Contents

Secondary markets

Slow but sure

European secondary CLO market activity in the week to 16 February

Although news surrounding the Greece bail-out continues to slow the European secondary CLO market, there continues to be some aggressive activity. At the same time, more signs of recovery are beginning to emerge for the primary market.

As one CLO trader explains: "It's been quite slow on the European side. I think a number of the people who have been participating in the market on a frequent basis have been taking a step back and seeing how the sovereign stories pan out."

Conversely, the primary market is beginning to increase in activity. One CLO dealer says the market has been "much more active in terms of new business potentially going into the CLOs, which is the first time for a year or so that we're actually looking at primary business. But, at the same time, it's just as well because the secondary market has increased in price to the extent that there's nothing much left to buy on the secondary side. So this has probably come through just in time."

Dealer aggression continues to drive prices higher and has decreased the amount of available paper, while client activity dwindles (SCI passim). "Intuitively things should be weaker because we are seeing less participation from customers, but having said that the bid lists are still trading well," the trader confirms.

He believes that the willingness to pay at rich levels is due to dealers positioning themselves. Specifically, he adds: "I've heard Morgan Stanley is pretty aggressive right now. But maybe they have a trade idea, or maybe they're sourcing to build a portfolio; who knows."

However, the dealer is quick to add: "Even though the prices have gone up, we're only performing closer to par than we ever have been before."

While aggressive dealer positioning does occur from time to time, the trader notes that: "It's slightly strange this time because it coincided with news from Greece, Portugal and Spain. So you've got the rest of the market feeling a little bit nervous from a sovereign point of view [see also separate News Analysis], but then these guys are obviously stepping up and paying reasonable levels for CLO products."

In particular, triple-C paper has seen increased demand over the past week. The dealer reports: "We've had some really interesting bids in for some of our poorly performing names - the triple-C names, for example, where bidding in the 80s is not unusual. That's eased off over the last few days, but the general tone of things has been very positive."

He goes on to explain: "There are a number of distressed debt investors who are trying to put their money to work and I think they're a bit worried that they might lose their opportunity if they don't jump in now. That is both in terms of more people chasing the same names, but also they've widened their sphere. People are looking to buy for the first time in a long time."

For example, Ineos - a triple-C rated loan - is currently trading close to the mid-90s for senior debt and very close to 90 on the second lien. This is a significant improvement from the low period of February/March 2009, when the Ineos senior debt was at 35 and the second lien was trading at 10. However, since peaking last week, both have lost between three and 10 points on the back of the continuing speculation regarding Greece.

Moving forward, the dealer suggests that although there is still no appetite for investors to invest more on the liability side, sentiment is improving. "Everyone I've spoken to on the CLO management front is seeing a gradual improvement and reduction in current defaults. We've also seen a couple of names upgraded from triple-C, which helps the results a bit."

"I would imagine everyone is showing improved results in terms of their CLO compliance, and hopefully that trend will continue," he concludes.

JA

CMBS

Unprecedented action

Stuy Town DCH issue sparks concern

Losses on the Stuy Town loan (see SCI issue 169) look set to wipe out junior noteholders in related CMBS transactions, likely forcing a new directing certificate holder (DCH) to be elected from the remaining senior noteholders. Unprecedented in CMBS-land, the possibility has sparked concern that any new DCH may not be well-suited to approving special servicer actions.

The DCH in a CMBS transaction is responsible for approving special servicer recommendations and in nearly all deals is also the special servicer. The B-piece buyer has historically become the DCH in the event of default, providing their certificate balance has not been reduced by losses.

The possibility that holders of investment grade CMBS notes might become the DCH was consequently never considered. However, the magnitude of the Stuy Town loss is so great that this now appears to be becoming a reality.

Kevin Riordan, ceo and president of CreXus Investment Corp, estimates that the loss on Stuy Town will be US$1.5bn (the firm doesn't have any investments that include the Stuy Town mortgage). This figure is based on a net operating income of US$120m, capped at 7%, reduced by the median liability associated with the J51 ruling.

"When large pro-forma loans - such as the Stuy Town loan - go bad, they go bad in a large way because they're underwritten on future rents; in other words, very optimistically," Riordan says. "But, in this case, the magnitude of the losses and when they'll occur remain uncertain. Large realised losses will determine new directing certificate holders pursuant to the respective CMBS documents."

The losses are expected to reach up into the investment grade notes, which are widely distributed across institutional investors. A mechanism determines which noteholder will become the new DCH in the event that the initial DCH's holdings are wiped out, but the minimum outstanding certificate balance of the new most subordinate class must also be equal to 25% of the original face amount.

In terms of timing of the loss, the cleanest result would be if Stuy Town changes hands because then there would be a new valuation, followed by a recognition of the loss and a triggering of the DCH mechanics.

Riordan suggests that the process of deciding who will be the new DCH for the Stuy Town loan will ultimately be done in reverse: with a holder proving to the trustee that it owns the notes and the trustee then gathering the noteholders together to elect the DCH. "Such a situation is unprecedented, so it's difficult to guess what might happen. But I assume that noteholders will be able to vote for the DCH that they believe will do the best job. My concern is whether the new DCH will have the wherewithal to perform well, given that it is a specialist role," he remarks.

At question is whether an institutional investor possesses the property-specific knowledge to deal with commercial property workouts, their ability to quickly respond to the special servicer's recommendations and if those recommendations are subject to the DCH's own internal investment committee oversight. Another issue is liability in terms of decision-making.

Manus Clancy, senior md at Trepp, indicates that it's not unreasonable for a senior noteholder to consider taking the role on if they had a large enough position in the transaction. However, he adds: "The noteholders are in completely unchartered waters. They'll probably farm the special servicing duties out rather than have one noteholder take on the role, but they still have to work out how to achieve this. Will they vote on it and, if so, under which circumstances?"

Many special servicers would assume the duties for the right fee, according to Clancy. "But where is the line between ensuring a democratic approach and someone actually assuming the special servicing role? The industry still needs to figure out how to achieve this," he remarks.

Although a different situation, Clancy points to the Extended Stay case as one example of legal manoeuvrings among CMBS noteholders to determine who will drive the deal forward (SCI passim). However, the resulting indemnity clause was seen to be quite controversial in terms of tilting the control of the transaction in that party's favour.

As more commercial real estate loans become distressed in the coming months, the workout process could throw up many more such challenges.

The Stuy Town loan represents up to 20% of the collateral backing related CMBS deals. Clancy indicates that any 2006 or 2007 vintage loan, which was underwritten to pro-forma standards and represents 15%-20% of a transaction's collateral, could experience similar special servicing issues as the Stuy Town case.

"There were about 1500 loans underwritten, where the loans were not generating enough cash to service the debt on day one," he concludes.

CS

Secondary markets

Volatility strikes

ABS mezz stays firm amid secondary widening

European mezzanine ABS spreads held up over the last week, amid a general widening led by concerns over Greece. Indeed, weaker than expected economic growth is anticipated to support the rally in that part of the capital structure going forward.

"Even though spreads in general are widening, the mezz is holding up pretty well because it was already at such wide levels," confirms a European ABS trader.

One portfolio manager believes that interest in mezzanine paper has primarily been from dealers. "We've seen a lot of dealers taking down paper at what I think are potentially rich levels," he says. "The proof will be in the next few months to see whether they were paying too much. Maybe in the next few weeks end accounts will catch up, but at the moment it feels like a lot of paper is going to dealers - they're the main buyers."

The secondary ABS market showed some weakness last week on the Greek bail-out. Ultimately spreads were unchanged on the week, but mid-week cash prices were said to be down one or two points, while spreads were around 50bp wider.

European securitisation analysts at Deutsche Bank note that although vanilla ABS spreads are expected to end the year tighter than where they began, the market will be subject to occasional bouts of volatility throughout the year. The driver of these more frequent volatility phases will stem from both ABS-specific and non-specific sources, they suggest.

"The onset of a more actively traded legacy market to include dealers and prop desks will likely sustain the former, while recent sovereign-related risks are just one (albeit sizeable) example of the latter," note the analysts. "For now at least mezzanine markets appear less sensitive to 'big picture' headline risk than the senior space, yet we remain mindful of a revision of recent pricing assumptions (lower prepayment, higher default and severity curves) leading to a correction in the observable rally year-to-date."

However, weaker than expected economic growth may minimise any disruption to the current rally among mezzanine ABS. Deutsche Bank economists last week revised downwards their forecast for base-rate rises from both the BoE and the ECB. In the UK rates are forecast to rise just 0.75% by the end of this year (previously 1.5%) and to 2.5% by the end of 2011, while in the Eurozone some 0.5% of rate hikes are expected by year-end (previously 1%).

"While of course any prolonging of a low interest rate environment would likely signal a stalled recovery with obvious collateral deterioration implications for ABS pools, in our opinion this is likely to be offset by a more benign affordability environment for borrowers," the analysts note. "Mezzanine pricing therefore should continue to reflect longer IO durations, with a delayed recovery in prepayments impacting seniors."

Meanwhile, another potential reason for the market's quietness last week is the lessening of dealer aggression. The trader explains: "It seems like the dealers got ahead of themselves and were bidding very high on the bid lists. Now I think they've realised that too and are taking a step back, which has made it a bit quieter. But on the back of that we've also seen investors coming in and being more active in ABS in general."

For example, a mid-week BWIC consisting of senior, double-A, UK non-conforming and some CMBS notes got the market's attention. "It traded pretty well, given some of the names on there and that they were quite small scraps. But they traded at pretty good levels," the portfolio manager confirms.

The recent extension of the Opera Uni deal was also of interest, as it could provide clues as to the future for other CMBS deals and help to alleviate investor concerns moving forward. As the trader explains: "A big concern in the CMBS market is what's going to happen to the loans that come up for maturity. It won't be possible to refinance a lot of those loans, which will lead to many EODs, but then the market could take different paths."

He points to forced liquidations, extensions or the development of business plans in order to try to sell the underlying assets as likely possibilities. "There are different options. People are trying to work out what the likely scenarios will be," the trader says.

In addition, RMBS is expected to continue to perform well, with Silk Road - the new deal from the Co-op Bank - being placed (see last issue). Broader market weakness - coupled with unease about the exposure to Co-op as basis swap provider - saw the publicly placed portion of the transaction downsized from £500m to £375m, with the triple-A notes pricing at 140bp over three-month Libor. The originator retained £1.125bn of the senior tranche, of which £750m will be repoed via JPMorgan. JPMorgan also bought £1bn of notes.

The portfolio manager nonetheless concludes: "All the RMBS deals so far, aside from the most recent Permament transaction, have traded well in the grey and on the break. I think this one will probably trade well."

JA & AC

Insurance-linked securities

ILS "poised for strong rebound"

S&P has just published extracts of a roundtable discussion on the insurance-linked securities (ILS) market it recently hosted. Based on the discussions held S&P suggests that though dislocated along with most other structured markets during the downturn the overall ILS market - including life and property and casualty insurance securitisation - seems poised for a relatively strong rebound. "The recovery is expected to include transactions with greater transparency, liquidity, and more streamlined and straightforward structures backed with high-quality collateral that can perform in stressful environments," S&P adds.

