Contents

ABS

Primary flurry

New European ABS deals brought to market

The primary European ABS market has seen a flurry of activity over the past week. The pricing of Santander's UK RMBS Fosse 2010-1 on 5 March was swiftly followed by announcements by VW Bank of a new auto ABS and by NIBC of a Dutch MBS XV transaction.

Fosse 2010-1, the first UK RMBS to be issued since 2007 without a put option, was upsized from £1bn to £1.4bn after good investor demand. The transaction was built through traditional book-building and investor roadshows in the UK and Europe. In total, over 40 accounts across 12 countries participated in the transaction.

Three triple-A tranches were issued: a £205m five-year FRN, which priced at 120bp over three-month Libor; a €775m five-year FRN, which priced at 120bp over; and a £525m seven-year fixed-rate tranche that priced at 120bp over mid-swaps. The final price is some 20bp tighter than Europe's most recent RMBS issue, Silk Road (SCI passim).

"This deal represents a significant positive step for European RMBS because, unlike competitor deals recently announced, the Fosse securitisation does not include an investor put back to the sponsoring bank - making this a true securitisation transaction," says Antonio Lorenzo, cfo of Santander UK.

In this case, the lack of put option was mitigated by a coupon step-up, which doubles the margin in case of non call. The underlying mortgages were originated by Alliance & Leicester and are representative of the overall mortgage portfolio.

Volkswagen Bank's new transaction - Driver Seven - is also expected to see good investor take-up. The transaction comprises a €457.5m triple-A rated tranche and a €17.5m single-A plus tranche, and is backed by auto loan receivables originated by Volkswagen Bank within Germany. The roadshow starts today (10 March) and ends on 16 March, according to WestLB, which is arranging the deal.

The transaction is static and will amortise from closing. The provisional portfolio consists of 38,305 loans, with an outstanding discounted principal balance of €500m and an average balance of €13,053 per loan.

Although price guidance has not yet been released by the arrangers, the class A notes are anticipated to price in the range of 80bp over one-month Euribor and the single-A plus notes at 180bp over. ABS analysts at Barclays Capital expect the deal to see good interest from clients, given the strong track record of the originator and the programme, along with the short WAL of 1.9 years and 2.16 years respectively.

"While the placement of the triple-A notes should pose no surprises, it will be interesting to see how the single-A plus notes will fare, given the lack of benchmarks in secondary and the lack of any similar placed tranches in the more recent deals brought to market," the analysts comment.

NIBC, meanwhile, will test demand for Dutch RMBS with its new issue, Dutch MBS XV. This is a €750m prime RMBS backed by Dutch residential mortgage loans originated or acquired by the subsidiaries of NIBC Bank.

Ratings have been assigned to six classes of notes ranging from triple-A to double-B. According to one London-based ABS investor, a two-year and a five-year triple-A tranche is being publicly offered.

Class A1 and A2, both rated triple-A, are sized at €182.1m and €530.6m respectively. The transaction has been arranged by NIBC and is being marketed by NIBC, Credit Agricole and Credit Suisse.

"It's tough to draw any real conclusions from this recent primary activity," says the ABS investor. "Supply seems to be meeting demand for now. As long as the secondary market hangs together and outstanding deals perform well, the primary market will benefit from a greater level of confidence."

He concludes: "However, many issuers still believe it is too expensive to bring a new deal at present. We'll have to see how these new deals price and how spreads look as we move into Q2."

AC

Secondary markets

Old and new

European MBS market activity in the week ending 9 March

The European secondary MBS markets have remained quiet this week, but do appear to have begun moving beyond concerns over Greece. While the CMBS sector has returned to old trading patterns, the focus of the RMBS market has been on recent new issuance (see separate News Analysis).

After a brief slow trading period on the back of Greece headlines, the European CMBS market has returned to pre-Greece trading patterns. One CMBS trader says: "I don't feel like Greece is a concern any more. There was a bit of a slowdown last week, but what we're seeing now is a return to the relentless hike upwards in terms of prices."

According to the trader, the trend for aggressive dealer bidding on BWICs - as seen earlier in the year (SCI passim) - has returned. "The trend has continued, with banks buying rather than investors buying. This seems to be the case because they're buying at levels that are often higher than bonds are being offered at, which doesn't make a lot of sense," he explains.

The reason for this continued trend is believed to be two-fold - new bonds are in short supply and BWICs offer an affordable alternative to dealers seeking to position themselves within the market. The trader agrees: "There continues to be a lack of bonds and, where there are bonds, they're primarily being bought by banks' trading desks rather than by clients. Current BWIC trade is based on very aggressive bidding, as I think it's still structurally one of the cheapest products out there."

As the market continues to gap tighter, the trader explains that he would like to start seeing some selling into these levels. "They do seem massively over-bought in terms of levels now versus the beginning of the year. There are many cases of bonds trading at 30 points higher than they did in January," he says.

Meanwhile, the European RMBS sector continues to show positive signs of recovery in terms of new issuance while the secondary market remains steady. One RMBS investor describes current secondary market activity as being quiet.

"Triple-As are still trading around the 90 level. But anything outside of that is fairly hard to pinpoint. There was a fairly decent flow in BWICs trading in January and early February. But from the second week of February, people have been using the Greece excuse to do nothing. The market hasn't kick-started," he adds.

In the meantime, the new issuance market has taken an increasing amount of traders' attention, with NIBC's announcement of its new Dutch MBS XV deal that is due to market in the next week. This follows the recent favourable reception of Santander's Fosse deal, which was upsized by 40% on the back of investor feedback (SCI passim).

JA

CMBS

TALF choices

New issue concerns remain for US CMBS market

As the TALF programme reaches its conclusion for legacy CMBS, lack of new issuance within the US CMBS market remains a concern for investors. At the same time, depreciating collateral values continue to affect current trading levels and is expected to do so well into the future.

US CMBS spreads nonetheless moved tighter last week. Heavy trading activity in second- and third-pay triple-As in particular was observed, likely driven by investors taking advantage of perceived heightened demand before the last TALF subscription date on 19 March.

Indeed, second-pay triple-A CMBS tranches have been the biggest beneficiary of the legacy TALF programme, according to CMBS analysts at Barclays Capital. Having traded at an average price of US$70-US$80 in March 2009, most such bonds are now said to be firmly in premium price territory.

"Since the inception of the programme, 42% of accepted loan requests have been for second-pay super-senior bonds by count," the BarCap analysts note. "We estimate that over 10% of 2007 vintage second-pay triple-As are pledged as TALF collateral, versus less than 1% for 2007 vintage LCF triple-As. With the legacy TALF programme presumably ending this month, we expect some further underperformance in this sector in the short term."

However, they indicate that any material widening should be viewed as a buying opportunity. "With zero CDR spreads in the 275bp-300bp over swaps range, select second-pay 2007 vintage super-seniors look attractive versus 2005 vintage LCF super-seniors. In terms of security selection, we would favour thicker tranche size second-pay bonds, which would be less susceptible to default-related prepays."

Although questions remain as to whether TALF will be extended for CMBS, the general consensus appears to be that it won't be. As a CMBS portfolio manager says: "For me, it doesn't make sense for legacy TALF to be extended. What the CMBS market needs now is help with new issues."

One trader agrees that a lack of new issuance is a key concern for the market at present. "You can count on one hand the number of deals done in each month, so there is no new issue market," he says. "The only new transactions have been resecuritisations and, to be honest, I don't even pay attention to them. Not because they're not valid, but just because they aren't widely available. Unless you're invited into the syndicate or someone will share a prospectus with you, you don't know anything about the deal."

The portfolio manager explains that there are two main reasons for a lack of new issuance within the market. "First, property values are going down so much that if an issuer originates a new loan, they would have to put in a significant amount of equity - and that's a problem because, for someone who has borrowed earlier, it would lose its original value and they'd need to put more money in. Second, if they do make a loan, there is no good way to hedge the risk of spreads moving between the time they originate the loan and when they securitise [SCI passim]."

However, the portfolio manager believes that intervention on the part of the Federal Reserve could help to boost new issuance. "I would think that maybe they should modify the existing TALF programme a bit to encourage more new loan origination," he says.

He explains that although the processes of the programme are complex, small changes could do much to ease the concerns of investors and encourage new issuance. For example, he suggests: "I think it should be set up so that if you originate before June it will be eligible, even though you may securitise after that time. Small things like that would make people more comfortable about originating."

In terms of current trade levels, the trader reports: "Like everything in structured finance of late, there's been credit barbelling. The on-the-run generic paper is still trading OK - in the 300bp-500bp over range. The biggest issue is evaluating whether a deal is going to extend because of underlying collateral performance."

He continues: "Even though the market has been very choppy, it shows that people are finally being smart and watching the actual commercial real estate market. I think trading is now responding to those fluctuations and bad headlines in underlying real estate collateral valuations."

Collateral devaluation is currently still a problem that the trader believes will continue to get worse before there is an improvement. He estimates that it will be another two years before underlying collateral levels show an improvement.

He explains: "All you need to do is come to the US and see the overbuilt capacity we have for horrible prideless strip malls everywhere and the number of empty businesses within them. There were so many businesses that were just hanging on, that are now finally going under. There's another whole cycle of devaluations to move down."

Despite this, the trader believes that the market is performing well and showing resilience in the face of the declining collateral values. "I don't think the market is supposed to do anything other than what it's doing, which is reacting to the reality of collateral value. That said, it's still easier to sell an imperfect piece of CMBS paper than to sell a second-tier triple-A rated credit card transaction, which used to be the benchmark," he concludes.

JA & CS

ABS

Final TALF offerings squeezed in

Premium Financing Specialists on 4 March priced its insurance premium receivables TALF-eligible offering after being talked in the market for weeks. Off-the-run issuers like Premium Financing Specialists have been lining up offerings ahead of this month's TALF ABS subscription deadline, which marks the last round of deals under the programme that is set to expire on 31 March.

The US$1.2bn offering, dubbed PFSFC 2010-C/D, was led via JPMorgan and Citi. The deal's largest US$800m tranche priced at 145bp over one-month Libor, according to an investor and a syndicate official.

Unlike the ease with which credit card and auto names have brought TALF and non-TALF offerings in recent months, off-the-run issuers have struggled to access the TALF programme. Marlin Leasing, for one, had several months of discussions before its TALF-eligible US$80m deal arrived last month.

Another first-time issuer that was poised for this round of TALF issuance, 1st Financial Funding, a subsidiary of South Dakota chartered financial services organisation 1st Financial Bank USA, will not be bringing its offering, however. The deal was expected to include a US$200m private placement offering with two tranches.

The Federal Reserve in general has not been so keen in taking on the esoteric exposure to some of the less common issuers, which are having a harder time in coming to market, says the investor.

Routine TALF issuers, meanwhile, such as Sallie Mae and SBA, wrapped up two final TALF-eligible transactions on 4 March. SLM Corp's US$690m SLCLT 2010-B offering features a US$207.7m tranche and a US$475.5m tranche. The deal priced via Citi at 75bp over the prime rate and 350bp over one-month Libor respectively.

SBA's US$272.2m SBAP 2010-20C offering will price next week, according to a dealer. The 20-year offering, which will consist of 489 loans, has price talk in the area of 50bp over swaps.

Though SLM's deal is TALF eligible, at least one investor believes SLM Corp could have come with a non-TALF offering. Credit card, autos and some equipment lease issuers have all been able to come to market with non-TALF deals already.

ABS spreads have tightened so much that the TALF programme end will not have a great impact on many of the more common issuers. It's still hard to get a generous IRR on the ABS deals since cash investors have driven spreads so tight, the investor adds.

