Contents

ABS

Under pressure

MBNA UK credit card trusts bolstered

In a move that is being seen as a major positive for the programmes, given recent higher charge-offs and lower excess spread within the trusts, MBNA Europe Bank has chosen to support its CARDS I and II vehicles. The broader European credit card ABS market is nonetheless expected to remain under pressure, with weak unemployment data and the potential implementation of onerous regulation.

MBNA has issued and retained unrated subordinate notes to support each series of CARDS notes, thereby adding 20.4% of pro-rata amortising credit enhancement to the outstanding bonds. In addition, receivables assigned to the trusts will be subject to a 5% discount until July 2010, after which the discount will gradually be reduced by 1% a month.

The news sparked renewed interest in secondary credit card ABS paper. According to one ABS trader: "All the news has been good for credit cards in the last week. Credit cards are becoming quite positive both from a fundamental point of view and a technical point of view, so excess spread has increased on most credit card shelves."

He adds that MBNA's increased support is "something that the market didn't necessarily think was going to happen because for the US issuers it's a stand-alone European programme. The worry was that they would just let that one go."

ABS strategists at Barclays Capital suggest that a lack of action by MBNA could have had a negative impact on the US investor base, which is much more important strategically for the bank's funding strategy. "Hence, we believe the current action was meant to reassure that particular investor base, but will nonetheless benefit existing bondholders of the UK trust deals in the process, while also keeping the bank's options open if it ever decided to use the UK trust for funding purposes."

Further, one London-based broker believes that the move could also have wider implications for the market. "It's definitely going to help. We've seen a lot of interest in mezzanine, and this just reaffirms it. There's not enough paper to go around - there's a lot more demand than supply of mezzanine credit card ABS and that's going to continue," he suggests.

The subordinated note issuance increases credit resiliency, while the discounting will support yield and excess spread in the transaction for that period, note European securitisation analysts at Deutsche Bank. However, they warn that negative excess spread-induced early amortisation will be more of a risk when Libor rates come off their current lows - which is likely to happen after the discounting has been phased out.

All three rating agencies had the CARDS notes on watch negative in anticipation of a sponsor decision. Fitch and S&P affirmed the ratings of the class A notes and upgraded the class B and C notes of various transactions to A+/A (from A/BBB) and BBB/BBB (from B/B) following MBNA's announcement.

The newly issued Series 2009-A notes provide support for the series from Cards Trust 1, Series 2009-1 provides support to the linked series issued from Cards Trust 2 and Series 2009-2 provides support to the delinked issuances from Cards Trust 2.

S&P notes that its rating actions take into account the worsening performance of the trusts since its previous credit watch placements, with its revised base cases reflecting this. For Cards 1, it has increased its charge-off base case to 14% from 11.5%, increased its yield base case to 20% from 18.0% and decreased its payment rate base case to 9.5% from 10.5%. For Cards 2, it has increased its charge-off base case to 15% from 12%, increased its yield base case to 20% from 17% and decreased its payment rate base case to 11% from 12.5%.

However, Fitch says that the increased credit enhancement levels, recent stabilisation of the charge-off rates, declining delinquency levels and modest reductions in the percentage of receivables subject to debt management plans support the stable outlooks it has assigned to class A notes and the positive outlooks assigned to the class B and C notes. Significant future deterioration in these performance metrics, relative to the current levels, would likely lead to negative rating actions.

In addition, with respect to the 2003-B and 2003-C series, Fitch notes the participation of US-based swap counterparties - JPMorgan Chase Bank and HSBC Bank USA respectively. Therefore these series remain subject to ongoing review with respect to the possible priority of any termination payment payable in the event of a default of the swap counterparty, it comments.

Meanwhile, the broader UK credit card ABS sector is likely to remain under pressure in the coming months. For example, the BarCap strategists suggest that the loss of capital relief from any future issuance from the CARDS trusts - combined with the significant increase in credit enhancement for all rating classes - signals there is limited incentive for the originator to try to tap the securitisation market going forward.

The Deutsche Bank analysts also point out that "recent weakness in UK unemployment data suggests the peak could be ahead of us". Additionally, with the US CARD Act - which will restrict various fees and rate increases (see separate News Round-up story) - coming into force, it is possible that UK regulation could become more onerous and thus limit yield generation in credit card trusts.

JA & CS

CLOs

Extension differentiation

CLO extension risk weighs on senior noteholders

Extension risk is a growing concern for senior CLO noteholders, as collateral managers increasingly look to extend underlying leveraged loans. However, there appear to be important differences across managers in the degree to which they have pursued the extension trade.

Angus Duncan, partner at Cadwalader, notes that CLO loan extension activity is an example of the potential conflict between junior and senior noteholders. "It depends on where an investor is in the capital structure: if they're a triple-A noteholder, it is more likely that it will be in their interests for the loan to be paid down; but if they're an equity investor, they would probably prefer the loan to be extended given the issues with reinvestment currently. Equally, for the sake of its junior fee, a manager may be incentivised to extend," he explains.

He adds: "It remains a challenging issue - who is the manager managing for? Triple-A investors have control as per the documentation, but within those constraints CLO managers also have to look towards the interests of equity investors."

The issue nevertheless points towards a CLO manager managing properly and looking at each investment on a case-by-case basis, according to Duncan. "If the deal is performing well, the manager might not need to generate more return by extending. It's a question of balancing credit risk and performance."

Loans backing transactions that have completed their reinvestment period will pay down if they haven't been extended. At the same time, if there is a concern about the debtor, the loan is unlikely to be extended.

Duncan expects the strain between such competing interests to continue, particularly as there are few signs that reinvestment in the leveraged loan market is becoming any easier. "There are some indications of new activity, but I expect it to continue to be a problem at least for the rest of the year," he says.

Structured credit analysts at Barclays Capital recently undertook a study of CLO loan extension activity and found that collateral managers have actively participated in extension opportunities and in many cases have replaced some of their exposure to shorter maturity loans with exposure to a longer maturity loan. However, the analysts also suggest that there are important differences across managers as to the degree of their loan extension activity.

Of the 130 managers analysed by Barclays Capital, 40 did not extend more than 50% of the extension candidate loans and 20 chose not to extend more than 75%. On average, managers had five to six extension candidates to decide on in their deals. The loans could have appeared multiple times across the deals.

Barclays restricted its attention to the managers that had at least four or more extension candidates to consider. Kingsland, for example, had five extension candidates across five deals and chose not to extend in 95% of the cases.

"Interestingly, managers with a large number of exposures - e.g. Ares (8), Katonah (9) and Sankaty (11) - seemed to apply the same decision across deals for a given name rather than making the same decision across names for a given deal," notes BarCap. "Although these are still very preliminary data and do not predict future manager behaviour, they do seem to suggest that managers are taking credit views on names rather than structural views regarding the CLOs."

CS & AC

RMBS

Upside opportunities

US HPA consensus emerging

Both ABX and subprime cash triple-As have been trading in a narrow 1-2 point range since mid-January, albeit on light volumes. Such stability suggests that a home price affordability (HPA) consensus is gradually emerging in the US.

A recent JPMorgan poll on expectations for future home prices shows that almost 70% of investors expect HPA to drop by approximately 8% from current levels, or a peak-to-trough of -35%. "The responses show that the Armageddon view for housing has nearly completely disappeared off investor radar screens," ABS analysts at JPMorgan note. The bank's own HPA model has a base-case scenario of -34.7%.

Indeed, based on the view that current market default assumptions are too punitive, JPMorgan maintains an overweight recommendation on subprime cash bonds. "Bond prices attach little upside to either a potential slow-down in delinquency transitions or to loss mitigation strategies (short sales, loan mods)," the analysts add. "To be clear, we do not expect loss mitigation strategies to provide enormous benefits in the subprime space; however, even modest reductions in defaults (3%-4%) can enhance yields by 2%, given low cash bond prices."

Hedge funds and asset managers are said to be looking at the bonds one below the top of the capital structure in the belief that liquidation timelines will extend and the housing market is likely to rally in the coming months. One ABS strategist indicates that such a trade could provide the double-digit returns that they were used to last year. "The numbers that are really going to move the sector will be unemployment and a sharp reversal in housing, from the Case-Schiller Index, for example," he adds.

The US secondary RMBS market has been relatively quiet following the announcement of Freddie Mac and Fannie Mae's buy-out plan (see last issue). One ABS trader reports that what activity there is remains cautious. He says: "There are people who are looking at opportunities, but they're being selective. They don't feel like there's any urgency."

In particular, banks are looking at the restructuring of mortgages and resecuritisation markets. The trader continues: "They're able to get a 5%-6% yield, which would be a better alternative than going into the agency-wrapped product, which is going to be 3%-4%."

The strategist agrees: "What people tend to be focusing on at the moment are the headlines and the macro picture." He adds that the GSE buy-out has wider implications for the market, especially in terms of the growing concerns regarding shadow inventory. "Approximately seven million homes are expected to liquidate over the next few years. If the buy-out programme continues, half the shadow inventory will be in loans that are backed by Fannie and Freddie."

Meanwhile, the number of homeowners converting to permanent modifications under HAMP continues to rise, according to data from the US Treasury and the Department of Housing and Urban Development (HUD). More than 116,000 homeowners now have permanent modifications, nearly doubling the number from December - which also marked record progress, the two government agencies say.

An additional 76,000 permanent modifications have been offered and are waiting only for the borrower's signature. In total, over one million homeowners have started trial modifications and nearly 1.3 million offers for trial modifications have been extended to homeowners.

At the same time, the JPMorgan analysts observe that over the past six months short sales have begun to increase as a percentage of liquidations across the non-agency space. The key advantage of a short sale is the reduced loss severity compared to liquidation out of REO, they note.

For RMBS investors, short sales also offer some advantages relative to loan modifications. For example, they side-step certain moral hazard issues in that a loan will leave the trust with a certain loss severity and won't attract borrowers that could pay, since they must leave their home upon the short sale.

JA & CS

Insurance-linked securities

ILS issuance on hold as secondary prices rise

Despite a continuing steady flow of maturing catastrophe bonds and potentially sponsor-attractive conditions, details of the 2010 issuance pipeline remains thin on the ground. With few deals expected to materialise in the near future, secondary market prices are moving ever upwards.

The continuing lack of new cat bond issuance in the face of unprecedented demand is raising concerns. Deal sponsors should theoretically be trying to rush out deals, given the low level of coupons they could reasonably expect to pay. But it appears that the tradition - as seen in the 'normal' times of 2008 - will prevail, with little or no issuance in the year until May.

Notable among recent maturities is Nephila Capital's collateralised risk obligation (CRO - SCI passim) Gamut Re. The deal matured on 31 January and while discussions about eventually launching similarly structured deals in the future are said to be continuing, difficulties in the credit markets preclude any such transactions in the next few months.

The lack of primary supply helped drive up secondary market prices throughout January and consequently the mark-to-market of participants' positions at month-end. So, as one investor says: "It's come as something of a surprise that we've seen secondary prices increase considerably over the past two weeks."

