Contents

CDO

Secondary equilibrium

Appetite for CDO liquidations to continue

The US CDO market looks set to continue trading sideways for the remainder of this year as investors work through the asset overhang and new issues remain scarce. Concerns about whether the market can absorb this volume appear overblown, however.

Marjorie Hogan, senior portfolio manager at Capstone Credit Advisors, expects the current equilibrium between buyer and seller in the US secondary CDO market to continue, following the deluge of assets on to the market that ended in mid-November. "There is a lot of money flowing into credit - away from, say, corporate bonds that aren't yielding much - so spreads should carry on grinding tighter," she says. "I expect the market to largely continue moving sideways for most of the year, albeit marginally tighter with decent trading volumes as investors work through the overhang. It's clear that the market is on a recovering trend."

Indeed, CDO liquidations will likely continue for at least the rest of the year. "There is such a backlog of assets that need to be worked through that liquidations will continue for a while longer," she explains. "Many deals are still under an event of default, but haven't yet liquidated, so there are plenty of assets due to come on to the market. However, achieving noteholder agreement to liquidate is usually a drawn-out process."

She adds: "Although senior noteholders typically would want to vote in favour of liquidation, it's often difficult to identify and then contact the relevant decision-maker. The trustee will send out notices, but sometimes they don't reach the necessary people." For example, in one case recently involving a mezzanine note, a firm's back office unwittingly approved a write-down because there was no-one else around to make the decision.

So far this year, liquidations in the CDO space have been dominated by Trups (from failing banks) and mortgage assets (from ABS CDO unwinds), as well as by CLOs from liquidating CLO-squareds (see also separate News Round-up story). In addition, many investors are seeking to downsize their portfolios, including hedge funds taking profits and then moving further down the capital structure.

According to RBS estimates, US$400bn of ABS, CRE and Trup CDO events of default have occurred since October 2007, with US$141.9bn (across 138 deals) already liquidated and US$15.2bn (14) in liquidation. A further US$260bn (294) is assumed to be under an EOD and - although not all deals will be able to liquidate - analysts at the firm indicate that CLOs could account for 3%, CRE/CMBS CDOs for 10%, ABS CDOs 13% and RMBS 70% of those that do.

Meanwhile, structured credit analysts at JPMorgan estimate that at least US$70bn of secondary CDO lists (including at least US$28bn of CLOs) have come onto the market since January 2009. And the strong run-rate of secondary trading so far this year (on average US$2.7bn a month) suggests that total 2010 activity could reach over US$30bn. However, the analysts anticipate secondary volumes to gradually ebb as spreads tighten, volatility eases and primary issuance slowly returns (see also last week's issue).

Looking ahead, senior tranches - especially in CLOs - are likely to see more demand than mezzanine and subordinate notes. Some US dollar-denominated equity pieces from Asia and CLO paper from Europe are also coming on to the US market - a trend that is likely to continue in the coming months, according to Hogan.

She concludes: "The Euro flow is mainly because the region's recovery is further behind that of the US, while the Asian flow is due to Asian banks realising that these investments aren't appropriate when they're highly distressed. Equally, CMBS will be a big focus over the next several years - we expect significant liquidity to emerge for CRE assets. It is a mainly different investor base for these assets though, as the focus is on property values and rent rolls rather than statistical information on companies."

CS

RMBS

Filling a void

Evolving re-REMIC market attracts investors

A continued drought of private-label US RMBS issuance is prompting many investors to consider re-REMICs as a viable alternative. While rating agency concerns over the underlying pools backing such deals remain, the re-REMIC sector continues to develop in terms of liquidity and the availability of risk/return profiles.

Roelof Slump, md at Fitch in New York, confirms that while rating requests for re-REMICs has dropped off in recent months, it is still an active part of the securitisation market. "Generally speaking, both current holders of RMBS and new investors have continued to express an interest in re-REMICs for certain portions of this market," he says.

Last year, re-REMICs surged in popularity given their ability to offer risk capital relief and OTTI benefits. The technique was not only employed on RMBS structures, but some CMBS and CLOs were also retranched and resold using the re-REMIC technology (SCI passim).

The sector continues to advance: while earlier RMBS re-REMICs tended to be created from prime collateral, the choice of underlying collateral now ranges from super-prime jumbos to option ARMs and subprime. The selection of available investment grade tranches has also expanded.

In typical super-senior/mezz re-REMIC deals seen in the past, the triple-A rated super-senior tranche was the only rated option available to investors. However, a new three-tranche sequential structure has emerged more recently.

The top two bonds in a super-senior/ senior mezz/junior mezz deal are rated investment grade. The super-senior re-REMICs are rated triple-A through to single-A, while the senior mezz pieces are rated all the way down to triple-B.

Securitisation analysts at Barclays Capital comment that super-seniors are attractive low-yielding investment grade assets, providing very strong protection against write-downs. Senior mezz tranches, on the other hand, have very attractive risk/reward profiles, being higher yielding assets with significant principal protection and investment grade ratings.

"This tranche [senior mezz] breaks only when losses are 30%-50% higher than our base case. Given the past credit performance of the collateral and the comfort we have in our models, in general, it would be very difficult to break them even with elevated loss expectations," they say.

The analysts also comment that the junior mezz tranche offers a leveraged recovery position with an option-like payoff where the potential downside is as big as the potential upside and is very security-specific.

In terms of the underlying, the most common re-REMIC structure has a single underlying asset. However, more recently, two classes - a floater and an inverse floater - have been combined to achieve a more desirable fixed rate pass-through coupon.

"In the most usual structure, tranches are paid down sequentially from the top down, and losses flow reverse sequentially," the BarCap analysts explain. "The super-senior bond receives front cashflows and takes losses only after the mezzanine bonds are completely written down. Typically, interest is paid to all the tranches throughout the deal cycle. Zero accretion mezzanine tranches, popular in the first half of 2009, have become less common as rating agencies stopped giving credit enhancement credit for coupon accretion."