From launch to end, the TALF ABS programme has tallied US$105bn eligible supply and US$58bn in loans made, according to ABS analysts at JPMorgan. The post-TALF market is nonetheless expected to normalise, with spreads gradually widening back out over the next few months.

KFH

Correlation

Trades mooted for declining correlation regime

As global economies recover and markets re-risk, credit derivatives strategists at Morgan Stanley expect correlation to continue to fall from the elevated levels observed over the summer of 2009. "The long default correlation trade expressed with long 0%-3% positions and short senior risk positions was very successful during the crisis. However, as spreads compress and credit spreads on tail names remain elevated, we expect risk to flow back into first-loss tranches at the expense of more senior parts of the capital structure," they note.

Morgan Stanley's key view is that not all credit risk will heal and that some amount of tail and default risk will remain in investment grade markets. The primary risk to the trade, the strategists say, is extreme moves in dispersion in either direction.

Owing to convexity and outright pricing levels, first loss is generally a tough tranche to short. Consequently, the strategists advocate implementing this view by going long IG 3%-7% risk versus short IG 0%-3% risk. However, they warn that delta amounts on these tranches are different, which could affect the optimal notional amount of each tranche and thus cashflows.

The strategists also suggest going short IG 0%-3% risk versus long index and single names. "Pricing on this pair trade will vary based on which single names are used; we advocate going long risk any tail credits."

Meanwhile, credit strategists at Goldman Sachs indicate that in Europe risk premia on senior tranches should be higher due to regulatory risk, among other factors. Goldman's model estimates of 'fair value' for implied correlation have substantially increased over the past few weeks.

"While correlation has declined a few points since the start of the year, our model now indicates correlation should be around 10% higher, based on various indicators of systemic risk, such as the level of spreads, financial spreads, stock volatility and swap spreads," the Goldman strategists write. "These risk factors have been spiking up in Europe, following the sovereign crisis that hit Southern European countries and banks (CDX correlation, instead, is close to our model estimate). In the medium-term, we think systemic and sovereign risks will normalise. But the recent increase, not followed by a proportionate increase in correlation risk premia, provides a good entry point for our new trade."

Goldman strategists recommend buying protection on the iTraxx S9 seven-year 22%-100% tranche, delta-hedged (0.46x ratio). "This reflects our view that increased regulatory risks will cause senior tranches to underperform their delta to the index and other tranches. We apply a stop gain/loss of +/- 1% to the strategy," they explain.

In contrast, mezzanine tranches - being the least affected by the new Basel 2 capital charges - should remain attractive. "Regulatory pressures and systemic risk may also push correlation levels higher, challenging our short view. But we believe the search for yield will outrun systemic risk from regulation," the strategists conclude.

AC

LCDS

Dealers nix cancelability in LCDS docs

Both tranche and index dealers have agreed to remove the cancelability or prepayment option for components of the North American leveraged loan index, LCDX. The move leaves the index, which is set to roll to series 14 on 5 April, trading more like a bullet structure similar to other CDS indices.

"It's an important move forward for the market for overall liquidity, not just for modelling security duration," says one LCDS trader.

A dealer call with LCDX tranche traders and index traders took place last week. Documents were sent around last Thursday, with back office and middle market personnel left making sure all systems were in agreement last Friday.

The cancelability function has been a sticking point for years (SCI passim). Historically, if a component of the LCDX index opted to prepay its first lien loans, it was forced out of the index. But now the component will stay in the index until the following roll, like other CDS indices.

Having single name LCDS contracts with a cancelability option has been challenging since restructurings have often left CDS positions in limbo as contracts become worthless. A notable case occurred ahead of last year's bankruptcy of Six Flags, whose contracts were left referring to the wrong entity.

The cancelability feature also wreaked havoc on the LCDX tranche market. Once a name dropped out of the index, it shrunk in size. The amortisation would come from the super-senior piece, so no loss would come from the equity, the trader explains.

LCDX tranche dealers have also decided to skip some rolls going forward. Debate centred on whether tranche traders should roll to series 14 or wait for series 15, but ultimately they agreed to have an annual roll as opposed to a semi-annual roll like the rest of the indices.

"After a number of failed rolls, it seemed pointless to keep rolling if interest is not there to roll," the trader adds. The LCDX index was originally planned to roll every six months.

Index traders wanted the tranche traders to roll at the same time as them to provide more support for the product, the trader continues. It was agreed to have a stop roll in series 14, whereby LCDX tranches will continue to roll to series 15 and then roll every other time afterwards.

Still, some participants have favoured the cancelability feature, since it differentiated the product somewhat from other CDS indices and acted more like the loan market where companies routinely pay back debt. But most dealers agreed on the call that the new changes should provide more interest in the index and in single name LCDS.

"There was a big difference between LCDX, the CDX index and the HY index," says another trader. "They want to make it a simple contract, exactly like the others."

The LCDX index will also now trade with accrued interest like other standard North American CDS index contracts. Previously, it traded with no accrued interest. Now, the standard IMM bond dates will apply.

KFH

Operations

Lifeline for distressed banks

Vanquish Capital Group has developed a programme designed to help distressed banks and insurance companies demonstrate that they're utilising their deferred tax benefits. Conceptually, the solution is based on these institutions investing in a pool of assets managed by Vanquish. Although the majority of the assets in this case are student loan ABS residuals, the structure isn't limited to any particular asset class.

"The concept came out of working with distressed banks that have generated significant losses - either through operating costs or writing troubled assets down," explains Don Uderitz, chairman and cio of Vanquish Capital Group. "When a firm loses money in this way they generate a deferred tax benefit, which is recorded as an asset for accounting purposes under FAS 109. But the issue is that the bank needs to make some money in order to take advantage of the benefit."

He adds: "Further, if the benefit isn't used within a certain timeframe (20 years for US banks), a firm has to write it down as a valuation allowance and thus allocate more capital to the asset. In any case, it is difficult to demonstrate enough income to prove that the benefit will be utilised. Banks are already under pressure to raise more capital, but our solution allows them to find organic non-dilutive capital internally by demonstrating that the asset will be utilised."

An interesting case involving deferred tax assets emerged recently. Section 382 of the US tax code states that if there is a change in control in a company that has experienced losses, the amount of deferred tax benefit that can be converted is limited by a formula.

Citi is said to hold about US$40bn deferred tax assets and it became apparent that if the bank raised enough money to pay back its TARP obligations, a change of control would be triggered. The IRS thus changed Section 382 to exclude TARP recipients from the rule, meaning that any new owner of a TARP recipient would benefit fully from the deferred tax assets, thereby making such institutions more attractive as takeover targets. Taking Citi as an example, based on a total market capitalisation of around US$90bn, a potential acquirer would be reimbursed for just under half the price paid.

Indeed, a number of larger banks are understood to be looking at how to manage deferred tax assets themselves, but Vanquish's programme is believed to be unique in terms of converting these benefits for third parties that don't have the expertise or resources to do so. "Most clients have exposure to residential or commercial real estate whole loans and ABS, so it's helpful if they understand the concept of ABS and the value of triple-A rated front-pay securities. However, the programme is only applicable to institutions that are profitable - helping them to stabilise and giving them a chance to turn the business around," Uderitz says.

Vanquish offers two other products designed to help distressed financial institutions: one provides capital relief and the other restructures distressed assets on balance sheet. If, for example, a holder can't sell the assets at the current bid level, they can be structured out of the position by substituting non-performing loans for triple-A securities via a secure exchange programme.

Certainly there is momentum towards finding solutions for distressed banks, according to Uderitz. "A lot of capital is available to take banks out of receivership, for example - albeit some should also be allowed to fail. But more concerning to me is the long-term performance of the assets: the FDIC is essentially guaranteeing 80% of the exposure."

CS

Operations

Back-to-basics underwriting 'key' to performance

A new study claims that risk retention provisions for home mortgages in the House Financial Reform bill and the draft Senate bill are no substitute for good underwriting, strong documentation standards and safe product design. The study was conducted by independent valuation and advisory firm Vertical Capitol Solutions for Genworth Financial, in collaboration with the Community Mortgage Banking Project (CMBP).

The analysis of the loan performance data in the study shows that the application of a handful of common sense underwriting standards improves loan performance dramatically. It is clear from the finding that policymakers should focus efforts on ensuring that financial reform legislation has significant incentives for home mortgages with strong underwriting standards, rather than sweeping risk retention provisions that treat risky and non-risky mortgages equally, according to the CMBP.

The move comes amid rising concerns that risk retention is a blunt tool that could significantly raise the cost of home mortgages (SCI passim).

The report examined more than 20 million loans made between 2002 and 2008, and found that riskier mortgages performed 2.9 times worse, as measured by loans that were 90 or more days delinquent. It is the first analysis to measure the difference in default rates between higher risk loans and traditionally underwritten, back-to-basics loans during the recent housing cycle.

Default rates were consistent across the seven years between the two types of loans, the study found. Qualified mortgages - that is, traditionally underwritten mortgages - performed 2.6 times better prior to the boom in 2002 and 3.25 times better at the peak in 2005. Qualified mortgages performed significantly better in each of the top 25 US metropolitan areas.

James Bennison, svp of strategy and capital markets for Genworth Financial's US mortgage insurance business, says: "This study confirmed what has long been suspected. Traditional underwriting standards, including full income documentation and straightforward loan features, yielded dramatically fewer defaults. Policymakers should be looking for ways to encourage liquidity for this type of lending. Unfortunately, the across-the-board risk retention would increase its cost and reduce its availability."

The Senate Banking is expected to consider a proposal to impose across-the-board risk retention requirements for all loans sold in the secondary market. It would require the SEC and the federal banking agencies to issue regulations requiring creditors and issuers of ABS to retain 10% of the credit risk on whole loans and securitisations. The provision would impact both traditionally underwritten mortgages as well as riskier mortgages, imposing additional costs on even the most responsible borrowers using back-to-basics mortgage products.

Glen Corso, md of CMBP, says that risk retention provisions are a reasonable approach for exotic mortgages that carry higher risks of default. That is not the case, however, for traditionally underwritten mortgages such as the ones offered by community-based mortgage banks, local bankers and credit unions, he adds.

Corso continues: "This study demonstrates why Congress should be careful not to impose an arbitrary risk retention requirement on all loans sold in the secondary market. Across-the-board risk retention will unnecessarily and unfairly raise costs on creditworthy borrowers seeking products that are demonstrably lower risk."

CMBP has urged the committee to exempt low-risk 'qualified mortgages' with strong underwriting and documentation standards and safe product designs. To define lower risk, the study examined eight traditional 'back-to-basics' underwriting criteria that are easy for consumers to understand, easy for lenders to apply and easy for regulators to supervise.

Qualified mortgages were those that included all eight of the following factors:

• Total debt-to-income ratio, including housing and other obligations, of 41 percent or less
• Fixed rate loans and ARMs with initial rates locked in for seven years or more
• Repayment periods of 30 years or less
• No balloon payments
• No interest-only features
• No negative-amortisation features
• Full income documentation of borrowers' income and assets
• Mortgage insurance required if the original loan-to-value ratio was greater than 80%.

Certainly, Fitch anticipates that more traditionally underwritten and higher credit quality loans will be the norm when the US RMBS market for newly-originated loans re-opens. In its recently released report, 'Prime RMBS Securitization: Back to the Future', the rating agency indicates that the rating and collateral performance for RMBS backed by these loans is distinctly better than the RMBS backed by the more loosely underwritten loans.

Fitch's analysis encompassed a sample of prime loans originated between 2005 and 2008 to determine the difference in performance between traditional prime borrowers and non-traditional. The comparison shows cumulative loan losses of 19bp for traditional prime borrowers as opposed 96bp for non-traditional, and delinquencies of 4.5% for traditional against 16% for non-traditional.

