Contents

CLOs

New activity?

CLO pipeline builds

Talk surrounding Citi's new CLO issue (see separate News story) intensified focus on the ever-elusive CLO primary market this week. Indeed, a pipeline of new CLOs is said to be building, despite concerns that the economics are still not at the point where the arbitrage for equity investors will work.

Moody's expects that in the current stabilised environment, new CLO issuance may pick up modestly from the deeply depressed levels of 2009. "The overall market improvement since last year means we might start to see new arbitrage CLO activity," says Yvonne Fu, group md at Moody's in New York. "The pipeline currently includes a number of US arbitrage CLOs."

In Europe there are several parties working on new CLOs, according to Thorsten Klotz, md at Moody's - although he doesn't see this turning into real deal flow just yet. "In general, European CLO issuance activity has dropped in recent months. In 2009 many banks used balance sheet CLOs as a funding tool in a difficult situation, but that need is now reduced," he explains.

He adds: "Banks have better access to other market segments, such as the corporate bond market. Added to that is that the ECB has extensively provided banks with liquidity over the course of 2009. Some banks may still contemplate issuing CLOs for funding purposes in 2010, but far fewer than in 2009."

CLO strategists at RBS suggest that no true new CLO issue has yet occurred because the current tranche pricing is still cheap to bank loans. They note that at these levels, a new issue deal would result in a below market yield for the equity.

"For the CLO arbitrage to work, the liabilities need to tighten relative to current loan market spreads, which may be facilitated by the impact on the US corporate loan market by troubles other sovereign nations are having currently," the RBS strategists add.

They believe that there will be limited issuance in 2010 until asset and liability prices converge. "While we do not foresee any major issues in the immediate future, investors should still be concerned that large defaults and surprise large-scale downgrades may occur. After all, the rating agencies have been less than predictable and downgrades can have a major impact on the CLO market in multiple ways. With the low hanging fruit off the table and these risks in the back of your mind, asset selection and trading will be more important than ever in 2010."

Moody's is, however, predicting a more stable rating environment for CLOs in 2010. Ramon Torres, svp at the rating agency, says: "From a US perspective, US cashflow CLO ratings will generally be stable in 2010, given the rating sweep in 2009 and updated assumptions brought in during 2009."

"The story is similar in Europe, although the current performance of the underlying loans in European cashflow CLOs is not as good as their US counterparts - the recovery in key metrics is slower to materialise," says Gillaume Jolivet, vp at Moody's. "We see a six-month lag between European and US performance: we expect to see European CLO performance stabilisation later this year."

Indeed, Moody's trailing 12-month global speculative grade default rate is projected to decline from 13% in December 2009 to just 3.4% by the end of 2010. This figure assumes an ongoing economic recovery and stable credit spreads through 2010.

"However, in a more pessimistic scenario where economic recovery is delayed for some reason and credit spreads would widen, our default forecast would change to 7%: we therefore still have a wide range of possible default assumptions," adds Klotz.

Meanwhile, the number of CLO documentation tweaks observed during 2009 - such as deep discount amendments or changes to the size of a transaction's triple-C buckets - is unlikely to continue at such a rate in 2010, thanks to the more stable market environment. "Many of the CLO documentation alterations observed during 2009, such as deep discount amendments, were driven by market conditions," comments Fu. "In Q109, the leverage loan market was under a lot of stress, but as leveraged loan prices improved, the need for these amendments diminished. At present, we are not seeing any requests on this front."

"We saw more requests for deep discount amendments than actually went ahead last year," adds Klotz. "This is because the controlling class' permission was not always given to make these changes."

Moody's is, however, seeing requests for other types of CLO amendments; for example, the establishment of tax-blocker subsidiaries. These allow CLO issuers to extend holding periods for equity securities that were received in exchange for defaulted assets.

AC

Regulation

Ups and downs

New structuring ideas emerging as regulatory regime develops

Regulatory change continues to impact the vitality of the securitisation market, but at least the parameters of that change are becoming clearer as the year progresses. Within these parameters, new structuring ideas are beginning to be discussed.

"The substance of regulatory change is pushing back on the vitality and robustness of the securitisation market, but I'm encouraged that at least some uncertainty is gradually disappearing," James Croke, partner at Orrick noted at a seminar held at the firm's offices last week. "The eventual outcome should spur the development of the technology and legal tools to enable the market to create better credit products. I'm optimistic about transaction flow this year: we're already seeing some interesting ideas being bounced around."

Martin Bartlam, partner at Orrick added: "The problem with regulatory regimes is that they typically herd everyone towards the same state of mind in terms of risk - for example, liquidity was not considered as a factor previously. The forthcoming changes will help deal with some of these issues, but the danger remains that if there is something wrong with the underlying model, it could hurt everyone. Capital requirements are ultimately likely to be greater than necessary, but this isn't an unexpected response and they could be refined over time."

He pointed to the EU's CRD 2 initiative, which is expected to be concluded this year, as an example of regulatory progress. "However, the market still needs more clarity around what investor 'due diligence' means and how 'skin in the game' should be measured, as well as what exactly constitutes a resecuritisation (as potentially any tranched deal could qualify) or significant risk transfer. One possible outcome of such stipulations is that a different market for 'non-credit institutions' could develop."

Croke identified the Basel Committee's liquidity risk management proposals and FAS 166/167 as the most significant regulatory changes impacting the US ABS market, suggesting that there is potential for an entity to exploit the tension between the proposed rules and the ability of corporates to raise finance. For instance, the consolidation of ABCP conduits and other managed vehicles under FAS 167 removes the impetus for the supply-side to finance assets in this way.

It will also be interesting to see how the market reacts to the FDIC's recent ANPR (SCI passim), according to Croke. "If sellers can still demonstrate a sale under FAS 166/167, the FDIC will allow the safe harbour to remain. It's a technical problem, but I'm not sure that this is such an attractive fix."

He explained that there is a 45- or 90-day period following an insolvency, during which the FDIC can step in and potentially disrupt cashflows. "It will be difficult for lawyers to give an opinion on bankruptcy remoteness in such a situation. It feels more like an enhanced form of secured lending, but perhaps this will become part of a new market paradigm."

The US government was described as having a "strong lever", especially in terms of mortgage securitisation, and so has included a number of policy objectives into the ANPR rule. Two objectives were highlighted in particular.

First, the compensation limitations for servicers and other counterparties involved in a securitisation. In some cases, compensation will be paid over a five-year period, depending on how the deal performs.

Second, all mortgage loans will need to be seasoned for 12 months before they're securitised. However, given that many US banks are retreating from asset warehousing, this stipulation could create an opportunity for third parties to hold loans for the duration of the seasoning period.

Meanwhile, Basel's liquidity proposals were described as signalling a "fundamental shift" for the financial system in that they require banks to hold significantly more permanent capital. Any payment obligation that a bank may be called to make within 30 days, including payment obligations on instruments issued under a consolidated securitisation, will generally need to be 100% collateralised by either US government securities or significantly overcollateralised amounts of certain high credit quality corporate or covered bond obligations.

"Obviously this will make short-term funding more expensive for banks and thus is a significant disincentive to financing assets in that fashion. I doubt that many corporate clients are fully aware that this financing route may dry up, given that corporate commercial paper is contingent on back-up facilities," Croke continued.

The ABCP sector is also being impacted by the resecuritisation rules under Basel 2. Programmes with partial sponsor support will be classed as tranched exposure and thus count as resecuritisations, while a liquidity facility on a single pool of diverse assets won't be. Consequently, bank investors will either be reluctant to buy CP that isn't fully supported or some form of tiering could emerge between supported and non-supported issuers.

At the same time, SEC rules for money market funds have also changed and now stipulate that they have to hold shorter maturities, including a 30% allocation of government assets maturing in 60 days or less or ABCP maturing in seven days or less. Croke indicated that these new requirements could prompt issuers to begin tailoring product specifically for this segment.

CS

CLOs

Paying up for quality

US CLO spreads generally held firm during the week ending 26 February in the face of continued volatility in European markets resulting the latest Greece bailout moves. However, investor concern regarding the potential impact on the US markets has resulted in lower volumes for mezzanine notes.

The US CLO market as a whole has maintained decent volume and spread levels in the past week. One CLO dealer says: "We've seen a fair amount of trading going on in the market. I think certainly there's been a good amount of secondary market activity, so levels have been fairly resistant. Some of the banks are selling, but there are significant amounts of hedge fund buying and there's also a good amount of overseas buying going on in the sector. So spreads are holding pretty well."

He adds, though, that the activity that is being seen is more cautious. He explains: "The market is continuing to tier, in that different deals of different quality can trade at fairly different levels and I think the market is getting more sophisticated about paying up for quality."

Another trader agrees: "There's clearly still strong demand for senior notes and I think there's still a strong tone to the market. However, in the subordinate space we've seen a little bit of softness and volumes come down slightly."

The dealer concurs that senior notes have remained firm and adds that equity paper has been similarly resilient. He explains: "We have this barbell approach where there's weakness in the centre of the curve and strength in the two corners. There's been weakness in the mezzanine part of the capital structure because the cashflows are much more back-weighted there - there's still plenty of market volatility and people don't like to see any sort of volatility when they're buying longer-dated back-ended cashflows."

Meanwhile, talk of a potential new CLO deal from Citi piqued interest in some market participants. However, the trader says: "It's a refinancing of an old deal. So it's not really a true new issue or an arbitrage type of deal by any means. I think it's a deal they did in January 2009, which they're refinancing. They're trying to roll the old triple-As from the old deal into the new deal."

The dealer adds that significant improvements in the market would need to take place before investors could look forward to the emergence of new issuance. He says: "The spreads within the new issue market aren't where they need to be to get a new issue done, in my opinion. So we need further tightening in the capital structure to make the economics work for the equity holder and we're not quite there yet."

JA

CMBS

Paris ruling brings FCT clarity

Investors in European CMBS Windermere XII received a boost on 25 February when the Paris appeals court ruled that the Paris commercial court incorrectly applied a safeguard procedure to the borrower - La Defense SAS (HOLD) - last year (see SCI issue 158). This latest decision from the Paris appeals court brings relative clarity to the position of non-Fonds Commun de Titrisation (FCT) SPVs in French securitisations, although it appears that the safeguard procedure can still be applied where an SPV faces immediate difficulties.

Investors have been wary of CMBS transactions with significant French collateral while this uncertainty persisted and this latest ruling may therefore prove a positive for prices of bonds issued by deals with such collateral, according to Chalkhill Partners analyst Michael Cox. "For Windermere XII bondholders, the decision is a positive as it gives control back to creditors from the court. However, there remain significant challenges to be faced, given an LTV of 132%, rising vacancies and significant short-term lease maturities," he says.

The borrower, a non-FCT SPV, had previously been granted protection from creditors while it formulated a plan to repay them. A safeguard plan was approved; however, a subsequent ruling in October 2009 undermined this plan by affirming the issuer's right to the rental income, pursuant to the Dailly transfer. This ruling was appealed by the borrower.

The Paris Court of Appeal on 25 February overturned the decision of the lower court to grant the 'sauvegarde' protection to both the borrower and its parent, in each case on the narrow grounds that neither had proved that it would have actual difficulty in carrying out its activities. In addition, the Court stated clearly that, absent such difficulty, the 'sauvegarde' proceeding cannot be used as a means of suspending the application of contractual provisions (in the case of the borrower) or preventing enforcement of a guarantee (in the case of the parent). The Court also rejected the borrower's appeal against the Dailly decision.

Fitch agrees that the decision to reverse the initial 'sauvegarde' protection granted to the borrower and its parent is positive for Windermere XII's noteholders. "This is the latest in a series of court rulings. Overall, these rulings suggest that where property income is pledged to a creditor under a Dailly transfer, borrowers will be unlikely to be successful, ultimately, in an application for 'sauvegarde' protection from creditors. Dailly transfers are a standard additional security for loans secured over French investment properties and therefore these judgements reduce the uncertainty associated with the workout process for non-FCT SPV borrowers across the sector. This is clearly beneficial to noteholders of Windermere XII and other such creditors, although these decisions may still be appealed."

Given the Court's reasoning, it remains possible for a non-FCT SPV to obtain 'sauvegarde' protection, provided it can prove that it has actual difficulty in carrying out its activities. However, in the case of a French CMBS transaction, if the rental income has been transferred to the lender by means of a Dailly transfer - and therefore no longer belongs to the borrower - it would appear that no meaningful reorganisation plan can be devised.

Fitch says it will monitor further events as they take place in the course of its review of the Windermere XII transaction, currently held on rating watch negative, including whether any of these decisions are appealed.