In terms of the short and long term trends in the insurance market and how they will impact the ILS market, the roundtable participants were broadly in agreement. Michael Halsband, vp at Goldman Sachs said: "I think that life insurance securitisation will absolutely be on the ascendancy in the coming year. Investors will differentiate themselves by participating in these transactions, independently doing credit work on these transactions, now that one can no longer rely on the additional level of independent review heretofore provided in wrapped transactions. In order for that market really to grow though, investors will have to get comfortable with non-recourse transactions."

Kenneth Pierce, partner at Mayer Brown, concurred: As far as trends on the horizon and then long term, life insurance is poised for tremendous growth. There are probably two drivers. The first is that life insurance companies were heavy investors in residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS) and other assets that have experienced losses--in some cases, realised losses, in some cases unrealised losses. The life insurance industry is replenishing its capital, and I think it's turning and will continue to turn to alternative sources of capital like the capital markets and techniques that have been developed on the catastrophe side and the P&C side, like sidecars, could very well be themes on the life side. The second driver is there is a massive global wall of demand for longevity protection.

On the P&C front Halsband observed: "Property catastrophe ILS will continue to grow. No doubt about it. I think the market has shown a great deal of resilience and success compared to other classes. I envision a stable market in the short term. I envision in the intermediate to long term a strongly disciplined market. I think indemnity triggered transactions will continue to play a role in the space because, quite frankly, it is an element that a number of sponsors are very much interested in and perhaps the only way they get comfortable with the sector. At the same time, though, I think it may be limited perhaps to the direct insurance companies because the investors feel - rightly so, perhaps - more comfortable the transparency they get with an indemnity transaction undertaken by a direct insurance company or a primary writer than necessarily by a reinsurance company."

Cory Anger, md Guy Carpenter and registered representative of GC Securities, added: "I think there are a variety of drivers for the P&C business in the shorter term and the longer term that will drive the P&C ILS market, in particular the stage of the rate cycle in the marketplace. Currently we're in a softening market. There's excess capital. In fact, many insurers and re-insurers - particularly reinsurers - have sat on excess capital for fear that if a catastrophe happened during the financial crisis they wouldn't be able to recapitalise if they didn't retain these proceeds. I think there was a view that it's best to hang onto excess capital given the difficulties of raising new capital. I think that the financial crisis has started to abate and with the softening market there's certainly a focus from the insurers and reinsurers on optimising capital management."

Anger continued: "A number of insurers and reinsurers have been involved in stock buybacks as a way of returning capital given the state of the marketplace. This is a great opportunity for the ILS market to step in when the pricing in the capital markets has softened to a point where it's much more comparable to where the traditional market is today. This is a time when sponsors should be thinking about stepping in and locking in multi-year protection... I see a continued movement of new sponsors moving to this space and that will create new issuance activity."

As Craig Wenzel, director at Deutsche Bank Securities concluded: "We view the insurance securities space as an important capital source. None of our clients want to have any one particular type of reinsurance dominate its insurance coverage or risk transfer. I think the question of growth, particularly in life insurance industry but also more broadly, is what is the cost of capital versus this alternative form of risk transfer?"

MP

Investors

US RMBS investor mulls strategy change

US fixed income manager Declaration Management & Research (DMR) is planning a more flexible approach to its RMBS investment strategy following the early liquidation of its two RMBS opportunity funds - DMR Mortgage Opportunity Fund and DMR Mortgage Opportunity Companion Fund - at the end of January (see last week's issue). Although the firm says intrinsic value in many private-label RMBS is no longer available, upcoming dislocation in the agency MBS market may offer a new source of investment opportunity (see separate News Analysis).

According to John Pluta, evp at DMR, the firm's basic strategy going forward is to be more flexible, to have the ability to move across to other asset classes and to use more long-short opportunities. "In the near-term we want to be underweight credit-risky assets within structured credit," he says. "On the other hand, we see interesting opportunities in agency MBS. For example, paired trades where we might short agency MBS that the government is buying versus long positions in some counterpart - such as 15-year pass-through notes that could fit into a bank portfolio as part of its carry trade. We are speculating as to where the new source of demand will be in this asset class as the Fed reduces its purchases."

He adds: "We expect to see dislocations in the agency MBS market over the coming months: the recent decision by Fannie Mae and Freddie Mac to remove delinquent loans from guarantee pools being a case in point. As a manager, this is the exact environment that we want to be working in."

Commenting on DMR's decision to liquidate the two RMBS funds, Pluta explains that the firm's premise was not to buy cheap bonds that could then be sold off once they re-priced at a higher level, but to buy cheaply and collect the cashflows over time. "That gave us reason to project a three-to-five year investment plan," he says. "[However,] as value investors looking to buy intrinsically cheap securities in a market that was rallying so quickly, we felt it was time to exit the funds. We're now seeing some RMBS trade above their intrinsic value, in our view."

Pluta suggests that the announcement of PPIP was a catalyst for the rally in RMBS prices in 2009. "Although the amount actually deployed so far by the PPIFs is relatively small [see SCI issue 170], the fact that these funds had raised cash in a transparent manner signalled to the market that a source of demand for certain assets would exist," he says. "It takes time for the big government programmes to get up and running, but in the time between its announcement and launch the market showed a stronger bid for RMBS."

Declaration had capital commitments in place in 2008, but most of its investment activity took place from January 2009 to May 2009. The first fund's capital was fully invested, but it only called on US$84m of the US$105m raised for the second fund. "This is because by the time we were ready to call for this fund, the rally in RMBS was already under way," explains Pluta.

The DMR mortgage funds' heaviest allocation was in senior prime securities, with the second biggest allocation in senior Alt-A securities. The average acquisition price paid for an asset was around 50c on the dollar.

Under the firm's original premise - i.e. holding assets for up to five years - it anticipated a loss adjusted yield in the mid-teens. Realised IRRs for the funds were 26.6% and 42.3% respectively.

AC

RMBS

Liquidity scheme termination poses UK RMBS risk

It is hoped that the wind down of the UK government's Special Liquidity Scheme (SLS) and Credit Guarantee Scheme (CGS) by 2012 and 2014 will force more issuers to access the relatively expensive funding that ABS offers. UK RMBS performance could be impacted if originators are unable to replace their SLS/CGS funds, however.

Moody's notes in its latest Weekly Credit Outlook that there is a significant funding gap compared to recent RMBS issuance volumes. "£319bn will need to be refinanced between 2011 and 2014 from the SLS and CGS schemes. Given the volume of RMBS that has been publicly placed since mid-2009 is around £10bn, it is highly uncertain that the RMBS market will have the capacity to absorb the level of refinancing needed in the required timeframe," it says. "If other debt markets, such as covered bonds, cannot take up some of the funding gap left by the government schemes, the impact on the UK mortgage market will be significant."

The rating agency adds that the presence of a funding gap will result in originators further limiting their lending volume through tighter credit criteria, which will lead to a slower housing market - making it more difficult for borrowers to sell their houses when experiencing payment problems. Additionally, borrowers will find it harder to refinance themselves, which may be of particular concern for borrowers with a bullet loan approaching its maturity. Finally, the funding gap may once again put financial pressure on mortgage originators, in particular smaller lenders, and may jeopardise their financial position.

European securitisation analysts at Deutsche Bank agree that the expiry of the facilities may force banks to rein in new lending, which could see incrementally lower prepayments in RMBS pools as remortgaging/moving home becomes less attractive. They estimate that £19bn of SLS-eligible ABS and covered bonds will redeem prior to April 2011, the majority of which will be in the form of sponsor calls rather than mortgage repayments passed through to bonds and must therefore be funded by the issuing bank.

"If the facility is indeed to be wound down on schedule, banks will likely have to put in place around £145bn in replacement funding for the swaps relating to ABS and covered bonds (which have a nominal value of £210bn by our estimate) over the course of the next two years to cover the expiry of the SLS and retained bond redemptions," the Deutsche Bank analysts note. "The bonds in the SLS are not investor friendly (low legacy coupons and no investor puts or material step-ups), at least ensuring that there is little risk of these flooding the market in their current form. The deals would more likely have to be unwound and restructured to be issued publicly or simply funded on balance sheet."

Moody's adds: "Since in UK RMBS transactions originators generally perform numerous counterparty roles, such as servicer, cash manager and swap counterparty, the deterioration of originators' financial strength would result in increased operational risks for the associated RMBS transactions."

Even though the securitisation markets are currently showing some signs of improvement, the agency further indicates that there is significant uncertainty over whether originators will be able to refinance the full extent of SLS- and CGS-related funding by the required repayment dates of 2011-2014. "If these amounts cannot be funded elsewhere, there will be a negative impact on UK RMBS performance as a result of weaker asset performance and a deterioration in the financial condition of originators," it argues.

The Deutsche Bank analysts observe that there is limited ability for the UK RMBS market to absorb this volume of paper. In 2006, the record year for UK RMBS issuance, £94bn was placed with investors. The expiry of the facility nonetheless emphasises the significant funding need of the UK banking sector in the years ahead and suggests that issuers will be willing to pay up to access the relatively expensive funding that ABS offers, they conclude.

CS & AC

RMBS

Effectiveness of MBS purchases analysed

Debate continues over how the completion of the New York Fed's US$1.25trn MBS purchase programme on 31 March will impact the US RMBS market. While some market participants expect spread widening to be kept in check by rising demand, others expect overhanging inventory to dampen sentiment.

According to Annaly Capital Management in its latest monthly commentary, the Fannie Mae current coupon rate has tightened by 181.7bp under the programme, from a wide of 6.146% on 18 July 2008 to the current 4.329%. The mortgage basis has also ratcheted in from a wide of 237bp on 4 March 2008 to the present 73bp.

Annaly suggests that such a significant move in absolute and relative yields should have sparked a refinancing wave directed squarely at the individuals who needed it most - the high coupon mortgage borrowers. But that appears not to have happened.

"Typically, mortgages that are 200bp 'in the money' or that are refinanceable with a 2% reduction in coupon, refinance at very fast speeds," the firm notes. "This was last observed during the 2003-2004 refinancing wave. Currently, however, the same collateral is refinancing at much tamer speeds."

Bank of America Merrill Lynch estimates that there are roughly US$810bn of Fannie Mae and Freddie Mac 6% to 7% RMBS, and - assuming a US$150,000 average loan balance and that this universe had been refinanced into a 4.5% rate - the average homeowner would have saved almost US$1,700 annually. "This US$1,700 average annual savings would have not only added US$9bn in potential consumer spending, but would have also reduced the overall credit risk exposure of Fannie Mae and Freddie Mac, since the default rate on the lower coupon mortgages is substantially less than that of the original higher coupon. In essence, the MBS purchase programme has benefitted MBS bondholders through tightened spreads, but it probably did not help out the homeowners who needed it most," Annaly observes.

It's difficult to forecast whether RMBS spreads will widen once the purchase programme ends. While there is likely to be some volatility, Annaly indicates that spread widening may be kept in check by rising demand.

Barclays Capital points out that most money managers have been underweight MBS during the purchase programme. For example, bond fund managers with US$344bn in assets under management collectively decreased their MBS allocations by 23% from December 2008 to December 2009.