Meanwhile, rating agencies continue to voice concerns regarding volatility and collateral performance in many of the underlying mortgage pools referenced in re-REMICs. Earlier this week Moody's placed US$500m of re-REMICs backed by option ARM, Alt-A, jumbo and subprime RMBS on watch for possible downgrade, triggered by a downgrade watch on the underlying ratings of the securities backing these tranches.

Fitch, which recently updated its rating criteria for re-REMICs (see last issue), is rating re-REMICs backed by senior prime bonds only. Slump explains that Fitch's analytical process includes an in-depth evaluation of the loan-level attributes of the pool and the cashflow structure of the underlying bond and the re-REMIC.

"A significant emphasis is placed on the evidenced pool performance, including delinquency roll rate behaviour. Additionally, pools that have concentrations of loans that are underwater are frequently not eligible to receive high investment-grade ratings," he says.

Slump concludes: "These concerns that Fitch has does eliminate a number of proposed transactions."

AC

ABS

Post-TALF positivity

US ABS activity in the week to 12 March 2010

The expiration of the ABS TALF programme played a key part in US market activity last week, although its affect was far from negative and is not expected to disrupt the market moving forward (see also Research Notes). Current pricing levels and activity have remained relatively stable and a positive sentiment regarding new issuance is prevalent among market participants.

One trader reports: "We had a lot of people selling paper into the TALF expiration when they could see that they could still sell bonds with the loan to other TALF buyers. There's been a lot of selling coming into the last two weeks. But the market has seemed to absorb it pretty well."

As a result, prices have dropped only slightly. An ABS broker explains: "We've seen triple-Bs and single-As both softening up a little bit in price. For example, we've seen the bid on some single-As in the 40s and we've seen the bid on triple-Bs in the mid-30s."

Despite this slight softening, the trader maintains: "The market has been quite neutral. There's been a lot of selling, but it's been met with decent demand."

A second ABS broker explains that - as with other secondary markets (SCI passim) - the demand that had previously come from dealers over the past few months has eased off. He says: "In the last week or two we've seen the dealer bid backing off, which has stabilised the market as far as price increases. We thought that maybe prices would drop, but we've seen some end accounts coming in and buying product instead."

Consequently, the trader suggests: "Although the expiration of TALF could have a negative affect on trading volumes for some names, for the most part it won't have that big an effect."

The second ABS broker agrees: "I have full confidence that the impact of TALF ending right away will be not as significant as some people think it will be."

Meanwhile, market sentiment is positive towards new issuance. The trader says: "I think there will definitely be more new issuance, which will be a little bit more spread out now; whereas before, everyone was crowding around the TALF issuance paper every month."

The second ABS broker concurs: "I think that there's enough money out there and enough demand from investors that'll drive new securitisations without the assistance of TALF. You just need to look at the amount of investors and the sheer volume of capital behind them, who are looking to put money to work and looking to buy these products."

In addition, the broker believes that the quality of new issuance will play a role in increasing demand. He explains: "Any sort of new issue out there is a much better product now in 2010 than product that was issued in 2006/2007. Underwriting guidelines have improved and there's a lot more performance data behind the underlying loans, so I think that there will be deals that will be sold. They might be a little wider than the TALF deals, but I don't think there'll be a case where they can't get done or that the deals will be significantly wider than where TALF pricing was."

As a whole, the market seems to be showing signs of recovery and a positive outlook moving forward. As the broker concludes: "We've been seeing a lot more product from community banks in the US, which is basically a sign that the banks have raised enough capital and are comfortable selling assets at a loss. They're willing to sell these assets and move on with their lives."

JA

CLOs

Primary lag

European CLO market activity in the week to 16 March 2010

While most structured finance markets have begun to regain ground after the sovereign-based market scare, the European CLO sector continues to lag behind with limited primary activity and supply. However, secondary trading has maintained good levels and recovery is expected moving forward.

One CLO trader explains the lag-effect of the CLO market, saying: "After the sovereign jitters, most of the accounts that were active closed their doors a little bit. But there is a lag because, while they may have reopened the door, it takes time for them to look at the deals. They can take days or even a week to look at a deal and buy."

A CLO manager confirms: "We're chasing up on a few deals, but it's still early days and we're trying to get invites and analyse the teasers that we've got. But at least there are some new deals coming through. That's about as good as it gets at the moment."

Despite limited primary CLO market activity, the tone has improved somewhat in the secondary market and pricing levels remain fairly resilient. The trader says: "In senior notes we've probably backed off from the mid-200s to high-200s DM. Double-As have backed off from mid- to high-70s to high-60s, low-70s. Single-As have backed off from high-60s to low-60s and triple-Bs from mid- to low-50s to mid- to high-60s. Double-Bs haven't changed much and remain in the 50s. Equity has held pretty strong; we haven't seen much weakness there and a decent deal will go well into the 20s plus."

In terms of the underlying loan market, the manager adds that investors have welcomed a recent deal from KKR's Pets at Home. He says: "We're waiting for allocation on Pets at Home, which hasn't quite come through yet. It's a deal the market's got comfortable with; it flexed slightly, but I think we can all handle the flex and that's evidence of the market working properly."

The manager expects the deal to perform well, but adds: "I can imagine that for most deals that come to market, there'll be a very strong appetite simply because there's a shortage of investment opportunities. But at least there are some deals coming through."

At the same time, the triple-C rated Ineos is still generating investor interest (see SCI issue 172). In February 2009 Ineos seniors had reached a low of 35 and the second lien was trading at 10. By February 2010 the senior paper had climbed to the low-90s and is now trading in the mid-90s.

The manager comments: "The price has gone up and up and up. So there could be some corporate activity behind the price action, though not everyone in the market believes that. Obviously some people are willing to pay lots of money, even though the idea of paying above 95 for an asset that is still triple-C rated is somewhat ridiculous."