CS & AC

CMBS

Fleet Street 2 resolutions passed

The extraordinary resolutions proposing amendments to the notes and to the loan in European CMBS Fleet Street Finance Two have been passed. The restructuring proposal is the first case in European CMBS that includes an extension of the legal final maturity of the notes by three years (see SCI issue 171). Acceptance of the proposal could lead to other single-loan deals following a similar route.

"The approval of measures put to FLTST 2 noteholders to extend the legal final of the transaction (among other changes) represents an important alternative for CMBS noteholders," European securitisation analysts at Deutsche Bank note. "Given where the senior bonds trade, one would expect such holders to be incentivised to enforce their security through eventual liquidation."

They add: "Evidently, however, senior noteholders - who most likely bought the bonds at or near to par - were unwilling to risk crystallising a loss, preferring to hold out for the possibility of full recovery. It is likely that such incentives drive many CMBS bondholders (particularly banks) and the above could herald further similar action in single loan CMBS deals."

It will be interesting to see whether this sets a precedent for other deals, agrees Michael Cox, analyst at Chalkhill Partners. "Our view is that note extension is only likely to be possible in three different scenarios: where there is a material risk of principal loss to the class A notes if the underlying portfolio is liquidated by original final legal maturity; where there is a significant cross-holding between different classes, so that sufficient class A noteholders are incentivised to agree to an extension to improve recovery prospects for notes further down the structure; and where there are significant concessions made to the class A noteholders. Otherwise, the class A notes would be unlikely to agree to an extension."

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

AC & CS

Advisory

A personalised service

Steve Curry and Mike Nawas, partners at Bishopsfield Capital Partners, answer SCI's questions

Q: How and when did Bishopsfield Capital Partners become involved in the structured credit market?
MN: Steve and I each have over 20 years' structured finance experience gained at ABN AMRO and RBS.

The recent turmoil in financial markets has led to unprecedented amounts of government support for the banking sector and market liquidity, a general aversion to structured credit by investors and the need for greater regulation and capital at banks. We believe that this will give rise to attractive restructuring and investment opportunities arising from general de-leveraging of bank balance sheets, government-sponsored economic stimulus packages and fundamentally sound credit risk that is perceived to be tainted by general association with Mike Nawas and Steve Curry                                                     structured finance.

So, after leaving RBS, we decided that what we really wanted to do was to set up our own company to work with clients on these opportunities. We set up Bishopsfield Capital Partners and obtained our licence from the FSA in August 2009.

It has been fulfilling to win mandates because of who you are rather than what it says on your business cards. Because we are personally engaged with only a small team supporting us, we are able to provide clients with a very high quality personalised service. Clients know that they're not simply going to be passed on to a junior; that's where we can add value.

Q: Do you focus on a broad range of asset classes or only one?
MN: We focus on European structured debt. We're involved in two main activities: advising on, arranging and structuring debt transactions; and developing investment partnerships to invest in small-scale, credit-intensive structured debt opportunities.

Our view is that one naturally arises out of the other. We are not active in trading.

Q: What are you working on at the moment?
MN: Our first idea was around TALF, targeting high net-worth investors, but then, while we were setting up, the market rallied tremendously and we realised that the returns - though still good for the risk profile with IRRs of around 9% - were not sufficiently attractive to launch our first fund. However, the experience provided us with some interesting insights on the advisory side of our business that proved to be easier to develop than we had expected in terms of competing with bank balance sheets.

This could be due to the market situation: many corporate clients have been bruised by the crisis. They are used to arranging debt in the most straightforward way, usually relying on their banks, but many have found that banks won't provide them with the balance sheet support they require any longer.

There is less of a panic now, but concerns remain that the market has fundamentally changed. Banks are reducing balance sheet and prioritising their clients, so corporates need to develop alternative sources of funding. In general, US corporates have been more used to diversifying their funding avenues than European corporates.

We're currently working on a reverse-enquiry structuring mandate that should close in April. It's a preplaced deal, sized at a few hundred millions. We've agreed with the client and investors on terms that the investors will buy it, so our mandate is to structure it to those covenants, security package and ratings.

Operational risk continues to be a big issue with the rating agencies; for example, how a securitisation would perform if the sponsor goes bankrupt. In this sense, we're addressing new concerns from rating agencies.

SC: The other deal we're working on is an innovative equipment financing in the transport sector. It will likely involve ECA financing.

We're working on it with a small investment bank, which has traditionally focused on the M&A market. It's a complementary partnership, based on our debt expertise and their corporate advisory experience. The client is a privately-owned company and doesn't do this size of financing often.

Q: How do you differentiate yourself from your competitors?
SC: The competition is principally from banks, but in their advisory businesses they lack independence because they also have a credit relationship to bear in mind. Also, they have lost experienced people.

Investment banks are taking a bit of a beating at the moment because of poor structures and mispricing of complex products in the past. This is an opportunity for us as we give truly independent advice, which is not influenced by the need to cross-sell other products and services.

We don't intend to build a large-scale distribution platform: there isn't much value for us to add there, as there are already a lot of teams in place to do this. We're not ignoring the distribution element, but we've found a number of smaller brokerages and distribution houses to work with on our transactions.

The expectation of other boutiques that do focus on distribution is typically that there are still lots of anomalies in the market and so relative value is in mispriced assets. We believe this, but it isn't our background and isn't client-driven.

MN: We're not tainted by credit relationships and are able to advise clients about, for example, direct placements with institutional investors rather than relying on their banking groups. A key area for us is boardroom advisory in terms of how corporates should arrange and manage their debt.

The crisis has driven the debt management activities of corporates to the top of their board room agendas. It has become what is termed 'share of mind' business in the banking market. This has traditionally been the realm of the M&A sector, but now that debt is higher on the agenda chief executives are beginning to take a personal interest because the ability to access funding can make or break a company.

Q: What has been the most significant development in the credit market in recent years?
MN: The dramatic change in the credit investor base. In volume terms it first moved from long-term real money accounts towards levered money and now it is moving back again to the way it was 10 years ago. Long-term investors are less concerned about mark-to-market volatility and, for structured credit, this is where the future lies: the industry needs to convince them of the longer-term value in the market.

The market will likely see some spread volatility in the future and base rates can only increase, so investors have to make up their minds about where to sit on the spectrum. Liquidity isn't so much of an issue now; it's more about understanding the product and transparency.

We need to step back and re-examine what an investment bank should be all about. It became the case that investment banks were interacting with each other at a far larger scale than their interaction with the real economy. In my opinion, the allocation of risk appetite by banks should be re-balanced towards client transactions rather than proprietary trading business.

The other significant development I'd mention is the hubris of mathematical accuracy in finance. Credit committee calculations were shown to mean little during the crisis because everything was resold and repackaged, so small assumptions had non-linear implications and consequently small problems became large problems by multiple factors. CDS correlations and CDS indices drove prices, but there was too much generic pricing and too little in-depth analysis.

SC: I believe the originate-to-distribute model in its worst guise was a significant low-point for the industry. The model was good in theory: the intention was to transfer risk and create liquidity in the debt markets. But, in practise, originators lost sight of the need for 'skin in the game' to keep them honest.

Consequently, the emphasis is now on better underwriting and risk management processes.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
MN: In terms of opportunities, investors can't always sustain a team to do reverse enquiry; that's where we come in.

SC: The reverse enquiry route is very relevant at the moment. Originators and issuers are nervous about bringing public deals to market that may not be successful and everyone's still trying to read the market in terms of volumes and prices, so it's a bit of a voyage of discovery. Reverse enquiry helps originators and issuers get over this by placing a minimum size of notes with an anchor investor.

On the other hand, investors are concerned that markets have widened too far and will snap back quickly. We have already seen significant spread tightening.

There is a wall of money waiting to be spent and a desire to get closer in order to influence the structure of a transaction. There is money to be made by matching buyers and sellers: investors don't necessarily know how to access certain opportunities.

Q: What major developments do you need/expect from the market in the future?
MN: The global regulatory authorities need to be empowered and act accordingly. To date, regulatory reform proposals in structured credit have been taking too much time to implement and often aren't fundamental enough. The proposed 5% retention rule for structured finance transactions, for example, doesn't have enough teeth - 5% of a vertical slice is most of the time not significant enough.

However, even though it's not that material, the industry is still pushing back. The problem is that there is no committee of practitioners and regulators with a clear mandate to implement reform globally. As it now stands, if any single country takes too much of a lead, their measures wouldn't be popular with their electorate.

And because every decision involves an international consultative process, change ends up taking too long to implement. But the economy is globalising, so regulators can't work individually either.

CS

ABS

Credit research head moves on

Peter Lin has joined ASAP Expo's board of directors. He was previously investment credit research manager at WesCorp, heading structured finance securities credit research for a US$30bn investment portfolio. His research coverage includes US and foreign RMBS, CMBS, ABS and CDOs.

Prior to joining WesCorp, Lin was an investment analyst at EquiView Capital, a hedge fund management company that specialises in small and mid-cap equities and offshore private placement investment.

Asia

Trading platform plans Asia expansion

Illiquid asset trading platform SecondMarket has raised US$15m in Series B financing from the Li Ka Shing Foundation (LKSF) and Dunearn Investments (Mauritius), a wholly-owned subsidiary of Singapore-based investment company Temasek Holdings. LKSF and Temasek each invested US$7.5m in SecondMarket, the proceeds of which will be used to further scale the SecondMarket platform and infrastructure in preparation for the company's upcoming expansion into the Asian markets.

"We identified a tremendous opportunity for SecondMarket in various Asian markets and, as we grow our business, add new asset classes and expand internationally, there are no better partners to support our efforts than Mr Li and Temasek," says SecondMarket ceo Barry Silbert.

SecondMarket currently has offices in New York and Silicon Valley, covering multiple asset classes, including private company stock, limited partnership interests, auction-rate securities, bankruptcy claims, RMBS and CMBS, CDOs, warrants/restricted stock in public companies and whole loans. In total, over US$25bn in illiquid assets are available for sale via the SecondMarket platform.

Asia

Securitisation pro to head China office

Orrick, Herrington & Sutcliffe has appointed partner Michelle Taylor as its China office leader. Based in Hong Kong, Taylor assumes responsibility for overseeing the management and administration of the firm's three offices in Beijing, Hong Kong and Shanghai.

Taylor began her career with Clifford Chance in London, before going to Hong Kong in 1997 to help develop the Asia-based English law securitisation and structured finance practices of Sidley Austin and then Paul Hastings. Taylor joined Orrick's Hong Kong office as a partner and head of the firm's Asia financial markets practice in 2007.

In addition, Orrick has promoted Andrew Dale to partnership in Orrick's dispute resolution practice in Hong Kong. Other job moves include Michael Haworth, who relocated to Orrick's Hong Kong office to lead the firm's regional real estate practice in January; Niping Wu from Cleary Gottlieb, who joined Orrick's Beijing office in December; Phoebus Chu from Paul Hastings, who joined Orrick in Hong Kong and Beijing in November; and Thomas Tobiason, who relocated from Silicon Valley to Shanghai in October.

CDO

Synthetic CDO manager replaced

S&P says it issued a total of 14 CDO rating confirmation letters in February, of which two were for cash and hybrid CDOs and 12 were for synthetic CDOs. The most common reasons for these rating confirmations have been: the replacement of an expired FX option and the extension of a currency forward in cash and hybrid CDOs; and the appointment of a new manager in synthetic CDOs. Specifically, Societe Generale Gestion replaced SGAM as the manager on Claris Gascogne Series 30/2004, 32/2004, 33/2004, 34/2004 and 35/2004.

CMBS

Alliance formed for CMBS loan restructuring

The BSC Group has formed a marketing alliance with 1st Service Solutions to exclusively promote their loan restructuring services to storage owners and investors nationwide. The alliance was formed to help self-storage property owners obtain lower interest rates, reduced monthly payments and modified loan terms for their distressed properties, the two firms say.

To achieve this, BSC and 1st Service Solutions team members will create strategic work-out packages, prepare clients for the work-out process and represent client interests during lender negotiations in order to support a continued financing relationship. Shawn Hill, a BSC Group principal, says: "Given our firms' respective experience and expertise in CMBS markets, there clearly is an overlap in our client and prospect profiles."

Distressed assets

Pair of credit opportunity funds closed

Aladdin Credit Partners (ACP) has closed its US$573m initial credit opportunity funds, Aladdin Credit Partners I and Aladdin Credit Offshore Fund I. The funds are focused on investing in restructuring-related opportunities, including rescue financing, debtor-in-possession financing and plan confirmation financing.