Cat bond prices had been heavily discounted in the secondary market since the fourth quarter of 2008 as a direct result of the financial crisis, but since mid-2009 levels have been heading back towards where they had previously traded. "Now we have stepped back over that threshold and 2009 vintage bonds have gone ever further," the investor says.

All 2009 deals are currently trading above par, with some being offered as high as 112. The perception of last year's bonds as having stronger collateral structures - but still offering higher coupons than sometimes available elsewhere - and longer outstanding maturities are their key attractions.

However, the lack of transparency in the secondary market as a whole means that it is unclear whether such elevated prices have actually been executed. Some participants report that - despite ever-increasing dealer prices - sellers are still very hard to find. Certainly, because the ILS market is small and illiquid dealers have no choice but to continue to put prices up until sellers, and indeed, buyers put on trades.

Nevertheless, few participants are concerned, given that this kind of activity is not anything that hasn't been seen before in the ILS market. But it does raise questions about how this current spate of activity will play out. Consensus appears to be that while the market is technically experiencing a bubble, that bubble will not burst in the same manner as others given that the bonds will, in the end, almost certainly mature at par.

MP

RMBS

Fed tightening to help MBS settlement failures?

Continuing trade settlement failures in the agency RMBS market, if left unaddressed, could result in higher regulatory capital requirements for dealers. However, the US Fed's decision to begin rolling collateral in March is expected to help remedy the situation.

Moody's outlines in its latest Weekly Credit Outlook what it believes to be the drivers of the continuing trade settlement failures in the agency RMBS market - extremely cheap carry costs, tight MBS spreads and Fed purchases of newly issued agency securities. In other words, failing has become cheap and not failing relatively more difficult.

One US-based investor agrees that failing is a cheap option at present and suggests that a systemically high fail rate is likely to continue until there is more supply in the system. "It will be interesting to see how rolling the collateral will impact the situation," he says. "The fails haven't been too disruptive so far, but it makes sense to resolve the issue, given that it could eventually become disruptive. A similar scenario occurred in the early-1990s, when interest rates were low, when the 4.5 coupons repeatedly failed for almost two years."

According to Alexander Yavorsky, vp-senior analyst at Moody's: "In addition to creating operational friction in the market, today's abnormal amount of fails, if left unaddressed, will lead to higher regulatory capital requirements for dealers and will also increase their balance sheet leverage. In the extreme case of a large dealer's default, unsettled trades would also expose counterparties to market risk and potential losses."

A trade settlement failure occurs when the seller fails to deliver securities on the settlement date. Both buyers and sellers are exposed to market risk if their counterparty defaults before the securities are delivered because the buyer/seller would have to buy/sell them in the open market for a potentially higher/lower price. 'Fails to receive' and 'fails to deliver' are assessed capital charges under the SEC's net capital calculation, which could be problematic for dealers with modest capital cushions, Moody's notes.

One failure can lead to a 'daisy-chain' of failures, if - having failed to receive securities in a buy trade - a dealer cannot deliver them in a sell trade. In addition to explaining the spiky nature of fails, this cascading effect can balloon a dealer's balance sheet, since fails will be represented as 'receivables from brokers/customers' asset and 'payables to brokers/customers' liability with no change in equity.

There are two other reasons why failures occur. First is naked shorting, where the seller sells an MBS security he does not own, for hedging or speculative purposes, and then 'procrastinates' on covering the short hoping that prices will fall. Moody's suggests that this becomes attractive when MBS is priced 'richly', as is now the case.

The second reason is when sellers choose to sift through MBS pools to find the cheapest-to-deliver bond based on prepayment rates, which can be a time-consuming process. In both cases, when a seller fails to deliver they don't receive cash that they can invest at the risk-free rate.

"But, with the Fed funds rate at an all-time low, failing has become very cheap. Currently, 'fails to deliver' exceed 'fails to receive' by about US$100bn - a good measure of 'intentional' fails," Yavorsky observes.

Further, dealers are finding it hard to source (borrow or buy) MBS for delivery. The Fed has purchased most of the 2009 agency MBS issuance and is now estimated to hold 20% of all agency MBS.

"Because the Fed neither lends these securities nor actively puts them back into the market through the dollar roll channel, finding the right securities to deliver has become more difficult - leading to higher incidences of 'daisy chain' failures. Preventing failures, then, could be another reason for the Fed to begin quantitative tightening," Yavorsky concludes.

CS

ABS

Senior hires added to SF team

HSBC has made two new senior appointments within its structured finance team, reporting to head of structured bonds for the EMEA region, Katrina Haley.

Stephane Derouvroy will take on responsibility for structured bond origination in France, Spain, Portugal, Greece and Benelux. Prior to this, Derouvroy worked within HSBC as head of structured finance for France and Benelux and co-head of debt capital markets in France. He will continue within these roles, in addition to his new appointment.

Matthew Bailey joins as a director to work across asset classes and geographies with a particular focus on structured bond origination in Germany, the Nordic countries, and Central and Eastern Europe. Bailey joins HSBC from Commerzbank, where he was a director responsible for ABS origination and asset management.

Bailey has over 13 years' experience in originating and structuring asset-backed financing transactions, having previously worked at UBS and Barclays Capital. He will be based in London and report to Scott Dickens, head of structured finance, debt capital markets in addition to Haley.

ABS

ABS research head retires

Deutsche Bank's global head of securitisation research, Karen Weaver, has left the bank. She is understood to have retired, having opted to work on a part-time schedule two years ago. Weaver joined Deutsche in 2000 and was previously head of ABS research at Credit Suisse.

The remaining members of Deutsche's US securitisation research team report to Steve Pollard, md and head of global markets research in the US. Weaver's departure does not affect this reporting structure.

Advisory

Research duo land at credit hedge fund

The team at PVE Capital, investment adviser to the Matrix PVE Global Credit Fund, has recruited to new investment professionals - Elena Ciampichetti as head of credit research and Judith Newman as research analyst.

Ciampichetti has over 16 years' experience in credit markets, having most recently worked at Citi as an md in fixed income. Her last assignment was to head leveraged loans analysis. Before Citi, she worked at Credit Suisse and Merrill Lynch.

Newman has worked as a credit analyst for 15 years, previously at Legal & General Investment Management, Julius Baer Asset Management and most recently at Credaris with PVE Capital partners Gennaro Pucci and Christian Evans.

The assets on which PVE Capital now advise have increased to over US$300m. The Matrix PVE Global Credit Fund, a joint venture between PVE Capital and Matrix, seeks to take advantage of the unique opportunities in global credit markets by trading in a broad range of liquid credit instruments, both long and short.

Chris Merry, ceo of Matrix Group, says: "The tremendous growth in assets is clear recognition of Gennaro's outstanding long-term track record and these significant hires will ensure that the team is well positioned to maintain this record. Elena and Judith will provide the important fundamental support and source pockets of value, which arise in the market through this cycle."

Gennaro Pucci, manager of the Matrix PVE Global Credit Fund, adds: "Our core prediction from last year was for renewed volatility at the macro level of the fixed income markets and this has now arrived. We have officially entered the aftermath of the financial crisis and we continue to expect that any recovery in economic conditions will suffer from significant spikes in volatility."

He continues: "The levered long credit strategy which has characterised 2009 seems over and credit managers will have to deal with the profound implications that this crisis has exposed for risky assets in general and credit assets in particular. Our core preference is still to maintain an exposure to collateralised assets, while expressing our short-term views on the cycle by trading actively and nimbly in liquid instruments."

Advisory

Investment advisory role swapped

SciVest Capital Management has assumed investment advisory responsibility for Global Credit Pref Corp and its underlying trust Global Credit Trust from Redwood Asset Management subsidiary Gatehouse Capital. Global Credit Pref Corp is a mutual fund corporation that issued 10-year redeemable, retractable cumulative preferred shares. The corporation has exposure, by way of an equity forward sale agreement, to a structured CLN issued by Toronto-Dominion Bank and held by Global Credit Trust, the return on which is currently linked to the credit performance of 120 reference entities.

The passive nature of the reference portfolio and investment objectives for the corporation have not changed as a result of this change, nor has any of the other service providers to the corporation or trust been affected, Gatehouse says.

Advisory

Cross-market trading advisory launched

Credit Derivatives Research (CDR) has launched a new equity options volatility (vol) advisory service, providing clients with trading ideas, strategies and data. The new vol service recommends strategies for trading contracts on equity options and for cross-market trades between equity options, bonds and credit derivatives.

"Our product uniquely integrates fundamentals and market data across credit and equity markets to identify the best opportunities for trades," says Byron Douglass, co-manager of the vol service. "This is a profitable tool for equity volatility traders, relative-value traders, option market-makers and anyone who seeks to take hedging or speculative position in options or across markets."

He adds: "By providing a view of implied volatility from a credit perspective, we plan to help clients identify profitable trading opportunities."

CDO

Broker adds in CDO sales

Broker-dealer Auriga USA has recruited Steven Hilfer as an md. In his new role he is responsible for sales and trading of illiquid structured products, focusing on CLOs and CDOs.

Hilfer was previously senior director of business development at Experian for a year. Prior to this, he was an md at Credit Suisse, managing the bank's US CDO structuring team.

CDO

Bank adds structured credit pros

Declan Tiernan has joined UBS as European head of European FICC structured product syndication. Tiernan was formerly head of structured credit distribution at Deutsche Bank, before joining Sciens Capital in January last year.

UBS has also hired Fabien Baetz as head of FICC ETF structuring within FICC. Baetz was previously a director within the structured credit team at Merrill Lynch, having worked most recently at Orchard Global Asset Management.

CDS

Derivatives specialist joins law firm

Mayer Brown has appointed international derivatives specialist Josh Cohn as a partner and leader of the US derivatives and structured products practice, and co-leader of the global derivatives and structured products practice in its New York office. Also named a co-leader of the practice is Edmund Parker, who is also leader of the derivatives and structured products practice at Mayer Brown's London office.

Cohn was previously a partner in the New York office of Allen & Overy and a member of its international capital markets practice. He represents dealers and end-users in a wide range of transactions and has extensive experience as US counsel to ISDA.

Cohn has been most recently involved in many aspects of derivatives and structured transactions in insolvency and dispute, as well as in clearing house and regulatory reform. Prior to joining Allen & Overy, he was a derivatives counsel at Cravath Swaine & Moore in New York; an svp and general counsel at DKB Financial Products; and a first vp and counsel at Security Pacific National Bank.

CDS

Fitoussi heads to RBC

RBC Capital Markets has hired Bertrand Fitoussi as an md and head of European structured interest rate sales. Fitoussi moves from Société Générale, where he was deputy global head of structured rate products, having previously headed up the bank's structured credit business.

Based in London, Fitoussi will report to Avril Pomper, head of fixed income and currencies and financial products sales, Europe.

CDS

ICE Trust replaces president

IntercontinentalExchange has appointed Christopher Edmonds president of ICE Trust, its US CDS clearing house. Edmonds replaces Dirk Pruis, who has left to spend time with his family before pursuing further professional interests.