However, ABS analysts at JPMorgan suggest that recent housing indicators and market developments "provide evidence that the price turnaround in the past 3-4 months was strongly related to the tax credit for first-time homebuyers and the housing demand will likely be pressed by overhanging inventory after direct policy support from the government expires".

The JPMorgan HPI model projects that home prices will bottom in the second half of 2010, with peak-to-trough HPA at -13.2% and -33.7% for the FHFA purchase-only and Case-Shiller national indices respectively. Meanwhile, the LoanPerformance home price index declined by 1.2% in December compared to November - the fourth consecutive drop since September 2009.

Annual price declines (12-month HPA) continue to moderate, according to the JPMorgan analysts. The LoanPerformance index recorded a 3.4% annual decline in December, compared to 4.8% in November and 6.9% in October. The FHFA purchase-only index and S&P/Case-Shiller 20-city composite were up 0.5% and down 4.5% respectively in November compared to last November.

CS

ABS

Lancaster adds two to strategy team

RBS has expanded its MBS, CMBS and ABS strategy team within its global banking & markets (GBM) division in the US with the addition of two key hires. The bank says that the new appointments are an integral component of its continued commitment to the structured finance markets and provide clients with strategic market insights to help them achieve their financial goals.

Gregory Reiter joins as md, agency residential security strategy, and Jeana Curro as vp, agency MBS/CMOs. Both will be based in Stamford, Connecticut and report to Brian Lancaster, head of MBS, CMBS and ABS strategies at the bank. Reiter and Curro are the latest of several senior-level additions to RBS's strategy teams in the US.

"These new appointments have first-class reputations as thought leaders in each of their respective areas of expertise and complement our non-agency residential and CMBS strategists. Given the complexity and dynamic change in these markets, it is increasingly vital to have leading strategists help clients identify investment opportunities and mitigate risks," says Lancaster.

Reiter will be responsible for developing investment strategies in the agency CMO and ARM product areas. He joins RBS from The World Bank, where he was a portfolio manager. Prior to that, he was with UBS from 2005 until 2008, where he was responsible for agency CMO and ARM strategies.

Curro will also work on developing agency MBS strategies. She was previously with UBS since 2004, where she was a director in fixed income strategy and generated trade ideas through regularly published strategy notes.

ABS

Asia-Pacific SF head appointed

Bank of America has appointed Kwee Tee Lim as head of structured finance for the Asia-Pacific region.

In his new role Lim will move from the firm's London office and will be based in Hong Kong. He joined Merrill Lynch in 2006 as director and senior correlation trader, and prior to this was with Deutsche Bank.

Advisory

Broker forms investment advisory group

Cantor Fitzgerald has launched a new investment and advisory business as part of its investment capital markets group. Stephen Ardizzoni has been appointed head of Cantor Investment Advisors.

Prior to Cantor Fitzgerald, Ardizzoni was global head of research for Union Bancaire Privee Alternative Investments and earlier served as global head of credit and event strategies, responsible for US$15bn of the firm's assets. While at Union Bancaire Privee, he also served on several advisory boards including Ichan Partners.

Previously, Ardizzoni was an md at Crestline Investors, a Bass family affiliated alternative asset manager, where he oversaw the firm's credit and event hedge fund strategies, including a dedicated US$500m distressed fund of funds for a large institutional client.

CDO

Permacap to repurchase shares

The board of directors of GSO's permanent capital vehicle, Carador, is to sell shares back to the company. The board believes that repurchasing shares at a discount to NAV will be advantageous to the company and shareholders, both by being accretive to the NAV per share and by potentially reducing the discount at which the shares currently trade. In addition, the board believes that repurchases will provide some additional liquidity in the market for the shares.

During 2009 Carador's NAV per share declined by 10.2% (euro class) and 8.7% (US dollar class). This was offset by the dividends distributed during the year, which equated to 10% of the opening euro class NAV per share and 11.1% of the opening US dollar class NAV per share, giving a total return for the euro class of -0.2% and for the US dollar class of +2.4%.

Carador invests in a diversified portfolio of senior notes of CDOs collateralised by senior secured bank loans and equity and mezzanine tranches of CDOs. As a result of the amendment to the investment policy and investment objective approved by shareholders in March 2009, the investment manager was able to acquire senior notes in the secondary market (see SCI issue 163 for more on permacaps changing investment strategies). As at the year-end, the balance of the senior notes and mezzanine notes purchased represented 27% of the portfolio and are currently being held at an unrealised gain.

Assuming market conditions remain favourable and, subject to the opportunities for investment of the current cash holdings, Carador is targeting a dividend yield as a percentage of NAV in the range of 6%-8% for the coming year.

CDPCs

Portfolio repositioning transaction completed

Primus Financial Products has completed its fourth portfolio repositioning transaction with a significant counterparty. The CDPC terminated US$300m notional principal of three bespoke tranche transactions and paid the counterparty a termination fee of US$35m, at a discount to the market value of the these transactions.

Primus Financial has been undertaking these repositioning transactions since 31 July 2009, resulting in the termination of approximately US$2.8bn of single name credit swaps and tranche transactions (SCI passim). In aggregate, it has paid US$66.5m to terminate or amend credit swaps. The company has also contributed US$126m of capital to two subsidiaries in connection with the portfolio repositioning transactions, which has enabled it to cap its exposure to an additional US$2.9bn of credit swaps.

The objective of these portfolio repositioning transactions is to de-risk components of Primus Financial's credit swap portfolio by actively managing certain industry concentrations and higher risk tranches, with the objective of narrowing the range of possible negative outcomes and preserve the portfolio's long-term value.

CDS

Warehouse Trust gets Fed approval

The Federal Reserve Board has approved the Depository Trust & Clearing Corporation's (DTCC) application to establish a trade information warehouse subsidiary that is a member of the Federal Reserve System. The new DTCC subsidiary will be called the Warehouse Trust Company (Warehouse Trust) and aims to further regulatory and industry objectives to bring greater transparency and added risk mitigation to the global OTC credit derivatives market.

While the Warehouse Trust will be directly regulated by the Federal Reserve and the New York State Banking Department, it is also expected to be subject to a global cooperative oversight framework involving other US and non-US regulators.

Peter Axilrod, DTCC md for new business development, says: "As the operator of the global processing infrastructure and trade repository for the OTC credit derivatives market, DTCC is committed to working with regulators and market participants worldwide to protect the safety and soundness of the OTC derivatives market. In establishing the Warehouse Trust as a regulated entity, our aim is to ensure that regulators, wherever they are located, have unfettered access to the information they need to assess risk exposure in this global market, and that industry participants have the assurance of that regulatory oversight over the critical infrastructure that supports their market activities."

Stewart Macbeth, DTCC md and head of the Warehouse, says: "Certainly, the Warehouse is a critical component of the global credit derivatives market's infrastructure. As a regulated entity, our aim is to work with global groups, such as the OTC Derivatives Regulators' Forum, in this critical area of global concern.

Macbeth adds: "The industry, working with DTCC, has provided regulators with voluntary access to OTC credit derivatives trade records for the past year. We look forward to collaborating with both members of the OTC derivatives community, lawmakers and regulators to ensure that the global infrastructure that is already in place continues to meet the evolving needs of all relevant parties."

In November, the New York State Banking Board also approved DTCC's application for Warehouse Trust to be regulated as a limited purpose trust company, so the Fed's approval is the final regulatory approval needed for the new subsidiary. The Warehouse Trust will begin operations once certain organisational conditions have been met, which are expected shortly.

Legislation and litigation

DoubleLine files cross-complaint

DoubleLine Capital has filed a cross-complaint against TCW, claiming up to US$1.25bn on grounds of breach of contract and related misconduct by TCW arising from its firing of DoubleLine ceo Jeffrey Gundlach (SCI passim). DoubleLine also filed an answer to TCW's earlier lawsuit, asserting that TCW "seeks to interfere unfairly with [DoubleLine's] new business by filing, and trumpeting, claims that it knows have no merit".

The cross-complaint states that TCW agreed with Gundlach to share with him and his team a predetermined percentage of the management fees and performance fees generated on the TCW funds his group managed. DoubleLine explains that as time went on, these funds performed so well that the anticipated future fees that would be owed under this agreement were reaching at least US$600m and easily approaching US$1.25bn and beyond.

The cross-complaint also states that TCW "hatched a scheme to deprive Gundlach and his group of this lucrative compensation package and to confiscate the huge future fees that would be generated as the result of the skill and hard work of Gundlach and his group".

"While I am disappointed by TCW's transparent attempt to use litigation as a means to slow our company's momentum, I have instructed my legal team to vigorously defend DoubleLine's interests while my team and I focus on what we do best: protecting and building our clients' capital," says Gundlach. "I believe the facts stack up overwhelmingly on our side. I would be delighted to see this case go to trial tomorrow, if that were feasible."

On 4 December 2009 TCW terminated the employment of Gundlach. At the time, he was cio of TCW, a member of its board of directors, group md of the TCW RMBS group and lead portfolio manager for many fixed income strategies and funds. Gundlach subsequently formed a new company, DoubleLine Capital, which announced a strategic partnership with Oaktree Capital Management. By early January 2010, more than 40 former TCW portfolio managers, traders, analysts and other professionals had joined DoubleLine.

At the same time, TCW experienced asset outflows of roughly US$6bn, or approximately 50%, from a public mutual fund previously managed by Gundlach and Philip Barach, who is now president of DoubleLine. TCW also faced account freezes by institutional clients, among them, the US Treasury, which froze TCW's active management of a US$2bn PPIP fund focused on the distressed mortgage market. On 7 January, TCW filed its lawsuit against DoubleLine, Gundlach and three other former TCW employees.

The cross-complaint and answer were filed on 10 February in the Superior Court of the State of California, County of Los Angeles, Central District.

Legislation and litigation

MBIA's motion to dismiss class action denied

A US district court judge has issued a decision denying MBIA's motion to dismiss a class action fraudulent conveyance lawsuit brought by Aurelius Capital and Fir Tree Capital (see SCI issue 128).

The lawsuit relates to MBIA's February 2009 'transformation' and alleges that MBIA "orchestrated a fraudulent conveyance transaction in which the monoline stripped over US$5.4bn of assets from MBIA Insurance Corp at the height of the worldwide financial meltdown to create a separate US municipal bond insurance subsidiary, leaving MBIA Insurance Corp insolvent, without sufficient capital and unable to satisfy the claims of its policyholders that purchased approximately US$241bn in structured finance products insured by MBIA Insurance".

MBIA moved to dismiss the complaint last May, principally on the ground that the transactions had been approved by the New York Insurance Department. In response, Aurelius and Fir Tree contended that the MBIA defendants misled the New York Insurance Department to obtain the approvals for the transactions by grossly understating their projected losses by billions of dollars, that the approvals did not address the fraudulent conveyance and bad faith claims presented in the lawsuit and that their lawsuit could not be dismissed based upon Insurance Department approvals for which they were not given notice or an opportunity to be heard in the approval process.

MBIA also asked the court to abstain from handling the case in favour of the similar state court fraudulent conveyance lawsuits brought by 19 banks against the MBIA companies. Following oral argument, Judge Sullivan denied the motion to dismiss in all respects.