Fitch senior director Grant Bailey concludes: "Lenders are returning to a more traditional style of lending, with loans containing better credit, full documentation and less leverage."

JA & JL

Regulation

CRD IV could 'hinder' the return of securitisation

The European Commission has launched a public consultation on further possible changes to the Capital Requirements Directive (CRD), which it says is aimed at strengthening the resilience of the banking sector and the financial system as a whole. However, there is concern that a number of the proposals could hinder the return of securitisation as a capital relief and risk transfer tool.

The proposed changes - known as CRD IV - follow two earlier EC proposals amending the CRD and relate to seven specific policy areas, most of which reflect commitments made by G20 leaders at summits in London and Pittsburgh during 2009. These commitments include building high-quality capital, strengthening risk coverage, mitigating pro-cyclicality and discouraging leverage, as well as strengthening liquidity risk requirements and forward-looking provisioning for credit losses.

The seven policy areas are: liquidity standards/liquidity ratios; definition of capital; leverage ratios; counterparty credit risk; countercyclical measures and through-the-cycle provisioning; treatment of systemically important financial institutions; and single banking rule book in banking, including prudential treatment of real estate lending. The treatment of securitisation features in three of these policy areas.

For example, under the first policy area - liquidity standards - ABS is excluded from the 'high quality liquid assets' definition. ABS analysts at Deutsche Bank note that corporates (apart from financials) and covered bonds are now included in the definition, as long as it can be shown that during periods of market stress bid-offer spreads remained less than 50bp.

"In our opinion, this proposed change will have little impact on ABS spreads, given that banks have held little, if any, ABS for liquidity purposes since the onset of the crisis. However, the proposal does certainly put paid...to the notion of ABS returning as a liquidity product," they add.

Securitisation is also mentioned under the leverage ratio section of the consultation, where two different approaches are discussed. In the first, all synthetic securitisations along with certain other securitisations - namely retained tranches and credit enhancements that do not meet accounting de-recognition rules - would be required to be included in the total exposure amount, the denominator in the leverage ratio calculation.

In the second more punitive approach, however, the relative merits of including all securitisations (even de-recognised securitisations in the total exposure amount) will also be considered, as such an approach could ensure international consistency in banks' leverage ratios. But either move could hamper the return of securitisation as a capital relief and risk transfer tool, albeit to varying degrees, suggest the Deutsche Bank analysts.

Finally, under the counterparty credit risk proposals, a separate supervisory haircut (at least double that of corporate debt) is to be applied to eligible securitisation transactions. The EC is looking for feedback on both the appropriate type of securitisation positions and haircut levels that would be considered for eligible securitisations, with double-B plus or lower mentioned as the minimum rating category. Resecuritisations, meanwhile, will be ineligible for repo collateral purposes.

"While the latter (as long as the definition is tight enough) - given the small market size - is unlikely to pose much trouble, the former again singles out securitisation unfairly," the analysts remark.

The EC says the changes set out in the consultation document are closely aligned with the forthcoming amendments to the Basel 2 framework and the introduction of a global liquidity standard that are currently being drawn up by the Basel Committee. All interested stakeholders are invited to reply to the consultation by 16 April 2010, indicating what impact the potential changes would have on their activities. The results will feed into a legislative proposal scheduled for the second half of 2010.

Any such proposal will be developed in the light of both responses to the consultations and an impact assessment examining the anticipated effects of options for achieving the outlined policy objectives, according to the EC. In this respect, it has also invited the Committee of the European Banking Supervisors (CEBS) to carry out a Quantitative Impact Study to aid the assessment of the aggregate effect of the proposed revisions.

EC internal market and services commissioner Michel Barnier notes: "It is essential that we learn all the lessons from the crisis. In that context, I want to ensure an effective follow-up of international decisions. It is vital that we further strengthen the solidity of financial institutions and put in place new rules in order to be better prepared for the crises of tomorrow."

He concludes: "But before making a proposal on 'CRD IV', I want to ensure that we have consulted widely and assessed the impact of the potential changes. I encourage all interested parties to reply and make their views known."

AC & CS

RMBS

FDIC resecuritisation bodes well for more deals

The FDIC's US$1.8bn Structured Sale Guaranteed Notes Series I (SSGN 2010-S1) priced considerably tight on 5 March. Similar to a re-REMIC, the Barclays-led deal consists of securitised private label mortgage bond obligations that the FDIC acquired from failed banks.

The US$1.33bn floating rate tranche priced at 55bp over one-month Libor - tighter than guidance in the area of 65bp. The US$480.1m fixed rate tranche priced at 85bp over swaps, in from guidance in the area of 90bp-95bp. The FRNs are backed by 34 senior option ARM bonds from 2005-2007 vintage collateral, while the fixed rate notes are collateralised by 69 fixed rate RMBS.

The notes are guaranteed for timely payment of interest and due principal on the senior notes by the FDIC. The transaction also benefits from the retention by the FDIC of the junior owner trust certificates.

Real money and traditional buy and hold investors are said to have eagerly bought up the unrated offering because of the FDIC guarantee.

The timing of the deal coincided with recent GSE buyout confirmations and Friday's release of agency prepayment data. "The deal was moved up to help take advantage of these buyouts," one structured finance strategist says. "Clearly some of that money went into here."

Fannie Mae last week said that it anticipates buying 150,000-200,000 loans from MBS trusts in the month of March (see SCI issue 174). Freddie Mac said last month it will purchase substantially all 120 days or more delinquent mortgage loans from its fixed rate and ARM mortgage participation certificate securities (see SCI issue 172).

ABS analysts at Wachovia expect Fannie Mae prepayment rates to increase and Freddie Mac prepayment rates to decrease next month. They also anticipate that GNMA prepayment rates will likely be faster as buyouts continue to elevate prepayment rates.

The FDIC deal gives the insurer little exposure to losses and the best execution, considering that it must have bought the securities at market levels below the losses, according to the strategist. "If they tried to sell these assets into the open market without the guarantee, they probably wouldn't get nearly as good execution," he adds.

The insurer is expected to issue additional resecuritisations from failed banks, though it is also working on other securitisations that include loans and commercial mortgages, according to a trader.

KFH

ABS

Structured products boutiques combine

ICP Capital is to transfer its domestic and international capital markets businesses to PrinceRidge Holdings to create an international investment banking boutique serving investors and issuers in the institutional fixed income markets. The combined firms will operate under the PrinceRidge Holdings name.

ICP Capital, established in 2004, is a 60-person structured products boutique with offices in New York, Chicago, Los Angeles, London and Copenhagen. The firm has established an active trading, origination and proprietary advisory business.

ICP is headed by Tom Priore, who serves as president and ceo. ICP will become a partner of PrinceRidge Holdings. Priore will advise on the combined firm's continued international expansion and strategic development initiatives in the US.

The business integration and closing is expected to be completed in Q210, subject to regulatory approvals.

ABS

US ABS research head named

Deutsche Bank has hired Steve Abrahams as an md and head of securitisation and MBS research within its global markets division. He is based in New York and reports to Marcel Cassard, md and global head of macro and fixed income research.

Abrahams joins Deutsche Bank with almost 20 years of securitisation research and portfolio management experience and was most recently the founder and an md at Citadel Capital Advisors. Before that, he was the global head of liquid product strategy at Bear Stearns. He was previously a credit portfolio manager at Freddie Mac and a senior analyst at Morgan Stanley.

Karen Weaver, Deutsche Bank's former global head of securitisation research, retired last month (see SCI issue 173).

ABS

Dutch structured finance practice launched

Linklaters is launching a structured finance practice in Amsterdam to be headed by newly-arrived Kees Westermann. The practice will function within the firm's global structured finance network, advising on a wide range of transactions.

Westermann joins Linklaters on 1 April 2010 from Clifford Chance, where he was a partner specialising in structured finance, including securitisations and covered bonds. The firm says he is known for his innovative practice, having worked on a range of complex securitisations, and has made a significant contribution to the covered bond market in the Netherlands and internationally.

Martijn Koopal, head of Linklaters' Amsterdam office, comments: "The Netherlands is an important jurisdiction in this area, as one of Europe's largest issuing countries of both securitisation notes and covered bonds. Our investment in this practice reflects our belief that the Dutch securitisation and covered bond market will remain an important source of financing for financial institutions."

Advisory

Illiquid asset advisory formed

Stifel, Nicolaus & Company has expanded its capital markets platform through the creation of Stifel Capital Advisors (SCA).

SCA will be led by Stephan Kuppenheimer and will include 15 other professionals joining Stifel from FSI Capital. Kuppenheimer's leadership experience in the space includes serving as ceo of FSI Capital, as well as director and co-head of the US structured credit products group at Merrill Lynch.

Based in New York, SCA provides asset management, portfolio advisory and capital markets services to financial institutions and governmental entities. SCA will also focus on creative structured solutions for illiquid assets.

Advisory

NewOak hires cfo

NewOak Capital has hired Paul Valenti as cfo. He joins NewOak from Open Link Financial, where he was also cfo, having previously held a similar position at Capital Group Partners.

CDS

New head of credit alternatives hired

The Carlyle Group has recruited Michael (Mitch) Petrick as md to fill the newly-created role of global head of credit alternatives and capital markets. He will also become a member of the firm's operating committee.

Petrick was at Morgan Stanley for 20 years, most recently as md and global head of institutional sales and trading, and was responsible for a diverse set of asset classes, including corporate, residential, commercial, proprietary trading and direct investments. He will be based in New York and begin at Carlyle later this month.

William Conway, Carlyle co-founder and cio, says: "With a proven track record of delivering absolute returns and leading complex enterprises, Mitch will play a central role in expanding the scope and depth of our credit and capital markets business."

In his new position, Petrick will lead Carlyle's array of leveraged finance, mezzanine and distressed teams - a total of 24 funds with US$19bn in assets managed by 57 investment professionals.

CLO Managers

CRE CDO management duties transferred

The management duties of several CRE CDOs are to be transferred from Centerline REIT to Centerline Servicing Inc (CSI). This follows the recapitalisation of Centerline Holding Co (CHC) by Island Capital Group.

After the recapitalisation of CHC by Island, CSI will be a wholly owned subsidiary of C-III Capital Partners, a newly-formed entity controlled by Island. Although the ownership structure of the existing CDO asset management platform will change as a result of the acquisition, the organisational structure, investment capabilities, key employees and technology infrastructure of the existing entity responsible for managing the CDOs are expected to remain in place.

The transactions affected by the transfer are: ARCap 2003-1 Resecuritization; ARCap 2004-1 Resecuritization; ARCap 2004-RR3 Resecuritization; ARCap 2005-RR5 Resecuritization; ARCap 2006-RR7 Resecuritization; AMAC CDO Funding I; and Nomura CRE CDO 2007-2.

All of the CDOs to be managed by CSI were issued between 2003 and 2008. According to Fitch, the portfolios generally consist of CMBS and commercial real estate loans (CREL). Five of the CDOs are considered B-piece resecuritisations, as the collateral consists primarily of the most junior tranches of CMBS transactions. Two of the CDOs, backed primarily by CRELs, are currently experiencing overcollateralisation test failures.

The new partnership between Island and Centerline - C-III - makes the newly-created private company one of the largest special servicers of CMBS in the US, as it is presently the named special servicer for approximately US$110bn of loans in 81 CMBS deals.

CLOs

Three Jefferies staff transfer to Babson

Babson Capital Management has confirmed its role as replacement manager on five Jefferies Capital Management CLOs - Victoria Falls CLO, Diamond Lake CLO, Clear Lake CLO, Summit Lake CLO and St. James River CLO (SCI issue 156 and manager consolidation database).