ACP is a joint equity venture formed by co-founders Luke Gosselin and Victor Russo, and Aladdin Capital Holdings. Prior to creating ACP in early 2009, Gosselin was head of private principal finance at Goldman Sachs in New York and London. Russo was previously president of CIT Business Credit, a subsidiary of CIT Group, in New York.

Gosselin says: "In what proved to be one of the more challenging fund raising environments over the past decade, we are pleased to have raised what we believe to be one of the largest global pools of capital in 2009. The partnership with Aladdin has proven to be the right strategic fit, while the strategy of investing into distressed and restructuring-related situations was consistent with the objectives of our institutional investor bases, anchored by investments from Mitsubishi Corporation and Intesa Sanpaolo."

Russo adds: "The current economic environment is very conducive to our business strategy, given the significant amount of corporate defaults and bankruptcy-related activities. We believe there will be an ongoing need in 2010 and beyond for funding for those companies in financial distress. ACP is well positioned from both a product and personnel standpoint to take advantage of the opportunity set."

Emerging Markets

Indian fixed income heads named

Nomura has appointed Nipun Goel as head of investment banking and Nitin Jain as co-head of fixed income in India. Neeraj Gambhir, who is currently the head of Nomura's credit business in India, will co-head the fixed income business along with Jain.

Goel joins from Merrill Lynch India, where he spent 14 years, and has broad experience in capital markets. Jain was most recently with ICICI Securities, where he was ceo of the primary dealership.

Gambhir joined Nomura in October 2008 from Lehman Brothers. Prior to this, he was global head of structured finance and advisory and global head of asset liability management at ICICI Bank.

Vikas Sharma, ceo for Nomura India, says: "Nomura India is pleased to announce these appointments. India is a market of key strategic importance to Nomura as the leading Asia global investment bank, and the invaluable experience of Nipun, Nitin and Neeraj will help us to further strengthen our presence in India. These appointments underscore Nomura's focused and ongoing build-out plans for India and highlight the strength of our platform to attract outstanding professionals. We continue to build and develop our team further."

Investors

Floating rate mutual fund launched

Delaware Investments has launched a new mutual fund in the US - the Delaware Diversified Floating Rate Fund. The fund, which seeks to provide total return, is an actively managed portfolio that - under normal circumstances - invests at least 80% of its net assets in floating-rate securities, including non-agency MBS and ABS.

The fund is managed by Roger Early and Paul Grillo, co-cios of Delaware's total return strategy; Kevin Loome, who leads the firm's high yield group; and David Hillmeyer, who specialises in corporates and bank loans. Early, Grillo and Loome are among the managers on Delaware Diversified Income Fund, while Early and Grillo also manage the Delaware Limited-term Diversified Income Fund.

Scott Coleman, evp and head of distribution and marketing at Delaware Investments, says: "In this economic environment when investors are seeking hedges against inflation, a floating-rate fund may be a strong addition to a portfolio. We believe the flexibility and diversification built into Delaware Diversified Floating Rate Fund, where investors gain exposure to floating-rate instruments with differing credit qualities across a variety of fixed income asset classes, is a timely solution."

The investment team uses a fundamental, bottom-up approach to select securities and relies on Delaware's three-pronged approach - combining portfolio management, research and trading - to deliver the best solution possible to investors.

Monolines

MBIA confirms litigation strategy

MBIA has confirmed its commitment to a number of RMBS and CDO-related litigation suits, despite being sued itself by a number of parties following the separation of its public finance business, National, from its structured finance and international business, MBIA Insurance, last year (SCI passim).

Michael Cox, analyst at Chalkhill Partners, suggests that in doing so, the monoline is seeking to transform itself from one of the causes of the crisis to one of its victims by "jumping on the bank-bashing bandwagon".

MBIA is seeking reimbursement via put-back recoveries in RMBS (SCI passim), as well as suing for fraud and misrepresentation in CDOs. MBIA has already included around US$1.5bn in put-back recoveries in its accounts so far, but - according to ceo Jay Brown - the amounts involved in these cases easily exceed US$4bn.

"We have filed complaints alleging fraud and misrepresentation against a small handful of financial institutions that manufactured CDOs and then purchased insurance coverage from us on those same transactions," said Brown during MBIA's 2 March results call. "In retrospect it is clear to us that they had far greater knowledge in understanding of the problematic content of those CDOs then they had represented to us at that time. It also turns out that a few of the institutions that we have cited in legal complaints are also the same plaintiffs or affiliated with the plaintiffs of the bank legal actions being pursued against our insurance transformation."

The amount at stake for the CDO-related litigation represents a significant portion of the US$2.5bn of present value of ultimate incurred loss that MBIA is estimating for its CDO portfolio. "While we think MBIA is clearly justified in complaining about cases of fraud and misrepresentation, we hope there is more substance to the claims than simply that the banks understood more about the transactions' risks than MBIA did," Cox comments. "The insurer, along with its peers, had previously prided itself on its superior credit skills."

He continues: "Overall, the future for MBIA appears to us highly dependent on the outcome of various court cases. However, it continues to have breathing space on the capital and liquidity front, so that it is more a question of whether it can move forward than one of whether it can survive at all."

S&P yesterday (2 March) cut the rating on MBIA Insurance Corp's preferred stock to single-C from single-B plus, as a result of the deferral of dividends.

Operations

AIG unloads Asian insurance arm, repays FRBNY

A definitive agreement for the sale of AIA Group to Prudential has been made for approximately US$35.5bn, including US$25bn in cash, US$8.5bn in face value of equity and equity-linked securities, and US$2bn in face value of preferred stock of Prudential, subject to closing adjustments.

The cash portion of the proceeds from the sale, the largest to date in AIG's ongoing restructuring efforts, will be used to redeem preferred interests with a liquidation preference of approximately US$16bn held by the Federal Reserve Bank of New York (FRBNY) in the special purpose vehicle formed to hold the interests in AIA and to repay approximately US$9bn under the FRBNY Credit Facility. AIG intends to monetise the US$10.5bn in face value of Prudential securities over time, subject to market conditions, following the lapse of agreed-upon minimum holding periods. All net cash proceeds from the monetisation of these securities will be used to repay any outstanding debt under the FRBNY Credit Facility.

Bob Benmosche, AIG president and ceo, says: "In considering two viable, very attractive alternatives to successfully monetise AIA, including an initial public offering, we decided that a sale to Prudential enables AIG to realise value on a faster track to repay US taxpayers. This transaction, the most significant milestone to date in our ongoing effort to repay taxpayers, also gives us greater flexibility to move forward with AIG's restructuring and focus on enhancing the value of our key insurance businesses, which will benefit all stakeholders."

Technology

Trepp acquires real estate analytics platform

Trepp is to acquire Foresight Analytics. Foresight Analytics provides real estate analysis for commercial and residential real estate in both domestic and international markets on behalf of institutional investors, lenders and developers. The terms of the deal were not disclosed.

Following the acquisition, Foresight Analytics research will be available to clients of Trepp's CMBS Analytics and TreppLoan products.

ABCP

Stable outlook for US ABCP ratings

The ratings outlook for ABCP in the US in 2010 remains largely stable, according to a Moody's report for the sector. As the economy recovers, underlying asset performance has become less of a concern and bank sponsors have been diligent in maintaining the credit quality of their conduits.

However, there is downside risk in that any removal of the systemic support currently provided to the banking system could impact bank sector ratings. Any downgrade of the Prime-1 rating of a conduit sponsor or liquidity provider would have a direct impact on the Prime-1 rating of the related conduit's ABCP.

The volume of ABCP issued in 2010 will largely depend on the economic recovery. Moody's svp Everett Rutan notes: "Banks seem willing to add well-structured transactions to ABCP conduits and there are sellers who desire such facilities."

Utilisation of those facilities is 10 to 15 percentage points lower than several years ago. If business activity increases, utilisation and the amount of ABCP outstanding should increase, Moody's says.

While 2009 saw US ABCP outstandings decline for the third straight year, otherwise it was a year that the market stabilised and strengthened. Support programmes established by the US government in the fourth quarter of 2008 provided liquidity to the market and these gradually wound down in the second half of 2009.

Rutan explains: "Declining ABCP volume helped to tighten spreads and extend maturities as money funds struggled to find high quality, high yielding investments."

The last government programmes ended on 1 February 2010 and the market has remained steady. However, regulation remains the final uncertainty overhanging the US ABCP market.

In addition to concerns about systemic support, the final implementation of Basel 2 may also impact the economic viability of bank-sponsored ABCP conduits. New money market fund regulations require increased attention to liquidity and this may affect their willingness to hold certain investments. Industry participants are currently working to determine how these will be implemented, Moody's notes.

ABS

Reversal for declining REO trend?

Remittance reports for the February distribution date indicate that the trend of declining REO stock in the US may have reversed, according to ABS analysts at Barclays Capital. The fraction of loans in REO rose by an average 3% month-on-month, due to an apparent increase in foreclosure-to-REO and lower demand.

"While ABX represents a small fraction of the mortgage universe and monthly data are noisy, January's data are indicative of the environment of rising REO supply meeting lower demand that has been the basis of bearish calls," the analysts explain. "Consistent with this backdrop, severities rose 2.8% to 72%."

CDRs fell across the board by an average of 3.3 points and foreclosure stock fell by 1.9%. But aggregate 60+ day delinquencies (including foreclosure and REO) increased by 0.43%, 0.05%, 1.43% and 0.94% across the 06-1 to 07-2 indices.

"We expect the backlog of 60+ loans to continue rising over winter from foreclosure paralysis, the implication perhaps being unexpectedly higher severities from adverse selection. Early stage delinquencies (30-59 days) fell by 27, 8, 16 and 24bp across 06-1 to 07-2. Historically, seasonal effects on current-to-30 roll rates are significant (+10%) in January," the analysts add.

Voluntary prepayments were generally lower on the month, with CPRs changing by 40, -42, 1 and -91bp across the 06-1 to 07-2 indices.

CDO

Dante ruling impacts more CSOs

Moody's has downgraded and/or placed on review for possible downgrade its ratings on 16 CSO transactions, which have exposure to Lehman Brothers Special Financing (LBSF). US$3.3bn of unfunded notes and US$700m of funded notes are affected by the actions

The rating agency explains that the actions are primarily based on the rating methodology for structured finance securities in default published in November 2009. All the rated tranches of the CSOs have been subject to interest payment default or deferred interest payments for an extended period of time. Interest on the funded notes payments and commitment fees on the contingent funding notes (the unfunded tranches) continues to accrue without a definite date of repayment, pending a resolution of the litigation affecting these transactions.

The rating actions also reflect the increased risk and uncertainties brought by the recent Dante ruling (SCI passim). The Dante ruling held that the market-standard assumptions relating to the subordination of swap termination payments owed to a swap counterparty following a swap counterparty bankruptcy are unenforceable under the US Bankruptcy Code.

In the event that the court decision is upheld and the transactions unwind following the resolution of the specific litigation affecting the liquidation of collateral in the CSOs, the amount of potential loss affecting each tranche is expected to be a function of the CDS termination payment, the liquidation price of the collateral and the position of the tranche in the capital structure of the transactions. Furthermore, the termination cost of the swaps could potentially be equal or exceed the liquidation proceeds of the collateral securing the repayment of the funded notes and the payment of accrued commitment fee of the unfunded tranches.

As a result, a large termination payment senior to the noteholders could cause a complete loss of principal and accrued interest on the funded notes, Moody's says. Similarly, it may also result in the loss of all accrued and unpaid commitment fees on the unfunded tranches.

The difference between the amounts at risk on funded and unfunded tranches is reflected in the difference in their updated ratings: at most B1 for the funded tranches and at most Ba1 for the unfunded tranches. Moody's also placed all the notes on review for possible further downgrade.

The resolution of these reviews will depend, among other things, on the future development of the US bankruptcy court decision, especially given that the trustee of the Dante transaction has stated its intention to appeal the decision. The review will also focus on determining the increased expected loss attributable to the notes as a result of the potential liquidation of the collateral and the potential of a swap termination payment being paid senior in the waterfall.

CDS

Increased flows seen in simple FTDs

A 'back to simplicity' bid in the structured credit market appears to be driving increased flows in simple FTD baskets, from both buyers and sellers of protection. Wide corporate credit spreads, high correlation and stress in the sovereign and US municipal sectors are behind the trend, according to credit derivatives strategists at Morgan Stanley.

"Given our fair value to constructive views on corporate credit along with our belief that default correlation has room to continue to fall, we in general like buying FTD protection and selling 2nd-to-nth to default protection in today's market environment," they note.