Edmonds has over fifteen years of risk management and market experience, including serving as chief development officer for ICAP Energy and ceo of ICAP Futures. Most recently, he was ceo of International Derivatives Clearing Group. As president of ICE Trust, Edmonds is responsible for managing the operational and regulatory aspects of ICE Trust.

CDS

CDS, monoline exposures commuted

Swiss Re says it has terminated substantially all of its exposures in portfolio CDS and liquidated several other CDS positions. Financial guarantee exposure was also significantly reduced by the commutation of CHF9.2bn notional protection. The firm expects a further significant reduction in remaining legacy exposures in 2010.

Swiss Re returned to profit in 2009, reporting net income of CHF506m, compared to a loss of CHF864m in the prior year. Net income was impacted by impairments of CHF2bn, mainly in the securitised products portfolio and by mark-to-market losses of CHF1.9bn on corporate bond hedges.

CLO Managers

CDO manager acquired

MJX Asset Management has acquired 250 Capital, an affiliate of Merrill Lynch. 250 Capital will continue to provide services in connection with the US$1.4bn Liberty Harbour CDO 2005-1, the US$308m North Cove CDO and the US$2.6bn North Cove III CDO, however.

"This strategic acquisition demonstrates our commitment to growing our structured credit business, along with our corporate credit business," says Hans Christensen, MJX ceo. "We continue to aggressively explore other such opportunities."

MJX manages over US$4.1bn of corporate credit assets and provides consulting services on more than US$14bn of structured credit assets.

CMBS

CRE services firm expands capital markets group

Peter Ruggiero and Lisa Birrittieri have joined CRE services firm Cassidy Turley's capital markets investment services group. Ruggiero will serve as md of US capital markets and Birrittieri will assume the role of vp for US capital markets. They both come from Colliers Investment Services Group.

Bill Collins, senior md of capital markets for Cassidy Turley, says of the two hires: "They strengthen our capabilities to provide investment sales, mortgage brokerage, joint venture structuring and structured debt/equity placement on a local, national and global basis. Their abilities will further ensure that we meet the varying needs of our corporate, institutional and investor clients through an integrated platform designed to provide world-class expertise backed by our deep connections and local market knowledge."

Based in New Jersey, Ruggiero has more than three decades of experience in investment sales and financing. He led a team of more than 50 senior investment sales professionals as national md of the Colliers investment services group. In this role, his team completed more than US$60bn in investment sales and financing transactions. Prior to Colliers, he served as a senior executive for Prudential Real Estate Investors, overseeing more than US$4.5bn in transactions.

Birrittieri joined Colliers in 2004, where she served as practice group manager for six to eight specialty practices. In 2006, she was promoted to vp in Colliers' investment services group. She became responsible for internal and external business development initiatives. Lisa also spent ten years with State Street Global Advisors.

The newly rebranded Cassidy Turley comprises: Colliers Turley Martin Tucker, Cassidy & Pinkard Colliers, Colliers Pinkard, Colliers ABR, BT Commercial in Northern California, BRE Commercial in Southern California, BRE Commercial in Arizona and Colliers Houston & Co. of New Jersey. The new brand will be officially launched on 1 March.

CMBS

Commercial mortgage fund to wind down

Colonial First State intends to liquidate the Colonial First State Mortgage Income Fund and begin a process of returning capital to investors. The fund totals A$852m in assets under management and is invested primarily in commercial mortgages and related securities.

Colonial ceo Brian Bissaker says "Winding up the fund and commencing the process of making quarterly proportional capital payments is the most equitable way to return capital to all investors."

Following a review of the fund, Colonial identified a small number of mortgages in its portfolio that had the potential to become bad debts. As a result of these developments, provisions have been taken within the fund to cover potential losses from these loans by reducing the income distribution rate paid to investors.

Consequently, the fund is unlikely to make income distributions to investors for approximately 18 months. Once provisions for loan defaults have been recouped, it could continue making monthly income distributions.

The fund was suspended in October 2008 and redemption requests through periodic withdrawal offers have consistently exceeded the cash available for payment. As part of the termination process, Colonial intends to provide quarterly capital payments to investors.

At the first capital payment in late March 2010, investors will receive at least 10% of their total account balance. Subsequent capital payment amounts will be determined by the cash available from mortgage repayments.

Payments will continue until all assets have been converted to cash and net proceeds paid to investors. Due to the maturity terms of the mortgages, completion of the wind-up is expected to take at least four years. There are currently approximately 480 loans in the portfolio that mature at various times, with the last of these maturing in 2014.

Separately, Colonial has also decided to terminate its Wholesale Guaranteed Mortgage Fund. This fund comprises US$13m in assets under management, with exposure to 13 loans.

The Wholesale Guaranteed Mortgage Fund, which has been closed to new applications since 2004, invests in a separate pool of mortgages that have not been impacted by bad debts to date. The decision to terminate the fund has been made on the basis of its small scale and the demand for repayment of capital from investors.

CMBS

CRE firm steps up servicing presence

Waterstone Asset Management has received a special servicer rating from S&P as the firm looks to expand its presence in US CMBS special servicing.

"The present marketplace for commercial mortgages and CMBS is a space in need of additional capacity for work-out of distressed debt as more and more commercial mortgage loans in default or at risk of imminent default are being transferred to special servicers," says John Church, ceo of Waterstone. "We are bringing a team of seasoned commercial real estate professionals to the special servicing market, ready to pick up business and address the growing volume of distressed loans on behalf of investors. This includes investors in CMBS securities who find themselves as the new controlling class representative for the CMBS trust, with the resulting need to appoint a new special servicer [see last issue]," he adds.

While prepared to handle loans owned by CMBS trusts, Waterstone Asset Management is also actively pursuing the servicing and asset management of loan pools from failed banks being sold by the FDIC and from other financial institutions seeking to dispose of certain loans on their balance sheets.

Waterstone was formed in 2004 by a core group of senior Wachovia Securities professionals, initially entering the commercial real estate capital markets as a CMBS defeasance advisor. More recently, the firm has expanded into a wider range of business lines, including primary servicing, special servicing, REO asset management, due diligence, underwriting and consulting.

Operations

Default servicing vp hired

Joseph Prat is to re-join Franklin Credit Management Corporation (FCMC)'s management team as vp of default servicing. In this role, he will be responsible for the default operations of the firm's servicing and recovery departments, including investor reporting.

For the past three years, Prat has served as a senior data architect at Fortress Investment Group, where he created, managed and implemented a data warehouse and related infrastructure for subprime mortgage origination and servicing applications, managed a team of information technology developers and worked closely with senior management and asset managers. Prior to this, he was employed by FCMC for approximately five years as vp of the management information system and information technology department.

Jimmy Yan, evp and md of servicing and recovery operations at FCMC, says: "Joe Prat brings a wealth of experience to Franklin and will be instrumental in our introduction and implementation of new asset resolution strategies and improved investor reporting for our clients."

RMBS

Servicing solutions firm hires two

The National Groups has hired Mitchell Oringer and Richard Fikani, filling two new leadership positions.

Oringer will assume the role of senior md for REO/loss mitigation operations at the firm. He was most recently with Titleserv National Default in Austin, Texas, where he was svp of loss mitigation services. Oringer brings more than 20 years of experience in the REO and loss mitigation industry to The National Groups, including senior positions with Indymac Federal Bank, GMAC Rescap, GMAC Mortgage Corporation and Clayton National.

Fikani steps in to the new position of md of default services for The National Groups. He also comes to the firm from Titleserv National, where he was vp and director of operations. Previously, Fikani was evp of mortgages for Wachovia Corporation in Charlotte, North Carolina.

The National Groups provides default services through utilisation of flexible technology, including ISIS, the firm's proprietary web-enabled default solution and data warehouse.

Technology

Risk software provider adds to board

Calypso Technology has named Masood Jabbar to its board of directors. He is the fifth independent director appointed to the board.

Jabbar is a 30-year veteran of the technology industry, having previously spent 16 years at Sun Microsystems, where he ended his tenure in 2002 as evp of global sales operations. In this capacity, Jabbar was responsible for all sales and support activities for the company. Prior to this, he was the president of Sun Microsystems Computer Corporation, where he ran the multibillion dollar business unit that developed, manufactured and marketed desktop and server computing systems.

Jabbar currently sits on the board of directors at Silicon Image, JDS Uniphase and RF Micro Devices.

Jabbar joins four other independent directors on Calypso Technology's board, including former PeopleSoft cfo Ronald Codd, former Credit Suisse First Boston global cio Frank Fanzilli, former BankOne evp and head of the international group Barry Sabloff, and former Veritas Software evp of worldwide field operations Paul Sallaberry. Kishore Bopardikar, the company's president, and Charles Marston, the company's ceo, have served and continue to serve on the company's board of directors since the company's inception.

Trading

Boutique expands credit sales and trading team

Heritage Capital has made four key appointments to its sales and trading team. Niels Nooy joins as md and head of emerging markets trading for EMEA and Latin America, reporting directly to Henry Nevstad, head of markets and execution at the firm. In addition, Veronika Orekhovskaia, Michael Rimmell and Severine Carayon join as directors in its London office.

Prior to joining Heritage Capital, Nooy most recently worked at Phoenix Partners Group, a credit derivatives broker, where he was responsible for launching and building its emerging markets group. Before that he worked at a London-based family office, where he focused on private equity investments and helped establish Global Evolution, an emerging markets asset manager based in Denmark. He has also worked at Paribas Capital Markets, ING Barings and Merrill Lynch.

Orekhovskaia joins Heritage Capital's emerging markets team as a director, responsible for developing client relationships with asset managers dedicated to the emerging markets asset class. She comes from private bank Lombard Odier Darier Hentsch & Cie. Before that she was head of fixed income sales for Russia and CIS at BNP Paribas, and held a similar role at Dresdner Kleinwort Wasserstein.

Rimmell joins as a director responsible for developing relationships with clients in the UK and Ireland, particularly asset managers, hedge funds, bank treasuries and building societies. He has experience within the financial institutions sales sector, with long-standing relationships in most European countries.

He comes from Natixis in London, where he was head of sales, responsible for a team focusing on Germany, Switzerland, Austria and Scandinavia. He worked at Commerzbank before Natixis, covering Switzerland, before expanding coverage to the UK and Ireland.

Finally, Carayon joins as a director responsible for covering France. Carayon started her career at CDC Ixis in London on the credit flow trading desk in 2001. She then joined BNP Paribas in 2004 as a CDS and bond trader, covering the telecoms, media and technology sectors in Europe. Carayon joins from Kyte Group-Market Securities, where she worked most recently in credit sales.

Joe Dryer, joint chief executive of Heritage Capital, says: "With the appointment of Niels and Veronika we are not only strengthening our origination and distribution platform in emerging markets, but also broadening our penetration of core European clients with the addition of Michael and Severine."

Nevstad adds: "Together with Niels, these three new hires are powerful additions to the trading and sales team and will help deepen Heritage Capital's distribution channels to key investor accounts."