As part of the transaction, three Jefferies Capital Management employees directly involved with the five funds join Babson Capital - Mark Senkpiel as portfolio manager for the funds and an md, Kimberly Atkinson as a director and Alyssa Tabora as an associate director.

Jefferies Group, Babson Capital and Massachusetts Mutual Life Insurance Company (MassMutual) maintain an active strategic relationship, including their joint ownership of Jefferies Finance, an originator of middle market credit solutions.

Including the Jefferies CLOs, Babson Capital has been named replacement collateral manager for 21 CLOs with a total of nearly US$6.5bn under management. The firm now manages 60 CDOs totaling US$22.1bn in structured credit assets as of 31 January 2010.

Insurance-linked securities

Catastrophe fund sees US$340m inflow

Nephila Capital has attracted inflows of US$340m from 11 UK institutions into its catastrophe reinsurance fund in the second half of 2009. The latest inflows bring the ILS specialist's total assets under management to US$$2.6bn.

Paul Dackombe, head of UK institutional sales at Man Group, which has a 25% stake in Nephila, believes that insurance-linked securities are gaining broader acceptance from institutional investors and consultants. He explains: "After the recent financial market turmoil, institutional investors are actively seeking return streams that are independent from the capital markets and catastrophe reinsurance certainly provides that portfolio benefit."

Co-founder of Nephila, Greg Hagood, comments: "Insurance payouts for damages caused by hurricanes Gustav and Ike and the heavy investment losses and liquidity constraints brought about by the financial crisis have led to a major market shake out. Remaining participants, such as Nephila, have therefore been able to capitalise on this opportunity and charge higher catastrophe premiums."

Investors

Long/short credit fund launched

Henderson Global Investors has launched the Henderson Credit Long Short Fund - a Cayman domiciled hedge fund managed by Stephen Thariyan, head of credit, along with fund managers Thomas Ross and Chris Bullock.

The Henderson Credit Long Short Fund targets a net return of 10%-12% per annum in a high conviction portfolio. The fund uses simple strategies, investment grade and high yield corporate bonds and CDS. The approach consists of pair trades and thematic positions over the medium term, as well as short-term tactical positions in liquid securities that exploit technical imbalances in the market.

"2009 was a strong year for credit returns and we expect a more challenging environment during 2010," says Thariyan. "However, we expect the markets to remain volatile, which we will be able to exploit through this product."

Investors

Fund to invest over US$30m in PPIP

Following the successful February offering of the Nuveen Mortgage Opportunity Term Fund, the fund has committed to invest US$33m in a public-private investment partnership (PPIP). The fund's investment objective is to generate attractive total returns through opportunistic investments in MBS.

The fund notes in its prospectus its intention to invest in MBS directly and indirectly through a separate investment in a public-private investment partnership formed pursuant to the PPIP. The fund has now committed to invest US$33m in a feeder fund, which in turn invests in a public-private investment partnership (the master PPIP fund) sponsored by Wellington Management Company.

The master PPIP fund invests directly in MBS and other assets eligible for purchase under PPIP. Wellington Management was selected by the US Department of the Treasury in July 2009 as one of nine managers eligible to participate in the PPIP programme (SCI passim). Wellington Management also serves as the sub-adviser to the fund.

The fund's capital commitment will be drawn down through a series of capital calls initiated by the master PPIP fund. The initial capital call took place on 2 March 2010.

The fund's full US$33m capital commitment represents between approximately 26% and 29% of the net proceeds of the fund's initial public offering, depending on the final number of additional fund shares issued pursuant to the underwriters' over-allotment option. The fund's entire capital commitment is expected to be called by 1 October 2010.

Investors

Investor relations md hired

BlueMountain Capital Management has expanded its investor relations and marketing team with the hire of Jennifer Strickland as md. Strickland will help shape the firm's marketing strategy to promote its integrated investment style and tailored product offerings. In addition, Josh Drazen has been promoted to md of investor relations and strategy.

Prior to joining BlueMountain, Strickland was director of investor relations at HBK Capital Management for nine years. Before HBK, Strickland was a vp at Citibank, where she led product development for high net-worth clients in the Asia Pacific region.

Drazen has been with BlueMountain for three years, previously serving as vp of business management and strategy. In his new role, he will be responsible for managing existing investor relationships, coordinating client communications, refining the investor relations infrastructure and working on marketing strategy. Prior to joining BlueMountain, Drazen was a vp at JPMorgan and Citigroup, working in various strategic roles.

Investors

Credit research team strengthened

Aviva Investors has appointed Jiten Joshi as head of knowledge services to lead a new six-person team of analysts to support its London-based credit team. The new capability, which is based in Mumbai, India, will be responsible for supporting and enhancing the London team's fundamental credit research capabilities both in investment grade and high yield, as well as providing technical and risk analysis.

In addition to managing the India-based research ream, Joshi will contribute to the development of absolute return capabilities for London managed products, focusing on special situations within the entire capital structure. He joins Aviva from Pali Capital, where he was director of special situations. Previously, he has held positions at ABN AMRO (co-managing the US exposure of a global credit proprietary trading desk), Gartmore Global Investments and JPMorgan Fleming.

Joshi reports to Mark Wauton, head of credit, in London. Wauton says: "In Jiten and the rest of the team we have added significant experience to our analytics capability in the technical and risk space by bringing highly talented individuals who are also familiar with long/short trade ideas."

RMBS

Broker hires in RMBS/HY sales

US broker-dealer BTIG has hired Alexander Piper and James Zurovchak for its high yield and RMBS sales teams respectively.

Piper joins BTIG as a director. Prior to BTIG, he was with Imperial Capital - where he spent five years in high yield, bank debt and equity sales - and Jefferies, where he handled bonds.

Zurovchak joins BTIG as a director and will also be trading agency CMOs. He comes from Source Capital Group, a New York-based RMBS boutique broker dealer, where he focused on RMBS sales. Prior to joining Source Capital, Zurovchak held various sales and trading roles at Federal Home Loan Bank of Chicago, Nomura and Kidder Peabody.

BTIG's fixed income group was launched in early 2009. The group focuses on sales and trading of credit products, which cover the full credit spectrum from investment grade to distressed debt.

RMBS

RMBS due diligence contractor certified

S&P has added RR Donnelley & Sons' global real estate services offering to its list of certified third-party due diligence contractors for RMBS.

Keith Gettmann, md of RR Donnelley's global real estate services, says: "This is an important validation that our firm is providing the quality services our clients and the industry require."

S&P designed this certification programme, which was launched in late 2008, to assist companies in identifying third-party review firms that adhere to the highest standards of data integrity, transparency and independence as a step towards improving the quality of RMBS. Gettmann adds: "RR Donnelley's comprehensive approach to data capture and due diligence allow investors to see accurate loan-level detail on a large scale. We continue to enhance our processes and technologies to ensure that our services deliver superb quality and value."

Structuring/Primary market

SBA pro added as Counsel

Bingham McCutchen has added Martin Teckler to its structured transactions practice group as a Washington-based Of Counsel, continuing the momentum and strategic growth of this group after its August combination with McKee Nelson.

Bingham describes Teckler, who joins from K&L Gates in Washington, as "one of the leading authorities" on Small Business Administration and other federal programmes that provide capital to small businesses, and in areas of government contracting and the provision of set-asides to small and minority-owned businesses. He served as deputy general counsel for the US Small Business Administration between 1984 and 1997, and as senior counsel for the SBA's Business Lending, Small Business Investment Company (Venture Capital) and Development Company programmes.

Reed Auerbach, a New York-based partner and leader of Bingham's structured transactions practice group, adds that the firm's structured transactions lawyers have had a longstanding relationship with Teckler, dating to his time at the SBA. "The initiatives of the Small Business Administration are a top priority for the Obama administration, and Marty is the dean of the SBA bar," he continues. "Having a lawyer with Marty's government and lending experience adds greater value for our securitisation and structured finance clients, and is another step in growing our market-leading practice."

Teckler follows Sarah Smith in joining Bingham's structured transactions group. Smith, who specialises in restructuring matters, joined as a partner in January.

Technology

Derivatives valuation provider acquired

Tullett Prebon has acquired OTC Valuations, a provider of independent derivatives valuation services.

OTC Valuations focuses on the valuation of illiquid, hard-to-value OTC securities and exotic structured products. It also provides vanilla instrument valuation services and comprehensive coverage across the spectrum of instruments traded in the global OTC markets, including fixed income, interest rates, credit, FX, equity, hybrids and structured products. This acquisition complements Tullett Prebon's market data business, Tullett Prebon Information.

Paul Humphrey, ceo of Tullett Prebon electronic broking and information, comments: "Recent market conditions coupled with increasing regulatory oversight have precipitated the growth in demand from fund managers for independent valuation services, notably in the area of complex derivatives. Given Tullett Prebon's extensive involvement in these markets, both as an inter-dealer broker and as a leading supplier of market data, building a presence in the valuations arena is a natural extension of our risk management services."

ABCP

Canadian ABCP ratings outlook 'stable'

Moody's says in its annual review and outlook report on Canadian ABCP that its rating outlook is stable for the sector, as bank sponsors demonstrate commitment to maintaining ratings on their conduits and the performance of the assets in them remains stable.

"Performance of consumer assets, which make up the majority of the assets funded in conduits, has been stable and there is more than sufficient credit enhancement to cover any potential losses," says Moody's vp Lisa Singman.

The rating agency says the Canadian economy performed relatively well during the global economic crisis and that this is a factor in its report. It notes the banks did not require state assistance and classes the banking system as strong.

Although Moody's does have negative outlooks on some of the banks that sponsor ABCP in Canada, no near-term rating action is likely to affect any Prime-1 short-term ratings on the ABCP. As of the end of 2009, it had assigned Prime-1 ratings to 24 conduits with a total of C$34bn outstanding.

The agency does not expect banks to create any new programmes in 2010. It says some conduits may shrink in size, possibly leading to some consolidation to reduce costs, and outstandings will likely remain the same over the year.

ABS

Senate urged to reconsider student loan act

The ASF has submitted a letter to the Senate Committee on Health, Education, Labor and Pensions and the Senate Committee on Banking, Housing and Urban Affairs regarding S. 1541, the Private Student Loan Debt Swap Act. The letter expresses the strong concerns of ASF members regarding the unintended negative consequences of this legislation.

The Private Student Loan Debt Swap Act is intended to allow the US government to refinance performing private educational loans through the creation of a student loan debt swap programme. According to the ASF, the Act "could substantially reduce the value of certain investments of pension funds, mutual funds and insurance companies, in addition to impairing prospective and current students' access to important financing options for their education".

The Association's primary concerns related to the legislation include:

• 'Cherry-picking' of performing loans by a government loan programme;
• Creating significant losses to pension/mutual funds and financial guarantors;
• Changing government rules after institutional investors put capital to work;
• Hurting current and prospective student funding needs;
• Setting a damaging precedent to broader consumer credit markets; and
• Redirecting administrative resources from helping troubled borrowers to refinancing performing borrowers.

The ASF says its members are already working towards the bill's goals of providing relief for many borrowers who have sought funding through private student loans. However, it asks the two Senate Committees to "consider both the impact of this legislation on the ability of the capital markets to continue providing financing for borrowers with demonstrated need, as well as its potential to reduce investor confidence at such a critical moment for the broader capital markets".

ABS

Swap headache for numerous ABN-linked ABS

A number of European ABS, RMBS and CMBS for which RBS NV (formerly ABN AMRO Bank NV) acts as swap counterparty are being monitored by Moody's, following the downgrade to A2 from Aa3 of the long-term senior unsecured debt rating of RBS NV by the rating agency last month.