The strategists confirm that they are seeing interest in both FTDs and their unlevered senior cousins 2-LTDs in both swap and CLN form. However, the constituent base differentiates these trades from their pre-crisis predecessors - namely European sovereign and US muni CDS are now being put into baskets. A long US basket, a short European basket and a short basket in US names with a high degree of European exposure are some potential ways to trade FTDs, the strategists suggest.

"In today's market we see plenty of reasons to use these simpler structures to implement views in levered or de-levered form," they add. "With headline risk and opportunities for both longs and hedges across corporate sectors and government debt, we think basket trades are uniquely positioned to express views - particularly against a backdrop in which investors are still favouring reduced structural complexity."

The product may also be interesting for investors with more of a single name credit or equities background, due to their structural simplicity and because the primary driver of valuation is the actual credits themselves.

CDS

'Compelling' basis trade opportunities in REITs

Compelling trade opportunities have emerged in sectors where the cash-CDS basis has recently become significantly more positive, according to credit strategists at Barclays Capital. These sectors include insurance, transportation and REITs.

On average, the cash-CDS basis has become slightly less negative since early January, moving from -57bp to -50bp. It has also been extremely volatile on a sector level, becoming more negative in sectors such as banking and retail, where cash has underperformed. In some cases, such as REITs and health insurance, CDS widened substantially - even though cash actually tightened over the period.

"The insurance sectors typically have a more positive basis than the rest of the market because of limited debt outstanding relative to counterparty risk-related hedging demands, and it is not unusual for the basis to become more positive during a period of market stress," the BarCap strategists explain.

They suggest that the change in the REIT basis is particularly interesting. It has traded in a fairly narrow range of -100 to -120bp since late August, while CDS moved tighter, and only began moving more positive since the beginning of 2010 as CDS widened. At this point, the basis is significantly more positive than the rest of the market, particularly after accounting for the absolute level of spreads.

"For many [REITs], we believe selling protection is a more attractive long-risk strategy than buying cash bonds, particularly for credits with a basis inside of 50bp," the strategists conclude. "These include AVB, EQR, KIM, PLD and SPG. For a name such as HCP, whose -111bp basis is the most negative in the sector, the recent move in CDS is a less compelling reason to take long positions in CDS form because there remains considerable potential for cash to outperform."

CDS

Healthier earnings implied by consumer services CDS

Tightening CDS spreads are pointing to healthier earnings for a handful of consumer service companies this week, according to Fitch Solutions' latest update on global CDS spreads/liquidity scores for companies scheduled to come out with earnings announcements this week.

For example, AutoZone's performance is shedding some positive light within the North American consumer services industry, with CDS spreads tightening 22%, compared with 1% sector-wide. CDS liquidity for AutoZone, however, has moved up ten regional percentile rankings over the same period, indicating increased uncertainty over the company's credit outlook.

Fitch Solutions md Jonathan Di Giambattista says: "AutoZone has proven itself to be countercyclical as demand for auto parts to up-keep older vehicles increases in bad economic times. Similar to other retailers, Autozone's current CDS liquidity is likely a result of diverging views on the future of the economy by credit market investors."

Staples saw the cost of credit protection on its debt diminish by 28% over the last quarter, thereby outperforming its peers. Meanwhile, decreasing CDS liquidity for the name further signals renewed market confidence in the company's ability to recover from the economic downturn.

In addition, markets continue to display confidence in Costco Wholesale Corporation's credit condition, with CDS spreads trading in the triple-A space, three notches above its Fitch long-term rating, and liquidity dropping to the 44th regional percentile.

CDS

Theta urged to adjust capital adequacy model

S&P has lowered its ratings on Theta Corp's class 1 US and Euro MTNs to triple-B minus and lowered its ratings on the vehicle's US and Euro CP to A-3. The ratings remain on credit watch with negative implications. The company is engaged in selling credit protection through CDS primarily on single name corporate reference obligations.

The vehicle has yet to confirm whether it will reparameterise its capital adequacy model to incorporate S&P's updated corporate-backed CDO criteria. The rating agency says that it if it does not receive confirmation from the company to that effect in short order, it is likely to withdraw the ratings.

The capital adequacy reports that S&P currently receive do not contain the information that is reflective of its updated CDO criteria. Theta currently has no outstanding class 1 MTNs and CP, and is in restricted operating mode.

S&P's rating actions reflect its analysis of Theta's CDS exposure and its funded portfolio composition, based on its reports, pursuant to the agency's updated CDO criteria and use estimates provided by CDO Evaluator. Pursuant to this analysis, the current credit support levels, in its view, are consistent with ratings at the BBB-/A-3 level for the company's class 1 MTNs and CP.

The ratings remain on credit watch with negative implications because of S&P's assessment of the likelihood that the company's capital adequacy reports following a reparameterisation would influence its views further.

CLO Managers

CSO tender offer announced

Deutsche Bank's London branch has announced a tender offer for the outstanding notes issued by Asgard CDO, a 2005 corporate synthetic CDO managed by Henderson Global Investors. The transaction issued notes in sterling, euros and US dollars.

A repurchase price of 84%, 83% and 82% is being offered for the series A, B and C notes respectively. The offer to tender notes will be open until 2 March and the transaction is expected to settle on 5 March.

CLOs

'Premium' standard unveiled for German SME CLOs

The Association of German Banks has unveiled a new, premium standard for German SME securitisations. Potential investors were involved in the development phase.

"Our goal is to revitalise the securitisation market, where investor confidence was largely lost as a result of the financial crisis," explains Markus Becker-Melching, md for competition and SME policy at the Association. "The primary objective is to support the funding of SMEs."

Securitisation was an important tool for the banks, he notes, enabling them to free up capital and create scope for lending. The securitisation market in Germany has been at a virtual standstill for the last two years, however.

"There's actually no justification for the loss of confidence in German securitisations, especially securitisations of SME loans, where losses were far lower than expected - even during the crisis. Securitisation nevertheless tends to be viewed with distrust; the new standards are intended to counteract this perception," adds Becker-Melching.

The underlying principle of the standards is that securitised loans should have a high level of transparency and quality. This means no resecuritisations, for instance. In addition, securitisation should only be permitted if the loan has been on the bank's balance sheet for at least one year or if the bank retains a portion of the loan.

Becker-Melching points out that there will be no non-performing loans in this premium segment, nor loans that do not reflect the other lending operations of the bank in question.

The new standards have been handed on to the True Sale International (TSI) securitisation platform. "TSI has the expertise and resources to establish this premium standard on the market in collaboration with all sectors of the banking industry and thus to ensure sustained high quality," Becker-Melching comments.

CLOs

RFC issued on supplementary CLO analytic

S&P is requesting feedback on a proposed supplementary analytic, CLO Tranche Recovery Metrics (CLO TRM), which aims to allow market participants to estimate recoveries on US CLOs under varying scenarios.

"The CLO TRM framework is designed as a supplementary analytic to complement our CLO ratings, which generally focus on the likelihood of default, by highlighting a different analytical vantage point in looking at the post-default characteristics," explains S&P credit analyst Zach Wolf. "It aims to allow its users to estimate a CLO tranche's recovery prospects, given a set of hypothetical future rating transition, collateral default and recovery assumptions."

This set of assumptions could be the user's own views on future collateral scenarios, although the rating agency is also considering publishing sample hypothetical collateral scenarios, as well as corresponding sample tranche recovery estimates for a subset of outstanding CLO transactions. "The proposed framework and the accompanying tool is intended to incorporate transaction-specific information - such as the composition of the collateral pool, including ratings, loan type and other features - as well as certain transaction-specific structural features, for example, the structural 'waterfall' mechanics," says S&P credit analyst Jake Cho.

According to Cho: "In addition, the framework may facilitate comparative analyses of multiple transactions under given scenarios the user defines."

CLO TRM reports the estimated recovery amount as a percentage of the current outstanding balance of the CLO tranche. Depending on the ratings composition of the relevant collateral pool and the transaction's structural features, the potential recovery levels from one CLO tranche to another could vary materially, S&P notes.

CMBS

Contested bids emerge for GGP

The bidding war that erupted last week over General Growth Properties and its retail mall properties confirms the market's continued interest in quality real estate and productive portfolios, Moody's notes in its Weekly Credit Outlook. Simon Property Group's all-cash bid for the GGP portfolio (see SCI issue 172) was parried by a more complex bid from Brookfield Asset Management.

"The contested bids are clear evidence that the value of GGP's properties has remained strong overall and that the GGP bankruptcy was driven primarily by high leverage, the liquidity crisis and GGP's looming debt maturities," says Merrie Frankel, vp - senior credit officer at Moody's.

Under Simon's bid, GGP's shareholders would receive more than US$9 per share of cash, Simon common equity or other consideration, while GGP debt holders would receive cash equal to the unsecured debt's par value plus accrued interest. Brookfield's plan includes a US$2.6bn investment in GGP, essentially leaving the company intact.

The Brookfield Group, which would own around 25%-30% of the emerging company, is proposing a complex recapitalisation of GGP at a plan value of US$15 per share for the equity and payment to the unsecured creditors of par plus accrued interest. The bid is part of a broad plan to raise US$8.3bn to fully pay GGP's creditors and is conditioned upon an additional US$5.8bn of proceeds, including the issuance of new equity, asset sales and limited new debt issuance. GGP will need to raise the balance of this capital with Brookfield's help.

The result is two divergent bids from well-capitalised companies that value good real estate, according to Frankel. "Despite all the noise and market pessimism about commercial property values, clearly high quality, productive properties still command strong interest. Both bidders have significant liquidity, as well as successful track records with complex transactions, integrating and managing large acquisitions, and working with institutional partners. Financial flexibility and access to multiple sources of capital including unsecured debt, secured debt and equity differentiate Simon and Brookfield from GGP, a REIT with consistently high leverage, material levels of variable rate debt and a secured debt funding strategy."

CMBS

Increased workouts expected for Euro CMBS

According to Fitch, upcoming European CMBS loan maturities in March and April will result in an increase in the number of loans that are currently in standstill or going through a workout process, given the small number of loans that have recently paid in full at their scheduled maturity dates. While only two loans will mature in March, a further 10 loans are scheduled to mature in April.

Charlotte Eady, director in Fitch's European CMBS team, says: "Of the €8bn of European CMBS loans that were scheduled to mature prior to March 2010, 69% by balance is still outstanding. Only 6% were paid in full either at or shortly after loan maturity, while the remaining 24% were prepaid, typically prior to the onset of the credit crisis."

Gioia Dominedo, senior director in Fitch's CMBS team, adds: "Half of all European CMBS loans that have passed their maturity dates and are still outstanding are in standstill or going through a workout process. The other half have had their maturity dates extended, either through a pre-existing extension option or a loan modification. Fitch expects to continue to see loan extensions being used as an alternative to or as part of a loan workout."

CMBS

Minimum liquidity stipulated for Singapore CMBS

The minimum liquidity protection for Singapore CMBS transactions should be no less than six months, according to Moody's in a new report. The rating agency states that the minimum liquidity protection in Singapore CMBS transactions should be sufficient to cover the senior payment obligations of the CMBS issuer for a period equal to the longer of either six months or one payment period.

Jerome Cheng, a Moody's vp and author of the report, says: "This minimum liquidity protection is important so that the CMBS issuer can meet its payment obligations in a timely manner. This minimum liquidity protection is premised on the transaction characteristics, and the legal and operational risks of Singapore CMBS transactions."

The minimum liquidity protection is based on results of Moody's request for comment regarding Singapore CMBS liquidity sufficiency, which was published last November. Actual liquidity protection will be analysed based on the merits of the individual transaction.

Cheng adds: "Moody's would consider greater liquidity protection for transactions with more embedded risks. To ensure rating consistency across all Singapore CMBS transactions, these new guidelines are applicable to all the future and existing transactions. The rating of a transaction lacking sufficient liquidity will be linked to the rating of the sponsoring S-REIT. The degree of rating linkage will be subject to the existing liquidity arrangement, the S-REIT's profile and the remaining term to maturity."

After considering the liquidity protection present in the existing deals, Moody's has put three CMBS transactions on review for possible downgrade due to the lack of relevant liquidity reserve and has affirmed the ratings of another three.

CMBS

EMEA CMBS central scenarios updated

Moody's has updated the central scenarios that it uses for its quantitative CMBS rating assessments (MoRE Analysis) in EMEA.

Oliver Moldenhauer, a Moody's avp - analyst, says: "Our EMEA CMBS central scenarios remain virtually unchanged compared to 2009 and, as a result, the rating impact of this update is expected to be limited. However, we expect that EMEA CMBS ratings will remain under pressure over the coming years. Downgrades will mainly be driven by tenant defaults, loan maturities and idiosyncratic events."