Trading

New vp for SF analyst team

Advantus Capital Management has promoted corporate bond analyst Erica Bergsland to the position of vp and director of research and trading. She will oversee the firm's 11-person fixed income and structured finance analyst team, as well as the trading group.

Bergsland entered the investment industry in 1983 and joined Advantus in 1993, as an investment officer. She says: "I believe an analyst's fundamental job is to frame risks well. I envision expanded use of new technologies to give our analysts even more tools to help them glean meaning out of today's vast information sources."

Previously, Sean O'Connell oversaw real estate and structured finance research, while John Leiviska oversaw corporate bond research. They, along with Craig Stapleton, are now portfolio managers and join Drew Smith in succeeding Lynne Mills, who has been a senior portfolio manager since 1999. Mills is retiring in March.

ABS

Trade receivable ABS opportunities mooted

Trade receivables have proved a popular choice of asset for securitisation in recent times due to their short maturities, relatively straightforward deal structures and ability to provide companies without a top credit rating access to the capital markets. Securitisation lawyers at Dechert expect trade receivable ABS to continue to see demand as the global securitisation market recovers.

An increased need for working capital on both sides of the Atlantic has resulted in many global corporations financing their European operations by methods more commonly seen in the US - via trade receivable securitisations. In addition, some lenders have been looking to Europe for short-term receivables assets because of a perceived saturation of the US trade receivables market and the appearance of room for growth on the continent.

Today, the majority of trade receivables in Europe are produced in England, France, Germany, Italy, Spain and the Netherlands. Dechert notes that there are several jurisdiction-specific issues that arise in multi-jurisdiction European trade receivable securitisations, such as currency risk, VAT considerations, true sale and legal considerations, consumer privacy and forms of payment ¬- and the time it takes to clear such payment in various different jurisdictions.

The law firm therefore recommends a longer lead time, should a multi-jurisdictional European trade receivable ABS be considered. "Whereas many US trade receivables opportunities may have already been absorbed by the market (or simply moved from one conduit to another), new opportunities are still available in Europe, particularly in relation to cross-border transactions," Dechert concludes.

ABS

US credit card ABS to face increased pressures

US credit card ABS trusts are well-positioned to offset performance repercussions from changes to US credit card regulations that went into effect on 22 February, according to Fitch. Despite this, the rating agency believes that credit card companies are set to face more acute pressures.

Fitch md Michael Dean says: "The impact on card performance variables will be felt most noticeably in gross yield, which will decrease slightly in the short to medium term. The resulting implications for performance measures are not likely to precipitate any rating actions for credit card ABS."

However, from a corporate perspective, Fitch senior director Meghan Neenan says: "Negative rating actions are a possibility this year for credit card companies as Fitch assesses competitive responses to the legislation and the resulting impact on issuers' longer-term profitability."

Fitch explains that many issuers proactively altered their business models and implemented portfolio-wide pricing changes over the last 12-18 months (SCI passim). In light of these changes, consumers can expect improved disclosure, a more favourable payment allocation, elimination of double-cycle billing and more predictable due dates.

With new limits on the issuers' ability to charge certain fees and to change interest rates dynamically, Fitch expects gross yield to decrease by 100bp-200bp over the coming months. Gross yield is comprised of interest, fee and interchange income expressed as a percentage of principal receivables. Although it will be more difficult to change APRs going forward, the pricing on many accounts has already been increased in anticipation of these changes.

Additionally, many accounts with fixed APRs have been converted to variable APRs indexed to prime rates and will trend higher as prevailing interest rates rise. As a result of issuers repricing and other actions, gross yield is currently running near record highs, according to the Fitch prime credit card index - despite the low overall interest rate environment.

January's reading for gross yield, which measures performance through to December month-end, was 21.15%. This is the third highest reading ever and the highest since April 1992.

Another provision that could affect gross yield is the change to the payment hierarchy that requires issuers to apply payments to balances pro-rata or with the highest rates first. While this could pressure gross yield over time, most issuers have significantly curtailed the volume of balance transfer offers and the associated APRs, especially those targeting existing customers rather than new accounts. As a result, they now have more uniform pricing across cardholder balances.

The changes also provide for additional disclosure regarding minimum payments and pay-down speed, as well as what payment is necessary in order to pay off the principal balance over 36 months. Although consumers will likely find this additional information useful, Fitch does not expect it to cause a material increase in monthly payment rates or a resulting decrease in gross yield.

For new originations, card issuers must consider the borrower's ability to repay the debt. Issuers can do this by reviewing documentation of an applicant's income or by using income estimator models based on credit bureau attributes. Either way, it is likely foster tighter underwriting, which should benefit portfolio credit quality over time.

Fitch believes the "networks may fare better from a profitability perspective than issuers reliant on spread income because of their higher proportion of fee income", says Neenan. However, interchange fees have come under increased scrutiny and any resulting regulation would have an outsized impact on the networks. Despite prospects for negative rating actions for credit card issuers, earnings are likely to improve across the board in 2010 as credit provisioning declines, portfolio re-pricing initiatives take hold, card spend volume rebounds following significant drops in 2009 and marketing expenditures remain cautious.

ABS

US credit card charge-offs show sharp increase

Charge-offs on US credit cards rose sharply to 11.15% in January, according to Moody's in its new credit card indices report. Early stage delinquencies, however, bucked the usual seasonal increases and decreased in January for the third month in a row.

Moody's svp William Black says: "The improvement in the early-stage delinquency rate was contrary to seasonal patterns that typically lean toward rising early stage delinquencies this time of year. In fact, this month marks the first January since 2004 where early-stage delinquencies declined from the prior December, an improvement that is an encouraging indication of stability or improvement in charge-off rates by mid-year."

Moody's base-case expectation is for the unemployment rate to plateau for much of the second half of the year. Under this assumption, and if delinquency rate trends continue to improve, it expects the charge-off rate to peak close to 12% during the next several months.

The 83bp climb in the charge-off rate index in January erased much of the improvement in the index since it reached its all-time high of 11.50% in August. The delinquency rate index in January fell below the 6% mark for the first time since September to 5.96%.

After increasing in December, the payment rate slipped back below the 18% during January to 17.53%. Yields on credit cards fell back below the 22% ceiling it pierced in December, ending January at 21.54%. Finally, in a sharp contraction, excess spread fell to 7.62% from 8.93% in December, as a direct result of the higher charge-offs and lower yields.

CDO

EODs to continue for Euro SF CDOs

According to Fitch, Euromax IV MBS has breached its EOD overcollateralisation ratio trigger, as reported in the February 2010 trustee report. The rating agency believes this constitutes an EOD based on the transaction's documentation.

Fitch expects Euromax IV to be the first of several Fitch-rated European SF CDOs to experience an EOD related to the breach of an EOD OC ratio trigger. In most transactions, in an EOD the most senior noteholders could vote to enforce and redeem the notes via an enforcement waterfall where the more junior notes are cut off from any cash payments until the most senior notes are fully redeemed.

A total of 14% of Fitch-rated European SF CDOs (11 transactions) have an EOD OC ratio trigger. In the agency's view, as the performance of underlying SF assets continues to deteriorate, more than half of the 11 transactions are likely to breach their EOD OC ratio triggers over the next year.

Fitch underlines that its current ratings of Euromax IV's notes, all of which are rated triple-C and below, already reflected the likelihood of an EOD OC ratio trigger breach.

For the purpose of calculating the OC ratio which drove the EOD, adjustments are made to reduce the par of distressed assets. Euromax IV's increasing single-B minus and below rated bucket, which is marked at market values or recovery estimates, contributed to the breach of the transaction's EOD OC ratio trigger.

CDO

Stable ratings expected for 2010 CDO market

A gradually stabilising global economy, improving performance trends for most underlying assets and the completion of the rating agency's efforts to bring ratings to a point of stability will lead to less ratings volatility for most Moody's-rated CDOs and derivatives in 2010. However, Moody's points out that ratings of CDOs linked to MBS will continue to face significant downward pressure in light of the continuing credit stresses in the RMBS and CMBS markets.

In the stabilised environment, new issuance may pick up modestly from the deeply depressed levels of 2009, particularly in the CLO and SME sectors, and will likely consist of less complex structures.

Moody's vp and senior analyst Jun Kim says: "In view of the likelihood of a sluggish economy, below-potential growth and still higher-than-average corporate default rates, we continue to see some pressure on the performance of assets backing most derivative sectors in 2010. However, because of the extensive rating actions we have already taken in recognition of the likely deep recession and subsequent slow recovery, Moody's ratings of the liabilities issued from most CDO sectors are expected to exhibit more stability."

During 2009, primarily in rating sweeps, the rating agency downgraded 9,812 tranches within 2,643 CDOs, affecting about 69% of all tranches and 76% of Moody's-rated CDOs outstanding at the beginning of that year.

As Moody's model-projected global speculative default rate is expected to fall to 3.4% in December 2010, compared to a rate of 13% in December 2009, the default rate of the corporate assets underlying most CDOs is anticipated to decline - which will bolster the performance of the rated CDO notes. However, the fundamental rating outlooks continue to be more often negative than positive across the corporate sectors - an indication that the credit quality of the assets backing CDOs is likely to continue a downward drift overall.

Further, the residential and commercial real estate sectors continue to face significant credit stress. Moody's recently increased loss projections for a wide range of RMBS assets, especially in the 2005 vintage, and placed a significant number of RMBS securities on watch for downgrade. As a result, numerous structured finance CDOs with material exposures to RMBS assets are expected to be downgraded in the coming months.

In 2009, Moody's rated 53 global CDOs totaling around US$65.9bn in rated liabilities. Both the number of transactions and rated volume were the lowest in more than a decade.

According to the agency, while certain transactions were motivated by multiple drivers, the vast majority rated in 2009 were structured to optimise regulatory capital requirements or to gain access to funding through repurchase programmes or liquidity schemes set up by governments and central banks, meaning that these transactions were not actually placed with real money investors in the market.

Alexis Michon, Moody's avp-analyst, says: "The dearth of new issuance in 2009 is hardly surprising against the year's economic backdrop: the worst recession since World War Two heightened investor concerns about the creditworthiness of structured finance assets, as well as many corporate and financial entities, while extreme risk aversion in the credit markets persisted well into 2009."

The relatively high spreads demanded by investors for liabilities, as compared to that earned on the underlying assets, does not currently provide returns adequate enough to stimulate real primary issuance. However, this gap is expected to continue to close as the year progresses.

For CLOs in particular, a substantial need to refinance speculative grade debt over the next few years may affect both credit performance and new issuance. Moody's expects new deals to reflect a clear desire on the part of investors to keep structures relatively simple and to avoid unnecessary risk.

According to Kim: "CLOs that closed in 2009 and in Moody's transaction pipeline have tended toward the following characteristics: simple capital structures, low leverage, high proportion of senior secured loans, almost no ramp-up risk and shorter reinvestment."