In each of the transactions the swap agreement requires RBS to post collateral within 30 or 45 calendar days of its rating being downgraded below A1, unless and until it transfers the swap to a replacement counterparty or obtains a guarantee. Moody's understands that RBS NV intends to transfer the swaps for the listed transactions to RBS Plc and, in the meantime, post collateral in favour of the issuers. However, in some cases, the amount of collateral to be posted may not be fully consistent with the agency's current published collateral formulas.

Further, for a number of the affected transactions, collateral will not be posted pursuant to a pre-existing collateral arrangement; rather, Moody's understands that new documentation will be drafted with the intention of implementing Moody's criteria. For these reasons, the agency is not yet in a position to determine whether, for all affected transactions, it will give value to the proposed collateral in assessing whether the rated notes are de-linked from the credit risk of RBS NV.

Over 50 transactions are affected by the review, including several Arena, EMAC, Granite, Paragon and Permanent RMBS.

ABS

US auto ABS performance improves

Seasonal weakness drove US prime auto loan ABS losses slightly higher in January versus prior months, according to Fitch. However, despite high unemployment and pressure on loss frequency, losses in January were over 20% lower on an annual basis for the third consecutive month.

Fitch director Benjamin Tano explains: "Tax refunds and credits will support performance for the remainder of this quarter."

According to the rating agency, one of the biggest factors supporting performance continues to be the mitigating effects of stronger used vehicle values resulting in higher recovery rates on repossessed vehicles, and lower loss severity. Tighter underwriting, including improved credit quality of the 2009 securitisation vintage, is also resulting in loss levels that are lower than both 2007 and 2008 vintages.

Fitch's prime 60+ days delinquency index crept up to 0.77% in January, up by 8.5% over December. On an annual basis, January marked the third consecutive double-digit drop at 11.5% lower than the same period in 2009.

Annualised net losses (ANL) were 1.61% in January, a 5.9% monthly increase, but were almost 28% below the level in 2009. In January last year the ANL index hit a record high of 2.23%.

Wholesale vehicle values remained strong through January as measured by the Manheim Used Vehicle Value Index, posting a modest gain in January to 117.6. The index remains within the 118.5 point record-high reached in September last year.

As a result, loss severity has not been such a strong driver of losses, aiding the moderation in Fitch's index. Despite this, Fitch remains focused on the loss frequency level due to its strong correlation to unemployment.

The agency's auto loan ABS indices track the performance of approximately US$55.3bn transactions issued from over 100 transactions currently. Of this amount, prime auto loan ABS totals US$45.7bn or 83% of the total amount issued from 77 transactions.

ABS

Continued stress for UK card ABS

Fitch says that the UK credit card ABS sector will continue to display signs of stress during this year, with the performance of the underlying receivables continuing to reflect the overall deterioration in the UK's economy. Charge-offs and delinquencies on credit cards in the UK are expected to rise further, although the negative impact on excess spread levels may be cushioned as a result of originator action to support the transactions, as seen recently with the MBNA CARDS transactions (SCI passim).

Although some trusts exhibited improvements in performance towards the end of 2009, delinquencies and charge-offs typically remain close to historical highs. Furthermore, the use of debt management programmes for many of the trusts remains a significant negative element of UK credit card securitisations.

"Debt management programmes are a heightened risk for securitised credit card portfolios," says William Rossiter, associate director in the European ABS surveillance team at Fitch. "They enable increasing numbers of cardholders - who would otherwise, in most cases, roll through the delinquency buckets and default - to remain within the securitised portfolios on reduced minimum monthly payments. This results in a build-up of more vulnerable receivables, which are more likely to be impacted by further stress."

Despite this, the increase in charge-offs during 2009 has resulted in a 'clear-out' of a degree of lower credit-quality borrowers securitised within some of the trusts. This should, in the short-term, provide some relief to the trusts. However, it is unclear whether these short-term improvements can be sustained throughout the year, with the continued strain on UK borrowers likely to result in further performance deterioration.

ABS

Drop in Euro auto ABS delinquencies

Overall delinquency rates in S&P's European auto ABS index decreased by 6bp in Q409 from the end of Q3, according to its latest report. The addition of five new transactions to the index in Q4, accounting for 5.2% of the index, partially explains the decrease.

S&P says that the performance of the Q4 transactions included in the report has stabilised around the levels observed in Q3, and that Spanish transactions still experienced a weaker performance than other European ABS transactions.

Ratings for some tranches of notes in four Spanish auto ABS transactions - one originated by BBVA Finanzia and three by Santander - have been lowered following a review. During the year's last quarter S&P rated five new transactions for a total issued amount of €4.84bn. Of these, two were originated in Germany, two in Italy and one in the UK.

CDO

CDO EOD volume expected to moderate

Mezzanine and subordinated tranches are now representing a much larger percentage of total CDO BWIC activity when measured by notional amounts, thanks to a number of large liquidations over the past month. However, such heavy mezz volume is expected to slow as new CDO events of default (EODs) moderate and existing obstacles to liquidations remain in place.

To date, roughly 42% of all ABS CDOs with an event of default (or US$144bn of a total US$348bn) have resulted in a liquidation, according to structured credit analysts at JPMorgan. "Total liquidations have trailed actual EODs because many CDOs have voting structures that make it difficult to achieve the required vote for a liquidation, following an EOD," they note. "For example, monolines will frequently seek to block a liquidation if they have sold CDS protection, to avoid making insurance payments in the near term."

Still, it's challenging to estimate the amount of CLO paper that could come out of liquidations due to the uncertainty post-EOD and the difficulty in accurately measuring holdings in some of the transactions. The JPMorgan analysts suggest that the aggregate CDO bucket in ABS CDOs is 10%-15% and that CLOs (mostly mezz) probably account for around 3%-5% of this bucket, with the bulk being other ABS CDOs.

"If we make a simple assumption that half of all ABS CDOs will be liquidated in the end, perhaps US$5bn-US$10bn of CLO paper could come out, but again, over an extended period of time. Finally, the EOD/liquidation risk for CLOs within CLOs is not on the table, at least for the typical transaction. We determine the average US CLO EOD cushion is currently about 28%, so the vast majority of CLOs with CLO buckets do not present EOD risk right now," they add.

Overall, triple-A lists appear to be being absorbed well, the JPMorgan analysts conclude. Further, the low dollar prices in mezz/sub tranches indicate that comparatively little risk is actually being sold to the market.

CDO

Tepid response to CSO tender offer

A tender offer announced last week by Deutsche Bank for six outstanding series of notes issued by Asgard CDO (see last issue) resulted in just €30m of the €327m series A euro floating rate notes being repurchased. No other notes in the tender offer were accepted for purchase.

Asgard CDO is 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% was offered for the series A, B and C notes respectively.

CDO

Dante ruling strikes again

Five notes from two synthetic CDOs (Elva Funding and Rembrandt I Synthetic CDO) have been placed on rating watch negative (RWN) by Fitch, as a result of the agency's global review of all such transactions with exposure to US-based derivative counterparties.

The rating actions affect securities from transactions with embedded CDS, where Fitch currently rates the securities higher than the CDS counterparty and where the agency believes that the counterparty could be subject to the jurisdiction of US bankruptcy courts. The agency says it will analyse other non-synthetic structured finance transactions with exposure to US-based derivative counterparties, usually in the form of interest rate or currency swaps, in coming weeks.

The move follows a US court ruling in January on the Dante transaction that held that clauses which subordinate certain swap termination payments below payments due to rated noteholders upon an event of default triggered by the counterparty's bankruptcy (flip clause) were unenforceable (SCI passim).

In determining the materiality of a counterparty exposure, Fitch views any termination type transactions - typically those with embedded CDS - with a maturity date after 31 December 2010 as transactions with material exposure to counterparty risk. Securities with legal maturities occurring during 2010 have not been considered for RWN because the short-term default risk of the current counterparties is viewed to be sufficiently remote.

Fitch has put the two CDOs on RWN because the securitised notes are rated higher than that of the counterparty. If the transaction parties do not demonstrate within three months that the risk of an unenforceable flip clause has been sufficiently mitigated, the ratings of the notes will be downgraded to the level of the counterparty's current rating, which for both transactions is the unrated Morgan Stanley Capital Services.

CDS

Positioning trades suggested ahead of index rolls

The Markit iTraxx and CDX indices, which are set to roll on 22 March (CDX.HY on 29 March), have begun the roll process. The move has prompted speculation about possible positioning trades ahead of the roll.

Structured credit strategists at Barclays Capital suggest that the CDS index rolls should take on added importance, given the notable re-pricing in single name CDS curves relative to the previous roll. Overall CDS curves have steepened significantly, in both the short and the long end, relative to levels in early September. For example, an IG three-year CDS trading at 80bp has a 3s5s curve of approximately 25bp at present, versus 10bp in September.

The strategists consequently recommend that investors consider rolling long protection positions ahead of the roll. "Our main concern is that the index curve looks modestly steep from a longer-run historical perspective, but the index trades more on technicals and we believe they have shifted in favour of the index steepener. Using 5y and 5s10s levels of 88bp and19bp respectively, the annual carry on the IG13 5s10s steepener is approximately 43bp," they add.

So far, it has been decided that International Lease Finance Corporation is not eligible as an IG index constituent. In addition, following the completion of the merger between Wachovia and Wells Fargo, the entity Wells Fargo & Company will be removed from the index because it is a licensed CDX market maker.

Meanwhile, credit strategists at BNP Paribas have highlighted some of the name changes that are likely to enter/exit the iTraxx indices. Based on DTCC data of gross notional outstandings as an approximate measure of liquidity and an overlay of the Markit depth number for the given names, they identify the three constituents most likely to be susceptible to the liquidity rule across the Main and Crossover indices. Zurich Insurance, Deutsche Bahn and SABMiller were chosen from Main, while Wendel, CIRINT and Alcatel Lucent were chosen from Crossover.

The strategists point out that, as these potential deletions are from the consumers sector, the additions will likely be from within this sector as well. "Potential names for the consumers sector in order of depth (from high to low) provided by Markit could be Tate & Lyle or Electrolux," they explain. "There is a possibility that Porsche could enter the Main index after potentially dropping out of the Crossover index as, although it is not rated, it does carry a triple-B implicit rating as its liquidity (via the depth number) is high at 13."

CDS

Sovereign CDS backlash reaches new heights

The political backlash against sovereign CDS reached new heights this week, as German chancellor Angela Merkel, French president Nicolas Sarkozy, Financial Stability Board head Mario Draghi and EC president José Manuel Barroso all called for a ban on speculative 'naked' sales of sovereign CDS. The move comes despite German regulator Bafin finding no evidence that CDS were used to speculate against Greek bonds.

Against this backdrop, European commissioners held an 'educational' call with ISDA and CDS dealers to clarify some aspects of the CDS market, including the concepts of gross and net notional amounts. The EC is expected to announce further actions or enquiries into the market in the future, however.

Whether the politicians achieve their goal remains to be seen. But credit strategists at BNP Paribas suggest that some form of regulation of sovereign CDS could emerge at some point, as governments try to prevent the shorting of their debt.

Talk of a possible ban appears to have added to the rally in sovereign spreads over the past few weeks. For instance, Greece five-year CDS fell by 106bp since 25 February, while the bonds' spread to Bunds only dropped by 78bp.

"This seems to suggest that it was not speculative protection buying that drove Greek government bond spreads wider, or the latter would have tightened as much as the CDS," the BNP Paribas strategists note.

DTCC data indicates that while the gross amount of CDS on Greece has doubled over the past 12 months, the net notional has barely increased. Interestingly, Greece has witnessed the second largest reduction of gross notional among sovereigns, albeit this resulted in a slight increase in the net amount outstanding (from US$9bn to US$9.1bn).

