration in overall real estate market conditions, which resulted in significant downgrades in 2009. Although the outlook for underlying asset performance continues to be negative in 2010, Fitch expects the pace of negative rating actions to slow, as valuations of underlying collateral property have already been adjusted downwards to reflect current and future expectations in market conditions. A stable rating performance, due to structural protection, is expected for the most senior classes.

The magnitude of negative rating actions on CDOs in 2009 was less significant than in 2008. Asset and rating performance in 2010 of global synthetic CDOs rated in Japan are expected to remain negative, however, as their reference portfolios incorporate multiple corporate entities rated triple-C or below.

Stable rating performances in ABS and RMBS are expected to continue in 2010, despite a likely deterioration of underlying asset performance in some cases, as they are expected to be mitigated by their transaction structures. Exceptions to this are Kikin ABS transactions, which were downgraded in 2009, following a review of the Japanese life insurance sector. They were also affected in early 2010 following an implementation of Fitch's revised rating criteria for hybrid securities.

RMBS

Co-op on the road

The Co-operative Bank is in the market with its first RMBS deal, the £2.9bn Silk Road Finance No 1, via HSBC and JPMorgan. The transaction will be rated by Fitch and Moody's.

Collateral comprises prime loans backed by owner-occupied residences originated under the Britannia brand name or by the former Britannia Building Society. The pool has a current LTV of 64% and seasoning of 29 months.

£1bn of the notes is expected to be retained, of which at least £750m will be repoed through JPMorgan, while a further £1bn has been subscribed to by JPMorgan. The remainder of the 3.9-year triple-A rated class A1 notes - anticipated to be around £500m - will be offered to third-party investors. All other tranches are likely to be retained.

According to Moody's, the notes include two unique features. First, if the class A1 notes are not redeemed in full on the expected maturity date (March 2015), noteholders have the option to have their notes redeemed by Silk Road in an amount equal to the then principal outstanding balance of the notes plus accrued interest, minus amounts recorded on the class A principal deficiency ledger (PDL). They will be redeemed from the proceeds of the Co-operative Bank subscribing to class D variable funding notes, which will then effectively replace the redeemed class A1 notes in the structure. The likelihood of this redemption occurring and the ability of the bank to fulfill it have not been assessed as part of the assigned ratings, Moody's says.

Second, although the transaction benefits from a basis risk swap, unlike those seen in most prime UK RMBS transactions it does not contain any replacement or collateral posting requirements following downgrade for the counterparty and thus does not comply with Moody's de-linkage hedge criteria. As a result, the rating agency has effectively ignored the basis risk swap in its analysis, treating the relevant loans as unhedged.

18% credit enhancement for the class A1 notes is provided by unrated subordinated class B1 notes of 14% and a fully funded non-amortising reserve fund of 4% of the initial mortgage pool balance.

European securitisation analysts at Deutsche Bank note that the substantial triple-A credit enhancement is well above that seen in typical prime UK RMBS. They add that a successful syndication of the publicly-offered portion of notes could signal the opening of the primary market to new/less vanilla issuers and programmes.

RMBS

Second liens complicate negative equity

RMBS analysts at JPMorgan have underscored the increasing investor concern over negative equity in the US housing market (see also Talking Point). They note that in 2009 rising current combined LTVs were a larger contributor to poor credit performance than unemployment in the prime sector.

For example, on loans with 100%-110% CLTV current to 30-day rolls were 0.2% higher in high unemployment areas over low unemployment areas. But loans that were 30% CLTV higher had a 0.4%-0.9% current to 30-day roll. Other sectors, like Option ARMs and subprime, showed an even weaker relationship with unemployment.

Consequently, some investors are calling for a shift in priority of the HAMP modification programme, whereby investors are first offered principal reductions before rate reduction and term extension. But, while it is clear that lowering a borrower's LTV reduces their likelihood of default, complexities around second liens will need to be addressed, according to the JPMorgan analysts.

HAMP suggests that the second lien be modified proportionally with the first. However, the additional hurdle of modifying the second lien continues to be a significant challenge for servicers: second-lien holders have a separate claim on the property, so getting the first- and second-lien holders to agree on modification terms is extremely difficult. Moreover, there is no infrastructure in place to match second liens to first liens modified under HAMP.

RMBS

Graphite transactions impacted

Fitch has downgraded three subordinated tranches and affirmed 11 tranches from the Graphite 2005-2 and 2006-1 deals. These transactions are synthetic RMBS transactions referencing loans originated by Northern Rock.

The downgrades in the Graphite 2006-1 transaction were a consequence of continued deterioration in the collateral portfolio underlying the issued notes, especially following the removal of £465m of loans from the portfolio in the December 2009 quarterly reporting period (see last issue). Fitch explains that although the removal of loans has resulted in the accelerated amortisation of the notes, it did not outweigh the adverse selection that has occurred within the collateral portfolio, particularly for the junior notes.