CDS

Sovereign risk drops amid increased protection buying

Sovereign risk dropped over the last week based on CDS market interpretations, according to Credit Derivatives Research (CDR), but government bond yields remain elevated and investors seeking protection via CDS increased notably. Although the CDR Government Risk Index (GRI) has fallen by 16% from its recent peak at 100bp on 8 February, it remains over 110% above its September 2009 lows and has risen by 24% year-to-date.

CDR chief strategist Tim Backshall notes that the reduction in sovereign CDS spreads may serve to calm some fears in the market, but in many cases the government bond markets underperformed CDS as the issuance calendar among the majors remains heavy, concessions high and the basis increasingly negative. "There are many factors which drive the basis, but supply-demand differences between somewhat divergently liquid markets remains a larger driver and - while risk has improved overall - it remains, as opposed to populist opinion, the bond market 'dog' wagging the CDS 'tail'," he comments.

The massive volumes of government bonds outstanding (compared to net notional outstanding in CDS markets) is different in character to the corporate bond market, where CDS outstandings can often be larger than the underlying bond market. However, the dramatic differential in size in sovereign CDS, which are among the highest net notional exposures in CDS markets, creates a greater degree of volatility on CDS spreads as government bond yields change.

UK, Japan, Greece and US sovereign CDS saw the largest rise in net notional outstanding over the last two weeks, with the UK more than double the increase of the others. The SovX index has become a liquid tool for managing exposure and has also compressed in the last two weeks, Backshall adds, but its net notional has risen by almost US$3bn to US$11.6bn. He suggests that some of the easing in individual sovereign spreads has been driven by index arbitrage.

CDR notes three themes in the sovereign and financial CDS space over the last two weeks: a rise in systemic risk overall; a change in the risk profile across time; and a short-term optical improvement in risk. "Even with the improvement in sovereign risk over the last two weeks (as EU/IMF chatter has calmed instantaneous fears), systemic risk has been uncorked again and - across most risk assets (at least in credit) - we remain notably above levels from two weeks ago. Financials, somewhat reliant on the implicit support of governments and explicitly exposed to the new riskier government debt markets, have seen risk rise around 15% in the last two weeks even as sovereigns improve, with subordinated debt underperforming senior debt and European financials underperforming US financials finally."

Most notably, the curve appears to be flattening in both sovereign and financial credits, implying that investors are pricing in a rising risk of short-term problems. This perception causes five-year spreads to come under technical protection selling pressure and, combined with real money managers unwinding their hedges as they reduce their government bond allocations, this provides a more flattering picture of risk than perhaps is apparent from investor anxiety.

CDS

Cemex settled, second FGIC credit event called

The final settlement price for the Cemex CDS auction, held on 18 February, was 97. 13 dealers submitted inside markets, physical settlement requests and limit orders to settle trades, with deliverable obligations denominated in US dollars and euros.

The administrators were notified by a participating bidder that their physical settlement request was incorrect. Under section 15(b) of the auction settlement terms, the administrators updated the net open interest to reflect the change from 90.007m to 90.425m to buy.

Separately, the ISDA Americas Determinations Committee has voted in favour of a failure to pay credit event on 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).

Meanwhile, ISDA's Japan Determinations Committee voted in favour of a bankruptcy credit event with respect to Japanese telecommunications company Willcom Inc. Willcom filed a petition for the commencement of corporate reorganisation proceedings with the Tokyo District Court on 18 February. However, an auction will not be held to settle the relevant transactions.

CDS

Continued liquidity for consumer services CDS

CDS on consumer services companies continue to trade with more liquidity than the broader market, given ongoing market uncertainty on the growth prospects for the global economy and the knock-on effect for consumer demand levels, according to Fitch Solutions. Companies from this sector account for 20% of the top 500 most liquid names globally, but represent just 12.6% of Fitch Solutions' global liquidity score universe. All other sectors make up a similar, but smaller proportion of the remaining names.

Jonathan Di Giambattista, md of Fitch Solutions, says: "The outlook for the consumer services sector is inherently linked to the health of global economy, which is being reflected in the CDS liquidity of general retailers, media, travel and leisure companies."

He continues: "Many consumer services firms, and several US retailers in particular, made heavy use of debt financings throughout the middle of this decade and therefore CDS liquidity is also likely driven by market speculation over how upcoming refinancing activity will play out in the face of tentative economic improvement."

More generally, CDS liquidity across all regions continues to reflect a high level of uncertainty as markets await details surrounding the European Union's plans for the bailout of Greece.

CLOs

CLO settles claim with Lehman

Gulf Stream Sextant CLO 2006-1 has terminated certain swaps with Lehman Brothers Special Financing, following the entity's bankruptcy. The transaction is managed by Gulf Stream Asset Management and was arranged and underwritten by Lehman Brothers. Lehman Brothers Special Financing was the class D coupon swap counterparty.

The deal's manager says that there no longer exists a market to replace - and therefore price - transactions of the specialised nature of the swaps. The transaction has therefore negotiated a settlement with the Lehman estate and has been granted certain claims of settlement.

The manager has since sold the claims and the net proceeds from the sale have been placed into a class D coupon swap collection account. These are to be used to pay deferred interest on the deal's class D notes or to pay interest on the transaction's class D notes until the end of the reinvestment period.

The net proceeds from the sale of the claims is approximately US$1.18m, of which approximately US$980,000 will be used on 22 February to pay deferred interest on the class D notes. The balance of approximately US$200,000 will remain in the class D coupon swap collection account.

CMBS

Additional TALF collateral monitor named

The New York Fed has added BlackRock Solutions as a collateral monitor with respect to TALF legacy CMBS subscriptions. BlackRock will work alongside Trepp, CWCapital Investments and PIMCO in this role.

Trepp focuses on both newly-issued and legacy CMBS, while BlackRock Solutions will focus solely on legacy CMBS. CWCapital Investments is assisting the Fed by providing underwriting advisory services in respect of certain commercial mortgage loans backing newly-issued CMBS. PIMCO focuses on both mortgage-backed and non-mortgage-backed ABS within TALF.

The collateral monitors and other agents will not establish policies or make decisions for the Fed, including decisions whether to reject a CMBS as collateral for a TALF loan or exclude loans from mortgage pools.

Some US$1.3bn in legacy CMBS TALF loans was requested during the 17 February facility, according to the Fed.

CMBS

Weak Aussie CMBS market spurs refinancing woes

Australian property companies will face refinancing difficulties over the next 12 to 24 months because of the anaemic state of the country's CMBS market and local banks' continuing reluctance to increase their exposure to commercial properties, suggests Moody's in its Weekly Credit Outlook.

Last week Leda CMBS, a privately owned Australian issuer of CMBS, announced that it would miss the maturity date of A$300m in securities. Although Leda later announced that it will refinance the maturing debt after all, the case reflects the challenging credit conditions that face property players, particularly smaller borrowers that lack strong relationships with bankers.

"Leda's announcement took the market by surprise: it is the first time an Australian issuer of CMBS has missed its refinancing," notes Moody's. "Throughout 2009, during the depth of the global financial crisis, issuers successfully refinanced or repaid all maturing CMBS, even though market liquidity was tighter and the fundamentals of commercial real estate were deteriorating. Australia's shopping centres, like those supporting Leda's CMBS, have held up well, with high occupancy rates, so the quality of underlying assets remains strong. Moreover, the original loan-to-value ratio for Leda's CMBS transaction in 2006 was 52%, a conservative level compared to CMBS deals done in the US and Europe," it adds.

In the broader real estate sector, larger property players, including most of the Australian real-estate investment trusts (A-REITs), have manageable refinancing profiles after having raised A$18bn in equity last year. For issuers of CMBS, firms with strong sponsors, high quality assets, low loan-to-value ratios and good banking relationships should not face the kind of refinancing difficulties Leda is currently experiencing, suggests the rating agency.

Australia's CMBS market is small. So far, banks have refinanced the bigger CMBS deals that matured last year, including A$1.3bn in CMBS issued by large players such as Centro, Dexus and Multiplex (now owned by Brookfield). Moody's estimates that a total of A$5bn in CMBS will mature this year and next, with nearly half that total due by the end of the third quarter of 2010.

CMBS

Early redemption proposed for Singapore CMBS

Ascendas Real Estate Investment Trust is proposing to redeem the €165m outstanding notes of Singaporean CMBS Emerald Assets Series P2-AAA-001 at 98% of the original principal, ahead of the current legal final maturity date of November 2013. Fitch says that, if passed, the early redemption proposal will likely result in the withdrawal of its rating (currently triple, outlook stable) from the notes, as the terms on which the notes were originally rated will have changed. S&P says its triple-A rating on the notes is not affected by the proposed early redemption offer, however.

A meeting of noteholders is due to be held on 15 March, at which their consent to the mandatory early redemption proposal will be sought. If the resolution is passed, the redemption will be executed within 45 days of the meeting date and thus will occur some 24 months ahead of the expected maturity date in May 2012.

Subject to the passing of the extraordinary resolution, the execution of the supplemental documents and the early redemption of the notes, the proposal also states that noteholders who submit (and do not revoke) valid electronic voting instructions in favour of the extraordinary resolution prior to the deadline (3 March) will be eligible to receive an additional redemption amount of 1% of the principal amount of the notes on the early redemption date.

Under the new terms, the contractual principal amount due on the notes to existing noteholders will be lower than that under the original documentation. However, if the resolution is not passed and the terms of the notes remain unchanged, Fitch does not expect to withdraw its current rating.

Fitch has reviewed the performance of the underlying collateral to assess whether the early redemption has been proposed to avoid a potential event of default. Between November 2008 and October 2009, the average issuer debt service coverage ratio was 21.6x, which was well above the covenant level of 2.2x. The average Fitch DSCR was 3.1x, which was above the 2.22x at closing, and the portfolio occupancy rate was high and remained above 95%.

Furthermore, since the originator has successfully refinanced the Emerald Assets P2-AAA-01 CMBS notes in August 2009, there are no signs of refinancing difficulties for the originator. The agency concludes that the collateral performance has been stable and performing above expectations and hence, does not view the early redemption as a coercive debt exchange for the avoidance of any potential event of default due to deterioration of the underlying credit.

The notes are secured by 23 cross-collateralised and cross-default industrial properties located in Singapore.

CMBS

Radamantis loan default 'likely', despite amendments

Moody's has placed on review for possible downgrade the class A notes issued by Radamantis (ELoC 24). The CMBS is backed by four loans originated by Morgan Stanley secured by first-ranking legal mortgages over four commercial properties located in the Greater London area.

The biggest loan (the Milton & Shire House Loan) represents 54% of the current portfolio balance, while the smallest loan (the Hayes Business Park Loan) represents 11.5%. As of the last interest payment date, all of the four loans in the portfolio were current.

On 19 February 2010, the servicer (Morgan Stanley Mortgage Servicing) announced that following recent negotiations, parties have agreed to certain amendments of the Milton & Shire House Loan in conjunction with an extension and amendment of the respective lease agreements with the single tenant Linklaters. An updated valuation of the property securing the M&S Loan, dated February 2010, has also been reported.