He adds: "Presumably those people believe that it's going to be refinanced in some way, which could happen. But it's certainly unsustainable for a triple-C asset to continue getting bids of 96.5 in this environment."

Looking ahead, the trader believes that the recovery of the primary CLO market will happen once other credit markets have fully stabilised. "I think people generally look around and see what's going on in the rest of the credit markets before they dip their toes back into the CLO market. But there's always been a lag in the CLO market; it's always slow to pick up on the trends. It's pretty frustrating," he concludes.

JA

ABS

Equipment-backed deals expected post-TALF

Though the TALF programme for consumer ABS did not have as much of a direct impact on the equipment finance and aircraft lease sectors as credit cards and auto ABS, it did make it easier for more issuers to retest the securitisation waters.

"We're seeing multiple lenders interested in equipment financing deals; it's not a bidding frenzy, but business is picking up," says a securitisation lawyer.

Investors are also on board with these offerings, since their portfolios are running off and they will be looking for the return of this product, says David D'Antonio, md at Diversity Capital. "Everybody likes a short-dated asset," he adds.

More equipment-backed deals are in store for 2010, agrees another securitisation lawyer - though he says that TALF going away is negative for the sector. "Just having a deal TALF-eligible made it much more sellable than otherwise would have been the case," he notes.

John Deere, Marlin Leasing and GreatAmerica Leasing were large enough to have benefitted from TALF and get traditional bank lines renewed, says a servicer. But recent equipment finance offerings, such as a notable one from Marlin, were also skewed much more to attract investors than in years past.

"From the investor side, it was a good deal but the issuer had to make the deal so sweet since there were not a lot of takers," comments an industry banker. Marlin last month issued a US$80.7m TALF deal, whose two tranches priced at 10bp over one-month Libor and 145bp over the eurodollar synthetic forward rate respectively.

While even the larger bank-owned type of lessors have been negatively impacted by the credit crisis as evidence by the lower advance rates on deals, the smaller, independently owned equipment lease companies have either gone out of business or are no longer originating.

Unlike previous years, equipment lease companies have to recapitalise their balance sheet in order to qualify for traditional conduit or term financing, adds the servicer. That entails them to go out and look for equity or subordinated debt before they can even have a meaningful conversation with the traditional debt providers.

"For some, they simply don't have that much liquidity and equity to be able to sustain that," he says.

Some specialty finance companies in this space have also seen their business shrink so much that they have changed their business models. Companies are now routinely relying on their own internal resources for funding, says D'Antonio.

But the equipment specialty finance lenders that are pure finance companies on the commercial side right now are having difficulties. If they are small enough, they can survive with small local bank relationships or by utilising current revolvers, he notes.

Equipment finance companies have also mostly cancelled their broker-originated business since it has a negative connotation in the market currently, adds the servicer. Even the larger banks will request equipment finance companies to no longer accept broker business, opting instead for direct sales or vendor businesses.

But, despite the few completed equipment finance deals in recent months and more that are expected, aircraft leasing issuers still stand a better chance of getting a deal done publicly via securitisation than the average equipment finance company, the servicer continues. "If you have that kind of collateral and the right kind of enhancement on a deal, you will have a better chance than in some other asset space."

Investors also often view aircraft lease collateral as higher quality than the average equipment finance offering, he notes. ILFC, Textron and RBS Aviation are a few of the issuers that he believes could come with offerings, despite well publicised challenges at the current and former parent level of these companies.

"People generally have liked the aircraft segment; it's a marketable, long-life asset," the servicer adds.

The aircraft leasing market has also been devoid lately of European institutional interest, which has historically been a large part of this market.

KFH

ABS

Tight Wyndham pricing paves way for others

The "aggressive" guidance out on Wyndham's US$250m Sierra Timeshare 2010-1 Receivables Funding's loan-backed note offering last week provides a good benchmark for other issuers who may be contemplating their own timeshare deals. The single-A senior tranche offering via Credit Suisse is marketed at 275bp-300bp over Libor.

"If they can achieve this level, that would be excellent pricing," says an industry banker, who believes the offering will likely widen out slightly heading into pricing.

Still, having a coupon under 5% is attractive for the issuer who chose a 2.6-year average life on the offering, the banker says. Starwood and Marriott will be back in the market to get these kinds of rates, he adds.

According to one timeshare industry advisor, companies will indeed be looking to do securitisations just to get some liquidity. Wyndham and Marriott were able to bring comparatively sizable timeshare securitisations last year along with Diamond Resorts International, which brought a US$182m deal last autumn that was upsized from US$100m. Starwood also brought two securitisations last year that were US$166m and US$181m in size.

There's more liquidity in the ABS market than there are bank warehouse line facilities availability, adds the industry banker. "Banks are much less likely to be putting money out for this than insurance companies are to buy rated bonds."

Advance rates have also risen over the past couple of months, which is making it more feasible for issuers to come to market. While Wyndham's initial return to the credit markets in Q1 of last year featured a first offering of just US$46m and advance rates below 40%, advance rates on several of the deals that followed have since risen to around 60% and even higher for the better rated credits. Wyndham's low advance rate at that time stemmed from using collateral in the deal that it was not able to securitise in prior years, says the banker.

Wyndham went on to issue US$175m single-A rated vacation ownership loan backed notes with an advance rate of 70% and US$175m triple-A rated loan backed notes with an advance rate of 55% last October. "What's happening is you are getting overcollateralisation on the advance rates, so why wouldn't you buy the paper?" asks the advisor. "It is a sign that the market is opening up a little - by how much will be determined over the next 6-12 months."

Inventory build-up in the short term has also added to the need for companies to bring deals.