The forward-looking central scenarios cover a horizon of up to five years and define specific inputs and underlying model assumptions in the MoRE Analysis framework. They reflect Moody's current expectations as regards the factors influencing the medium-term performance of CRE loans and complement the EMEA CMBS sector outlooks, which cover the next 12-18 months.

The rating agency says that its updated central scenarios are based on the assumption that a sluggish recovery remains the most likely global macro-economic scenario for the EMEA region. Focusing on the CRE markets of the UK, Germany, France and the Netherlands, which are the most relevant markets for EMEA CMBS, Moody's assumes that investment, occupational and lending markets relating to the prime segment will continue the gradual recovery that started in Q309, albeit at a slower rate than recently observed. Secondary commercial real estate markets are expected to bottom out only towards end-2010 or even in 2011.

Jeroen Heijdeman, a Moody's analyst, says: "The recovery will be moderate and distinctly polarised between prime and secondary properties. As such, it will be insufficient to significantly improve the outlook for outstanding loans securitised in EMEA CMBS."

The rating agency identifies at least three downside risks to its updated EMEA CMBS central scenarios: (i) that banks are unable to re-capitalise, resulting in a continuing or even increasing shortgage of available CRE financing; (ii) that a disorderly exit from current high stimulus policies leads to a substantial increase in long-term interest rates and, in turn, property yields; and (iii) that a slower than expected economic recovery weighs further on CRE occupational markets.

Raphael Smadja, a Moody's associate analyst, says: "In Moody's opinion, the realisation of one or more of these risks could lead to another significant CRE downturn in 2012/2013 and subsequent rating actions."

CMBS

70% of Japanese CMBS downgraded

According to the agency's latest report for the sector, 70% of all outstanding Fitch-rated Japanese CMBS classes have been downgraded. The average downgrade was 1.2 rating categories, with rating actions concentrated in the lower end of the capital structure. A significant portion of the downgrades were driven by the valuation reviews performed on all collateral properties, which saw a weighted-average value decline of 21% under stabilised analysis assumptions and 35% under more stressed scenario assumptions.

The 2009 surveillance reviews involved 181 classes from 34 transactions and focused on transactions that contained bullet maturity loans (SCI passim). The reviews did not include the interest-only classes or transactions backed by diversified fully amortising loan pools with schedules of 25 years or more.

For the higher rated classes, fewer downgrades resulted following the review, with 67% and 35% of the triple-A and double-A classes being affirmed respectively. In contrast, nearly 90% of the classes rated triple-B and below were downgraded, which brought classes rated triple-C and below up to 18% (32 classes) of the overall rated portfolio from 1% prior to the reviews.

More severe downgrades occurred to transactions with exposures to liquidation-type loans. This was primarily due to the assumption that no further liquidation of properties, leading to the de-leveraging of the loan, would occur during the remaining loan term. Other aspects of the analysis discussed in the report include loan pool maturity dates and payment structures.

Following the comprehensive review of collateral property evaluations, the weighted average cap rate of the overall property portfolio, initially valued by Fitch, increased from 5.6% to 6.7% and 8.2% based on revised Fitch values and Fitch stressed-sale values respectively.

The agency does not expect loans going into default at their maturity dates to directly trigger a rating review or a rating action, since the current Japanese CMBS ratings have factored in the foreseeable market downturns. Fitch expects individual events and circumstances on transactions and loans, such as the progress in work-outs on defaulted loans and the transaction's status in relation to the tail period to be the key drivers of rating actions in 2010. It is expected that rating actions will continue to be concentrated at the lower end of the capital structure, though to a lesser extent than in 2009.

Distressed assets

Number of 'troubled' banks on the rise

The FDIC's Q4 report suggests that problems in the US banking system are far from over. The industry as a whole recorded a marginal profit (US$984m across 8012 banks), but this was driven by the 107 large banks (with assets over US$10bn), which reported a collective net income of US$3.1bn. The 7905 other smaller banks (assets under US$10bn) reported a collective loss of US$2.2bn.

Credit strategists at BNP Paribas note that it isn't surprising therefore that 702 banks are now considered to "troubled" by the FDIC at the end of 2009, accounting for US$403bn of assets (sharply up from 252 banks at the end of 2008, accounting for US$159bn in assets). "Although the FDIC says that banks were helped by higher trading revenues and lower goodwill impairments compared to a year ago, we think this applies to the larger banks. On the other hand, smaller banks have a significant share of commercial and other real estate exposure, which we believe have still not been written down (or provided for) to reflect the average 40%+ decline in real estate prices," they say.

140 US banks failed during the year compared to 25 in 2008. The report indicates that had results of the failed banks been included, the overall numbers would have been much worse.

The FDIC's deposit insurance fund (DIF) decreased by a further US$12.6bn during the quarter to a negative US$20.9bn, mainly due to the US$17.8bn allocated for failing banks. For the year the fund declined by US$38bn, bringing the DIF reserve ratio to 0.39% as of end-2009 - the lowest reserve ratio on record. Given industry estimates of many more bank failures this year (and next) and the structure of the loss-sharing arrangements of recent bailouts, it is quite likely that this could force the FDIC to tap into its line with the Treasury or force a further levy on banks, according to the BNP Paribas strategists.

Documentation

Islamic hedging documentation unveiled

The International Islamic Financial Market (IIFM) and ISDA have launched the ISDA/IIFM Tahawwut (Hedging) Master Agreement, marking the introduction of the first globally standardised documentation for privately negotiated Islamic hedging products. The Agreement is the first financial industry framework document that is applicable across all jurisdictions where Islamic finance is practiced.

IIFM and ISDA jointly developed the Tahawwut documentation under the guidance and approval of the IIFM Shari'ah Advisory Panel for this project and in consultation with market participants. The published document consists of the Tahawwut Master Agreement and an Explanatory Memorandum, both of which are part of the official Shari'ah Pronouncement.

"Given the growing nature of the Islamic finance industry, the institutions operating on Shariah principles can no longer afford to leave their positions un-hedged," comments Khalid Hamad, chairman of IIFM and executive director of banking supervision at Central Bank of Bahrain. "Hence, some key hedging products are now becoming common across jurisdictions to mitigate risk. The ISDA/IIFM Tahawwut Master Agreement gives the industry access to a truly global framework document, which is neutral in terms of treatment to both the transacting parties and at the same time strictly conforms to Shariah principles. IIFM is honoured to have achieved this milestone in collaboration with ISDA and I am confident that such joint efforts will continue in the future."

"Demand for customised, privately negotiated hedging tools that conform to the principles of Islamic finance has increased in momentum," adds Eraj Shirvani, chairman of ISDA and md, head of fixed income for the EMEA region, Credit Suisse. "The Tahawwut Master Agreement provides the critical framework for the growth and evolution of Shariah-compliant hedging instruments."

The ISDA/IIFM Tahawwut Master Agreement provides the structure under which institutions can transact Islamic hedging transactions, such as profit-rate and currency swaps, which are estimated to represent most of today's Islamic hedging transactions. It is designed to be used between two principal counterparties as a master agreement.

Parties understand that no interest shall be payable or receivable and no settlement based on valuation or without tangible assets is allowed. Moreover, the counterparties to the Tahawwut Master Agreement make representations as to the fact that they enter into Shariah-compliant transactions only.

It is a completely new framework document, though the structure of the document is similar to the conventional ISDA Master Agreement. However, the key mechanisms and provisioning such as early termination events, closeout and netting are developed based on the Islamic Shariah principles.

"Standardisation is a key element in the progress of Islamic finance, though it is not a simple process as evident from the efforts put in to the development of this master agreement," continues Ijlal Ahmed Alvi, IIFM ceo. "A record number of drafts - 24 drafts - were developed during the industry consultation and Shariah guidance process before ultimately reaching the final version, which is comprehensive as well as practical in terms of usage with no compromise to Shariah principles. It was indeed a pleasure to work with such an experienced and dedicated execution team and the efforts were supplemented by exemplary understanding and cooperation shown by ISDA, our joint partner. We express our heartfelt thanks to the Central Bank of Bahrain for their continuous support and to all who were involved in completing this important project. "

"IIFM has taken a lead in preparing Shariah-compliant Master Agreements for specific areas of Islamic finance, which a number of financial institutions globally have recognised and adopted in order to avoid misunderstanding, uncertainty and confusion; and also to seek clarity and sound business activities. The adoption of these Master Agreements will pave the way not only for Shariah compliance, but also product innovation," says Ahmad Rufai, IIFM Shariah head.

He adds: "The IIFM Shari'ah Advisory Panel have considered the Tahawwut Master Agreement to be a necessary step forward for promoting global standardisation for Islamic financial product standards, because the absence of a global Shariah-compliant standardised agreement may lead to negative effect in the industry. On this occasion, the IIFM Shari'ah Department would like to thank the IIFM Shari'ah Advisory Panel for their indispensable and greatly appreciated support. We don't know where the TMA development would be without their invaluable help and patience in reviewing many of the drafts. Maybe it would not have seen the light."

In addition to developing documentation for Islamic transactions, ISDA in coordination with IIFM is in contact with various regulators in a number of Islamic jurisdictions, such as the Gulf Cooperation Council (GCC) region (namely UAE, Bahrain and Qatar, plus Pakistan) to improve the local legal framework for hedging products and close-out netting provisioning.

Emerging Markets

Russian/CIS SF performance stabilises

The performance of Russian and CIS securitisation transactions stabilised in H209 after the deterioration seen in the previous six months, according to Moody's. The rating agency notes that most RMBS transactions have seen arrears levels decrease compared to June 2009.

The Moscow Stars transaction has recently experienced high default levels, with outstanding defaults standing at 7.47% of current pool balance in December 2009. Excess spread has consequently been used to cure the principal deficiency and was not available to build up the reserve fund to the required level.

In most other CIS RMBS deals outstanding defaults have levelled off over the past six months. However, due to differences in delinquency and default definitions and the practice of originators repurchasing defaulted loans, it is difficult to accurately assess performance and comparison between transactions should be made with caution, Moody's notes.

Meanwhile, Gazprombank MBS 2007-1 was restructured on 25 January (SCI passim), whereby the class A1 notes were redenominated from euro to roubles at a rate of 34.7 RUB/EUR, which is lower than the exchange rate of 42.1 EUR/RUB at the time of the restructuring.

This resulted in a loss to the A1 noteholders of about 13% of the original note balance. All the other classes of notes benefited from the restructuring as it removed the EUR/RUB exchange risk to which the transaction had been exposed following the default of the cross-currency swap provider.

In 2009 the Russian economy fell deep into a recession, contracting 7.9%, after having expanded 5.6% in 2008. Unemployment had increased to 8.2% in December 2009, up from 7.8% a year earlier, and Moody's expects unemployment to continue to rise in Q110 as firms adjust to ongoing spare capacity.

Monetary policy is increasingly accommodative, with the latest cut in interest rates to 8.5% becoming effective on 24 February 2010. Moody's expects interest rates to be cut further to 8% during 2010 as the Bank of Russia tries to stimulate growth in lending. The lower interest rates and a rebound in energy exports are expected to stimulate the economy in 2010; however, it may take until 2012 before growth reaches its pre-crisis levels.

One new RMBS was issued in CIS in H209, bringing the outstanding balance of CIS RMBS to US$2.2bn. The transaction is National Mortgage Agent VTB 001, the first domestic securitisation of loans issued by Bank VTB24, one of Russia's leading retail banks. Over the past six months two auto ABS transactions have been fully repaid, leaving only two deals outstanding in the market.

Indices

Continued improvement for troubled companies index

The Kamakura index of troubled public companies has improved in February for the tenth time in the last eleven months. The index declined from 10.23% in January to 9.96% in February, having reached a recent peak of 24.3% in March 2009. Kamakura defines a troubled company as a company whose short-term default probability is in excess of 1%.

Credit conditions are now better than credit conditions in 71.1% of the months since the index's initiation in January 1990, and the index is 3.77 percentage points better than the index's historical average of 13.73%. This month's index is the first that includes public firms in China. With the addition of 1,889 public firms in China and 271 firms in Indonesia to the KRIS universe, the index is now based on default probabilities for more than 29,200 companies in 32 countries.

In February, the percentage of the global corporate universe with default probabilities between 1% and 5% decreased by 0.13 percentage points to 6.82%. The percentage of companies with default probabilities between 5% and 10% was up 0.02 percentage points to 1.57%. The percentage of the universe with default probabilities between 10% and 20% was down 0.11 percentage points to 0.89% of the universe, while the percentage of companies with default probabilities over 20% was also down, decreasing 0.05 percentage points to 0.68% of the total universe in the month.