"Evidently, there are market participants out there who still need to hedge their exposures, despite the political risk CDS positions are currently subject to," the strategists conclude.

CDS

Succession events pending

Two succession event determinations are outstanding. First, BNP Paribas has requested that the ISDA EMEA Determinations Committee determine whether a succession event has occurred on Nordic Telephone Company Holding. The request is in connection with the merger of Nordic Telephone Company Holding ApS (NTCH), Nordic Telephone Company Finance ApS, Nordic Telephone Company Investment ApS and Nordic Telephone Company Administration ApS (NTCA).

The latter has received Nordic Telephone Company Holding ApS' 174,369,910 shares in TDC A/S, equivalent to 87.9% of the aggregate share capital and 87.9% of the total voting rights. NTCH was dissolved as part of the merger and NTCA replaces NTCH as issuer under the 2016 notes.

Second, a decision by ISDA's Americas Determinations Committee is pending on whether a succession event has occurred with respect to Northwest Airlines (NWA). NWA merged with and into Delta on 31 December, ending NWA's existence as a separate entity.

The first meeting to discuss this question has been delayed until 19 March.

CDS

Collateral management recommendations made

ISDA has published its 'Independent Amount Whitepaper' and 'Market Review of OTC Bilateral Collateralization Practices'. Both documents have been developed by the ISDA Collateral Steering Committee under the auspices of the ISDA Industry Governance Committee.

"Collateralisation has become a key method of mitigating counterparty credit risk in the derivative markets," says Julian Day, head of trading infrastructure, ISDA. "ISDA and the industry continue to work toward the increased smooth functioning of the collateralisation process of OTC derivatives transactions through its efforts in relation to standards and best practices, and collateral law reform efforts across the globe."

The documents are designed to provide better understanding of current market practices. In these documents, a number of recommendations were made for market participants to enhance practice or understanding in the collateral management arena.

The Independent Amount Whitepaper examines the risks associated with under-collateralisation or over-collateralisation associated with Independent Amounts under ISDA Credit Support Annexes, and the potential alternatives that may be developed by the derivatives market to protect participants. The Whitepaper was jointly produced by ISDA, the Managed Funds Association (MFA) and SIFMA. It was one of the commitments outlined in the derivative industry letter to global supervisors dated 2 June 2009 (SCI passim).

The Market Review of OTC Bilateral Collateralization Practices is a broad market review of bilateral collateralisation practices for OTC derivatives to facilitate better understanding of current market practice, especially as it relates to the different types of counterparties active in the market. The objective of the review is to enable a more complete appreciation of the use of collateral as a credit risk mitigant across the diverse OTC derivative market, including some of the motivations, capabilities, limitations and typical practices of market participants engaging in collateralisation. ISDA says it has worked collaboratively with regulators to determine the appropriate scope of this analysis.

The Independent Amount Whitepaper and the Market Review are both key publications from the ISDA Collateral Steering Committee that provide the context for collateralisation as a risk reduction technique across market participants.

CDS

Developed economy sovereign CDS improve

Fitch Solutions says the announcement of Greece's revised austerity package on 3 March has helped to ease CDS market concerns on the prospects for developed market sovereigns over the past two weeks. Its developed market sovereign CDS liquidity index fell from 8.39 to 8.55 during the period 23 February to 5 March. Sovereign spreads improved over the past week, with European sovereigns tightening by 13% to help the market as a whole tighten by 8.4%.

Fitch Solutions md Jonathan Di Giambattista says: "The positive market reaction to Greece's revised austerity plan has meant CDS liquidity for developed market sovereigns appears to be diverging again from emerging market sovereigns, bucking the convergence anomaly witnessed during much of 2009 and early 2010."

Meanwhile, companies in the global oil and gas sector are trading with the most liquidity on average, having overtaken the telecommunications sector. Despite recently underperforming the broader market, oil and gas CDS spreads continue to price tightest to relative historical levels.

"There appear to be diverging views on the future prospects for the oil and gas sector among CDS market participants," adds Di Giambattista. "Beyond speculation on future commodity prices, an increase in M&A activity may result in additional leverage, while in North America the possible future elimination of tax incentives for oil and gas producers may also be weighing on market sentiment towards the sector."

CLOs

US outperforms Europe in CLO equity returns

Citi has published a new report on the performance of CLO equity returns in order to analyse both past returns and current valuations. In the analysis, structured credit strategists explore the historical returns of 529 US CLOs and 181 European CLO transactions spanning across 132 and 55 managers respectively.

In the report the Citi strategists find that average quarterly cash-on-cash return through to the end of 2009 was 3.85% for US and 3.05% for European CLO equity positions respectively. In addition, CLO equity tranches provided strong returns for their holders through the Q308, generating an average annual cash-on-cash return in the mid- to high-teens.

CLO equity returns in the US are found to be significantly higher than those in Europe. The strategists suggest that this is due to US leverage being somewhat higher than in Europe and the reopening of US high yield markets resulting in strong refinancing activity. Excess spread in US CLOs consequently increased by over 50bp, contributing to higher equity returns, whereas European loan spreads have remained virtually unchanged.

In addition, the strategists found that both the vintage and manager of a CLO transaction have a significant effect on equity performance, with some managers consistently ranking at the top of their respective cohorts in terms of CLO equity distributions, while others consistently underperformed their peers.

Looking ahead, Citi's results suggest that there is strong correlation between past performances and expected future returns. The report found that cash-on-cash returns are significantly lower for Europe than for the US, which reflects the lower recovery value for European loans and lower prepayment speeds. However, some market participants believe that the European high yield market may follow the US, resulting in higher collateral excess spread and recoveries.

In conclusion, the strategists address the belief that US CLO prices are currently too high. They point out that Citi's future projections for the average price of US CLO equity are in the mid-30s, which is in keeping with current market prices.

CLOs

Loan/CLO disconnect doubles

A softening in double-A to double-B CLO spreads throughout February alongside relative stability in leveraged loans has led to a doubling of the leveraged loan premium or 'disconnect' to CLOs, according to structured credit analysts at JPMorgan. At six to seven points, this disconnect is at the upper end of its trailing range for the last few months and the analysts highlight the greater intrinsic value in CLOs compared to January.

"As markets recover, we advocate near-term trading opportunities, keeping in mind the quality tiering across CLO transactions," they note.

On a fundamental level, declining defaults, reopening primary loan markets (JPM strategists forecast volumes of US$75bn-US$100bn in 2010) and improving economic trends bolster the case to risk in CLOs. For example, the analysts indicate that the average US double-B CLO tranche has moved back into o/c compliance and the trend for expected losses higher up the stack is positive, as losses decline and as managers rebuild par and excess spread.

JPMorgan's mid-year CLO 2010 targets - even following the softening - are low US$90s for double-As, US$80s for single-As, US$70s for triple-Bs and US$60s for double-Bs. "We believe the most immediate upside is in single-As, which sold off about 10 points on a generic basis and offer 10% area yields at present. On a risk-adjusted basis (o/c cushion comfortably at 4% on average) single-As should be attractive to a variety of real money investors, given that PIK risk is easing," the analysts note.

They also expect super-senior and generic triple-A spreads to slowly grind tighter, maintaining JPMorgan's 100bp and 150bp targets. As TALF winds down for triple-A ABS, triple-A ABS spreads are anticipated to remain firm and therefore a negative feedback loop to triple-A CLOs is unlikely to occur.

"We believe triple-A ABS investors will increasingly look to triple-A CLOs for spread pick-up and to take advantage of the improving fundamentals in high yield corporates and, by doing so, avoiding lower-quality (or more subordinated) ABS after the withdrawal of support," the analysts conclude.

CLOs

Small payout for Lehman CLO

The receivers of a balance sheet CLO issued by Lehman Brothers in August 2008 - Clio European CLO - intend to make an interim distribution of approximately €193.57m to its most senior investors this week.

The €700m (approximately) transaction, which is understood to have repoed the single-A rated class A1 and A2 notes with the ECB under its previous minimum rating requirement of single-A minus (SCI passim and CDO database), is not expected to pay out to holders of any notes other than the class A1 notes.

The distribution amount comprises €33.9m of accrued but unpaid interest and €159.2m in respect of principal. This amounts to a redemption of 38.8% of the principal amount outstanding of the class A1 notes.

The receivers (Deloitte) have retained funds to cover the costs of the receivership and by way of provision against various contingencies, it says, noting that it is not possible at this time to determine whether any further distribution will be payable from this retention or to determine its timing or amount.

Clio European CLO was backed by senior secured and mezz second lien loans from the US, Denmark and Austria. Avoca became replacement manager for the transaction in July 2009.

CLOs

US CLO concentration risk analysed

S&P has published its quarterly report regarding concentration risk in the outstanding US CLO transactions that it rates as of Q409.

The rating agency reviewed 645 outstanding rated US cashflow CLOs to determine the concentration risk in CLOs for the period. It then identified the top 100 corporate obligors that appeared most often in the approximately 5,000 corporate obligors that are held in those rated CLO portfolios and ranked them based on their total outstanding principal amount.

There has been limited movement in the top 10 corporate obligors of these rated CLOs since the last report was published, although each obligor's relative ranking may have changed slightly in some instances. The CLOs included in this report currently hold approximately US$10bn in cash proceeds in aggregate across all of the related portfolios, which represent approximately 3% of all holdings of all CLOs rated by S&P.

As of Q409, Texas Competitive Electric Holdings and HCA maintained their rankings as the top one and top two exposures respectively of all the agency's rated CLOs.

CLOs

Manager-specific default rates analysed

All European CLO managers experienced defaults in their CLO portfolios during 2009. However, a wide dispersion range of 1.4% to 26% in the actual default rate per manager existed, according to Moody's. Without naming specific managers, the rating agency comments that default rates for more than 85% of managers fell into a range between 5% and 14.5%.

The average default rate of Moody's rated CLOs in 2009 was 10.2%, similar to Moody's European speculative grade default rate over the same period of 10.3%. The European default rate per manager was 10.8% - much higher than the 6% level found in a similar study of US CLO managers. However, Moody's points out that the default period covered in its European study covers the whole of 2009 in contrast to the US study, which was based on the first eight months of 2009.

As might be expected, there is a cluster of managers (17, or 27% of the total) with default rates near the mean, falling in a range between 9.5% and 11.5%. A nearly equal number of managers exhibited better or worse performance than this group.

Managers with only one deal under management represent 37% of the universe (23 out of 62 managers); they also represent seven of the ten managers with the highest default rates. Other than this observed trend, the size of the manager does not seem to be correlated with default performance of CLO portfolios, says Moody's.

CLOs

Documentation discrepancies hit CLO cashflows

Subtle differences in CLO mechanics may significantly influence the potential cashflow that noteholders receive, according to a new report from S&P. Some of the most common variations pertain to the calculation of overcollateralisation (o/c) tests, event of default (EOD) conditions and the voting rights of the controlling classes (typically senior noteholders). S&P warns that even the slightest variations can have economic consequences.

In CLO transactions, o/c tests and haircuts typically serve as risk mitigants for the senior noteholders. O/c tests are generally designed to act as deleveraging/early-amortisation mechanisms and haircuts are designed to trigger the early redemption of senior notes when the credit quality of the portfolio is deteriorating. While o/c tests and haircuts are generally standard facets of CLO structures, the language present in transactions that dictate how and when these features work, is not.

S&P explains that historically, o/c haircuts were first applied to defaulted CLO collateral with most transactions including haircuts that account for the par erosion associated with defaulted assets. "While it may seem obvious that a defaulted asset would not receive full par credit, not all CLOs treat defaulted assets at values less than par immediately after defaults," the rating agency says. "A typical CLO assigns a haircut to an asset deemed as a defaulted asset by the transaction documents until it incurs actual losses either through a sale or recoveries."