Meanwhile, in a separate case, Bank of America is facing a class action securities lawsuit in the US for violating the Securities Act of 1933. The complaint alleges that BoA sold shares in January 2008 in a Series K Offering while omitting to disclose the full extent of its impairments on loans, leases, CDOs and CMBS.

The complaint also claims that BoA failed to properly record losses for impaired assets, the firm's internal controls were inadequate to prevent it from improperly reporting its impaired assets and that its capital base was inadequate relative to the magnitude of impaired assets.

The lawsuit - Montgomery versus Bank of America Corporation - is now underway in the US District Court for the Southern District of New York on behalf of persons and entities that acquired certain Bank of America shares up to and including 12 September 2008.

Legislation and litigation

Kohlberg faces fair value suit

Glancy Binkow & Goldberg has filed a class action lawsuit in the US District Court for the Central District of California on behalf of investors who purchased Kohlberg Capital Corporation securities between 16 March 2009 and 24 December 2009. The complaint charges Kohlberg and certain of its executive officers with violations of federal securities laws.

The complaint alleges that throughout this period defendants knew or recklessly disregarded that their public statements concerning Kohlberg's operations and financial performance were materially false and misleading. Specifically, the plaintiff alleges that the firm reported inflated earnings that violated GAAP by failing to properly account for the fair value of its investment portfolio under FAS 157 - Fair Value Measurements.

Panellists at the recent ASF conference indicated that the number of such suits could be expected to rise in the coming months, as regulators begin to pick up on the theme of potential mispricing (see last issue).

On 9 November 2009 Kohlberg announced that its auditor, Deloitte & Touche, had raised questions concerning its methodology and process in valuing its loan portfolio under GAAP. As a result of these questions, the firm stated that it would not be able to timely file with the SEC its third-quarter results for the period ended 30 September 2009. As a result, its stock price fell by US$0.56 per share, or more than 10%, to close at US$4.96.

Kohlberg originates, structures, finances and manages - including through a number of CLOs - a portfolio of term loans, mezzanine investments and selected equity securities in middle market companies.

Operations

CIBC Mellon's corporate trust business acquired

BNY Mellon has signed a definitive agreement to acquire the corporate trust business of CIBC Mellon. The acquisition will more than double BNY Mellon's share of the corporate trust market in Canada and expand its presence in servicing domestic and cross-border debt issuances, structured credit and securitisations, government stimulus programmes and public private partnership transactions, it says.

The acquisition is expected to close by the end of the first quarter, subject to regulatory approvals.

Upon completion of the deal, BNY Mellon, through its wholly-owned subsidiary BNY Trust Company of Canada, will service approximately US$300bn in outstanding debt with offices in Vancouver, Calgary, Toronto and Montreal. In addition, it will offer clients a range of new services, such as cross-border issuer services, administration outsourcing, portfolio analytics and document custody.

Operations

Offshore SF lawyer to head finance group

International financial law firm Walkers has appointed Jersey solicitor Alexandra Corner as head of the firm's Jersey finance and corporate group. Corner has been working in the finance and corporate department of Walkers' London office since 2006, with a principal focus on Jersey and Cayman Islands structured and asset finance and capital markets work.

Prior to joining Walkers she worked for Mourant du Feu & Jeune in both London and Jersey, having been practicing law offshore since 1998. Corner has been admitted into the partnership at Walkers and going forward will be working out of both the firm's Jersey and London offices.

Antonia Hardy, managing partner of Walkers' Jersey office and global head of finance and corporate, says: "Alexandra has built up a significant degree of experience in both the London and Jersey markets over the past twelve years, specialising in complex Jersey and Cayman Islands cross border finance transactions. This combination of jurisdictional experience benefits both our local and international clients and demonstrates our continuing commitment to delivering world class service and expertise."

Regulation

CLN ban lifted for Singapore three

The ten Singaporean banks that were banned by the Monetary Authority of Singapore (MAS) for selling CLNs linked to Lehman Brothers (see SCI issue 145) have undertaken actions to comply with the Authority's subsequent directions. As a result, the ban is to be lifted for three of the ten banks.

MAS will lift the ban on the sale of structured notes for DBS Bank, Malayan Banking Berhad Singapore Branch and the Royal Bank of Scotland Singapore Branch with effect from 12 February 2010. These banks have formally confirmed that they have taken measures to rectify all the weaknesses identified in the Authority's investigations. The banks have also reviewed and strengthened their internal processes and procedures regarding financial advisory services across all investment products.

In addition, DBS has assured the Authority that in order to uphold a consistent set of standards across the region, it will not sell structured notes to retail customers anywhere in the group until it has rolled out enhanced measures and sales processes in all its key markets. The status of the MAS' directions for the other banned financial institutions are:

• DMG & Partners Securities and UOB Kay Hian have asked the MAS for additional time to ensure that the enhanced measures put in place are sufficiently robust and in accordance with its directions.
• The ban on the sale of structured notes continues for the remaining four financial institutions - CIMB-GK Securities, Kim Eng Securities, OCBC Securities and Phillip Securities - until the end of the period of their ban. MAS says it will only lift the ban when it is satisfied with the measures they have put in place.
• Hong Leong Finance Limited has voluntarily ceased the provision of new financial advisory services, including the sale of structured notes.

Under the Authority's directions, the financial institutions were required to appoint an external person to review their action plan and report on its implementation. DBS Bank appointed KPMG, while Malayan Banking Berhad Singapore Branch and the Royal Bank of Scotland Singapore Branch appointed PricewaterhouseCoopers. These reviews have now been completed, and both KPMG and PwC are satisfied.

In addition, the banks have agreed that the reviewing of remuneration frameworks, training and supervision of staff and the enhancing of the sales and advisory process will continue on an ongoing basis. The MAS will hold the board and senior management of the financial institutions accountable for meeting this commitment, it says.

Structuring/Primary market

Director hired for SF team

Yorkshire Bank has appointed Russell Oliver as a director in its corporate and structured finance team, based in Manchester. Russell joins from Bank of Scotland, where he started his career 15 years ago as a graduate trainee.

He has specialist knowledge of funding mergers and acquisitions and during his time with the bank he spent a year managing its leveraged finance team in Amsterdam before launching a leveraged finance team in Stockholm. Since he returned to the UK two years ago, he has been area director of its real estate team in Leeds, managing a team providing funding for the Yorkshire property market.

Technology

Valuation service extends into Asia

Pricing Partners has opened a new regional office in Singapore to provide global distribution of its products and services suite across Asia. The Singapore office will be directed by Rosh Rai who has over 15 years of sales/business development experience in Asia. Prior to working with Pricing Partners, Rai worked for a leading derivatives solution firm and Thomson Reuters Financial in both Hong Kong and Singapore.

CDO

Fund's CDO equity valuations jump

Axa Investment Management's permanent capital vehicle, Volta Finance, recorded a 30.1% mark-to-market increase on its equity CDO investments in January. ABS investments recorded a 1.9% increase, mezzanine CDO investments a 9.5% increase and corporate credit investments a 2.8% decrease.

These performances reflect the modest widening of spreads in the corporate credit area and the acknowledgement by market participants of the improving situation of residual positions in CLOs, according to the firm.

Excluding principal payments from short-term ABS investments (€0.1m in January), Volta's assets have generated the equivalent of €1.6m of cashflows during January 2010, bringing the total cash generated for the current semi-annual period that began on 1 August 2009 to €7.4m (excluding principal payments from short-term ABS), compared with €13.7m for the same six-month period in 2008 and with €8.8m collected for the previous semi-annual period ended in July 2009. At the end of January 2010, the gross asset value (GAV) of Volta was €86.8m or €2.87 per share, an increase of €0.28 per share from €2.59 per share at the end of December 2009.

CDO

US bank Trups CDO defaults escalating

Bank default rates within US Trups CDOs continued their steady climb this past month and are now approaching 11%, according to Fitch's Bank Default and Deferral Index. Bank default rates on Trups CDOs have climbed from a near non-existent level of 0.1% in January 2008 to 10.8% as of 31 January of this year.

Fitch md Kevin Kendra says: "Banks will continue to default at an escalated rate in the coming months. Seven new banks defaulted, while 20 additional financial institutions began deferring this past month." The newly-defaulted bank issuers adversely affected 20 Trups CDOs. Additionally, the deferrals impacted interest proceeds on US$156m of collateral held by these CDOs. These results bring the cumulative combined default and deferral rate to over 27%.

Fitch's Bank Default and Deferral Index tracks defaults and deferrals by banks and bank holding companies within Fitch's rated universe of 85 bank Trups CDOs (encompassing approximately US$37.6bn of bank collateral originated). The index includes all types of securities issued by banks and bank holding companies such as Trups and senior and subordinated debt.

Meanwhile, Fitch has placed 179 notes from 72 bank Trups CDOs on rating watch negative to reflect the increased default and deferral activity in bank Trups assets. In many portfolios the recent default and deferral activity has now exceeded Fitch's expectations from its portfolio review in April 2009. Consequently, 295 notes from 76 Trups CDOs have been downgraded, reflecting realised losses from defaulted assets and anticipated losses from deferring assets in the respective portfolios.

The downgrades primarily impacted notes rated below investment grade, with 159 of the notes downgraded previously rated triple-C or double-C and 40 notes carrying other below investment grade ratings prior to downgrade. A majority of the notes downgraded were downgraded by one rating category or less.

The level of distress for local and regional banks that financed through Trups CDOs has resulted in US$2.7bn of new bank Trups defaults and US$2.4bn of new deferral activity since 31 March 2009. Fitch loss projections in April 2009 averaged 11.6% of a transaction's portfolio. Meanwhile, realised and imminent losses from new defaults and deferrals now average approximately 20.6% of the portfolio.

The RWN reflects Fitch's view that the loss expectations for these portfolios have exceeded expectations. Where loss expectations significantly exceeded previous assumptions, the rating agency downgraded notes to reflect its current credit opinion of the quality of the notes.

CDO

CRE CDO delinquencies continue climbing

US CRE CDO delinquencies continued their steady climb in January due in part to the ongoing troubles surrounding the Peter Cooper Village/Stuyvesant Town loan, with delinquencies increasing to 13% from 12.3% in December, according to the latest CREL CDO delinquency index results from Fitch.

Five mezzanine loans backed by interests in Peter Cooper Village/Stuyvesant Town added to total delinquencies. These five interests, totalling 77bp, became delinquent in January 2010 and affect five different CDOs. Further, on 24 January 2010, the borrower requested to return the property to the special servicer via a deed-in-lieu.

"The deed-in-lieu transfer will be a prolonged process as an agreement is negotiated and any remedies available to the holders of the US$1.4bn in mezzanine debt are determined," says Fitch senior director Karen Trebach. "Fitch will continue to model these assets at a full loss to each CDO."

Other new delinquencies included three maturity defaults (18bp), seven term defaults (37bp) and seven credit-impaired rated assets (37bp) consisting of a mix of CMBS, CRE CDOs and bank loans. There were also three repurchases, which included one 90+ days delinquent B-note and two lowly rated CRE CDO assets. All three received limited recoveries and were exchanged by the asset managers for higher rated collateral.