According to the updated valuation, which is based on the initial lease agreements in place, the market value of the M&S property declined since closing by 24% to £270m. The valuer indicated a potential further £10m uplift to £280m based on the assumptions of (i) the extension of the existing leases by five years to 2026 and (ii) the removal of the remaining break clause in one of the leases. The current underwriter's LTV increased to 99% from 75% for the senior loan and to 112% from 85% for the whole loan, compared to closing.

The amendments to the M&S Loan agreement include (i) an extension of the loan maturity date by 1.5 years to October 2012 from April 2011; (ii) continued interest payments to both the senior and junior lender; (iii) commencing in April 2011 the introduction of scheduled senior loan amortisation of £750,000 per quarter (£4.5m in total); and (iv) effective immediately the suspension of the cash sweep payments towards the junior lender. The scheduled amortisation should reduce the senior loan balance to £262m in October 2012.

However, this will in Moody's opinion have only a limited impact on the expected whole loan and senior loan exit LTV. Based on its preliminary assessment, the agency views these amendments as mildly positive for the lenders as a whole. Due to the extension to October 2012, the M&S Loan now matures co-terminus with the South Quay Plaza Loan.

According to the transaction documentation, the payment allocation structure under the notes reverts to fully sequential, if (i) more than 21% of the principal amount outstanding of the loans are specially serviced loans; or (ii) the cumulative percentage of the loans (based on the total loan amount as of the closing date), which have defaulted since the closing date, is greater than 21%. Based on recent discussions with the servicer, Moody's understands that in the event that the M&S Loan would default at its extended maturity date in October 2012 it would not necessarily immediately qualify as a specially serviced loan, thereby not breaching the sequential payment trigger on notes level.

However, in Moody's opinion, there is still a high likelihood of default of the M&S Loan, despite the extended loan maturity date in October 2012. It also has concerns over a delay of a sequential payment trigger breach after the initial maturity date of the M&S Loan in April 2011, which could result in a modified pro-rata allocation of repayment proceeds of the South Quay Plaza Loan in October 2012 at the notes level and thereby delay the redemption of class A notes and reducing available credit enhancement for class A noteholders.

CMBS

Negative performance continues for Euro CMBS

Conditions in the real estate market in January continued to put downward pressure on ratings and loan performance within European CMBS, according to S&P. Six more loans fell into arrears in this sector, while four additional loans were reported to have breached non-monetary obligations. All but one of the delinquent loans failed to refinance on their maturity dates.

In January, as a result of collateral performance and market conditions negatively affecting S&P's assessment of credit quality of European CMBS, the agency lowered the ratings on 67 classes of notes across 16 transactions and affirmed the ratings on 79 classes of notes across 21 transactions. At the same time, it placed on credit watch negative the ratings on three classes of notes across three transactions.

Indices

US CRE prices rise by 4.1%

US commercial real estate prices as measured by Moody's/REAL Commercial Property Price Indices (CPPI) increased for the second month in a row in December, rising by 4.1%. It was the largest month-over-month increase in the nine-year history of the CPPI and followed a small 1% gain in November.

The volume of transactions also rose in December, as is typical for the end of the year. Overall, 716 transactions totaling US$9bn were recorded in the month.

Moody's is uncertain whether the price increases represent passing the bottom of the market or are only the volatility of a market in transition. "Although we are unable to conclude that the bottom to the commercial real estate market is here, we do believe that the period of large price declines is over," says Moody's md Nick Levidy. "We will need to see data from the first few months of 2010 to develop a better picture of where things stand."

As of the end of December, prices are down 29.2% from a year ago and 39.8% from two years ago. They are 40.8% below their peak values.

National property type indices, which are quarterly, show three of the four major property types recording price gains in the fourth quarter, with only retail posting a slight decline of 1.5%. Offices had the largest gain, at 7.9%, while apartments improved by 7% during the quarter and industrial increased by 5.6%.

For the year, however, prices for the four property types have declines that range from 19% to 23.2%.

Ratings

Fitch complies with EU regulation

Fitch is to apply for registration under the European Regulation on Credit Rating Agencies by the end of the summer. The regulation requires rating agencies to add symbology to denote the ratings of structured finance instruments.

As such, Fitch intends to add the symbol 'sf' to its structured finance ratings and intends to do so globally. The 'sf' symbol will only indicate that the security is a structured finance instrument and will not reflect any other change to the meaning or definitions of Fitch's ratings.

The rating agency says it also intends to endorse ratings issued by other parts of its groups located outside the EU that are eligible for endorsement under the EU Regulation. Fitch will make similar adjustments to its ratings to denote that a rating by a non-EU Fitch entity has been endorsed for use within the European Union.

S&P announced a similar move last week (see last issue).

Ratings

Greek triple-A tranches hit

The three major rating agencies have taken rating actions on triple-A rated Greek transactions. The move comes as a result of an initial assessment of these deals within the context of the evolving sovereign situation, as well as the current economic and financial environment.

This included a consideration of the existing credit enhancement levels because, in the event of the local economy coming under further stress, the default probability of the assets in the underlying pools may potentially increase. In addition, certain deals are exposed to both refinancing risk and local banks.

Moody's placed the triple-A ratings of all except one Greek ABS, RMBS, CLO and covered bond transaction under review for possible downgrade. The affected transactions include nine ABS, eleven RMBS, two CLOs and one covered bond programme, which are all backed by pools of Greek assets.

Moody's notes that in one transaction, Karta 2005, a credit card ABS transaction, the triple-A rating of the class A notes has not been affected as it benefits from structural elements. This transaction has entered into a cash accumulation period (during which all proceeds are kept in cash rather than reinvested in assets) and the class A notes are currently cash collateralised at 91.4%, with cash held with a highly rated bank (Deutsche Bank) located in the UK. In view of the very high degree of certainty of repayment of these notes with funds already collected by Karta, the agency has concluded that the credit risk of these notes remains consistent with a triple-A rating.

S&P simultaneously downgraded all triple-A rated Greek ABS tranches (including Karta) to double-A as a result of the increased Greek country risk and the sovereign ceiling. Fitch followed by downgrading the senior classes of 15 Greek RMBS transactions to double-A plus from triple-A.

The majority of these notes remain on rating watch negative (RWN), while the remaining senior notes have been assigned negative outlooks. The majority of the other note classes of the 15 deals remain on RWN. The rating watches will remain in effect pending the imminent outcome of the agency's criteria review.

Although the performance to date of all the RMBS deals has been good, the rating action reflects Fitch's opinion that Greece's sovereign risk is increasing and may negatively impact the future performance of rated securitisation transactions. The macroeconomic and event risks associated with a less remote sovereign default in Greece increase the stress that securitisations rated above the sovereign are expected to withstand.

Ultimately, Fitch believes that these increased levels of risk and stress are not compatible with the degree of stability associated with ratings in the highest rating category at triple-A.

As the Greek public finance situation has markedly deteriorated and is likely to remain highly challenging, Moody's downgraded the government bond rating to A2 from A1 last December and changed the outlook to negative. Given the macroeconomic stress likely to be associated with efforts to address the deficit, it is reassessing the adequacy of the credit support on these transactions at their current rating levels. Specifically, the agency's review will focus on whether the incremental loss to the worsened environment is compatible with the triple-A ratings assigned to the existing transactions.

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

Ratings

Irish bank guarantee expiry threatens SF ratings

The September 2010 expiry of Irish government guarantees for certain obligations of Irish banks may have a negative rating impact on some structured finance (SF) transactions and covered bond programmes where certain Irish banks remain counterparties and no further mitigants are put in place, according to Fitch. However, the rating agency has received feedback from covered bond issuers indicating that they plan to take mitigating action prior to the expiry of the guarantee and expects similar action to be taken for SF transactions.

The expiry of the state guarantees for on-demand deposits and swap termination amounts on 29 September 2010 means that some SF transactions and covered bond programmes will likely seek replacement of - or guaranteeing of - bank accounts and swap positions. Fitch expects that affected issuers will, however, take remedial measures well before the expiry of the Irish government's Eligible Liability Guarantee (ELG) and Credit Institution Financial Support Scheme (CIFS) schemes.

"If appropriate remedial measures are not taken, the extent of any rating downgrades will be reviewed on a case-by-case basis and depend on the actions of the respective counterparties, but notes rated above the long-term issuer default rating (IDR) of the bank account or derivative provider would in any case not be downgraded below the provider's long-term IDR," says Fitch.

If the counterparties' actions are in line with Fitch's counterparty criteria, no rating actions are expected to occur. In addition, the agency expects the documentation of any new SF transactions or covered bond programmes to comply with the remedial action expected for swap and bank account providers in the absence of a counterparty having suitable ratings.

Ratings

EMEA residential mortgage loss criteria enhanced

Fitch has published a new criteria report detailing its rating methodology for assessing credit risk in EMEA residential mortgage loans. The new master-criteria report replaces the country-specific criteria reports previously in use in the region.

Gregg Kohansky, md and head of EMEA RMBS at Fitch, says: "The new criteria approach for assessing credit risk in EMEA residential mortgage loans allows for a more forward-looking analytical process that better aligns loss expectations with the collateral risk and current market conditions. A single criteria for assessing credit risk for EMEA residential mortgage loans also allows for greater consistency between country-specific criteria assumptions."

Fitch has made several enhancements to its criteria. In particular, the agency has formalised a forward-looking approach to ratings exposed to residential mortgage loans in EMEA. This means that rating expectations, assumptions and scenarios associated with lower rating levels will change more frequently relative to the position in the economic cycle, due to their relative proximity to potential default. In contrast, higher rating scenarios are relatively remote from default and can be expected to be more stable and 'through the cycle' to a much greater degree.

The new criteria also enhance cross-country benchmarking of criteria assumptions. A standardised approach is used across all EMEA countries for determining frequency of foreclosure and loss severity-related assumptions that are specific to each local market.

EMEA RMBS ratings have, in general, seen relatively minimal rating migration over the last three years. However, this masks individual areas of weaker performance, such as UK and Spanish non-conforming transactions, which have experienced negative rating migration. Accordingly, this type of collateral in particular has seen amendments to frequency of foreclosure-related assumptions in the criteria review.

In addition, while ratings performance has generally been in line with expectations, assumptions at high rating levels have been amended in some countries to ensure stresses were considered remote in the current environment. Since assumptions at lower rating categories are intended to be reflective of mortgage default expectations in the current and expected macroeconomic environment, these have been amended for all countries to reflect current expectations given the economic outlook.

Current loss severity-related assumptions such as the market value decline (MVD) reflect current (for lower rating categories) and remote (for higher rating categories) house price decline (HPD) expectations, as well as an assessment of the forced sale discount for properties that go through the repossession process. A review of the assumptions for foreclosure timing and cost through to realisation of properties for defaulted loans has also been performed.

The published criteria assumptions will be used for rating new RMBS transactions and covered bond programmes and for maintaining covered bond ratings. The surveillance process involves a number of quantitative and qualitative factors, including an assessment of market developments, loan-by-loan and pool level analysis, and a comparison of current credit enhancement levels against a stressed loss assumption at each rating category. The new criteria assumptions in themselves are not expected to result in rating actions on existing transactions for most countries since most rating actions taken to date already reflect the factors that have been inputs to the criteria development process.