KFH

ABS

Utilities return to alternative securitisations

Rate payer obligation charge (ROC) bonds, often viewed as an alternative to traditional securitsation, are gaining ground once again. Such stranded cost securitisations were popular before the credit crisis, but the securities - along with hybrid variations - are currently in favour as utilities fend off rising rate costs and, in some cases, the inability to pass along crucial expenses to customers.

"It's a viable option for issuers since funding costs are competitive," says one securitisation banker, who expects more deals to be on tap.

Spreads on longer-dated ROC bonds are pricing in a comparable manner to credit card deals, albeit short-end card transactions price through Libor since there is such a liquid market in the short end. An Allegheny Energy US$78m ROC bond offering that was issued last December priced considerably tight compared to other deals in that sector last autumn. Allegheny's bonds priced at the equivalent of 106bp over the 30-year US treasury.

Recent deals continue to price inside some of their historic benchmarks due to the kind of collateral and credit enhancement involved, notes a credit analyst. "It's a cost effective way for the utility to recoup sunk costs," he adds.

The Allegheny offering followed a CenterPoint US$665m stranded cost rate payer obligation bond and an Entergy US$545.9m securitisation last autumn.

Investors also see value in the high credit quality of the assets. "With spreads coming off their tightest levels, there are good returns for a triple-A rated offering," the banker says.

Investors particularly favour the long-dated terms of the offerings, since in past years deals went out at least 20 years. Most of the recent ROC deals are in the 7- to 10-year range, though Allegheny's offering had a weighted average life of 19 years.

Indeed, the stability of the cashflows is a key draw for long-term investors. "Insurance companies with long-dated liabilities found [the Allegheny issue] tremendously attractive," says Joseph Fichera, senior md and ceo of Saber Partners.

"This is the one segment of the securitisation market that one doesn't have to retool and rethink as a result of everything that happened with the credit crisis," he adds, saying investors do not typically view the securities like a highly structured securitisation.

Utilities have in the past contemplated the securitisations to assist with the funding of nuclear power plant construction. Allegheny issued its bonds to finance environmental control costs at its Monongahela Power Company's Fort Martin generation facility in West Virginia.

According to the credit analyst, there remains very strong investor demand for these products. "It would make sense for these companies to come to market," he says, though he cautions that any further issuance from the utility sector in general would be on a case-by-case basis.

The low cost of the ROC bonds has got more people talking about them, adds Saber Partner's Fichera. "They are realising it's an established market now."

Utilities, however, would not get to earn a regulated return if they fund entirely with a debt offering as opposed to funding partially with an equity component, adds the credit analyst.

Progress Energy, for one, has no plans to securitise, according to Tom Sullivan, chief risk officer and treasurer at the company. Progress did not securitise storm exposure in recent years similar to other peers since their costs were not as large, he notes.

KFH

CMBS

Innovative Asian CMBS launched

Singaporean real estate investment trust Ascendas (A-REIT) has launched an innovative CMBS that gives investors the option to convert their notes into equity at any time during a specified exchange period. The deal, dubbed Ruby Assets, was fully subscribed by investors and is expected to prompt other CMBS originators in the region to consider this structure for future transactions.

S$300m of exchangeable collateralised securities (ECS) were sold earlier this week to institutional and accredited investors via sole bookrunner Citigroup Global Markets Singapore. The notes - rated triple-A by Moody's and S&P - priced at a rate of 1.6% per annum. The transaction is backed by a secured convertible loan to A-REIT and is secured over 19 industrial properties located in Singapore that are owned by the company.

"A unique feature to this transaction structure is that the notes include a range of conversion options that can be exercised at the discretion of the investors," says S&P credit analyst Gloria Lu. "If the notes are converted prior to the expected maturity date, any outstanding notes at that time may be extinguished and the investors are expected to either receive units of A-REIT or a cash payment."

According to Jerome Cheng, vp and senior credit officer at Moody's, Ruby Assets is the first CMBS-like structure in Asia to employ the equity conversion feature. "The structure of the transaction also allowed the originator to tap a wider investor base," he says. "This is a very interesting development for the Asian CMBS market. Other originators will likely study this case closely to see if a similar approach might work for them."

Helen Lam, avp and analyst at Moody's, comments that the deal also offers a longer-term financing solution for the issuer. "The expected tenor of the deal is 2017 - a longer tenor than is offered through bank loan financing," she adds.

Moody's, which used its CMBS methodology when rating the transaction, notes that the portfolio backing the deal is diversified and in good locations. The properties include one business/science park building, eight light industrial properties, four logistics and distribution centres and six hi-tech industrial properties. Most of the properties are in fairly good condition, with easy access to public transportation and major expressways.

It is expected that the proceeds of the transaction will be used to refinance an existing A-REIT CMBS, finance acquisitions by A-REIT and/or the general working capital purposes of A-REIT. A-REIT has previously sponsored three Singapore CMBS transactions.

The once-active Singaporean CMBS market saw conditions improve over the course of 2009, with all five transactions needing to refinance finding solutions (see SCI issue 155). One such refinancing was done through new CMBS issuance. The pipeline of upcoming CMBS is, however, unlikely to build at a rapid rate over the coming months, given the continued attractiveness of alternative CMBS refinancing options, such as bank loans.

AC

Ratings

Transition trends

Andrew South, senior director at S&P, notes that market volatility led to varying ratings behaviour in European structured finance last year

In 2009 the severe economic recession and the ongoing rationing of credit to both corporate and household borrowers continued to place significant downward pressure on European structured finance ratings in some sectors. In addition, evolution in S&P's methodologies also caused some ratings migration. However, despite the extremes of the current economic and capital market environment, the effect of these developments was that 70.2% of ratings still remained unchanged or were raised over the year, compared with 82.2% in 2008.