Partially offsetting these new delinquencies was the removal of 22 previously delinquent assets for various reasons, including loan restructurings, note sales and extensions. In total, 42 loan extensions were reported in January, including six former matured balloon loans.

US$47.7m in realised losses were reported in January, which is lower than the total reported last month of US$80m. To date, total realised losses to CREL CDOs are approximately 4.5% of the total collateral balance. The largest single loss in January was US$18.7m, which resulted from a discounted note sale by the special servicer of a 90+ day delinquent whole loan.

All 35 Fitch-rated CREL CDOs reported delinquencies in January, ranging from 1.3% to 42.4%. Additionally, 13 Fitch-rated CREL CDOs were still failing at least one overcollateralisation (OC) test. Failure of OC tests leads to the cut-off of interest payments to subordinate classes, including preferred shares, which are typically held by the CDO asset managers.

The universe of 35 Fitch-rated CREL CDOs currently encompasses approximately 1,100 loans and 350 rated securities/assets with a balance of US$23.8bn. The CREL delinquency index includes loans and assets that are 60 days or longer delinquent, matured balloon loans and the current month's repurchased assets.

CDS

Second FGIC credit event debated

Citibank has asked the ISDA Americas Determinations Committee whether a failure to pay credit event has occurred with respect to FGIC. The reference entity failed to make a payment of interest due and payable on its senior unsecured 6% senior notes due 2034 on 15 January. The 30-day grace period for the payment expired on 15 February.

In December 2009, the ISDA Americas Determinations Committee called a failure to pay credit event on FGIC following the New York Insurance Department order for the monoline to suspend paying claims on 20 November (SCI passim).

CLOs

BarCap reclassifies CLO portfolio

Barclays Capital has reclassified £8.03bn of CLO assets wrapped by non-investment grade rated monolines previously held for trading to loans and receivables.

The effective interest rates on the assets ranged from 0.50% to 2.99%, with undiscounted interest and principal cashflows of £8.8bn. In the period prior to reclassification, £1bn of fair value gains were recognised in the consolidated income statement. Since 25 November, pay-downs and maturities of £26m along with foreign exchange movements on the assets and accrued interest resulted in a carrying value as at 31 December 2009 of £8.09bn.

The carrying value of the securities reclassified during 2008 into loans and receivables has decreased from £3.9bn to £1.3bn, primarily as a result of pay-downs and maturities of the underlying securities of £2.7bn. However, no impairment has been identified on these securities.

The bank says that if reclassifications had not been made, the group's income statement for 2009 would have included net losses on the reclassified trading assets of £49m (2008: £2m). After reclassification, the reclassified financial assets contributed £192m (2008: £4m) to interest income.

At 31 December 2009, the fair value of the transferred assets was £7.9bn and the net exposure to monoline insurers was £559m. The remaining non-investment grade exposure continues to be measured at fair value through profit and loss.

CMBS

Multi-borrower CMBS completed

Keystone Property Group has successfully completed a US$53.5m refinancing for one of its investments, Keystone Summit Corporate Park, via a multi-borrower CMBS. Keystone says the closing is a reflection of its "proven track record, as well as the strength of Keystone Summit Corporate Park's 'best-in-class' position in the marketplace".

Keystone purchased the property in September 2008, when the asset was less than 75% leased. It subsequently initiated a targeted leasing and US$2m capital improvement programme at the property, signing more than 345,000 square-feet of new leases since the acquisition and raising the property's net operating income from US$1.7m to US$6.2m.

Capital advisory firm Ackman-Ziff represented Keystone during the loan negotiation. With this refinancing, Keystone was also able to cash out two-thirds of its equity.

Matthew Pestronk, md of Ackman-Ziff, says: "The capital structure we were able to obtain was similar to what was available in the market prior to the credit crisis, the actual closing of which is concrete evidence of a dramatic improvement in the availability of capital in the marketplace. We candidly believe that the economics of this deal were the most aggressive that we have seen since 2007, and it is fitting that such a top-quality sponsor in Keystone Property Group received these terms."

CMBS

GGP CMBS loan impact analysed following SPG offer

Simon Property Group (SPG) has made a written offer to acquire General Growth Properties in a fully financed transaction valued at more than US$10bn, including approximately US$9bn in cash. SPG's offer would provide a 100% cash recovery of par value plus accrued interest and dividends to all General Growth unsecured creditors, the holders of its trust preferred securities, the lenders under its credit facility, the holders of its exchangeable senior notes and the holders of Rouse bonds, immediately upon the effectiveness of a definitive transaction agreement. This consideration to creditors totals approximately US$7bn.

Analysts at Trepp are speculating as to what will become of the associated CMBS loans. "Clearly, Simon will want the loans assigned to it. That would represent a low cost of funds, given the current market, and would not require Simon to dip any further into its war chest. On Tuesday, most CMBS pros we spoke to were banking on that outcome," Trepp notes.

However, the analysts question why a firm operating under bankruptcy - GGP - would negotiate a modification agreement that allowed for a six-month period where lock-out and prepayment penalties were suspended. "We don't have a good response to this. Perhaps the answer can be found in the 600-plus pages of the modification agreement... Maybe GGP simply wanted the freedom to sell off assets piecemeal - but then why limit the window to six months?" the analysts ask.

"We can't say that someone with more familiarity with the issue won't step forward to blow our concerns to smithereens, but for now it might be wise to operate under the premise that GGP negotiated the clause because the assignment option wasn't cut and dried," Trepp adds. "That means, if you are a buyer of premium first-pays or IOs from GGP deals, you may want to see how much risk you are taking if the GGP loans pay off over the next few months. Of course, if you are selling these bonds, carry on."

CMBS

Increase in special servicing for US CMBS

US CMBS loans are transferring to special servicing in larger batches and with increasing speed, according to Fitch in its weekly US CMBS newsletter.

Last month saw 248 loans totalling US$4.27bn move into special servicing. This figure is over four times the balance that transferred in January of last year. The size of specially serviced loans has increased 2.4 times from 2009 to US$17.2m, with five loans greater than US$100m.

Fitch md Mary MacNeill says: "More loans will approach final maturity without available extensions or a refinancing commitment. Available liquidity remains limited, which is making refinancing large loans more difficult even when they are performing."

Within the hotel sector, 275 (US$11bn) loans transferred to special servicing out of 2131 (US$49.3bn) in the rated universe. 872 (US$9.8bn) multifamily loans transferred to special servicing out of a total of 9,320 loans (US$62.2bn) within the rated universe.

Of office loans, 509 loans (US$7.5bn) went into special servicing of the 6,559 loans (US$141.5bn) within the rated universe. Finally, within retail, 842 loans (US$15bn) were transferred into special servicing of the 12,837 loans (US$127.3bn) that make up the rated universe for the sector.

CMBS

January posts largest increase in CRE delinquencies

The delinquency rate on loans included in US CMBS increased by 52bp in January to 5.42%, according to a new report by Moody's. The jump represents the largest increase in the delinquency rate thus far in the downturn, as measured by Moody's Delinquency Tracker (DQT), which tracks all loans in US conduit and fusion deals issued in 1998 or later with a current balance greater than zero.

"409 loans became newly delinquent in January, adding more than US$3bn to the delinquent balance," says Moody's md Nick Levidy. "We continue to expect loan performance to deteriorate further in 2010."

Retail loans, which account for 30% of the total outstanding balance, made up nearly 40% of the newly delinquent loans in January. As a result, the retail delinquency rate increased by 72bp to 5.24%.

By contrast, loans backed by office properties experienced the smallest delinquency increase of the five major property types in January, rising 34bp to 3.53%, also the lowest overall rate of the five major property sectors.

The hotel DQT increased by 75bp and currently stands at 9.82%, the highest of any property type. January marked the first time in five months that the hotel sector was not overrepresented in the newly delinquent loan balance.

In January, 116 loans backed by multifamily properties accounted for roughly 22% of the newly delinquent loan balance. The multifamily delinquency rate stands at 8.77%, a 63bp increase over the month before.

Finally, the 46bp increase in delinquencies for industrial properties, which brought the rate to 3.88%, represents the second highest increase in the history of the sector.

The Western US region saw the largest monthly increase of the four regions included in the DQT, with an increase of 71 points bringing the delinquency rate to 5.99%. Delinquencies in the Midwest increased by 62bp to 6.24%, with retail loans accounting for over 50% of the newly delinquent balance.

Retail was a poor performer in the East as well, accounting for 33% of newly delinquent loans. The overall rate in the East now stands at 3.54%, the lowest of the four regions, after a 42bp increase in January.

An increase of 53bp pushed the delinquency rate in the South to 7.53%, Moody's notes, as the region maintains its status as the poorest performer overall.

CMBS

Japanese CMBS loan defaults decrease

The rate of defaulted Japanese CMBS loans to outstanding loans (Y3.4trn, or approximately US$37bn) has declined by 0.1 point month-on-month at the end of January to 7.7%, according to a recent Moody's report for the sector. This follows the resolution and full recovery of two such loans amounting to approximately Y7.1bn (US$79m). The report also notes that defaulted loans amounted to Y258.4bn (approximately US$2.9bn) at the end of January 2010.

The total amount of maturing loans backing Japanese CMBS rated by Moody's, amounting to Y1.1trn (as of end-December 2009, approximately US$12bn), will peak in 2010. Of these loans, three loans amounting to about Y43.6bn (approximately US$484m) matured in January 2010.

Of the matured three loans, Moody's confirmed that two loans (Y41.5bn, approximately US$461m) backed by office buildings in Tokyo were repaid in full by their maturity dates, according to reports from servicers. A loan of Y2.1bn (approximately US$23m), which defaulted in January 2010 due to failure to pay at its maturity date, was an underlying multi-borrower transaction backed by multifamily properties in several cities.

CMBS

Strong cashflows for Singaporean CMBS

Singaporean CMBS transactions are enjoying strong cash flow from their underlying properties, according to Moody's. The rating agency sees no rating implications on any of the outstanding Singaporean CMBS transactions, based on the performance of the underlying properties.

According to the ratings agency's quarterly report for the sector, most transactions enjoy at least three times actual debt service coverage ratio, and appraisers' loan-to-value ratios are in the 16%-32% range. Two transactions have to be refinanced in 2010. With the economy gradually improving, Moody's expects that they will be able to obtain the necessary funding by their expected maturity dates.

Jerome Cheng, a Moody's vp/senior credit officer says: "There is an oversupply of office space in the market and both rental and vacancy rates have deteriorated. However, for securitised transactions, rents have been stable so far and are higher than Moody's stabilised assumptions. Yet, vacancy rates have risen because of tenants moving out."

Cheng adds: "In terms of net cash flow, the most recent performances show that the deterioration in vacancy rates is more than offset by the better than expected rental rates."

Marie Lam, a Moody's vp/senior credit officer says: "There is also an abundant supply of retail space in the market, with two integrated resorts scheduled to open in early 2010. But take up for retail space in the market has been encouraging thus far. Suburban mall rental and occupancy rates are also very firm."

Meanwhile, securitised industrial building rental and vacancy rates are very close to Moody's stabilised assumptions. Emerald Assets Limited - the only transaction with industrial buildings - is enjoying strong debt-service-coverage ratio.