Ratings

Fitch enhances research, analysis output

Fitch has launched a new quarterly report for the European structured finance market. The 'EMEA Structured Finance Snapshot' combines existing and new content, including previously unpublished data and multimedia content that will be updated each quarter.

Karen Skinner, Fitch's head of EMEA structured finance business development, says: "The Snapshot is a key part of Fitch's strategy to provide investors with more forward-looking, transparent and timely research and rating analysis. It encapsulates Fitch's latest EMEA structured finance thinking in an easily navigable, interactive document and is designed to offer insight that goes beyond traditional credit ratings."

As well as data-driven content, the Snapshot includes market commentary from Fitch president Paul Taylor and Fitch's global head of structured finance Ian Linnell. Future editions will contain interviews with third-party market participants, the agency notes.

Previously unpublished information includes aggregated data for transactions not rated by Fitch in 2009 and a breakdown of the reasons for not rating them, in addition to consolidated results of the agency's transaction screening committees. The Snapshot also provides examples of distressed deal case studies in easy to read chart format, highlighting the key issues that faced the transactions and an explanation of how Fitch will factor such concerns into its analysis in the future.

Regulation

Trade associations call for safe harbour extension

SIFMA, CMSA and the ASF have submitted formal comment letters to the FDIC concerning its safe harbour rule, which protects the underlying assets of securities held by failed banks.

Although FDIC officials have said that the safe-harbour period may likely be kept in place beyond March to ensure a smooth transition to the new accounting standards FAS 166/167 (SCI passim), all three associations call for the transition period be extended beyond 31 March 2010. CMSA explains that this is due to the amount of time that will be needed to formulate sound policy and implement the new safe harbour requirements, while SIFMA believes an extension of at least six months is necessary in order to work with industry participants to outline safe harbour criteria.

The three trade associations share similar concerns regarding the uncertainty created for investors by including potential preconditions to the new safe harbour and the potential harm caused by a unilateral approach to securitisation reform. The ASF, in its letter, also highlights the inadequacy of the FDIC's proposed 'security interest' approach to a safe harbour for securitisations that do not meet sale accounting.

Chris Killian, vp at SIFMA, says: "We support reasonable efforts to restore and reshape the securitisation market, but we do not believe the proposed safe harbour is an appropriate means of regulation. Changes to regulation of the securitisation market must be done in a coordinated manner which incorporates the views of various market participants, regulators and policymakers."

SIFMA stresses the need for regulation to be coordinated within the broader context of regulatory reform and to base criteria for a safe harbour on the legal principles of isolation of assets in insolvency. Similarly, in its comment letter, CMSA suggests that the FDIC work in concert with Congress, the Obama Administration and the other agencies that are developing securitisation reforms to ensure that its safe-harbour efforts do not lead to a regulatory framework of conflicting or overlapping requirements that may impede the restoration of functioning credit markets.

Regulation

FSA says no systemic threat from hedge funds

Hedge funds do not pose a systemic threat to the market, according to a new report from the UK's Financial Services Authority (FSA). The report comments on the findings of two surveys - the hedge fund as counterparty survey (HFACS) and the hedge fund survey (HFS).

The HFACS data suggests that, as of 31 October 2009, major hedge funds did not pose a potentially destabilising credit counterparty risk across the surveyed banks. Meanwhile, HFS data shows a relatively low level of leverage under the FSA's various measures and indicates a contained level of risk from hedge funds at that time.

"While our analysis revealed no clear evidence to suggest that, from the banks and hedge fund managers surveyed, any individual fund posed a significant systemic risk to the financial system at the time, this position could change and future surveys will be an important tool in identifying emerging risks," says the regulator.

"It is also notable that the Alternative Investment Fund Managers Directive, which is currently under negotiation in Europe, may at some point in the future require national supervisory authorities such as the FSA to collect certain data from alternative investment fund management sectors, including hedge funds," it adds. "We hope that our work in this area can contribute to the ongoing debate about the Directive."

The HFACS has been running semi-annually for five years. It surveys some of the largest FSA-authorised banks with exposures to hedge funds about their associated credit counterparty risks. The FSA asks about the size, channel and nature of the larger credit counterparty risks that individual banks have to hedge funds, both individually and all together.

The HFACS mainly focuses on the credit channel for systemic risk. The HFS was introduced in October 2009 to complement the HFACS. It asks 50 of the largest FSA-authorised investment managers about the hedge fund assets they manage and about the larger individual hedge funds for which they undertake management activities.

RMBS

New Fosse RMBS prepped

Santander-owned Alliance & Leicester is set to sell new notes from its UK prime RMBS master trust, Fosse. Three tranches from the Series 2010-1 transaction have been assigned provisional triple-A ratings by Fitch, Moody's and S&P, all of which are sterling-denominated. The final size of the transaction has not yet been disclosed, although it is expected to be around £1bn-£1.5bn.

This is the fourth issue out of the Fosse Master Trust structure. At closing, the trust property for this transaction will consist of approximately £5.5bn of loans. No new loans were added for this issuance.

The reserve fund will be funded to 1.67% of the total Funding 1 Notes outstanding at closing and the total credit enhancement for the triple-A notes will be 14.37%.

According to Moody's, the class A3 notes will pay fixed interest rather than floating interest. Barclays Capital, Credit Suisse, Deutsche Bank and Santander are understood to be working on the deal.

RMBS

Hope for H4H programme?

Banker's Portfolio says it has secured a forward commitment for the purchase of Hope for Homeowners (H4H) securities and is rolling out the H4H product to existing mortgage investors, loan servicers and asset managers as an alternative to foreclosure.

"Existing mortgage investors will embrace the H4H solution only if it's in their best interest," comments Banker's Portfolio business development director Joel Harrison. "With the purchase commitment Banker's Portfolio has secured, the H4H programme will finally be able to deliver the winning combination of a higher pay-off and a shorter timeframe to liquidity that the mortgage investors have been looking for."

Banker's Portfolio is an outsourced solution that enables mortgage investors to capitalise on the H4H programme, without added certification or specialised training, the firm explains.

RMBS

UK RMBS CPRs drop again

UK RMBS master trusts exhibited weak CPR rates in January, averaging just 14.5% compared to 20.2% in December 2009, according to Deutsche Bank figures. Granite's CPR - in the news last month due to its higher than average CPR (see SCI issues 169 and 170) - had an 11.5% implied CPR rate in January. This is down almost two-thirds from the previous month's reported level.

Securitisation analysts at Barclays Capital said earlier this month that they expected Granite CPR to revert to its recent run-rate level of 14%-18% over the next few months. "While 11.5% is clearly below that level, it does not represent a huge shock and could be a temporary fall in prepayments caused by administrative changes resulting from the amendment to the Northern Rock structure," they note.

Secondary market prices reacted to the news of Granite's CPR rate by falling slightly on the day by about half a point, only to revert the following day. "The price reaction seemed to indicate that the CPR news had temporarily surprised some market participants, who were perhaps hoping that last month's reported CPR of about 30% would be more than just a one-off," the BarCap analysts report. "This reaction was surprising to us, because at least part of the increase was explained in the investor report by a one-off accounting adjustment."

BarCap expects CPRs to remain flat at the recent levels of about 14%. "In any case, the [secondary market] price reaction was only short-lived, with prices coming back to the 90s area the following day, and Granite continuing to be the most traded name as it has been for more than half a year now," the analysts add.

European securitisation analysts at Deutsche Bank also point out that January gross mortgage lending data from the CML showed the weakest level (£9.1bn) since February 2000, pointing to low re-mortgage activity. "However, the first month of the year has typically shown seasonally weak repayments, so the shift may correct next month," they comment.

Paragon transactions appear to be the exception to the trend, with traders reporting rising CPRs across the programme and hence increased demand for the paper. One says that client interest also remains for Granite triple-As and double-As.

RMBS

Lanark sub notes restructured

UK RMBS master trust issuer Lanark has redeemed its Series 2007-1 subordinated notes and issued new, unrated Series 2010-1 class Z notes. The 2007 subordinated notes had an earlier scheduled maturity date than the remaining senior notes, but could only be redeemed if the ratings on the senior notes were left unaffected. Therefore, the unrated class Z notes were issued to give extra subordination to the remaining senior notes.

The class Z notes are subordinate to any rated notes in both the principal and interest waterfalls. Specifically, in the funding interest waterfall the class Z principal deficiency ledger sits directly below the reserve fund and the class Z interest sits further down with other residual payments.

Both Moody's and S&P say the restructuring will not affect ratings on the transaction's class A notes.

Lanark Master Issuer is backed by prime and buy-to-let mortgage loans originated by Clydesdale Bank and Yorkshire Home Loans. According to S&P, the trust's performance has been in line with its peers: 90-plus day arrears were 1.52% as of the end of December, as excess spread continued to clear any losses (total losses stand at £481,618 since closing). As with most of the UK market, prepayments have maintained a downward trend: the one-month annualised payment rate is now 16.7% (December 2009), down from a peak of 31.3% in December 2007.

RMBS

New Zealand RMBS bolstered

An additional NZ$1.27bn of Class B notes have been issued by The New Zealand Guardian Trust Company, in its capacity as trustee of Kingfisher NZ Trust 2008-1. There are already NZ$4.89bn triple-A rated Class B notes outstanding.

No further issuance of unrated Class C notes was made, due to the increased subordination provided by way of principal pay-down on the Class B notes. Fitch has affirmed the ratings on the transaction. As at the date of this rating action, there was no outstanding issuance of Class A notes.

The collateral pool at the cut-off date consists of 62,539 loans with a total portfolio balance of NZ$6.61bn, a current weighted loan-to-valuation ratio of 58.4% and a weighted average seasoning equal to 34.1 months. Reduced documentation loans are not included in the transaction.

RMBS

Delinquent loan sale for NC RMBS

The majority of loans greater than 90 days in arrears in the Moorgate Funding Series 2009-1 portfolio have been sold to an external party at a discount. This discounted sale created a loss of £33.13m, of which £26.2m remains as an uncleared class B principal deficiency ledger (PDL) after available revenue receipts. The unrated B class is subordinate to the reserve fund in the revenue waterfall.

Taking into account the uncleared class B PDL and the principal payment to the class A noteholders from the sale and prepayments, there has been a small increase in credit enhancement, according to S&P. This increase, coupled with the absence of loans greater than 90 days in arrears, has led the rating agency to affirm the class A notes at triple-A.

The transaction has shown robust levels of excess spread so far. If these levels are maintained, S&P expects the class B PDL to be substantially cleared in the next two years.

Moorgate Funding 2009-1 is a UK non-conforming RMBS transaction that closed in March 2009. The collateral comprises first-ranking mortgages secured over residential, owner-occupied and buy-to-let properties in the UK.