Earlier pressures that focused on global financial institutions and parts of the US securitisation landscape gave way to a more widespread economic downturn, which in our opinion heightened credit risk in a broad array of European asset classes. Low rates of transaction amortisation offered little support for upgrades, while the sharp deterioration in economic fundamentals, such as GDP and unemployment, led to a decline in our view of creditworthiness - and consequent downgrades - for a large number of European structured finance securities.

More downgrades, while upgrades uncommon
The rate of downgrades for European structured finance securities accelerated in 2009 compared with historical averages. The number of ratings lowered exceeded the number raised for a second successive year and by a factor of almost 25.

Overall, 113 (1.2%) of S&P's outstanding European structured finance ratings ended the year higher than they began. Excluding triple-A ratings, which cannot be raised, the upgrade rate was 1.7%.

On the other hand, we lowered 2,765 (29.8%) of the outstanding ratings over the year. This year's downgrade rate is significantly higher than the 2008-equivalent figure of 17.8% and the upgrade rate of 1.2% is also lower than the 2008 figure of 1.7%.

Magnitude of transitions declines
Certainly, the relative number of ratings undergoing transition in one direction or the other is in our view one measure of credit performance. However, the magnitude of those transitions, measured in terms of the number of rating notches, we believe is also significant.

Analysis of this data reveals that, for those ratings lowered during 2009, the average net downward move over the period was 5.1 notches for European structured finance ratings, significantly lower than the average 8.1 notch downward move in 2008. The average magnitude of upward rating transitions was significantly less than that of downward transitions, at 2.3 notches (see chart below).

Of the upward and downward transitions, 43% were of three notches or fewer and about 15% of all transitions were only one notch. Highlights of the downward transitions were as follows:

• Of the 2,765 ratings lowered, 1,120 (41%) were lowered by between only one and three notches over the year.
• 822 (30%) ratings were lowered by between four and six notches.
• 823 (30%) ratings were lowered by more than six notches.

Highlights of the upwards transitions were:

• Of the 113 ratings raised, 107 (95%) were raised by between one and three notches.
• Four ratings (4%) were raised by between four and six notches.
• A further two ratings (2%) were raised by more than six notches.

Almost 90% of the downward transitions of more than six notches were among CDO ratings. This followed significant negative rating migration - including defaults - among certain investment grade corporate issuers, which were commonly referenced in CDOs. Combining this data with the number of ratings remaining stable leads us to an overall assessment of the average change in credit quality.

For this purpose, we define average change in credit quality as the average number of rating notches by which ratings changed over the year, where we take the average across all ratings in the universe under consideration. In this averaging, we count downgrades as a negative number of notches and upgrades as a positive number.

Stable ratings undergo a transition of zero notches. We believe this measure acts as a useful summary of credit performance, as it captures both the number and magnitude of transitions across the set of ratings under consideration, as well as accounting for those ratings that remained stable.

By this definition, 2009 saw what we view as a significant 1.5 notch decline in average credit quality for European structured finance securities - slightly worse than the average decrease in credit quality of 1.4 notches recorded in 2008.

Trend in default rate reverses
In 2009 we recorded 100 defaults across 81 transactions. By original notional amount, this resulted in an annual default rate of 0.15% - reversing the rising trend from previous years (see chart below), but still significantly higher than the one-year average default rate of 0.09%.

Of the 100 defaults in 2009, 42 were in the CDO asset class and generally followed breaches of certain thresholds related to the performance of underlying assets. There were also interest shortfalls recorded on 28 classes of notes in 25 RMBS transactions, 19 classes of notes in 18 ABS transactions and 10 classes in eight CMBS transactions. We consequently lowered these ratings to D.

Defaults were significantly more common among tranches rated speculative grade at the beginning of 2009 than among those rated investment grade, with default rates of 4.24% and 0.04% respectively. In fact, most of the defaults in ABS and RMBS were on deeply-subordinated tranches in Spanish transactions, which were originally rated triple-C minus.

Significant number of ratings on credit watch negative
We believe the 2009 rating transitions should be viewed in the context that an unusually large number of ratings - 20.8% - remained on credit watch negative at the end of 2009. These widespread credit watch placements were generally due to the pending application of recently updated rating methodologies to the analysis of certain transactions.

In particular, this affected the covered bond and CDO asset classes, where 68% and 32% respectively of the ratings included in this study were on credit watch negative at the end of 2009. In addition, 31% of CMBS ratings were on credit watch negative at the end of 2009, due to performance reviews.

However, we also note that in each of these three asset classes, we placed between 45% and 68% of the ratings that remained stable during 2009 on credit watch negative by year-end for the reasons mentioned and therefore have a heightened likelihood of experiencing a downward rating migration in early 2010.

CDO transitions dominate downgrades
The severe economic recession has had a widespread influence across numerous countries and asset classes in 2009, making this difference less pronounced - although CDOs in any case still dominate our headline statistics, given their large number. The distinction in rating performance between CDOs and all other structured finance asset classes lessened in 2009, in our view in part given the weaker performance of CMBS.

Overall, CDOs saw a downgrade rate of 41.6%. Excluding CDOs, structured finance securities saw a much lower downgrade rate of 19.3%. CDOs saw a lower upgrade rate of 0.2%, compared with 2.1% for the rest of European structured finance.

Some aspects of aggregate CDO rating statistics are in our view due to the relative homogeneity of the asset class, which in our sample is dominated by synthetic CDOs of global investment grade corporate credits. Unlike in most traditional securitisation asset classes, many different CDO transactions of this type can be backed by the same underlying credits.

Indeed, we have found that the 15 most common corporate names, for example, are referenced in more than 50% of all the synthetic CDOs we have under surveillance. One effect of this feature is that rating performance of the CDO tranches themselves is in our view relatively highly correlated. As a result, our analysis suggests that aggregate observed transition rates among a group of CDOs can be relatively volatile.