Kamakura's president Warren Sherman says: "The rated firms showing the largest increase in one-month default risk in February included Insight Health Services, SAS AB of Sweden and Blockbuster for the second month in a row."

Investors

Credit investors indicate 'much improved outlook'

A recent survey undertaken by Fitch of US fixed income investors reveals a much improved outlook for the US economy and the credit markets in 2010. While survey participants do not expect to see a meaningful improvement in the unemployment rate in 2010, a majority still place US GDP growth in a range of 2%-3%.

On the corporate side especially, opinions have turned not just less negative but modestly bullish, with most investors expecting credit improvement over the coming year and a renewed focus on growth-oriented activities. Among the more constructive responses in the survey were comments on anticipated corporate strategy with mergers and acquisitions and capital expenditures receiving more votes as uses of cash, and defensive measures such as debt amortisation or maintaining a cash cushion receiving less.

By a margin of three to one, US fixed income investors continue to believe that inflation is a greater risk going forward than deflation. But a majority also responded that a weak US dollar is a positive in supporting the US recovery and that easy monetary policy remains important in 2010.

"Survey responses show that the low interest rate environment offers a challenging mix of good and potentially bad news, but in the near term at least investors see more good in low rates," says Mariarosa Verde, md of Fitch Credit Market Research.

Along with further improvement in corporate credit quality, investors expect the US high yield default rate to be moderately or significantly lower in 2010, within the context of the 13.7% default rate experienced in 2009. With regards to lending conditions over the next year, most investors believe standards will remain somewhat range-bound either moderately tighter or moderately looser. A very small share believes that standards will loosen in any meaningful way in 2010.

Several opinion trends held steady in the recent survey, including optimism for emerging market growth. Roughly two-thirds of investors place emerging market growth at above 3% over the coming year. Investors, however, continued to hold the most negative views for Europe, with 50% believing that growth in 2010 will fall in a range of 1%-2%.

In the US, opinions surrounding commercial and residential real estate remained bleak; however, less so than in the June 2009 survey, Fitch notes.

Operations

Front office driving CVA take-up

Algorithmics has published a white paper that examines how institutions are using Credit Value Adjustment (CVA), as they move beyond the traditional mindset of credit limits to dynamically pricing counterparty credit risk (CCR) directly into new trades. The market volatility experienced during the crisis has forced financial institutions to reassess their traditional approach to CCR in favour of using CVA to price counterparty risk, according to the firm.

Bob Boettcher, senior director, product strategy at Algorithmics, says: "Many institutions are pricing CVA into trades at deal time and are investing heavily to enhance their counterparty risk system capabilities. When institutions have the ability to calculate real-time incremental CVAs rather than relying upon simple CVA add-ons, they gain the ability to price trades that lead to risk reduction more aggressively than risk increasing trades. We see much of the push for incremental CVA coming from the front office, with traders concerned that the inability to properly assess CVA is resulting in lost business due to the use of simple, overly-conservative charges."

Algorithmics conducted in-depth interviews to gain insight into how firms are currently measuring CVA and how CVA practices are expected to evolve. Key findings of the white paper are: many institutions said that they had under-emphasised CCR, since a significant amount of their derivatives exposure was with counterparties that were perceived to be 'too big to fail'; while other institutions relied only on limits as a means of preventing the exposure to any single counterparty becoming excessive, but did not actively price or manage the underlying risk.

Some financial institutions used CVA to price the counterparty risk in their derivatives books, but without recognition of their own potential default. Boettcher concludes: "Counterparty credit risk has rapidly become the problem of all financial institutions, big or small. We see institutions changing their approach to counterparty risk with improvements to the traditional methods for measurement and control and many are now starting to implement CVA programmes. Proper management of pre-deal pricing and transaction structuring can provide firms with a competitive advantage and pioneering firms that accurately assess and integrate CVA within their risk culture are better able to pursue an overall risk strategy by providing transaction level incentives for the front office."

Ratings

Assured Guaranty drops Fitch ratings

Assured Guaranty has asked Fitch to withdraw its insurer financial strength (IFS) and debt ratings of Assured Guaranty Corp (AGC), Assured Guaranty Municipal Corp (AGM), Assured Guaranty Re and other rated subsidiaries of Assured Guaranty at the current rating levels.

Dominic Frederico, president and ceo of Assured Guaranty, says the action was taken following Fitch's announcement that it is withdrawing its IFS ratings on all Assured Guaranty insured bonds for which it does not provide an underlying rating on the issuer. "As Fitch's action withdrew the bond insurer ratings on approximately 90% of issuers in AGC's and AGM's combined insured portfolio, we believe the ratings no longer provide the same value to investors in our insured transactions," he adds.

AGC and AGM each continue to carry S&P's financial strength ratings of triple-A (negative outlook) and Moody's financial strength ratings of Aa3 (negative outlook).

Ratings

EMEA SF ratings remained resilient

Fitch has published detailed data that outlines the migration of its EMEA structured finance ratings through the current financial crisis. The data shows that high investment grade structured finance ratings in the region have proven resilient.

The vast majority of Fitch's EMEA triple-A structured finance ratings have remained stable through the crisis. 78.6% of securities rated triple-A at the start of the crisis either retained their triple-A rating or had been paid-in-full 2.5 years later.

Ian Linnell, global head of structured finance at Fitch, says: "This data will help to re-focus the debate regarding the performance of structured finance ratings on fundamental credit issues. Credit ratings do not address the heightened mark-to-market risk that we've seen through this crisis. As the prices of highly-rated securities fell, rating agencies were criticised in Europe for not downgrading the tranches in question, but from a credit perspective most have performed as anticipated and prices have now rebounded to close much of this credit versus liquidity gap."

In contrast, 56% of non-investment grade structured finance ratings in EMEA were downgraded during the period compared with 19.3% of investment grade ratings.

Linnell adds: "Downgrades, particularly of junior notes, are to be expected during a crisis of this magnitude. It shows that the junior capital tranches, which are designed to protect the senior notes by absorbing cyclical losses, have done exactly that."

However, Fitch's revision of its structured credit criteria in late-2007 (SCI passim), coupled with credit deterioration in the sector, resulted in significant downgrades of CDOs across the rating spectrum. 47.9% of the agency's structured credit portfolio was downgraded over the 2.5-year period from July 2007.

But, despite the weakness in the sector, half of the agency's EMEA CDO ratings remained stable or the securities were paid-in-full. Linnell concludes: "Fitch had revised the majority of its synthetic CDO ratings to be in line with its new criteria before the wave of financial institution credit events in September and October 2008. These updated ratings proved resilient, with downgrades directly as a result of these credit events largely confined to junior notes."

Ratings

Continued delinquency pressure on global ratings

Negative structured finance (SF) rating actions in Q409 were predominantly concentrated in CMBS and CDOs, according to Fitch. The pace of downgrades in the troubled US RMBS sector moderated significantly compared to previous quarters, while ABS and non-US RMBS continued to demonstrate good stability, particularly at the highest rating levels. The rating agency believes that the mixed rating trends reflect the tentative nature of the global economic recovery.

Andy Brewer, senior director EMEA structured finance performance analytics at Fitch, says: "In EMEA, negative CMBS rating actions continued in the fourth quarter as Fitch downgraded 157 note classes related to continental European commercial property-backed transactions. Downgrades were particularly evident in Germany. Whilst commercial property values declined less precipitously on the Continent than in the UK, lease lengths tend to be shorter, and a higher percentage of transactions closed in 2006 and 2007 which have caused high rating volatility."

EMEA CDO downgrades were concentrated in SME CDOs. Late-vintage Spanish SME CDOs experienced significant increases in arrears, leading to revised default expectations, and have substantial exposure to the troubled real estate and construction sectors. In addition, the full impact of Fitch's revised 2009 SME CDO criteria was felt in Q409.

Rating actions in non-conforming EMEA RMBS were predominantly positive in Q409, with affirmations and upgrades outnumbering downgrades. Early indications show a number of transactions beginning to generate sufficient excess spread to cover losses, which will help reduce principal deficiency ledgers or top-up reserve funds

EMEA ABS also held up well overall, as only 7% of the sector's ratings were downgraded in Q409.

Meanwhile, Alison Ho, senior director, head of structured finance performance analytics Asia Pacific at Fitch, says: "The majority of ratings in Asia Pacific continued to perform in line with expectations, as evidenced by the fact that most rating actions in Q409, and the year as a whole, were affirmations."

Downgrades of 82 publicly-rated Japanese CMBS tranches following the publication of revised surveillance criteria and reflecting Fitch's negative view of Japan's commercial real estate market and real estate finance environment dominated Asia Pacific rating actions in Q409. A total of 31 Japanese CMBS tranches are currently on rating watch negative and the sector accounted for half of the 174 Asia Pacific public international SF ratings on negative outlook at the end of December.

Seasoned APAC transactions continued to perform well. A total of 28 publicly-rated Australian and New Zealand ABS and RMBS tranches were upgraded during the quarter, due to increased credit enhancement levels and availability of excess spread.

However, in the US, economic events continued to weigh on structured finance. Labour markets remain weak and Fitch expects the unemployment rate to remain around 10% for much of 2010, near a 25-year peak, and believes that anaemic prospects for employment combined with muted growth will continue to depress consumer sentiment. However, the agency believes that the number and extent of negative rating actions will moderate as economic conditions and consumer demand fundamentals slowly improve.

The pace of downgrades in US RMBS moderated to 3,151 in Q409 from more than 20,000 in Q309. The 76 upgrades in Q409 greatly exceed the total of just three in the first nine months of 2009.

Although credit performance deteriorated across all sectors, US ABS demonstrated a higher level of rating stability, most notably for senior tranches and prime transactions, as rapid deleveraging and other factors helped mitigate declining collateral performance. Fitch expects that 2010 negative rating actions in US ABS will largely be restricted to lower rating categories.

US credit card ABS performance stabilised in December following record delinquencies in the previous month. Although ratings are expected to be stable in 2010, high unemployment and slow income growth will continue to negatively impact delinquencies.

Auto loan/lease ABS remained resilient, with 37 upgrades and 33 downgrades during 2009. A majority of downgrades were in subprime auto loans.

A total of 19 transactions that contained surety policies were downgraded following insurer downgrades in 2009. Fitch expects asset performance to improve in the early part of the year, with loss frequency remaining elevated throughout 2010 as employment and consumer fundamentals remain weak.

Latin America continued to see only limited rating actions in Q409.

Early vintage SF CDOs saw continued downgrades in Q409. Meanwhile, ratings of CRE CDOs backed by 2005 vintage CMBS were placed on RWN, joining those backed by 2006-2008 vintage CMBS already on RWN.

Rating action was taken on 64 tranches from 13 REIT Trups CDOs, with senior classes mostly downgraded to triple-C or lower. Negative outlooks were assigned to senior notes from 64 bank Trups CDOs.

A number of largely non-senior tranches of high yield CDOs were downgraded due to significant credit deterioration and defaults.

Negative credit migration and defaults were pronounced in middle-market CLOs during Q409; however, high investment grade ratings remain stable with downgrades focused on single-A rated and lower rated tranches.

Regulation

SEC steps up IFRS prep

The SEC is to issue a statement that lays out its position regarding global accounting standards, reaffirming its belief that a single set of high-quality globally accepted accounting standards would benefit US investors. This follows the SEC's proposed roadmap in November 2008 and subsequent market feedback.

After proposing the roadmap, the Commission received more than 200 comment letters from market participants, who expressed support for the goal of having a single set of high-quality globally accepted accounting standards but differed in their views about the approach in the proposed roadmap. Therefore, the Commission's statement indicates that it is important to carefully consider and deliberate whether such a change is in the best interest of US investors and markets.

The Commission also directed its staff to execute a work plan, in order to aid its evaluation of the impact that the use of IFRS by US companies would have on the US securities market. Included in this work plan will be consideration of IFRS, as it exists today and after the completion of various 'convergence projects' currently underway between US and international accounting standards-setters. By 2011, assuming completion of these convergence projects and the staff's work plan, the Commission will decide whether to incorporate IFRS into the US financial reporting system and, if so, when and how.

The staff's work plan will address a number of issues, including:

• Determining whether IFRS is sufficiently developed and consistent in application for use as the single set of accounting standards in the US reporting system.
• Ensuring that accounting standards are set by an independent standard-setter and for the benefit of investors.
• Investor understanding and education regarding IFRS, and how it differs from US GAAP.
• Understanding whether US laws or regulations, outside of the securities laws, for example tax laws and regulatory reporting, would be affected by a change in accounting standards.
• Understanding the impact on companies, both large and small, including changes to accounting systems, changes to contractual arrangements, corporate governance considerations and litigation contingencies.
• Determining whether the people who prepare and audit financial statements are sufficiently prepared, through education and experience, to make the conversion to IFRS.