RMBS

UK NC RMBS performance continues to improve

The level of arrears in UK non-conforming RMBS transactions continues to decline, according to a recent report from Fitch. The rating agency's three-month plus arrears index for Q409 reveals that the volume of non-conforming loans currently three or more months in arrears stands at 18.6% of the current value of outstanding loans, which is down from 19% in Q309.

The downward trend in arrears was accompanied by falling current repossessions, due to an increased sale of properties and lower levels of new repossessions. An increase in house prices has helped stabilise losses realised from the sale of properties. However, losses continue to have a limiting effect on credit enhancement growth by suppressing the net excess spread available to increase reserve funds back to their target amounts.

Although collateral performance has improved, Fitch explains that it still has significant concerns over the high overall arrears and significant loss severities being experienced by non-conforming transactions in the UK.

Technology

Analytics, assumptions published on web portal

S&P's valuation & risk strategies group has launched an analytics platform on the web-based Global Credit Portal, which will provide pricing data for over three million global fixed income securities and market-based assumptions used in the price generation of 1.4 million structured finance securities (see SCI issue 171). The resource was previously available to S&P customers through a data feed.

Assumptions include default probability, loss severity and prepayment speed. "Investors in the current marketplace find that they need to go beyond standard pricing data to rigorously analyse the inputs and assumptions that went into deriving those prices," explains Frank Ciccotto, svp, S&P's valuation & risk strategies. "By publishing the assumptions that are used in our independent pricing process alongside our pricing data and making this information available through a web-based analytics platform, we are able to give investors the ability to engage in a much deeper level of analysis. This move toward providing a greater level of transparency is a major initiative that we will be expanding throughout the year."

Technology

New version of FpML in the works

Version 4.7 of ISDA's financial products mark-up language (FpML) is in the final stages of development. As well as including additional coverage of other asset classes, Version 4.7 of the standard marks further improvements in interest rate, commodity and credit derivatives.

FpML is an XML-based, freely licensed, business information exchange standard for electronic dealing and processing of derivatives and structured products.

RMBS

Evidence of strategic default

Ying Shen, research analyst at Deutsche Bank, finds that policy designed to keep borrowers in their homes should be differentiated based on negative equity levels and differences in recourse

The worst housing crisis since the Great Depression left 14 million Americans with "negative equity",¹ the situation where a homeowner's total mortgage debt obligation exceeds the home's current market value. With a further 10%-12% US home price drop expected from current (Q309) levels, based on our latest MSA-level home price forecast,² we estimate that an additional six million homeowners will be "underwater" by the end of 2010.

Understanding how negative equity impacts default is crucial to policymakers, lenders and investors. A high percentage of negative equity implies a high serious delinquency rate. This is depicted in Figure 1, which is derived from non-agency borrowers' loan-level performance across top 100 MSAs defined in our housing price forecast.

Historically, much of mortgage default research focused on involuntary default, when borrowers lose their homeownership due to financial distress and inability to keep their mortgage payment obligations. When analysing involuntary default, negative equity is a necessary but not sufficient condition, as discussed in the article by Foote, Gerardi and Willen of the Boston Federal Reserve Bank.³

However, many existing academic studies have been based on the implicit assumption that negative equity is a sufficient condition for default. They usually model the default decision based on the theoretical hypothesis that a borrower would exercise a default option when it is in-the-money, i.e., when the borrower's property has negative equity.^4,5

Therefore, an underwater borrower would default even when they have not experienced any change in income or mortgage payment, if the lender has no recourse.⁶ However, the existence of recourse to assets other than the mortgaged property has been perceived as a disincentive for underwater borrowers to exercise their in-the-money default option.

Following the recent work on strategic default from Richmond Federal Reserve Bank's working paper by Ghent and Kudlyak,⁷ we present our empirical analysis on the four 'sand states', where California and Arizona are non-recourse states, and Florida and Nevada are recourse states (a detailed classification of 11 non-recourse states can be found in the Ghent and Kudlyak paper). We found, unsurprisingly, that recourse has significant impact on the default likelihood among non-agency loan borrowers who were underwater as of July 2007.

Our findings are as follows:

1. Recourse has a significant deterrent effect on underwater borrowers' exercise of their in-the-money default option. Default among underwater borrowers in FL and NV is 37% lower than in the non-recourse states CA and AZ (see Figure 2).

2. The magnitude of the deterrent effect of recourse on default depends on how deep the borrower's default option is in-the-money. We found that
a. among borrowers who are underwater with mark-to-market CLTV between 105 and 125, recourse deters default by 36% (Figure 3);

b. among borrowers who are deeply underwater, with mark-to-market CLTV greater than 125, recourse deters default by 51%. Equivalently, default among deeply underwater borrowers in non-recourse states tends to double that among those comparable borrowers in recourse states (Figure 4).

Obviously, the difference cannot be explained by the home price depreciation in those four sand states. As depicted in Figure 5, the two recourse states have experienced slightly larger aggregated peak-to-Q309 and Q207-to-Q309 home price depreciations.

The big difference in defaults suggests that some defaults are in fact strategic. And recourse has greater deterrent to borrowers with greater negative equity.

Conversely, the lower default rate among recourse states implies that many underwater borrowers are actually capable of making their mortgage payments. Our analysis on the existence of strategic default confirms the economic theory that borrowers with significant negative equity will exercise their in-the-money default option.

Government policymakers and lenders should pay special attention to curtail the second wave of housing crisis triggered by strategic default. Additionally, we conclude that any policy to save borrowers from losing their homes should be differentiated based on the level of their negative equity position and, given differences in recourse, should be crafted at the regional-level.

References

1 We define a mortgage loan to be in a position of negative equity if the current mark-to-market combined loan-to-value ratio is greater than 105%.
2 Weaver, K. Y. Shen, and K. Reeves, Update: The Outlook for U.S. Home Prices, 17 December 2009.
3 Foote, C, K. Gerardi, and P. S. Willen, Negative Equity and Foreclosure: Theory and Evidence, June 2008. Working paper, No. 08-3, Federal Reserve Bank of Boston.
4 Kau, Keenam, Muller, and Epperson. A Generalized Valuation Model for Fixed-Rate Residential Mortgages, Journal of Money, Credit, and Banking, 1992, 24(3): 279-99
5 Deng, Quigley, and Van Order, Mortgage Terminations, Heterogeneity, and the Exercise of Mortgage Options, Econometrica, 2000, 68(2): 275-307
6 Recourse loans allow the mortgage lender to go after the assets of the defaulted borrowers. The borrowers are liable for any amount greater than the value of the home at the time. State laws often dictate whether a mortgage loan is a recourse loan or not.
7 Ghent and Kudlyak, Recourse and Residential Mortgage Default: Theory and Evidence from U.S. States, WP 09-10, October, 2009.

© 2010 Deutsche Bank Securities Inc. All rights reserved. This Research Note, entitled 'Non-agency RMBS: Evidence of Strategic Default', is an extract from Deutsche Bank's Securitization Monthly published on 8 February 2010.

Trading

Trading ideas: volatile fortune

Dave Klein, senior research analyst at Credit Derivatives Research, looks at a long volatility trade on Fortune Brands Inc

Fortune Brands' CDS and equity provided a roller-coaster ride for investors over the last year. In contrast, the company's implied volatility drifted ever lower.

While the company posted decent Q4 results at the end of January, it provided earnings guidance for 2010 below that of analysts' expectations. Fortune's vol continues to trade near 52-week lows, while its CDS is well off early January tights.

The company's CDS trades near fair value and its implied vol should rise to close the credit-vol disconnect. With that in mind, we recommend a long vol trade.

Directional view
When screening for vol opportunities, we start with our directional vol model. The cross-sectional model takes both market and fundamental factors into account to construct a fair value-implied vol surface for each name in the universe we cover.

Market factors include credit-implied volatility (a view on vol based on CDS levels and leverage), realised vol and beta. Fundamental factors include interest coverage, free cashflow and accruals.

Exhibit 1 charts four-month market against fair implied vol at the delta corresponding to Fortune's June US$40 strike puts. Dots above the orange line indicate that market vol is cheap, whereas dots below the line indicate vol is rich.

Fortune (red dot) is trading about 13 points cheap compared to its peers in the consumer non-cyclical sector. The company's interest coverage and free cashflow are a drag on its ranking, but all factors lie below the level required to justify current vol levels compared to its peers.

Empirical view
Starting in March 2009, Fortune's CDS and implied vol both dropped substantially (Exhibit 2). However, since last May the company's five-year CDS oscillated between 100bp and 200bp. Since the beginning of the year, Fortune's CDS widened off its tights (orange arrow), while vol held steady (blue arrow), increasing our expectation of a rise in volatility.

Exhibit 3 charts the company's four-month market implied vol against the fair value given by our empirical vol model. Given the difference in CDS and vol dynamics, Fortune's implied vol tended to trade cheap since May, but reconnected briefly in October as vol rose and CDS levels rallied.

Both our MFCI model and equity-CDS model find the company's CDS trading very close to fair value and a big idiosyncratic move from current levels is not expected. With CDS levels holding steady, vol should rise to come back in line with fair value.

Looking at the surface
We look across the implied vol surface to identify the best place to take a vol position based on both the disconnect from fair value, as well as liquidity. Exhibits 4, 5 and 6 chart the market and fair 90 and 180 put wing skew, and 90-180 day 50 delta skew.

The empirical model produces an expected volatility surface based on the recent market relationship between the vol surface and CDS present value, combined with expected fair CDS and equity levels. Compared to the past, we expect a parallel shift of the vol surface upwards to reflect recent weakness in the credit market.

In essence, the empirical model is neutral as to which maturity and delta is best when going long vol. The directional model shows a greater disconnect across maturities and deltas, but also points to a parallel shift up. Therefore, liquidity provides the driving factor for choosing where to trade on the vol surface and the June 10 US$40 strike puts show the most promise.

Risk analysis
The trade faces a number of risks and the biggest fall into two categories.

Model risk: Any trade motivated by relative value models faces the risk that out-of-model factors, market technicals and events can distort trading relationships for an extended period of time. Our empirical model makes the implicit assumption that the markets in the near future will trade as they did in the recent past. Our directional vol model assumes that the factors we use provide forecasting power for future vol moves and that a company's vol trades similarly to peers of equal ranking. For these reasons, we use our models as filters and not as black boxes.

Hedging risk: Any vol trade implemented with equity options must balance hedging transaction costs against gamma exposure. Clearly, clients implement a wide range of hedging strategies. At CDR, we flatten delta each night on our vol trades with the expectation of minimising losses due to theta. The goal for the trade is to capture an expected rise in implied volatility as efficiently as possible and, from a tracking perspective, capture the path-dependency within the P&L. Large daily moves in Fortune's stock will have an outsized effect on trade performance.

Time horizon
We expect to close the trade within two months. We will exit sooner if Fortune's CDS and vol reconnect or if the shortened time to maturity causes the trade P&L to be dominated by gamma rather than changes in implied volatility.

Position
Buy Fortune Brand's June 2010 US$40 strike puts delta-hedged at US$170/lot, 29.4% implied vol, 32.4% delta and equity price of US$42.71.

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).