Moody's is also reviewing the liquidity sufficiency of the outstanding CMBS transactions to ensure investors get paid on a timely basis in case of any cash flow disruption.

Distressed assets

Pair of FDIC structured transactions closed

Lennar Corporation has closed two structured transactions with the FDIC, involving the purchase of two portfolios of loans with a combined unpaid balance of US$3.05bn. A subsidiary of Lennar, Rialto Capital Advisors, will conduct the day-to-day management and work-out of the portfolios.

Lennar acquired indirectly 40% managing member interests in the limited liability companies created to hold the loans for approximately US$243m (net of working capital and transaction costs), including up to US$5m to be contributed by the Rialto management team. The FDIC is retaining the remaining 60% equity interest and is providing US$627m of non-recourse financing at 0% interest for seven years. The transactions include approximately 5,500 distressed residential and commercial real estate loans from 22 failed bank receiverships.

Lennar says the aim of the acquisitions is to manage, work through and add value to the portfolios. The firm has been preparing to invest in this space for the last two years and the transactions are expected to be accretive to its 2010 earnings.

Jeffrey Krasnoff, Rialto ceo, notes: "We have been assembling and incubating the Rialto management team within Lennar since late-2007. Many on our team have worked together and with Lennar for several decades. Our track record of successfully managing the resolution of distressed real estate loan portfolios puts us in a unique position at this point in the cycle. We are very pleased to be partnering with the FDIC and look forward to the opportunity to build on our business relationship."

Rialto Capital is a real estate investment management company focused on distressed real estate asset investment, management and workouts. The firm's senior management team brings, on average, over 20 years of broad experience in residential and commercial real estate investment, finance, development and management. A Rialto-related entity is also a sub-advisor to Alliance Bernstein's PPIP.

Indices

New leveraged loan index launched

Markit has launched the iBoxx USD Leveraged Loan Index (Markit LLI). The index is designed to serve as a benchmark for investors' cash loan portfolios and to enable comprehensive performance attribution analysis.

The LLI leverages data from Markit WSOData and Markit Loan Pricing to provide asset managers with a benchmarking tool that will enhance their performance management capabilities, the firm says. It also expects the index to encourage new investors to enter the loan asset class by offering them a more accurate, transparent representation of the loan market.

At launch, the index will consist of approximately 800 loans from over 700 issuers. The index will have minimum size requirements, liquidity measures and weighting caps at the issuer, facility and sector level to ensure proper representation within the index. The LLI will serve as the basis for expanded offerings during 2010, including European leveraged loan indices, customised leveraged loan indices and performance attribution and analytics products.

Indices

Dinkum Index shows mixed results

Fitch's latest Dinkum Index report indicates that Australian mortgage delinquencies showed mixed results across the board. Some pockets of arrears improved during Q409, while others deteriorated.

"Delinquencies in the 30-59 day bracket remained constant or deteriorated, with the worst performers being non-conforming low-doc borrowers, whose delinquencies increased by over 50%," says Leanne Vallelonga, associate director in Fitch's structured finance team. "Though non-conforming borrowers represent a small portion of the market, as expected they were the first to be impacted by the increases in interest rates which took place in Q409. Further deterioration is expected."

Although prime/conforming delinquencies improved for the most part in Q409, with 30+ day arrears decreasing to 1.19% from 1.21% in Q309, this decrease can chiefly be attributed to the index constituent methodology, as there were five new transactions added, which helped in pulling the overall index lower. If these five deals were omitted, there would have been a slight increase in 30+ day arrears to 1.23% in Q409 from 1.21% in Q309.

Low-doc, both conforming and non-conforming, 30+ day arrears worsened in the quarter. Non-conforming low-doc arrears deteriorated to 16.47% from 15.59% in Q309, with conforming low-doc arrears deteriorating to 4.82% from 4.72% in Q309. These increases are mainly due to rises in the 30-59 day buckets, where conforming low-doc arrears rose by 28% from Q309 and non-conforming low-doc arrears rose by 50% from Q309.

Improvements were seen across all 90+ day arrears categories, which Fitch believes is due to the rebound in property prices during the latter half of 2009, improving lenders' ability to sell properties. The agency expects some increase in arrears across all products through 2010, brought about by Christmas seasonal credit card spending (a factor specific to Q110), increasing interest rates and the risk of higher unemployment as the year progresses.

Ratings

Additional SF symbol adopted

S&P is to apply for registration under the European Regulation on Credit Rating Agencies (Regulation (EC) No 1060/2009), in force from December 2009, which stipulates that rating agencies regulated within the EU will be required to add a symbol to ratings on structured finance instruments. The agency intends to give all ratings on structured finance instruments such an additional symbol on or before 7 September 2010.

"Having carefully considered various options, we believe that operationally it is most practical to have a global application of this rule and accordingly determined that our attribution of a symbol to structured finance instruments will be global," S&P says.

The symbol that it will use is '(SF)', added as a subscript to the existing ratings symbology. No other changes are intended to the rating categories applied to structured finance instruments.

S&P will designate structured finance instruments with a subscript irrespective of where they are issued, the location of the issuer, originator or assets, or the subject of the instrument.

The Regulation provides a definition of "structured finance instrument", which cites the definition in the Capital Requirements Directive. In the coming months, S&P says it will be considering which instruments will require the application of the subscript based on this definition.

Ratings

Athilon downgraded further

S&P has downgraded CDPC Athilon's issuer credit rating from single-A minus to triple-B minus. At the same time, the rating agency downgraded its rating on Athilon's senior subordinated notes to single-B from double-B minus.

The rating actions reflect S&P's view of the updated lifetime loss projection on Athilon's exposure to senior tranches of an ABS CDO (transaction B), including its view on the underlying RMBS and other structured finance assets, as well as the updated projected losses associated with the possibility that a credit event cash settlement payment on the CDS on transaction B's two senior tranches could occur after 4 October 2014.

Ratings

Harrier MTN ratings on review

Moody's has placed Harrier Finance Funding's Euro and US MTN programmes under review for possible downgrade. The action affects £157m and US$1.8m of current outstanding debt securities, which are currently rated A2.

Harrier is a SIV managed by Brightwater Capital Management, a wholly-owned subsidiary of WestLB. The rating agency explains that the rating actions are the result of WestLB's long-term rating of A2 being placed on review for possible downgrade on 8 December 2009. The sponsor's Prime-1 short-term rating is unaffected.

There is a direct linkage between the ratings of Harrier and WestLB, due to support by WestLB to provide funding necessary to repay any maturing senior liabilities. This funding support is provided by WestLB's commitment to purchase any senior debt issued by Harrier for the purpose of repaying any maturing third-party held senior debt.

Termination of such support will only be triggered when there is no further debt outstanding held by a third-party investor. This funding support is to be effective even during enforcement.

Harrier has no outstanding US or Euro CP. Its MTNs have a bullet weighted average maturity of 6.62 years. Currently 99.5% of the SIV's portfolio is comprised of cash.

Ratings

LatAm SF stable, but under pressure

The rating outlook for Latin American structured finance will remain stable for most regions and asset types in 2010, according to Fitch. However, the far-reaching implications of the global financial crisis will leave some regions vulnerable to performance pressure.

Fitch md Greg Kabance says: "Mexico will continue to show signs of deterioration during the first half of this year, most notably in RMBS. Elsewhere, issuance activity is expected to increase in Brazil as this country has been fairly resilient and the least impacted by the global financial crisis."

On the new issuance front, Fitch projects new transactions to emerge with more frequency and build on their modest showing from 2009. Mainstays that have weathered the global financial crisis reasonably well, such as unsecured consumer loans, auto loans and future flows, will remain primary asset types of choice for markets such as Argentina, Colombia and Brazil.

Some Latin American regions will also exhibit a stronger market presence, while some new asset types surface more frequently in other areas. "Brazil will continue to see a rising number of issuances backed by shopping centre rent receivables, auto loans and transactions related to the oil and gas sector."

Of its 881 rated structured finance tranches. Fitch affirmed 771, downgraded 96 and upgraded 14 tranches in 2009. Most of the downgrades, not surprisingly, came from Mexican RMBS. Fitch expects the ratio of negative to positive rating actions to diminish as compared to last year.

Ratings

CIFG ratings withdrawn

S&P has withdrawn its double-C financial strength, financial enhancement and counterparty credit ratings on CIFG Guaranty, CIFG Europe and CIFG Assurance North America, at the monoline's request.

The double-C ratings and negative outlook reflect the significant declines in statutory surplus levels at these companies, which leave them vulnerable to regulatory intervention. The ratings also reflect the companies' insured exposure to various asset classes that could experience adverse loss development, which would further weaken their surplus positions.

Ratings

Limited first-half issuance prospects for South Africa

The performance of the South African auto loan ABS and RMBS markets continued to deteriorate in 2H09, according to Moody's. In addition, the rating agency anticipates limited new issuance throughout 1H10.

Over the past year the weighted-average cumulative loss trend for RMBS has doubled to 0.27% of original balance, mainly from issuers under the Blue Granite Investments and Homes programmes. The cumulative loss trend of auto loan ABS transactions rose to 1.74% of original balance in December 2009, which constitutes an increase of 58% over the past 12 months. Moody's 90+ days delinquency trend index, an indicator of the expected increase in defaults and potential losses, has increased to 2.17% of current balance (0.83% for 2H08) for RMBS transactions and to 5.62% of current balance (3.25% for 2H08) for auto loan ABS transactions.

Although South Africa's economy has been relatively more resilient than other countries within EMEA, with an expected contraction in GDP of only 2% in 2009, the economic environment remains weak. High debt-to-income ratios will continue to put pressure on borrowers' ability to pay, despite the South African Reserve Bank cutting interest rates from 12% in December 2008 to 7% in December 2009.

Inflationary pressures are continuing to creep up, threatening any further decreases in interest rates and also increasing household costs. Furthermore, if approved, Eskom's 35% per annum proposed increase in electricity tariffs for the next three years will provide an unwelcome shock to household outlays. Rising inflation, if combined with a slow economic recovery, will prove to be a poor combination for South African household borrowers.

According to Moody's, the negative performance outlook for South African auto loan ABS and RMBS remains unchanged from the previous update published in July 2009. The negative sector outlooks reflect the depressed economy and poor industry outlook, as well as expectations of delayed asset recoveries. Performance is anticipated to remain under pressure for 1H10; however, Moody's expects it will then begin to level off - although it will remain stressed compared to long-term historical trends.

As of December 2009, the total outstanding portfolio balance of Moody's-rated South African RMBS transactions stood at ZAR²6.9bn, which constitutes a decline of 15% over the past year. Despite the fifth tap issuance of Auto Series Investment in 2H09, the outstanding balance for auto loan ABS continued to contract to ZAR3.9bn from ZAR10.6bn in the previous year.

Issuance in 2010 is likely to be initially slow, but there may be signs of improvement in 2H10, largely driven by refinancing requirements. Total issuance in 2010 will largely depend upon the recovery of both the local and international credit markets and particularly the return of investor credit appetite at lower note spread levels.

Ratings

SMART extended to Indian ABS, RMBS

Fitch has launched its Surveillance Metrics Analytics Research Tool (SMART), an online web-based platform that provides monthly performance data, for Indian ABS and RMBS transactions.