The SEC staff will provide public progress reports on the work plan, as well as the status of the FASB and IASB convergence projects, beginning no later than October 2010 and frequently thereafter until the work is complete.

Feedback on the proposed roadmap also suggested that US companies would need approximately a four- to five-year timeframe to successfully implement a change in their financial reporting systems to incorporate IFRS. Therefore, if the Commission determines in 2011 to incorporate IFRS into the US financial reporting system, the first time that US companies would report under such a system would be no earlier than 2015. The work plan would further evaluate this timeline.

Regulation

Further OTC infrastructure commitments made

ISDA has jointly submitted a letter with market participants and industry associations to global supervisors detailing ways in which the industry will work to further strengthen the robustness of the OTC derivatives market infrastructure, improve transparency and build a more resilient risk management framework. These commitments comprise central clearing, transparency, standardisation, operational efficiency targets and collateral.

In terms of central clearing, the industry says it intends to broaden the set of OTC derivatives eligible for clearing, taking into account risk, liquidity, default management and other factors. It also commits to elevated targets for clearing dealer-to-dealer swaps and to work with clearinghouses to accelerate the growth of clearing for transactions between dealers and buy-side market participants.

As for transparency, repositories have been launched already for credit and interest rate products and the industry is in the process of building a repository for equity derivatives in order to give regulators insight into trading activities of all market participants. Further, the industry affirms its continuing commitment to achieve further product, processing and legal standardisation in each asset class with a goal of securing operational efficiency, mitigating operational risk and increasing the netting and clearing potential for appropriate products.

Finally, the industry has set new goals in the areas of portfolio reconciliations and dispute resolution, and has updated a roadmap for improving collateral management.

In addition to containing further industry commitments, the letter also serves to update the global supervisory community on the progress that has been made since the group's June 2009 letter.

Eraj Shirvani, chairman of ISDA and md and head of fixed income for EMEA at Credit Suisse, says: "ISDA and the industry recognise the need for further enhancements to the infrastructure and framework of the OTC derivative markets. The commitments that the industry is making today build upon solid foundations already laid and further underscore our focus on transforming and strengthening OTC derivatives markets. They reflect the strong partnership of the major dealers, significant buy-side institutions and global supervisors, with a goal of reducing systemic risk by improving market transparency, standardisation and risk management practices."

Regulation

Comptroller calls for balance in regulatory reforms

The central challenge for bank regulators over the coming year will be to strike the right balance between capital and credit availability, according to Comptroller of the Currency John Dugan in a speech to the Institute for International Bankers.

Dugan said: "On the one hand, we need to adopt the kinds of real prudential reforms - to capital, liquidity and risk management - that will fortify the financial system to prevent inevitable future problems from mushrooming into the type of meltdown we sustained in the fall of 2008, with devastating effects on the real economy."

He continued, saying: "On the other hand, if we swing the pendulum too far too fast - requiring banks to hold too much capital and liquidity - we risk a significant and sub-optimal restriction of credit, which can also have dire consequences for the real economy."

In his speech, Dugan said it is important to work on an international basis, given the global scope of the crisis, and cited recent work by the Basel Committee on Banking Supervision as providing a basis for addressing capital and liquidity issues. Of particular importance, he said, the Basel Committee is focusing on the quality of capital, as well as the amount of capital banks must hold.

"This is a very important change that will place a much greater focus on holding higher proportions of the most loss absorbing capital, i.e., common stock," he cpmmented.

Also important is the focus on liquidity. "A key characteristic of the financial crisis was a massive withdrawal of liquidity and the inability of banks to deal with the liquidity shortage," he said.

The Basel Committee is attempting to address that issue by proposing a global minimum liquidity standard for internationally active banks that includes both a 30-day liquidity coverage ratio and a longer-term structural liquidity ratio (see also separate News Analysis). Dugan added: "This new regime is designed to strengthen liquidity risk management, measurement and supervision, but in many ways designing a widely applicable liquidity standard is more challenging than designing a capital standard, because liquidity risk can be much more idiosyncratic."

He continued: "But more importantly, its purpose is to help answer the critical 'how much' questions. How much additional capital and liquidity should be required for each of the proposed new standards, and how much higher should overall capital and liquidity be for each bank? And how do the myriad new proposed standards fit together and work together?"

He explained: "As policymakers make decisions on how much capital and liquidity banks should be required to hold to make the system stronger and safer, they will need to assess how much such actions could inappropriately restrict the flow of credit to individuals, businesses and governments that is so important to economic growth."

Dugan said the Basel proposals generally strike the right balance, but added that much work lies ahead in fine-tuning and implementing them. He concluded: "We need the best possible input to make our financial system strong, resilient and able to safely provide the funding fuel that is so critical to all parts of the global economy."

Regulation

Hedge fund data collection template released

The IOSCO Technical Committee has published details of an agreed template for the global collection of hedge fund information, which it believes will assist in assessing possible systemic risks arising from the sector. The template was developed by the task force on unregulated entities following requests from the Financial Stability Board (FSB) and IOSCO members.

The template aims to enable the collection and exchange of consistent and comparable data amongst regulators and other authorities in order to facilitate international supervisory cooperation in identifying possible systemic risks. IOSCO believes that participants are best monitored through their trading activities, the markets they operate in, and funding and counterparty information.

Kathleen Casey, chairman of the technical committee, says: "IOSCO believes that regulators should seek to develop a comparable and consistent set of data to be collected from local hedge fund managers and advisers to monitor systemic risks and prevent gaps in regulatory reporting requirements. We recognise that the legislative process is ongoing in many jurisdictions and their outcomes could further influence the information needed to monitor systemic risk in the hedge fund sector, as well as who collects the data. Nonetheless, setting out these categories of information may help regulators in the assessment of systemic risk and help to inform the relevant legislative debates."

There are 11 proposed categories of information that incorporate both supervisory and systemic data, and build on the data collection recommendations. The categories include:

• General manager and adviser information
• Performance and investor information related to covered funds
• Assets under management
• Gross and net product exposure and asset class concentration (for instance, the value of long and short positions in securitised credit products or CDS positions, including an indication of the geographic split of assets)
• Gross and net geographic exposure
• Trading and turnover issues (including the clearing mechanisms for balance sheet instruments; e.g. OTC versus exchange traded and CCP versus bilateral clearing)
• Asset/liability issues
• Borrowing
• Risk issues
• Credit counterparty exposure
• Other issues.

RMBS

Fannie enhances buyout disclosure

Fannie Mae has released further details about its buyout of delinquent loans from MBS trusts, which was announced last month (see SCI issue 172). The total dollar volume of all loans that were four or more months delinquent in the GSE's single-family MBS as of 31 December 2009 was approximately US$127bn. Of that amount, approximately US$82bn backed its CL prefix MBS and approximately US$45bn backed its non-CL prefix MBS.

Fannie says it anticipates purchasing approximately 150,000-200,000 loans from MBS trusts in the month of March and will continue purchasing loans in each of the subsequent few months until it has substantially reduced the current population of loans that are four or more months delinquent. Loans that become four or more months delinquent after 31 December 2009 will be included in the purchase population as they become eligible.

Generally, when determining which loans to purchase, priority will be given to mandatory purchases (such as modified loans and loans that become 24 months delinquent), loans in MBS having the highest MBS pass-through rates, loans backing CL or CI prefixes and loans having the highest unpaid principal balances. To enhance visibility of purchase activity for security holders, Fannie plans to provide monthly updates through to the end of 2010.

RMBS

MI claims-processing delays increasing

Mortgage insurer (MI) claims-processing delays for both individual loan and pool policies have become more common, according to Moody's in its latest ResiLandscape publication, due to their requests for new documents such as foreclosure deeds. Moreover, MI companies are requesting origination documents earlier, at the time of foreclosure referral, rather than subsequent to the foreclosure sale. Such reviews enable them to detect origination fraud that potentially can result in denied claims, the rating agency says.

Moody's has undertaken a survey of mortgage servicers and uncovered a number of areas in which MI companies have been increasingly likely to deny or curtail claims. First, servicers report that MI carriers now scrutinise expenses for property preservation and utility bills more closely than they had done in the past. Often, such claims are denied by asserting that the charges are not "reasonable and customary".

Second, servicers receive reduced reimbursements on tax and insurance advances that result from extended holding times. As unsold home inventories continue to build and as foreclosure and REO timelines grow longer, losses to securitised trusts are expected to increase to the extent that MI companies are not covering such expenses.

Third, servicers report that mortgage insurers often curtail claim reimbursements related to servicers' loss-mitigation practices, which include modification documentation-preparation fees and accrued interest associated with modification-processing delays. The greater use of loan modification over the last 18 months, especially since the introduction of HAMP, has substantially raised the costs for both the document preparation and the legal operations borne by mortgage servicers.

"Many of these expenses, which historically have not been contested, are now being denied by the MI companies as 'costs of doing business'," explains Aleksandra Simanovsky, associate analyst at Moody's. "In addition, extensions in foreclosure timelines that result from modified loans that re-default are being reduced by the MI companies. In cases where modification efforts are not successful, the unreimbursed costs associated with the modification process are assumed by the servicer."

Bank of America recently brought a suit alleging that MGIC, as mortgage insurer, has denied and continues to deny valid mortgage insurance claims submitted by Bank of America as servicer. The suit is emblematic of the roadblocks that servicers have increasingly faced as they attempt to recover losses on defaulted mortgage loans from MI companies, according to Simanovsky. She suggests that the ultimate success of servicers' efforts at mitigating such losses depends on the outcome of protracted negotiation, as well as on the resolution of the Bank of America suit - which could last for years.

Claim rescission rates have shot up from a historic rate of around 7% to as much as 25% over the last few quarters. Moody's says it is now assuming high rescission rates for the future and, as such, has reduced the advantages afforded to MI policies in RMBS transactions. Furthermore, the rating agency notes that the below-investment grade ratings of MI companies, such as Radian and MGIC, further constrain any benefits it might allow to the pool policies in RMBS transactions.

RMBS

HARP extended by a year

The Home Affordable Refinance Program (HARP) has been extended to 30 June 30 2011. It was set to expire on 10 June of this year.

Federal Housing Finance Agency acting director Ed DeMarco says: "FHFA has reviewed the current market situation and the state of mortgage insurance availability and has determined that the market conditions that necessitated the actions taken last year have not materially changed."

DeMarco continues: "Accordingly, to support and promote market stability, and to encourage lenders and other mortgage market participants to fully adopt the HARP programme - including the implementation of the October 2009 expansion of loan-to-value ratios (LTVs) to 125% - FHFA is authorising the extension of HARP until 30 June 2011."

In 2009, Fannie Mae and Freddie Mac purchased or guaranteed more than four million refinanced mortgages. Of a total 190,180 were HARP refinances with LTVs between 80% and 125%. The HARP began in April 2009 and has grown over the past few months.

RMBS

RMBS recovery estimates to be published

Moody's is to publish its estimates for recoveries on most of the RMBS it rated issued during 2005-2008. Specifically, the rating agency is launching an initiative to publish bond recovery estimates for every security or tranche of all US subprime, prime jumbo, Alt-A and option ARM RMBS transactions that it rated in the period.

With the deterioration in the housing market continuing, Moody's expects many of these securities to take write-downs on their principal. Moody's svp Debash Chatterjee says: "The timing and the extent of the write-downs, however, will vary significantly across securities, driven primarily by the magnitude of losses on the underlying collateral, transaction structures and loss mitigation practices adopted by servicers. Therefore it is important to provide investors with expected recovery estimations that are at the level of the individual security."

The agency will publish the bond recovery estimates in its ongoing pool expected loss publications. In addition to the recovery estimates, Moody's will enhance its current pool expected loss publication by adding the estimated future loss severity for pools and the proportion of loans in the pool that are less than 60 days delinquent that it expects to default in the future.

The rating agency expects to post recovery estimates on over 35,000 securities over the next few months as it proceeds through the ratings review following its recent announcement that it had placed securities from 2005-2008 vintage subprime, prime jumbo, Alt-A and option ARMs on watch after revising underlying loss projections. It will then update the recoveries on a periodic basis.

The recovery estimates are based on Moody's baseline loss expectation on the underlying mortgage pool, which take into consideration that home prices will decline by another 7% to 10% and unemployment will peak at roughly 10.5%, both in the second half of 2010. The agency notes that when assigning ratings it takes into account not only the estimated recovery at a given rating level, but also the volatility of recoveries at stressed loss levels. To illustrate the volatility of bond recoveries as losses change, Moody's will also be reporting tranche recoveries under two stressed scenarios in which collateral losses exceed its base expectations.