In 2009, European CMBS has experienced a similar effect. While, in contrast to CDOs, different CMBS transactions do not contain the same loans as one another, they may be exposed to similar property and/or tenant dynamics, and typically share exposure to a systemic downturn in the European commercial real estate market, as has occurred over the course of the current recession. As such, their rating behaviour has in our view also been highly correlated, leading to a high downgrade rate.

ABS downgrades driven by SME transactions
Overall, the ABS asset class exhibited a downgrade rate of 15% in 2009 and an upgrade rate of 1.9%. This represents a relative deterioration in performance compared with 2008, when the downgrade and upgrade rates were 4.6% and 3.4% respectively.

Of the 157 ABS ratings we lowered over the year, 50 were in Spanish and 46 in German transactions backed by loans to SMEs, giving downgrade rates of 27.3% and 44.2% respectively for these subsectors. SME transactions account for around 42% of the ABS ratings under consideration in this study. Credit card ABS was the subsector with the next highest downgrade rate of 22.9%.

Indeed, economic pressure on European consumers and companies has in our view resulted in significant collateral deterioration for some ABS transactions. Spanish transactions have experienced the greatest rise in arrears, in line with a more pronounced economic slowdown and increase in unemployment. For Spanish SME ABS in particular, a concentration of underlying corporate borrowers in the real estate and construction sectors has led to higher arrears, since these sectors have been most adversely affected by the economic downturn.

RMBS performance differs between countries
In 2009 downgrades gathered pace in the RMBS asset class, as there was continued house price weakness and rising unemployment in many European countries. While the upgrade rate increased to 3.1% in 2009 from 2.3% in 2008, the downgrade rate increased to 17.3% from only 6.1% in 2008 (see chart below).

While a few of the downgrades continued to be due to counterparty rating actions or unhedged interest rate risk, the majority were due to our assessment of rising risk in the underlying mortgage loan collateral, as captured by rising delinquency rates and indexed loan-to-value (LTV) ratios. Realised losses also increased throughout the year as house prices remained weak in many countries, especially Spain and Ireland. The net effect was an average decrease in our opinion of credit quality of 0.46 notches in 2009, following a decrease of 0.18 notches in 2008.

However, we believe it is important to distinguish 2009 performance between subsectors within European RMBS. In fact, more than half the downgrades in all of European RMBS were in the UK non-conforming subsector, with Spanish and Irish RMBS also contributing significantly, although in absolute terms there are relatively few Irish RMBS ratings outstanding.

Technology

Solid operations

Douglas Long, evp business strategy at Principia Partners, answers SCI's questions

Q: How and when did Principia Partners become involved in the structured finance market?
A: Principia Partners was established in 1995. The initial focus was on structured products more broadly, before structured finance as an asset class gained significant traction. Certainly before 2000 Principia concentrated on derivative products, enabling clients to structure, value, risk manage and account for these complex transactions.

That strong capital markets strength proved highly valuable as our focus moved towards structured finance and our client base developed. Now our clients include a wide range of banks, insurance companies, credit investment managers and other specialised shops; for example, Sallie Mae, EBRD, Genworth Financial, GE Capital, Channel Capital and Rabobank to name just a few.

We spent a number of years building up the structured finance capabilities of our portfolio and risk management solution, the Principia Structured Finance Platform (Principia SFP), introducing additional ABS/MBS functionality in around 2000. The fact that securitisations are dynamic, with constantly changing amortisation schedules and forecasting assumptions meant the product lent itself to tackling the challenges of understanding those products. It was a natural transition to become involved in the structured finance market and that is where we have been 100% focused ever since.

Q: So what has the product developed into? What can investors expect?
A: Principia SFP links all the operational aspects of managing and understanding a structured finance portfolio. It enables investors to manage their entire investment portfolio, alongside any associated derivatives and liabilities throughout its lifecycle. Portfolio managers use the system to support initial investment decisions, as well as proactively monitoring and adjusting their existing portfolio of investments.

The system supports the full deal structure of a transaction, including all the associated issuance and performance metrics. This can then be analysed in the context of the portfolio and its operating guidelines over time.

Being able to drill down to the tranche, collateral performance or credit enhancement level for any security you have data for is one advantage. It also gives you a world view to structure, view and manage your hedging positions and liabilities, and assess your ability to fund purchases of additional securities.

The idea is to achieve a complete view of a structured finance investment business, creating a backbone between the information provided from third parties and trustees in all its forms, and the ABS portfolio. You can consistently bring all the elements together to carry out sophisticated risk management and surveillance and have the transparency to process and disseminate risk information for any stratification of the business.

Along with this, it gives you the operational control to perform timely reporting, maintain compliance and flow all your positions through to accounting. Such a platform is particularly relevant now, given the increasing regulatory demands and the need to disclose valuation and performance assumptions for compliance monitoring and accounting treatments. Having all the information and data in one place allows end-users to more efficiently stress test asset or portfolio performance and better demonstrate the use of robust valuation techniques.

To proactively address the market demands since the crisis we accelerated our release cycle to every six months. For example, we launched a standard feed to bring in and normalise issuance and performance data from multiple sources in our last release and we are now working on bespoke integration with some of the leading performance data providers. Our goal is to continue to deliver the most comprehensive and standardised infrastructure for the operational management of ABS, MBS and CDO securities - right of out of the box.

Q: How do you differentiate yourself from your competitors?
A: We identified a niche and dedicated our development efforts to the unique requirements of the structured finance investor base. The emphasis at present is on being able to consolidate all the analytics and data required to manage multi-asset class portfolios.

Organisations often use multiple sources of data for the performance information of the transactions they hold - different asset classes or geographies often have different specialist data providers. We provide the functionality to consolidate that universe of information and model past, actual or future performance off the back of it and then use that for investment analysis, risk oversight, compliance and accounting.

The main opposition comes from the development of internal databases and spreadsheet-based systems. We have seen that in the new environment a piecemeal approach to consolidating and managing these portfolios makes it very difficult to satisfy all the internal compliance and regulatory pressures being placed on organisations.