S&P notes that typical CLO documents include a set of definitions that determine when an asset is defaulted, but it has found no universally accepted definition for a defaulted asset across all of the transactions it rates. Consequently, a particular loan could be categorised as defaulted and haircut in one transaction but not in another.

In addition to having varying definitions for what constitutes a defaulted asset, CLO documentation varies with respect to the amount of haircuts that are applied. A typical CLO applies a haircut to a defaulted asset until it incurs actual losses either through a sale or recoveries. In some cases, however, defaulted assets receive full par credit in the o/c calculation until actual losses occur.

In a study of CLOs rated by S&P, the rating agency found that transactions generally haircut defaulted assets using the lower of the market value and an expected recovery value (rating agency assumptions are sometimes used as proxies in this regard). Other transactions specify that defaulted assets be carried at zero (i.e. 100% haircut, or receive no credit in the o/c test) either immediately upon default or after a predefined period following a default.

S&P points out that the method for calculating the market value of a defaulted asset may vary from one deal to another, which may cause further differences in how o/c is calculated among different CLOs. "Since the calculation of o/c relies on defaulted asset and haircut calculations, a particular asset may be categorised and haircut differently across multiple deals," it says. "This may cause o/c to be treated differently for the same asset across multiple transactions. In this way, it's possible for two CLOs to hold the same loan but receive different treatment in their respective o/c calculations."

CMBS

Velocity of RE deals to improve

The velocity of real estate transactions is expected to improve in 2010, according to FTI Schonbraun McCann Group, as property pricing stabilises. Debt maturities are likely to force action upon sellers and a return of liquidity to the capital markets is likely to spur buyers, providing the catalysts for greater transaction volume.

"Despite weak fundamentals, I believe the real estate industry has moved beyond survival mode and is once again forward-thinking about emerging opportunities. The capital markets have historically been a leading indicator and their message is clear: the real estate industry is poised for recovery and by the second quarter in 2010, the industry's revitalisation will be palpable," says Bruce Schonbraun, the group head of real estate of FTI Schonbraun McCann Group and head of the global real estate practice of FTI Consulting.

Among the real estate industry trends he identifies that will characterise this shift toward a recovery in 2010 is the role that REITS will play in investing in a diverse array of property types. Student housing, healthcare facilities, self-storage and multifamily properties are also likely to be attractive investments for REITs.

REITs, not assets, are expected to be the investment of choice for institutional investors that have cash to invest. Not only do REITs offer liquidity, but the public markets are marked daily and provide a gauge to institutional investors on the state of their investments.

Additionally, the management teams of REITs will again be comprised of real estate company executives who have come from other public real estate companies and are real estate operators. This is in contrast to the wave of financial engineers and Wall Street professionals that played a meaningful role in the previous real estate up-cycle.

Other capital sources should also begin to flow more freely in 2010. Recent changes to REMIC rules may promote more proactive solutions to CMBS servicers. With bank profits gradually increasing, banks may be more inclined to work out their commercial real estate loan portfolios, according to Schonbraun.

Amid all this, the real estate industry is likely to shift its focus to asset-based returns. The real estate industry will look to operational efficiencies to create and preserve value of their assets, in a shift away from a focus on financially-based returns.

Meanwhile, foreign investors will be among the most active buyers of distressed assets in the US. Investors from China and Saudi Arabia are expected to be among those most interested in marquee properties here in the country.

"The real estate industry will be watching, however, how the government and lending institutions will account for the massive amount of debt that is coming due in the next few years in an effort to prevent pricing and market turmoil. With this, we remain cautiously optimistic that 2010 will likely be the beginning of a recapitalisation period for the real estate industry, which will allow like-minded buyers and sellers to finally transact and help foster equilibrium in the market," Schonbraun concludes.

CMBS

Specially serviced loans surge

In their latest update on CMBS remittances, securitisation analysts at Barclays Capital note that what was "particularly troubling" for February was the surge in specially serviced current loans. By current balance, more than US$3.3bn of current loans transitioned to their respective special servicer during the month.

"As we have repeatedly stressed, specially serviced current loans are a strong leading indicator of future delinquencies in today's environment; the roll rate from specially serviced current to 30+ day delinquent has been at 11% per month on average over the past six months," the analysts explain. "We also noticed a slight pick-up in the pace of loans transitioning to foreclosure status. This is led by the US$103.5m Maguire Anaheim loan (1.37% of GSMS 07-GG10) that Maguire Properties walked away from in September."

The largest loan in the conduit universe, the US$3bn Peter Cooper & Stuyvesant Town pari passu loan, did not contribute to the pick-up in delinquency, however. The loan was reported to have made its February payment, as the special servicer was likely able to sweep enough reserves in combination with property cashflow to cover debt service.

"We do not expect this to be the case next month; the loan will likely be reported as delinquent within the next two months," the analysts remark.

CMBS

Secondary CRE loan prices see small increase

The aggregate value of commercial real estate loans priced by DebtX that collateralise CMBS increased to 76.7% as of 29 January, up from 75.9% as of 31 December. Loan values are down from 81.3% compared to January 2009.

"Loan prices rose in January due primarily to the downward shift of the treasury yield curve and a modest tightening of whole loan spreads," says DebtX ceo Kingsley Greenland. "These improvements in the capital markets were partially offset by weak commercial real estate fundamentals."

DebtX says it priced 59,759 commercial real estate loans collateralising 627 US CMBS trusts with an aggregate principal balance of US$700.2bn as of 29 January. The platform's valuations are based on actual secondary market sales of CRE loans.

CMBS

CMBS extension 'not the start of a trend'

Noteholders of German single loan CMBS transaction, Fleet Street Finance Two, approved the extension of the maturity date of the notes by three years from 2014 to 2017 (see last issue). However, Moody's does not expect many such extensions to follow for other deals.

Moody's explains in its latest Weekly Credit Outlook that final maturity extensions will only happen in circumstances where the interests of senior and junior noteholders are aligned, which is often not the case in European CMBS. Therefore, the rating agency expects that the typical loan work-out strategy will be to receive recoveries before the un-extended final maturity date of the CMBS notes.

In many European CRE markets, loans maturing between 2010 and 2012 are an impediment to a sustainable market recovery. Foreclosures of loans that are deeply under water could increase property supply, which at best caps future price increases.

Bank lenders can theoretically extend maturing loans forever in order to avoid a loss-making property sale, but CMBS issuers are limited by the maturity date of the issued bonds. Most securitised CRE loans in Europe mature between 2011 and 2013, while the CMBS bonds' maturity date is, on average, four to five years later.

Between 2012 and 2016, Moody's expect that CMBS special servicers will sell properties of defaulted loans. CMBS maturity extensions would remove pressure to sell from special servicers, thereby reducing property oversupply.

To extend the maturity date of a CMBS transaction, noteholders of all classes need to consent. This is more likely to happen if the interests of noteholders are aligned.

At first glance, an extension seems to be positive for all noteholders as the servicer gets more time to work-out the underlying loans. This option is often positive for junior noteholders, which might have suffered a principal loss upon an immediate property sale. Senior noteholders, in contrast, would often prefer to get their investment back sooner rather than later; in most cases, even after the sharp downturn, senior classes are still covered by property value.

In Fleet Street Finance Two, the interests of classes were more aligned than in other cases, according to Moody's. The single tenant (Arcandor - Karstadt) is insolvent and there was a threat that the company would be liquidated and vacate the properties, thus causing a decline in the properties' value. With the extension of the CMBS maturity, the issuer was able to extend the single loan.

This gave the borrower the requested flexibility needed to agree to the restructuring plan of the tenant's insolvency administrator. Through the extension of the loan term, the borrower has more time to wait for the stabilisation of the tenant, which might increase the chances of successful refinancing at extended loan maturity.

In other cases, senior and junior noteholders will have divergent opinions on note-maturity extensions. Therefore, Moody's does not expect extensions to become a common trend in European CMBS. They will remain isolated events, it says, if the specific situation allows getting all noteholders on board.

This is more likely to be the case in single-loan than in multi-loan transactions. Moody's says it anticipates further loan and transaction restructurings, but those will keep basic note terms, like the maturity date, untouched in most cases.

CMBS

Defaults continue for Japanese CMBS

Moody's has released its February 'Japan CMBS: Monthly Loan Performance Report', which provides updates on loans maturing last month, loan payment conditions and defaulted loans, as well as an analysis of the characteristics of loans maturing this month.

Twelve of the loans backing Moody's-rated Japanese CMBS, together amounting to Y47.8bn (US$531m), matured in February 2010. Two, at Y13.7bn (US$152m), were paid down in full by their maturity dates, while ten - totalling JPY34bn (US$378m) - defaulted. Two loans, amounting to Y107.5bn (US$1.2bn), were prepaid.

Of the ten loans that defaulted, nine were multi-borrower deal loans. These were small to medium-sized loans with an average value of Y3.4bn (US$38m), ranging from Y400m (US$4.4m) to Y8bn (US$88.9m).

Total payments during the month came to nearly Y121.2bn (US$1.3bn), with none of the defaulting loans being resolved. Defaulting loans amounted to Y288.8bn (US$3.2bn) at the end of February, up by 12% from January.

Four loans were paid down in full last month, including two multi-borrower deal loans. One was backed by a number of several land rights for retail outlets in the Tokyo metropolitan area; the other was backed by a single tenant retail outlet in Tokyo.

Nine loans amounting to Y124.2bn (US$1.380bn) will mature in March.

Insurance-linked securities

New cat bond begins marketing

Swiss Re has begun marketing the second series of notes under its Successor X catastrophe bond programme. The new notes will be exposed to both major North Atlantic hurricane risk in selected states within the US and Puerto Rico, and major European windstorm risk in selected countries in Northern and Western Europe between March 2010 and March 2013.

S&P has given the deal, which is yet to have an indicative size, a preliminary rating of single-B minus. The agency notes that the transaction is the first catastrophe bond that it has rated using PERILS AG's industry benchmark for European windstorm catastrophes.

S&P says: "In order to realise its full potential, we believe PERILS will require wider participation from the insurance market. As is evident from the probability of attachment and the assigned ratings, we added a significant stress to account for the recent introduction of PERILS and the limited market coverage, which introduces professional judgment into the loss calculation. This is not equivalent to us assuming poor judgment on the part of PERILS, but instead reflects an attempt to quantify the unknown variable associated with human error."

The new notes cover hurricanes above an index value of 694.5 on a per-occurrence basis, up to an index value of 829.0. The notes also cover European windstorms above an index value of 607.0 on a per-occurrence basis, up to an index value of 784.4. EQECAT has undertaken its hurricane and European windstorm risk modelling using the EQECAT WORLDCAT enterprise version 3.13 model.

The collateral for the deal will be invested in Treasury money market funds.

Operations

Mangusta loan enforced

Special servicer Hatfield Philips has enforced the €159m Mangusta loan, originated in 2005 and maturing in July 2012. This follows the transfer of the borrower's interest in the loan from German domiciled entities to an Austrian domiciled entity and the acceleration of the loan.

Hatfield Philips says it reacted quickly to enforce the loan. The realisation of enforcement rights based upon German Law in Austria requires a much longer timeframe and is more costly than similar enforcement processes in Germany and could have disadvantaged the ability of the lenders to enforce their rights.

Christian Daumann, Hatfield Philips md, says: "Domiciliary of borrowers' interest is critically important when looking at the actions that we can take on behalf of lenders. Jurisdictions across Europe can have significantly different legal procedures, which can fundamentally impact on the ability to restructure or enforce on loans."