"Fitch has launched SMART as part of its ongoing commitment to transparency and to provide timely and relevant risk information to Indian structured finance investors," says Dipesh Patel, senior director in the structured finance team at Fitch.

SMART gives credit analysts, investors and issuers the opportunity to analyse key performance trends, such as current credit enhancement, delinquencies, collection efficiencies and prepayments for each Fitch-rated transaction on a monthly basis.

Real Estate

COP warns of community bank CRE exposure

The Congressional Oversight Panel (COP) has released its February oversight report, 'Commercial Real Estate Losses and the Risk to Financial Stability'. The Panel says it is deeply concerned that a wave of commercial real estate loan losses over the next four years could jeopardise the stability of many banks, particularly community banks, and prolong an already painful recession.

The report notes that CRE loans made over the last decade totalling US$1.4trn will require refinancing in 2011 through to 2014. Nearly half are at present "underwater", according to the COP.

"Even borrowers who own profitable properties may be unable to refinance their loans as they face tightened underwriting standards, increased demands for additional investment by borrowers and restricted credit," it notes.

Community banks face the greatest risk of insolvency due to mounting commercial real estate loan losses. According to federal guidelines, 2,988 banks nationwide are classified as having a "CRE concentration".

None of these banks are among the 19 largest bank holding companies. Forecasts project that banks will suffer their worst losses well after the timeframe examined by the Administration's stress tests - an exercise conducted only on the nation's 19 largest bank holding companies - and well after Treasury's authority expires under TARP.

Because community banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery and extend an already painful recession, COP notes.

Regulation

Call for common regulatory approach

Together with dealing with Greece's budget problem, EU finance ministers were expected to address the recent initiative in the US on financial sector reform in a meeting on 16 February. President Obama's backing for the so-called 'Volcker' rule has thrown the evolving international consensus on the regulatory response to the financial crisis into doubt, according to International Centre for Financial Regulation director of research Richard Reid. A desire to avoid pushing risks to other parts of the financial system appears to be at stake.

"Although different jurisdictions have their own approach to the correct regulatory response, there is one strong common underlying theme - finding a way to make banks bear a bigger share of the tax burden involved in either rescuing them or for clearing up after financial failure," Reid comments.

For example, the recent G7 meeting in Canada seemed to favour a levy or fee to establish a stability fund. In addition, international debate has focused on the relative merits of crisis prevention versus containment and resolution.

Apart from linking higher capital requirements to the degree to which riskier activities are being undertaken, there has also been discussion over how much by way of capital buffers should be accumulated in the good times. "Of course, such buffers carry an economic cost in the sense that by holding higher capital than they would otherwise do in 'normal' times, this may crimp lending and therefore economic activity," adds Reid. "This is a cost that many electorates and governments may feel is no bad thing at present. But would that view hold in the future?"

Furthermore, relying solely on this regulatory response does not relieve the agency problem of financing banks, namely that investors will go on charging a premium for supplying large amounts of equity to finance banks in order to compensate for the risks of poor governance and mismanagement.

A number of suggestions have consequently been made for dealing with the issues of bank funding, 'too big to fail' and moral hazard. As well as contingent capital (SCI passim), an idea that appears to be gaining in popularity is that of an insurance 'policy'. This would involve giving banks the option of a higher capital requirement or of acquiring an insurance policy that pays in the event of a catastrophe.

Under this scenario, the insurer (say a sovereign wealth fund) would put a sum into a 'fund' of government securities, for example, and then receive both the premium from the banks and the interest plus the sum at the at the end of the life of the 'policy'. Such a premium is likely to be less burdensome than the higher capital requirement and so this might reduce banks' incentive to exploit regulatory arbitrage.

In any event, suggests Reid: "The banking sector itself seems now to be reconciled once more to having to accept more cost sharing. Exactly how this is applied is another question. The more the G20 and the Financial Stability Board can do to show a common approach, the easier it will be to avoid delaying tactics on the part of the financial sector which seeks to exploit indecisive or piecemeal responses on the part of policymakers."

Regulation

CMSA supports OCC regulatory proposals

Following US Comptroller of the Currency (OCC) John Dugan's recent remarks on the need for a vital and robust securitisation market (see SCI issue 170), the Commercial Mortgage Securities Association (CMSA) has announced its support, agreeing that certain accounting and regulatory standards may limit credit availability.

Dugan noted in a speech at the recent American Securitization Forum conference that he fully recognises the potential for counterproductive action and for swinging the pendulum too far in the accounting and regulatory response. "If we do not appropriately calibrate and coordinate our actions, rather than reviving a healthy securitisation market, we risk perpetuating its decline - with significant and long-lasting effects on credit availability," he said.

While the OCC did say it supports accounting and regulatory changes that more appropriately align securitisations with risk, it conceded changes make it more difficult for these transactions to qualify as true sales. CMSA agrees with Dugan's notion that an examination of each asset type as a means for incentivising better underwriting may have benefits, particularly since the regulator recognised that risk retention itself may not be the only solution.

CMSA remains concerned that risk-based capital changes, FDIC-proposed rulemaking and the proposed skin-in-the-game provision could, when combined, impede the recovery of the securitisation market. The CMSA says it is very encouraged that the OCC recognises several factors, including certain accounting reforms that could adversely affect capital levels when securitised assets are brought onto a balance sheet.

Patrick Sargent, president of CMSA says: "We believe the Administration's proposed new and unprecedented financial reforms must provide certainty and confidence in our markets and support, rather than impede efforts to restore private lending and investing critical to a commercial real estate recovery. With the number of key distinctions between CMBS and other ABS, we support OCC Comptroller Dugan in recognising the prudence required when fashioning broad securitisation-related regulatory reforms."

Regulation

'Protectionist' provisions reinserted in AIFM Directive

The Alternative Investment Management Association (AIMA) has warned that a provision of the Alternative Investment Fund Managers (AIFM) Directive that is currently being debated in Brussels is protectionist. AIMA's expression of concern comes after the publication of the most recent AIFM Directive compromise text by the current presidency of the European Council, Spain. The new text is being debated by the AIFMD Council Working Group in Brussels this month.

The Spanish text reinstates a provision from the original draft that may result in EU investors, such as pension funds, being prevented from accessing non-EU funds and managers (see SCI issue 147). The provision - Article 35 - had been removed from the Directive by the previous presidency, Sweden.

Under Article 35, non-EU based managers would only be able to market funds within the EU if there were co-operation arrangements in place between the regulator of the manager's jurisdiction and that of the EU member state in which the investors are located. Andrew Baker, AIMA ceo, says: "Stipulating that these co-operation arrangements must be in place sounds reasonable enough, but we are worried that they would be difficult to establish and to comply with. The practical consequence would be that the EU market would be closed to non-EU funds and managers, with obvious protectionist implications."

European institutional investors are currently free to seek out the best managers globally. Any restrictions imposed on European investors would also hit asset managers in financial centres, such as the US, Canada, Switzerland, Hong Kong, Singapore, Japan, Australia and South Africa, the Association says.

"With the Council Working Group debating the Spanish compromise text this month, this represents a critical moment in the process. We hope all parties concerned reflect on the global consequences of this provision and reach a sensible and workable solution," Baker comments.

Regulation

CML warns on BTL 'double regulation'

The UK Council of Mortgage Lenders (CML) has responded formally to the Treasury's consultation on whether to extend the scope of mortgage regulation in the UK to buy-to-let (BTL) loans. The CML agrees with the proposals to extend regulation to cover second-charge mortgages and to ensure that borrowers are sufficiently protected when mortgage books are sold on, but disagrees for several reasons with the proposal to extend "conduct of business" regulation to buy-to-let lending.

The CML says regulation should only cover acquirers when they take day-to-day decisions on the interest rate, other charges, service levels and arrears management. Where the power over these decisions has been delegated to a servicer or administrator, which is itself regulated for these activities, then there should not be "double" regulation. The Council cautions that it is also crucial to avoid unintentional problems for securitisation and covered bond transactions.

The CML says the proposal to extend regulation to buy-to-let loans would not result in increased consumer protection, would almost certainly capture an inappropriate range of commercial transactions and fails to address the issue of advice on whether to invest in property at all - which is much more likely to be a cause of consumer detriment than the mortgage itself. It is also, it says, the wrong way to address concerns about systemic risks, which are more appropriately addressed through prudential rather than conduct of business regulation.

RMBS

Italian RMBS protected against forbearance scheme

UniCredit has launched a scheme that is intended to curb any negative impact on its RMBS transactions connected with the Italian government's mortgage borrower forbearance scheme (Piano Famiglie). Affected transactions include the Cordusio, F-E Mortgages and Heliconus RMBS.

The Piano Famiglie scheme allows borrowers that meet certain criteria to enjoy a payment holiday period of a maximum of 12 months of either interest and principal or just principal (SCI passim). The criteria that borrowers have to meet to participate in the scheme are: loss of employment; receipt of temporary unemployment benefits (cassa integrazione) for more than 30 days; death of an income-producing family member or the occurrence of conditions of non self-sustainability; or termination of self-employment.

An additional condition is that one of the above events occurred between 1 January 2009 and 31 December 2010. Moreover, the mortgage loan has to be granted for an amount below €150,000 and the annual taxable income of the borrower has to be below €40,000.

Unicredit plans to provide loans to borrowers to facilitate payment on all amounts that fall under the payment holiday directly to the SPV. If the borrower was in arrears, the originator will pay all the arrears to the SPV, so that the loan is reclassified as performing. Ultimately, this process aims to mitigate any decrease in cashflow generated by the pool due to the implementation of the scheme.

European securitisation analysts at Deutsche Bank note that while the move could potentially defer default and ultimately exaggerate losses down the line, it at least removes the risk of imminent rating downgrades due to implementation by an RMBS issuer rather than a sponsor.

Moody's has affirmed all ratings on UniCredit's RMBS transactions, but also suggests that the scheme may delay the enforcement of non-performing loans and cause an increase of back-loaded defaults, which could be higher than those assumed at closing of the transaction.

"Government intervention across European jurisdictions is set to intensify in our opinion, as the political pressures of bailing out individuals rather than banks come to the fore," the Deutsche Bank analysts write. "Indeed, Ireland became the latest in a long line of countries, when the regulator formally announced that regulated firms must wait a minimum of 12 months before applying to the courts to commence enforcement proceedings on primary residences."

RMBS

Variability in EMEA issuer reports highlighted

Fitch has updated its issuer report grades (IRG) for all its rated EMEA RMBS transactions. The rating agency believes there is room for improvement in portfolio level issuer reports in conjunction with promotion of loan-level reporting data, as recently proposed by regulators (SCI passim).

Fitch has identified 33 (5.6%) reports within EMEA RMBS that receive the highest five-star rating, while 50 (8.5%) issuer reports have been judged as poor quality, thereby receiving a one-star IRG from the agency. The outstanding five-star reports were released by UK non-conforming issuers and set a high standard for other issuers. Of the one-star reports, most are Dutch issuers, which omit data relating to NHG loans, as well as some key factors, such as the outstanding balances of notes.