The challenge is to understand credit and asset exposure on a bond-by-bond level first, but then on a portfolio level as well. Trying to link this understanding to the delivery of mark-to-market and compliance reporting can be inefficient using disparate ancillary systems. Trying to track all the dynamic cashflows for multiple asset types together or forecasting future cashflows can be an operational burden unless monitored in a single, controlled software environment.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: During the peak, demand for the Principia platform was driven by the need to demonstrate conservative operations, strong risk surveillance and very specific reporting capabilities - so for us really the opportunity is very similar now. In fact it is greater than ever because today anyone managing structured finance assets must focus on exactly these core competencies.

The main shift has been who derives value from the solution. Prior to the crisis, rated operations - such as SIVs, conduits, bond funds and CDPCs - benefited from our software.

These were small shops, run like mini-banks. They needed to manage large portfolios with a limited number of staff while proving to rating agencies and investors that they had robust operations in place to understand these portfolios through to maturity.

Although only a small proportion of our total client base, we were the predominant provider of software to them because of the operational capabilities of the platform and our understanding of the compliance issues that needed to be addressed. Now, the opportunity is huge because anyone managing or investing in structured finance assets is being mandated to have this same level of operational control, due diligence and transparency.

As assets have come on balance sheet, the value of having data, portfolio management and risk surveillance systems dedicated to ABS and MBS is something we hear about on a daily basis. Where financial institutions often managed these assets on existing treasury platforms or spreadsheets, they now have to get to grips with the nuances and moving parts of these securities. They can't be treated like a straight bond anymore just because they are highly rated.

Some larger banks and investment managers did build strong internal capabilities in this area, so the challenge initially was to break into the broader market, which we began to do in 2006-2007.

We are exposed to the same challenges facing our clients and we work diligently to understand the impact of the upcoming tsunami of regulation. This is also an opportunity for us though - we have spent three years developing and delivering software that can help satisfy the conditions and specific risk management techniques that authorities and regulators are now demanding.

Q: What major developments do you need/expect from the market in the future?
A: The Basel Committee has layered on a qualitative measure for capital charges associated with structured finance exposures: financial institutions won't qualify for capital relief unless the investor can demonstrate that there are strong operations in place. We will see this becoming a reality over the next year; as the CRD is implemented in the EU for example. A paradigm shift occurred during the crisis and this focus is not surprising - robust operations and risk surveillance are now a necessary part of running a business.

There are many challenges around justifying investment decisions and lots of data to analyse. It's extremely operationally-intensive: in the time it would take our system to do the work, you may have only covered 10% of the detail by doing it manually. This isn't seen as a viable way to run a structured credit portfolio, from an internal and now an external perspective.

Looking ahead, the biggest challenges for the structured finance market are related to translating regulatory requirements and market demands into practise. We still have a long way to go.

There needs to be more clarity about the impact of converging regulatory policy and how rules work in unison to stimulate issuance and restore investor confidence. This will help the secondary market to stabilise further; that way, more long-term investors will return.

There are signs that the new issue market is coming back, stimulated by some return to normality in lending activity and the provision of consumer credit. This, in combination with more transparency, disclosure and simpler structures, will provide a foundation for the future. The interesting thing to see now will be how investors prepare themselves to participate in this new world.

ABS

Asset manager names new recruits

CQS has named Jason Walker as a portfolio manager for the CQS ABS Fund, with a focus on European RMBS and global CMBS, and also appointed Jessica Hadad as an analyst.

Walker joins from Henderson Global Investors in London, where he was an investment manager for its European ABS opportunities fund. He has previous experience in various portfolio management and trading roles with the Bank of Scotland, London, TD Securities and Abbey National.

Hadad, who joins from Vertical Capital in New York, will have a particular focus on due diligence. At Vertical she was an investment analyst with responsibility for detailed credit analysis and stress testing of MBS and ABS investments.

"The opportunities in ABS continue to be very attractive," says Michael Hintze, CQS ceo. "Adding depth to the ABS team will allow us to take further advantage of the growing opportunity set for the benefit of our investors. I am very pleased we have been able to attract such high calibre people."

ABS

Law firm adds SF partner

Law firm DLA Piper has appointed Roger Rosendahl to its corporate and finance practices as a partner in the New York and Los Angeles offices, moving from Kaye Scholer. Rosendahl's practice focuses on corporate, finance and securities transactions, including mergers and acquisitions, project and structured finance, and restructuring.

"Roger's wealth of experience in cross-border project and structured finance, and corporate and M&A matters significantly advances our strategy to expand our corporate and finance capabilities across the country and globally," comments David Young, DLA Piper's head of corporate and finance in Southern California.

Advisory

Boutique beefs up in advisory

European Risk Capital has recruited David Cain as executive advisor. As an executive director with the Rothschild Group, Cain founded the firm's structured finance advisory business and developed its European securitisation activity in line with its core strength in corporate finance and debt advisory. This encompassed the design and implementation of a number of strategic initiatives in structured capital markets, leading to a board-level appointment by 2003.

At European Risk Capital, Cain's primary responsibility will be for non-bank financials and real estate. His expertise extends to structured capital advisory and fundraising activities, including debt restructuring and acquisitions in consumer finance, commercial finance, corporate finance and overall property sectors.

Cain's track record is spread across a wide range of asset classes, from credit cards and residential mortgages to auto leasing and life settlements. He has structured and led a multitude of complex deals, including arranging a £400m UK credit card portfolio acquisition, a €200m structured facility for a Netherlands-based mortgage lender and a £100m funding line for a leading independent auto lender.

Tony Gioulis, managing partner at European Risk Capital, comments: "The breadth and depth of David's skill base are the result of over two decades of experience in structured finance across the UK and Europe; this represents a significant enhancement of the Group's capabilities in a sector, which is pivotal both to our service offering as well as the overall market."