RMBS

Same default drivers for prime and NC mortgages

A Fitch study of more than 700,000 UK residential mortgage loans has found that fast-track mortgages in the prime sector do not appear generically more risky than income-verified prime loans. However, in contrast, self-certification mortgages in the non-conforming sector invariably turn out to be more risky than those originated with certified income.

Gregg Kohansky, md of Fitch's European RMBS team, says: "Lenders typically apply stricter credit scoring criteria for fast-tracked mortgages than for fully verified loans, so the results are not necessarily surprising. However, for Fitch to treat these loans on a par with one another in our ratings analysis for specific transactions, the agency will need to perform a detailed performance assessment showing this relationship holds."

The study confirmed the commonly-held assumption that, with the exception of this point on income verification, most drivers of default for prime mortgages are also relevant for non-conforming mortgages. This includes the original loan-to-value (LTV) ratio, debt-to-income ratio, interest-only only loans and self-employment of the borrower.

Focusing on determinants of relative default risk among UK residential mortgages, the study has been a key input into the recently performed review of rating criteria for UK residential mortgages. Fitch also found that adverse borrower information dominates any other risk factor. This is consistent with the market convention to separate prime from non-conforming originations.

Atanasios Mitropoulos, senior director in Fitch's European structured finance team, says: "Using the historical information to gain deep insight into the functioning of the mortgage market is a strong basis on which to form a sound rating methodology. Fitch supplements this with its analytical experience and the economic outlook of the region to form robust and consistent forward-looking rating assumptions."

A further conclusion of the analysis is that the risk indicators themselves can change over time. For example, there is evidence of problems with mortgages for new-build properties in the 2006 and 2007 vintages (which can be attributed to a loosening of underwriting procedures); and a higher correlation of self-employment to defaults (which can be attributed to self employed individuals being more vulnerable to general economic deterioration compared to employees).

The study is based on arrears and repossession information of mortgage loans originated in the UK across the prime and non-conforming sectors. The data stems from performance information on over 20 Fitch-rated transactions and covers mainly origination vintages between 2004 and 2007, while tracking performance up until March 2009.

RMBS

German foreclosure risk examined

Fitch has published a new report providing an assessment of historical residential mortgage loan foreclosure frequencies in Germany and discusses its forward-looking view regarding future foreclosure risk in mortgage loan portfolios. The analysis described in the report forms the basis for risk assessing German residential mortgage pools that are used as collateral in structured finance transactions and covered bonds programmes.

The report's review of mortgage loan foreclosure risk was based on an extensive dataset of default event information. Eberhard Hackel, director in Fitch's RMBS group, says: "When analysing the performance of RMBS transactions, it is important to consider time-to-maturity profiles, amortisation profiles and different borrower, loan and property characteristics as German RMBS portfolios can differ substantially in these regards."

Accounting for different portfolio characteristics, amortisation profiles and loan terms, the agency derived a historical likelihood of foreclosure for a residential property securing a typical German mortgage loan. Stephan Jortzik, director at Fitch, adds: "With regard to a specific mortgage loan, it is significant to note that each borrower's individual probability of default is significantly influenced by the borrower's financial strength, the loan characteristics and the property specifics securing the loan. It is vital to identify appropriate risk indicators within this context. For example, an important indicator of a borrower's financial strength and economic prospects appears to be the purchasing power of the region where the borrower lives as measured by the purchasing power index."

Hackel continues: "With German unemployment on the rise, foreclosure risk in the near future will differ to historic averages." The report discusses forward-looking adjustments of foreclosure assumptions and the resulting shape of the foreclosure frequency curve, taking into account the severity and length of the current economic stress.

The probabilities for loans with short remaining tenors entering foreclosure are assumed to be severely affected by the economic situation compared with through-the-cycle averages, while the probabilities of foreclosure of loans with longer remaining tenor are thought to be much less affected.

RMBS

Recovery trends in Spanish RMBS analysed

In a new special report Moody's has analysed the drivers of severity and subsequent trends in Spanish RMBS.

Frank Julia-Sala, a Moody's analyst and author of the report, says: "There is some uncertainty in Spain regarding how recoveries of non-performing mortgage loans are going to unfold as the adverse economic cycle progresses. This is exacerbated by the lack of visibility of the market price of properties during the current recession and of the level and time at which prices will settle after the recession."

To better understand the drivers of severity of 90 day arrears, the rating agency obtained loan-by-loan recovery data from 59 Spanish RMBS deals, amounting to 26,626 cases of loans entering 90 day arrears between 1997 and August 2009.

In the report, Moody's findings suggest that there are two main drivers of 90 day arrears severity. The first is the frequency of a loan curing the arrears, which has been declining since 2006.

Second is the recovery of non-cured loans, which include exits through refinancing and property sale. The report explains that "this indicates that severity is affected by both the state of the property market and the borrower's ability to pay or refinance during arrears".

Julia-Sala adds: "This severity is not directly comparable to the loss severity on sold properties."

The study also suggests that the loan-to-value (LTV) and the point in the economic cycle have a strong influence on severity. It further examines roll rates to default and additional drivers related to property characteristics.

The rating agency cautions that its findings are subject to some limitations. As a number of loans in the most recent 90 day arrears vintages may still be waiting for the sale of the property, it expects final severity for these vintages to improve from the levels currently reported.

RMBS

Mexican RMBS faces continued pressure

Mexican RMBS faces continued pressure in 2010, according to a new report from Fitch. In particular, the rating agency expects a continued increase in delinquencies within most of the UDI-denominated transactions originated by Sofoles.

However, it also says a rebound in the economy and employment, an increase in collections efforts and a successful loan modification programme on selected loans would allow for stabilisation during H210. "Peso-denominated loans and certain bank-originated transactions will continue to outperform UDI-denominated loans, as these loans were originated with higher underwriting standards and were directed mostly to higher-income individuals with stronger job stability," says Fitch.

The economic slowdown in Mexico during 2009 had a negative impact on the performance of Mexican RMBS. Delinquency levels rose across most transactions in Fitch's portfolio, especially Sofoles UDI-loan-backed securities.

The agency attributes the increase in delinquencies during 2009 mostly to rising unemployment and decreasing available income, resulting from under-employment within the informal sector. In addition, it is apparent that weaker underwriting standards were employed in many of the more recent UDI-denominated RMBS transactions originated by Sofoles.

Fitch says loan modification programmes and increased collections efforts will also be a key component for stabilisation in RMBS delinquencies; therefore, servicers will face challenges during 2010. It will closely monitor the performance of the assets during the transition period, as this mechanism has not yet been tested within the Mexican RMBS market.

During 2009, Fitch's Mexican RMBS portfolio experienced 27 negative rating actions on 23 different tranches. Additionally, in February 2010 the agency downgraded the ratings of 10 tranches and reaffirmed two ratings. All of these tranches were related to transactions backed by UDI mortgages originated by Sofoles/Sofomes.

SIVs

SIV's 'inadvertent' long-term ratings withdrawn

Moody's says that, due to an administrative oversight, it inadvertently assigned long-term ratings to Cheyne Finance 's Euro and US CP programmes, which were only intended to carry short-term ratings. It has consequently withdrawn these ratings.

Moody's downgraded the long-term CP ratings to Ca on 15 July 2008. The SIV's current short-term CP ratings of Not Prime are unaffected by the action.

CLOs

Relative value: trading the global basis

Rishad Ahluwalia, executive director at JPMorgan, finds that while some narrowing of the CLO basis is warranted, uncertainty of fundamentals poses a problem for lower-rated positions

This week we focus on the global CLO basis, or the pricing relationship between US and European CLOs. While the CLO market has traditionally been a global market, given the similarity in structures and cross-regional nature of large parts of the investor base (banks, monolines), in this rally there has been a lag in European CLO prices, due in large part to the relative underperformance of the European leveraged loan market versus the US. In recent months, we have noticed US benchmarked investors considering the relative 'cheapness' of European CLO bonds and in our 18 September 2009 FIMS edition we discussed the global CLO basis and argued for some of the then current basis to decline.

Some (limited) narrowing of the CLO basis in store
Nearly six months on, and it is still a challenge to accurately compare regional CLO valuations, given differences in portfolio diversity, private collateral ratings, the bank-driven (more consensual) nature of restructurings and broader disparities, such as between the economic cycles of the US versus Europe. But, while some of the basis has narrowed since our September note (Chart 1) - particularly as senior-rated European bonds closed in on the US - the reduction in basis between the underlying loan markets (Chart 2) calls for some, limited further narrowing of the CLO basis.

Indeed, based on a sample of CLOs and this week's asset marks, we find European pools typically price in the mid- to high-80s, while US CLO pools are around 90 to the low-90s - a 3-5 point difference, which has dropped from near double-digit levels earlier in 2009. This has been a driver of price momentum in European triple-A, double-A and single-A bonds, with some single-As now looking covered on a market value OC basis.

Declining distress and defaults...
In the US, default activities continue to decline. The par weighted default rate decreased to 9.41% from 9.55%, its lowest level since March 2009. Similar to the US, rising European loan prices over the last few months have been a result of improving market conditions as distress and defaults decline.

It's challenging to assess default risk from both a historical and forward-looking perspective due to the private ratings, as well as other issues, but for the broad European loan market S&P recently estimated a 14.6% private default rate versus a 10.4% public default rate and also noted that defaults have been easing over the last few months. Factors which are improving the near-term default outlook include the continued historically low Euribor and low debt service costs, as most European loan issuers do not have interest rate floors, the willingness on the part of lenders to minimise debt write-downs and improving issuance conditions in the high yield bond market, especially in senior secured, with some bond-for-loan takeouts.

Indeed, in January 2010 S&P LCD tracked only two issuers defaulting or entering a formal restructuring and only seven issuers in default or entering restructuring in the quarterly period ending 31 January, down from 12 in Q409 and 18 in Q309. Chart 3 illustrates this trend.

...but an uncertain longer-term credit profile
While conditions in the European loan market have improved, they are far from resurgent. The start of the year seemed to herald a reopening of the primary market to fund buyouts, M&A and other financings, with €2bn new-issue volume in January - the highest since September. But the market took a step back in February, coming under pressure from regional economic concerns, sovereign risk and headline noise, with several IPOs cancelled or delayed (e.g., Travelport, New Look).

All of this speaks to the longer-term question of whether private equity sponsors will be able to exit current investments, which, in turn, creates uncertainty about future loan activity. Our European high yield strategist, Daniel Lamy, argues that while near-term default rates appear low, in the longer-term the structural factors create future upward momentum to default rates.

While it is true that amend-to-extend transactions will prevent some defaults, in many cases this will simply delay the inevitable, and the pace of restructurings (Chart 3) will likely pick up in a couple of years as economic growth downshifts during multi-year fiscal consolidation (peripheral EMU countries and the UK). Looking beyond 2010, default risks are not very clear. Until recently much of the terming out of default risk in bond-for-loan takeouts occurred in defensive cable and packaging credits, and credits with more challenging stories have only really been able to push back amortisations by a couple of years or have required high coupons, so it very much depends on how accommodative capital markets are in allowing issuers to term out debt beyond the 2012-2014 maturity cliff.

Conclusion: CLO basis compression tempered by relative cheapness of European ABS
Ultimately, credit losses in European CLOs over the next few years will depend on portfolio concentrations, the extent to which issuers are able to weather the emerging fiscal consolidation and monetary tightening pressures, and if a CLO market comes back, similar to in the US market. From a relative value perspective, we think European CLO triple-A to AA/A valuations are marginally cheap versus the US, as the lower diversity and fewer manager data points is less of an issue given the seniority and O/C cushion (Chart 4 - average CLO O/C cushion per rating).

But, while some US benchmarked players may well see the existing basis as creating opportunity, unlike in the broad US ABS market (Chart 5) European CLOs are by no means 'cheap' when compared to European ABS (Chart 6). While we do see value in European CLOs relative to US CLOs, our ABS team is also overweight UK RMBS and UK credit card triple-As, for example, and valuations are comparable to European CLOs (Chart 6).

To conclude, while some incremental narrowing of the CLO basis is warranted, the longer-term uncertainty of fundamentals poses a problem for lower-rated positions, relative to the US at least. Further, up the capital structure the relative cheapness of European ABS triple-As would need to decline for European CLOs to look properly cheap.

© 2010 JPMorgan. All rights reserved. This Research Note, entitled 'Relative Value: Trading the Global Basis', is an extract from JPMorgan's CDO FIMS Weekly published on 26 February 2010.