The updated scores reflect the implementation of Fitch's new criteria for the EMEA RMBS and structured credit (SC) sectors, which outline the methodology for assigning a score to the quality of the report.

In the SC sector, there is a high degree of variance in the quality, frequency and usability of performance reports, Fitch notes. Due to variations in portfolio composition and structural features, a report issued by a granular Spanish SME CLO will contain different performance information than a concentrated European CDO of privately rated leveraged loans. To address this variation within European SC, Fitch uses a sector-specific matrix for European SC based on the weakest link approach.

RMBS

Index reflects heightened subprime valuation concerns

Heightened concerns about the valuation of US subprime RMBS assets manifested in an across-the-board drop for all vintages, according to Fitch Solutions' latest RMBS CDS indices results. The US Subprime RMBS Price Index fell by just under 6% month-on-month to 7.17 as of 1 February, down from 7.62 from 1 January.

All vintages dropped in value, highlighting concerns about the valuation of RMBS subprime assets across the board, according to Fitch Solutions. Driving the declines was the 2007 vintage, which dropped by 17.7%, with the 2005 vintage falling by 9.5% month-on-month.

Recent loan-level analysis conducted by Fitch Solutions on the indices' constituents found that the 2007 vintage showed a significant jump in historical 90-day plus delinquencies, rising from 13.7% to 14.2%. "The rise in delinquencies is signalling a potential increase in 2007 loan defaults," says Fitch Solutions md Thomas Aubrey.

Further evidence of a potential rise in defaults is in the six-month constant default rate (CDR) for the 2007 (to 29.3% from 29.5%) and 2005 (to 23.68% from 23.71%) vintages, both of which fell only marginally. This is in stark contrast to much larger declines among the 2004 and 2006 vintages, the firm notes.

RMBS

UK non-conforming repossessions decline

The performance of the UK non-conforming RMBS market continued to stabilise in December 2009, according to the latest indices for the sector published by Moody's. Weighted-average delinquencies remained flat at 19.7% since November. This constitutes a minor increase from 19.4% recorded six months previously; however, the value is clearly above the 13.7% recorded in December 2008.

The rating agency notes that the repossessions trend continued the decline that began in February 2009, reaching 1.7% in December from 2.0% in November and 3.5% in December 2008. Sales of repossessed properties led to a further increase in losses.

The cumulative losses reached 1.5% in December 2009, which compares with 1.3% in November and 0.6% in December 2008. The total redemption rate fell into single digits, recording 9.7%, which is substantially below the 20.7% recorded in December 2008 and 31.9% in December 2007.

The current value indicates that if the present conditions persist, less than 10% of the currently outstanding non-conforming mortgage debt will be repaid in one year. Historically, the value was much higher due to refinancing opportunities available in the market, which allowed borrowers to prepay their mortgages while switching to another lender.

In 36 UK non-conforming transactions, reserve funds were not at their target levels. This has remained unchanged since November.

Two transactions have been able to increase their reserve fund levels from the available excess spread, while four transactions have further drawn on their reserve funds. 12 transactions have now fully depleted their reserve funds.

The current weak but stable performance of the UK non-conforming market is largely in line with economic forecasts. In its quarterly Inflation Report, the Bank of England predicts a slow recovery in economic activity, the strength of which remains highly uncertain.

However, the downside risks to the current economy are deemed to be smaller than expected in November. The unemployment rate is expected to continue to increase in 2010, peaking at 8.6% in Q210.

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

Moody's outlook for the UK non-conforming RMBS market is negative. A total of 127 UK non-conforming RMBS transactions have been launched and rated by the agency since 2001.

As of December 2009, a total balance of £25.6bn was outstanding in this market, compared to £29.6bn one year before. Since January 2009, no new UK non-conforming RMBS transactions have been issued.

Secondary markets

RMBS valuation methodologies 'converging'

Investors' default rate forecasts for collateral have risen dramatically in nearly all classes and vintages of US RMBS since S&P's previous quarterly survey. Meanwhile, predictions for European mortgage default rates have fallen across all classes and vintages, with the exception of Spain.

In January, S&P's valuation and risk strategies group undertook a quarterly Valuation Consensus Survey. For US, UK, Spanish, Dutch and Italian RMBS, S&P invited respondents to provide their valuation input assumptions at the asset class level, the vintage level and on a transaction-by-transaction basis.

Twelve-month default rate expectations on certain US RMBS collateral have doubled since the previous quarterly survey, with US 2007 Alt-A pay option ARM RMBS collateral default rate predictions rising to 25% from the 12% polled in Q3. For the same vintage, US prime fixed-rate collateral default forecasts rose to 5.75% from 4%; US prime adjustable-rate collateral default forecasts moved up to 10.5% from 6.25%; and US subprime collateral default forecasts increased to 34.36% from 23%.

By contrast, 12-month forecasts for UK non-conforming loan RMBS collateral default rates across an average of vintages fell to 4.61% from the 9% polled in Q3; for prime UK mortgage default rates, the 12-month average forecast for all vintages fell to just 1.09% from 2%; forecasts for Italian and Dutch mortgage default rates dropped to 1.21% and 1.32% respectively; while Spanish mortgage default expectations were stable at 2.8%.

Loss severity forecasts on all vintages and classes of US RMBS collateral have increased since the Q3 survey. Most significantly, 12-month loss severity assumptions on the mortgages behind US prime fixed-rate and US prime adjustable-rate RMBS have increased to levels close to alignment with the mortgages behind lower quality US Alt-A pay option ARM RMBS and US subprime RMBS.

For 2005, 2006 and 2007 US prime RMBS vintages, the average 12-month loss severity forecast for collateral is 59% (up from the 47% polled in Q3). However, for the same vintages of subprime collateral the forecast is 64% (up from 62% in Q3).

This contrasts with the UK, where 12-month loss severity estimates on all vintages of UK prime RMBS collateral dropped to 26.7% from 27.6%, and for UK non-conforming loan RMBS collateral to 33% from 36% in Q3.

The survey implies a bottoming out of US and European real estate markets before the end of 2010, with US national home prices expected to average a 5% decline over the next 12 months compared with a 5.8% fall predicted for UK house prices.

In contrast to the previous survey, European structured finance market participants are in broad agreement when the UK, Dutch and Italian national housing markets will trough, with 50% predicting Q410. However, they do not expect the Spanish housing market to trough until 2011.

In the US, most participants expect total non-agency RMBS issuance in 2010 to amount to less than US$10bn, excluding re-REMICs that securitise existing RMBS. US participants believe that RMBS transactions issued in 2010 will predominantly possess prime characteristics (with, on average, borrower FICO scores ranging from 721 to 740, coupons between 5.1% and 6%, and loan-to-value ratios ranging from 60% to 80%).

In the UK, however, the consensus appears to be for between £11bn and £25bn of UK prime RMBS issuance in 2010. The buy-side (33%) expects between £1bn and £10bn, while the sell-side (29%) predicts as much as £25bn to £100bn.

Peter Jones, senior director of S&P's valuations and risk strategies, says: "The figures from the latest survey show that there remain concerns for the performance of some classes of mortgage collateral, particularly in the US, and, further, that there remain some disparities between the valuation approaches of different sides of the market. Over the past 18 months it has proved difficult to deliver truly comprehensive methods for security and portfolio valuation. But, encouragingly, the results from our latest survey also imply signs of converging valuation methodologies within the structured finance market."

Structuring/Primary market

Corporates urged to diversify funding sources

Debt markets are likely to be severely squeezed in coming years, due to a continued significant withdrawal of banks from the syndicated loan market, warns Bishopsfield Capital Partners in its latest Market Insight publication. The report, entitled 'Bank de-leveraging in practice - considerations for European corporates', suggests that corporate borrowers should be planning early for any refinancing or extension of bank loans, as well as actively looking to develop alternatives to bank borrowing in order to avoid being caught out.

"We believe the syndicated lending market will contract for a further 2-3 years and that this will also put a lot of strain on the corporate - or corporate-sponsored - credit markets, which already have a massive pipeline of refinancing due in this timeframe," says Mike Nawas, partner of Bishopsfield Capital Partners.

The firm believes the contraction in bank lending will continue to be felt most in asset classes that offered excessive leverage in the past - leveraged loans and commercial property loans. This has been reflected in recent cancellations of IPOs by Travelport and New Look, in part on investor concern over their leveraged debt structure, according to Steve Curry, partner of Bishopsfield Capital Partners.

He says: "These events raise the issue that there could be a spill-over effect surrounding leveraged buyouts - from the loan to the equity markets - as equity investors shy away from companies that have excessive leverage."

As margins rise in response to over-demand for loans, corporate borrowers who have not developed other forms of funding will likely face an increased cost of capital and a reduction in future funding options. "Corporates that develop alternative funding sources early and strongly also stand to benefit by keeping their powder dry for future borrowing requests. If a unique growth opportunity presents itself that requires bank funding, it is more likely to be within reach," Nawas concludes.

Trading

Trading ideas: controlled recovery

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright long on Johnson Controls Inc

Johnson Controls delivered solid first-quarter results in January, bringing the company's bottom-line back to healthy status. While keeping costs down, margins, revenues and cashflow all reverted back towards 2007 levels.

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

Johnson Controls' fundamentals sunk to their nadir in the second quarter of 2009. Revenues sunk to a measly US$6.3bn for the quarter, a dollar amount the company has not witnessed since the year 2004. The company's margins and free cashflow also took direct and sizeable hits (see both Exhibits 1 and 2).

However, the issuer staged an incredible comeback towards the end of 2009, which certainly provided fodder for those who anticipated a V-shaped recovery. Its margins, revenues and cashflows all aggressively snapped back to 2007 and 2008 levels.

Management also controlled its total expense levels down at multi-year lows. Given the intensity and depth of the recent recession, we are certainly encouraged by the rebound and do not believe it is fully priced into the company's credit spread.

Johnson Controls' strong liquidity and leverage profile deserve mentioning. The company holds total debt of US$3.4bn, along with cash and equivalents of US$791m. It does not have any debt maturing until 2011 and its US$2bn revolver due in 2011 remains available.

From a liquidity standpoint, Johnson Controls should not come under any pressure over the next year. As far as leverage goes, the company's latest total debt to LTM EBITDA decreased down to 2.1x. As earnings continue to tick upwards, we expect the ratio to drop even further.

The company's market cap of US$18.7bn puts its debt-to-market cap leverage at only 18%. Both measures clearly show the company's leverage to be minimal.

We expect Johnson Controls' spread to drop below 100bp. The expectation, based upon our quantitative credit model, is due to its equity-implied, change in leverage, leverage and free cashflow factors. In the fall of last year, our model correctly forecast a 200bp rally in Johnson Controls' credit spread (Exhibit 3).

Since, there has been little deviation between its market and fair spread levels until earlier this year. The differential is currently at its widest level of recent months at roughly 35bp.

We believe its CDS will revert back to fair over the coming months and therefore recommend selling protection. Though we do expect its CDS to trade back down to its recent tights below 100bp, we will keep a tight stop-loss on the trade at 150bp.

Position
Sell US$10m notional Johnson Controls Inc 5 Year CDS at 127bp.

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

Copyright © 2010 Credit Derivatives Research LLC. All Rights Reserved.

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