The weighted average loan-to-value of the pool has increased to 82% in the December 2009 IPD from 76% in the September 2009 IPD. In particular, there has been an increase in borrowers with a 'Together' mortgage product to 24.81% from 18.48%. A similar deteriorating trend was also seen on the buy-to-let (BTL) loans: an increase to 37.35% in the December 2009 IPD from 30.79% in the September 2009 IPD.

Fitch considers these loan types to carry a higher default risk and therefore the expected loss of the transaction has increased and has been the key driver in the rating actions taken. The adverse selection experienced within this pool has caused loans in arrears for more than three months to increase to 6.43% in the December 2009 IPD from 5.07% in the September 2009 IPD. Three-month plus arrears have increased by over 260bp from a year ago.

Both affected transactions feature a threshold amount as the first-loss piece. Due to the synthetic nature of these transactions, the outstanding threshold amount is not replenished with excess spread.

Currently, Graphite 2005-2 has depleted 41% of its allocated threshold amount and Graphite 2006-1 has utilised 62% of its initial amount. Fitch expects losses realised from the sale of repossessed properties to deplete both threshold amounts and start being allocated to the most junior notes within these transactions in the near future.

The depletion of the threshold amount and allocation of loss to the junior notes will weaken the credit support for the rated notes, Fitch notes. Although the portfolio will have reduced in size the current performance is not in line with the initial expectations and therefore the ratings on Graphite 2006-1 have been downgraded and the outlook on the most junior rated tranche of Graphite 2005-2 has been revised to negative.

RMBS

Downgraded Russian RMBS upgraded again

The recently redenominated class A notes of Russian RMBS Gazprombank Mortgage Funding 2007-1 have been upgraded to Ba1 by Moody's, having been downgraded to Caa2 by the rating agency less than a week earlier.

Last month, noteholders from the deal voted in favour of converting the class A1 notes from euros to roubles at an exchange rate of €1 to Rbs34.7. Lehman Brothers Holding Inc (LBHI) was the guarantor for both the swap provider and the liquidity facility provider in the transaction when issued in June 2007, meaning the deal was fully exposed to foreign exchange and interest rate risk (see SCI issue 169). The class A1 notes were downgraded, given that they would crystallise a principal loss of approximately 14% due to the local currency depreciation from closing.

Moody's says its initial downgrade to Caa2 reflected the principal loss compared to the initial rating promise of the class A1. However, the most recent rating action (on 9 February) brings the rating of class A1 to the appropriate level, given the new rating promise following the distressed exchange, explains the rating agency.

Under the new promise, the notional of the notes has changed from euros to rouble and is now Rbs3.12bn, compared to €89.8m (equivalent to Rbs3.8bn before the restructuring). "The revised rating reflects the fact that the principal and interest is being paid pro rata for classes A1 and A2 and considers the new reduced rating promise under the A1 class," says Moody's.

Technology

VaR module launched

Pricing Partners has released a new module providing VaR and stress-test calculations.

Delivered online, Price-it VaR is a generic risk solution that leverages the Price-it financial library and independent valuation service. It covers all major derivatives asset classes, from vanilla to the most exotic products, and is highly customisable, Pricing Partners says.

Price-it VaR includes portfolio capture, security description, pricing engine, VaR and scenario engine reporting.

CDS

CLNs: flexible and with higher yield than cash

Michael Hampden-Turner, structured credit strategist at Citi, discusses the customisation options available via CLN structures

The flexibility of CLNs can make their yield more attractive than bonds on the same name. Most of these advantages come from the increased scope for customisation.

Currency, coupon type, maturity and recovery can be tailored to any degree, regardless of the debt trading in the market. This means that investors can create bonds for names where few bonds trade or in a currency into which it has never issued.

Figure 1 illustrates why taking this route can actually be more attractive than buying the cash bond in yield terms. Investors willing to take some risk on the collateral underlying the SPV can boost their returns.

Additionally, they can take advantage of any positive basis on the CDS relative to bonds or even cross currency. The ability to customise the recovery exposure of the CDS also enables CLNs to apply moderate amounts of leverage. Let's go through some of these in more detail.

Uplift from a positive CDS basis
The term 'basis' is very over-used in finance: in this context it refers to the difference in credit spread between bonds and CDS. By convention, the basis is described as the CDS spread minus the bond spread.

A positive basis implies that the CDS is trading wider than its cash bond. Therefore, it is more attractive to take risk synthetically as yield is better than it is in cash.

There are all sorts of drivers of the basis, but by far the most important are market 'technicals'; i.e. a mismatch of supply and demand or liquidity.

Historically, the CDS/bond basis has always been relatively tight because of the 'no-arbitrage' relationship between bonds and CDS. For example, if the CDS trades too tight, an investor can buy the bond and buy protection on the bond until this relationship reverts

There are all sorts of drivers of the basis, most of which have to do with the 'technicals' of the corporate bond market. In general, while spreads are tighter than they were in the height of the credit crisis, there are still some interesting opportunities.

CDS can be more attractive than bonds if a positive basis exists and this can be magnified in the case of cross-currency exposure. For example, a dollar CDS on a European name with euro deliverables can carry a positive basis.