The firm has successfully brought German insolvency proceedings against the relevant Austrian company and will be working with the preliminary insolvency administrator in order to reach an agreement regarding the administration and management of the assets of the Austrian company and a possible disposal strategy in respect of the underlying properties. It is also investigating what further legal steps may be taken regarding the unfulfilled obligations of the sponsor.

The Mangusta loan is the second largest in the €723.3m Titan Europe 2006-1 portfolio and is secured on 13 properties providing office, retail, residential and hotel accommodation across Germany. Tenants include major retailers, hotel chains and German government departments.

Ratings

RFC issued on revised NHG criteria

Fitch says it is seeking feedback from market participants in respect to its revised criteria for rating transactions of Dutch mortgages backed by the Nationale Hypotheek Guarantie (NHG).

The NHG is a state-sponsored guarantee that compensates lenders and issuers for potential losses on guaranteed mortgages. However, guarantee administrator Stichting Waarborgfonds Eigen Woningen (WEW) may not indemnify mortgage losses if, upon submission of the claim, it deems that affected loans are not compliant with the guarantee's terms. In addition, the guarantee coverage of each loan amortises, while most Dutch mortgages do not.

Lara Patrignani, senior director in Fitch's European structured finance team, says: "The current consideration for the seller's obligation to make up residual losses results in an undesirable linkage between the rating of most senior notes and the financial viability of the seller."

Fitch's proposed criteria changes relate to the agency's analysis of both the operational and the amortisation risks. One of Fitch's proposals is to no longer assume any repurchase of WEW-rejected loans by the seller at rating levels above the seller's rating. The agency also proposes to apply a rating-dependent adjustment to its pay-out assumptions, to incorporate the risk of a possible tightening of WEW's pay-out policy in a distressed economic context.

Fitch would also amend its analysis of the amortisation risk by assuming that defaults will occur later than previously assumed in a loan's lifetime and after the guarantee coverage is largely amortised. As a result, the agency's loss expectations would depend significantly on the capital accumulated in the repayment vehicles attached to the loans. Repayment vehicles other than of the savings type have no standardised features and without a minimum of information on these, the agency does not believe it can assume any such capital accumulation.

"Market trends in recent years have led Fitch to reconsider certain aspects of its criteria for Dutch NHG-backed mortgage loans," says Nicolas Ardoint, director in the agency's European structured finance team. "The demise of the financial markets in 2008 underlined concerns as to whether the capital invested in the loans' repayment vehicles efficiently compensates for the amortisation of the guarantee coverage. WEW pay-outs also seem to have decreased in recent years, perhaps as a reflection of policy tightening."

Fitch requests that feedback be provided on its exposure draft by 23 April 2010.

Regulation

Coordinated reform 'at risk of fragmentation'

The Institute of International Finance (IIF)'s Market Monitoring Group (MMG) has issued a statement on potential systemic risks, following its regular quarterly meeting. It says this is in keeping with its mandate to advise market participants and policymakers of emerging vulnerabilities in the global financial system.

IIF md Charles Dallara explains: "The MMG believes it appropriate at this time to signal concerns about risks arising from the current high level of uncertainty, both on the regulatory front and in the conduct of fiscal policy. In particular, uncertainty related to fiscal policy challenges - both near-term, as in the case of Greece, and medium-term, such as those facing many important countries - have unsettled markets and could generate market pressure on interest rates, weakening investor and consumer confidence and undermining global recovery."

MMG co-chairman Jacques de Larosière, former md of the International Monetary Fund and former governor of the Banque de France, adds: "There is a clear need for regulatory reform, which is essential for progress towards a stable, more resilient financial system. However, uncertainties about the prospects for reform - which have been heightened by the recent proliferation of national proposals - are thought by MMG members to pose additional risks to economic recovery."

He continues: "Reforms will inevitably have an impact on both the supply of and the demand for credit, as well as prospects for raising capital. It is essential that in their deliberations on the nature and timing of new regulatory measures, policymakers remain mindful of the paramount need not to undermine the recovery of the banking sector and the wider global economy."

De Larosière cautions that the valuable framework for international coordination of reform efforts laid out by the G20 in Pittsburgh last year is at risk of fragmentation. "Globally coordinated agreement on a core set of reforms, focusing on capital, liquidity, cross-border resolution and enhanced risk management, remains the principal responsibility of the Group of 20, the Financial Stability Board and the Basel Committee on Banking Supervision," he notes.

Meeting participants highlighted that many financial institutions face a backlog of non-performing assets, notably in commercial real estate and to a lesser extent in residential real estate. Against this backdrop, the forthcoming end to the US Federal Reserve's purchases of MBS is likely to have considerable repercussions for mortgage rates and home prices, and thus for the banks that hold mortgages and mortgage-related securities.

RMBS

Resi re-REMIC criteria updated

Fitch has published an updated 'US Residential Mortgage Re-REMIC Criteria' report, summarising its current criteria for analysing credit risk in the issuance of new securities backed by US RMBS. According to the rating agency, analysis of RMBS resecuritisation transactions incorporates loan-level analysis of expected losses to the underlying pool of mortgages using the ResiLogic loss model, examining recent performance trends to make adjustments to ResiLogic loss expectations using roll-rate and pipeline liquidation analyses on a pool level, and analysis of the payment structures on both the underlying bonds and the resecuritisation.

Currently, Fitch is not rating re-REMICs collateralised by subprime, Alt-A or other esoteric mortgage products due to ongoing performance volatility, and is only providing ratings on the senior bonds in US RMBS resecuritisation structures. It does not provide ratings on US RMBS resecuritisations backed by subordinate or support senior bonds either.

Finally, transactions with high mark-to-market combined loan-to-value ratios may not be eligible for a triple-A rating, though a rating of single-A or lower may be considered.

RMBS

Dutch RMBS prepayment index increases

The weighted-average Dutch RMBS prepayment index increased to 6.08% in Q409 from 4.56% in Q3, according to a report published by S&P. This uptick in constant prepayment rates appears to mirror a slight increase in the number of housing transactions completed in the Netherlands.

S&P's total delinquency index for Dutch RMBS transactions increased from 1.19% to 1.28%, maintaining its low arrears levels. Ratings on the Hermes XIV transaction were withdrawn and ratings on the Dutch Mortgage Portfolio Loans transaction were affirmed.

Ratings on Shield 1 remained unaffected after ABN AMRO's split from the Royal Bank of Scotland NV, as they also did on the transactions originated or serviced by DSB Bank NV, despite DSB going into administration.

As of December 2009, the outstanding total Dutch securitised mortgage loan balance that S&P rates was €96.6bn, down from €97.1bn in Q3.

SIVs

SIV-lite ratings withdrawn

S&P has withdrawn its credit ratings on all of Duke Funding High Grade II-SEGAM I's notes. Before withdrawing the ratings, the class C and D notes were removed from credit watch negative.

The withdrawal follows a prolonged period of insufficient information received on the SIV-lite. Furthermore, S&P says it does not expect to receive any future reports.

Ratings on the class A-2, B-1 and B-2 notes were lowered to D in December 2007, following the non-payment of interest due on those notes. At that time, S&P lowered the ratings on the class C and D notes to double-C and kept them on credit watch negative.

The class C and D notes are deferrable. The agency removed the credit watch negative placements and withdrew its ratings on classes C and D, since it has no new information on the status of these tranches.

"We are unable to confirm whether these notes continue to defer interest as is permitted under the terms and conditions on the notes," it says.

Whole business securitisations

Increased concerns for UK pub sector

Moody's has published its latest performance update for the UK pub sector covering developments over 2009. The rating agency currently rates the corporate family rating (CFR) of one pub operator, Enterprise Inns, and four whole business property transactions secured by pub portfolios located in the UK.

In the last two years, the UK pub sector has experienced significant pressure ensuing from the current economic downturn, as well as changing beer-consumption habits and the ban on smoking in public places. Pub operators are enacting meaningful changes to limit the negative impact of the economic downturn, particularly as the quality of pubs and the marketing concepts behind them are becoming essential in the challenging market.

Owners of leased pubs have tried to support their licensees during the downturn through rent concessions and beer discounts. The managed pub companies focus on improving operational standards and reducing their overall operating costs.

The owners of highly leveraged pub portfolios, like Punch Taverns, are also focusing on disposing of non-core and underperforming pubs and using the sale proceeds to increase free cashflow and reduce their overall levels of debt. The observed declining cashflows, as well as decreasing operating and profit margins reported by the transactions have resulted in increased concerns about the medium-term cash flow generation ability of the securitised portfolios relative to the outstanding debt levels in the transactions.

Magdalena Umsonst-Suminska, a Moody's avp, analyst and co-author of the report, says: "All four transactions reported declining performance trends over the past year; albeit to different extents. Overall, decreasing cashflows and worsening business prospects have adversely affected the current and expected debt service coverage ratios and, consequently, negatively impacted ratings in 2009."

Thomas Babin, a Moody's associate analyst and co-author of the report, adds: "As of early 2010, Moody's remains cautious about the short- to medium-term trading prospects of the UK pub sector and expects the weak UK consumer environment to persist during 2010 due to the current difficult economic environment as well as continued uncertainty in respect of changing customer habits and profile."

Trading

Trading ideas: advanced decay

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at an outright long volatility trade on Advanced Micro Systems Inc

Even though AMD experienced a recent upswing in good news with the US$1.25bn settlement from Intel and consensus beating fourth-quarter results, the implied volatility market zealousness is considerably overdone. Analysing the inherent risk of AMD from a credit perspective, both our technical and fundamental indicators point to a strong upswing in AMD's implied volatility. We recommend buying longer-dated downside puts to profit from our forecast.

Our directional volatility model forms the starting point for the valuation of AMD's fair implied volatility surface. The cross-sectional model takes both market and fundamental factors into account to construct a fair value implied vol surface for each name in our universe. It provides a medium-term forecast of the volatility surface.

Considering AMD's factors, we expect the implied volatility of its one-year 25 delta puts to increase from 49% to 62%. AMD's credit-implied volatility is one of the worst among all non-financials and a driving force in the valuation. This is largely driven by its wide credit spread, which currently trades 3% upfront.

A company's interest coverage, by far one of the best forecasters of a company's potential for default, is one of the fundamental factors in the model. Even though AMD's coverage level is entering back into positive territory, its current level of 1.6x is extremely low and indicative of a high risk company (Exhibit 1).

One of the technical factors in the directional model is the difference between an equity's realised and implied volatility. We like to buy vol on equities that have higher realised vol in order to profit from gamma hedging and offset losses from theta decay. AMD's recent 30 and 90 day historical volatilities are more than 15 points greater than its implied vol (Exhibit 2). Given the massive differential, we expect an accompanying increase in implied vol.

Our empirical model compares single name CDS to implied volatility over the recent past. The model provides a short-term forecast of the volatility surface based on the assumption that the near future will look similar to the recent past. It takes into account both the relationship between equity price and CDS, and implied volatility and CDS.

As Exhibit 3 demonstrates, the mean reversion of AMD's implied volatility to its CDS-implied fair vol has been strong over the past year. The recent drop in implied vol has been not been accompanied by an equivalent tightening in its CDS spread. The empirical model indicates AMD's implied volatility is priced more than 10 vol points too low.

Hedging risk: Given that the trade is motivated by both short- and medium-term forecasts of volatility, we recommend buying options with at least six months left to maturity. We do this to limit the initial and future gamma exposure of the position in order to allow enough time for reversion to fair implied vol. We recommend flattening delta each day on the close. The goal for the trade is to capture an expected rise in implied volatility, as well as the differential between realised and implied volatility.

Position
Buy AMD's Jan 2011 US$7.50 strike puts delta-hedged at US$106/lot, 49.5% implied vol, 31.6% delta and equity price of US$8.35.

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

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

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