This is a CDS versus CDS basis; the dollar CDS is wider than the euro CDS. The following two examples benefit from both types of basis (see Figures 2 and 3).

Recovery premium
On default, a bond will have a recovery value based on its post-default price. CDS mirror this recovery value.

After the default trigger event, the CDS will settle on a final price achieved in a specially arranged market-wide auction of the defaulted debt. Investors will receive the cash equivalent of the recovery rate determined in the auction.

However, it is also possible to trade CDS with fixed recovery; i.e. where the final payout is fixed on the trade date. CDS with fixed recovery can also be thought of as vanilla CDS with a recovery swap.

The fixed recovery CDS can be set at zero, which means investors waive their rights to any recovery in the event of default. The downside risk on a zero recovery CDS is higher than a vanilla CDS.

Investors are taking on a moderate amount of leverage, which improves the spread they receive. We have termed this additional spread the 'recovery premium' and it reflects the additional leverage an investor has taken on by investing in a CLN with 0% recovery.

This recovery premium is proportional to the additional risk an investor has taken. For example, if recovery for a given asset is assumed to be 40%, then an investor's loss will be 100/60 more for a fixed 0% recovery note (see Figure 4). Simplistically, this is the equivalent of taking on US$16.6m of CDS exposure on a US$10m note.

The CDS premium can be scaled in the same way, giving us 166bp rather than 100bp. However, liquidity is not perfect in the fixed CDS/recovery swap market.

Typically, this cannot always be hedged efficiently (or at all) with all names, with the result that the full benefit of the recovery premium cannot be passed on by the arranger. There is no particular logic to fixed recovery CDS (or recovery swap) liquidity, other than it is typically CDS with high spreads that trade in this way. In our examples we have conservatively assumed that the fixed recovery CDS does not trade and, as a result, we haircut the recovery premium by 50%.

Bespoke bonds, regardless of underlying
Some corporate issuers have a very active CDS market, but a cash bond market that is inaccessible or not denominated in a convenient currency. CLNs can be used to create a synthetic bond of any maturity and almost any currency.

Taking credit exposure in CLNs rather than bonds is typically used in emerging markets, where bonds can be inaccessible, but is often used within G8 countries too. Inaccessible bond issuers are more common that one might think.

For example, Dixons (DSG International) is an actively traded constituent of the iTraxx Crossover index (Figure 5). However, it only has one sterling bond - DSG 6.125% 15/11/2012 - that is highly illiquid. Investors wanting a, say, seven-year euro exposure to this issuer could get it using CLNs.

Sanofi-Aventis (Figure 6) is another example; there are not many bonds that trade and the CDS basis is highly attractive. CDS offer an attractive pick-up relative to the euro-denominated May 2016s and October 2019s. A Sanofi-Aventis CLN might offer a considerably better yield than the equivalent bonds, with a much greater flexibility of maturity.

Boost yield using financial FRNs as SPV collateral
A special purpose vehicle (SPV) is a counterparty default-remote entity designed specifically for issuing bonds. The vehicle is administered independently and has noliabilities other than those pertaining to the bond(s) it issues.

The SPV needs to generate a stream of cashflows. This is typically achieved using the proceeds from the purchase. In its most simple form, the cash can be put on deposit and rolled over until maturity.

More interestingly, they can be used to purchase FRNs of a similar maturity to the note. These cashflows can then be aligned with a swap between the SPV and the arranging bank and the CLN's proposed coupons. This alignment swap can also be into fixed interest flows, as in our example below (Figure 7).

The SPV then assumes the credit risk of the CDS reference entity and, in return, the arranging bank pays premiums to the SPV for taking that credit risk. These CDS coupons are paid with the same frequency as the interest rate swapped collateral and combine to form the coupon of the CLN.

In our example above, 500bp from the CDS combines with 270bp from the five-year fixed swap and150bp from the collateral to create a CLN fixed coupon of 9.2%. 150bp of the coupon in our example has come from the financial FRN collateral.

While the collateral performance over the life is irrelevant, the note is clearly at risk from this collateral defaulting. Investors uncomfortable with this should consider low risk collateral.

In the event of default of the CDS entity, the proceeds from the maturity of the collateral are split between the investor and the arranging bank. The investor receives a payment equivalent to the recovery rate achieved on the CDS reference asset, while the arranging bank receives the contractual loss amount on the CDS. In the case of a zero recovery rate CLN, the investor receives nothing.

A CDS pays out shortly after the final price is determined in the defaulted debt auction. In the case of the CLN, any recovery due is not paid out until the maturity of the note when the SPV collateral matures.

Additional costs
There are series of costs associated with setting up an SPV that we have not included in any of the examples in this note. Setting up an SPV incurs administration, custodial, listing and legal costs.

Some are fixed and others scale with the size of the deal. These are only typically prohibitive for very small deal sizes and/or tight final yields.

© 2010 Citigroup Global Markets. All rights reserved. This Research Note, entitled 'Credit-linked notes: flexible and with higher yield than cash', was first published by Citi on 29 January 2010.