Advisory

Capital markets firm gains senior adviser

A new senior adviser, Donald Layton, has been appointed at NewOak Capital. Layton will also become co-chairman of the firm's investment committee.

NewOak says Layton will take a lead role in developing the firm's private equity vehicle for bank recapitalisation investments. "We value Don's tremendous wealth of proven experience and leadership in the financial industry, both as vice-chairman at JPMorgan Chase and as chairman and ceo of E*Trade Financial Corporation, where he led their turnaround to financial health. Don's in-depth banking industry expertise will greatly enhance and complement NewOak Capital's state-of-the-art credit loss estimation, asset valuation and restructuring, and broad financial industry advisory capabilities," says Ron D'Vari, NewOak ceo.

Layton stepped down from his roles as chairman and ceo at E*Trade Financial Corporation in December. He had previously spent 29 years at JPMorgan Chase, where he was vice-chairman. He remains a director of Assured Guaranty.

Alternative assets

Asset manager expands credit, distressed capabilities

Alternative asset manager Kohlberg Kravis Roberts & Co (KKR) has reorganised its KKR Asset Management (KAM) platform, with four senior staffers taking on new roles.

Erik Falk and Chris Sheldon take charge of KAM's leveraged credit strategy, including leveraged loans, high yield bonds and structured products. Falk joined KKR in 2008 after eight years in Deutsche Bank's credit business, where he started the special situations proprietary trading group and co-headed the securitised products group. Sheldon, a portfolio manager within KAM, joined KKR in 2004 from Wells Fargo and has 11 years of credit experience.

Meanwhile, Jamie Weinstein and Nathaniel Zilkha have been made responsible for KAM's global special situations strategy, which includes distressed debt, debtor-in-possession and rescue financing, as well as other structured investments. Weinstein, previously a portfolio manager within KAM, joined KKR in 2005 and has 11 years of industry experience. Zilkha joined KKR in 2007 after spending eight years with Goldman Sachs, where he invested in private equity and principal debt transactions.

KAM invests across the corporate credit spectrum, including secured credit, bank loans and high yield securities, as well as alternative assets such as mezzanine financing, rescue financing, distressed investing and debtor-in-possession financing.

"As a firm, we are very well positioned to invest across all parts of a company's capital structure. Given the set of current and expected global opportunities, we are creating more focus and devoting more resources that will enable the team to continue creating unique solutions for global businesses and generating good returns for our clients," says KAM ceo Bill Sonneborn.

CDO

Broker bolsters structured credit platform

PK Jain has joined Advisors Asset Management (AAM) as md and head of structured credit and mortgage products. He was previously md and head of CDOs/CLOs at Broadpoint DESCAP.

The move strengthens AAM's ABS and CDO capabilities across both arms of the business - its retail brokerage and its separately managed accounts platform. The next area of growth for the firm is understood to be emerging markets.

CDO

CDO issuer to liquidate

BlackRock's New York-based REIT, Anthracite Capital, has filed a voluntary petition for relief under Chapter 7 in the US Bankruptcy Court for the Southern District of New York. The filing, authorised by the company's board of directors, comes three months after the firm defaulted on its unsecured debt payments.

The court will appoint a bankruptcy trustee that will be responsible for the liquidation of the business through the bankruptcy case. According to court documents, the firm has estimated assets of between US$1m and US$500m and estimated liabilities of between US$500m and US$1bn.

Anthracite Capital brought a number of CRE CDOs in the past decade, including the first European CRE CDO - Anthracite Euro CRE CDO 2006-1 (see SCI issue 13).

CDPCs

Hire to help build credit protection business

Robert Lusardi, a long-time Primus Guaranty board member, has been recruited by the firm as senior advisor to accelerate the development and launch of a new credit protection business. Primus is seeking to create a rated, regulated credit-related risk insurer that would focus on selling credit-related protection to market participants in key segments of the insurance and structured credit markets (SCI passim).

In his new position, Lusardi will work closely with Primus ceo Tom Jasper, Douglas Renfield-Miller (the ex-Ambac executive who is also advising Primus) and the firm's management team. He will remain on the board of directors of Primus Guaranty, which he has served on since March 2002.

Lusardi was previously a senior executive with White Mountains Insurance Group, from 2005 to 2010 and with XL Capital from 1998 to 2005. From 1980 until 1998, he was at Lehman Brothers, where he served as an md and headed the insurance and asset management investment banking practices. Lusardi is also a director of Symetra Financial Corporation, a life insurance entity, and chairman of specialised investment funds Pentelia and Eolia Diamond.

CDS

Duo hired for new structured credit desk

Agency broker Mint has hired David Ezra and Bruno Choumon to run a new structured credit and illiquid bonds team, as the firm reports a continued need for trading in more exotic asset classes. The new team will look to target private banks, institutional investors looking for diversification and increased returns, and treasury departments of corporates and corporate pension funds.

Ezra joins Mint from Evolution Securities, having previously worked at Goldman Sachs, where he spent seven years building flow credit and credit derivatives distribution to France, Belgium and Luxembourg and to the francophone hedge fund client base in London. Choumon joins Mint from ConduitCapital Markets, a new investment bank where he was executive director. He previously held roles at JPMorgan, Barclays Capital, Société Générale, Nomura and BGC Partners.

CLO Managers

Second replacement manager for ACA CLO

Nomura Corporate Research and Asset Management Europe (NCRAME) has resigned as collateral manager on ACA Euro CLO 2007-1 and is expected to transfer management duties to Avoca Capital. NCRAME was appointed as replacement CLO manager on the transaction in 2008, the original mandate having belonged to ACA Capital Management.

Avoca Capital was named replacement manager on KBC Financial Product's Lombard Street CLO in December last year.

CLO Managers

Amundi takes on EM CDO

SG Asset Management (SGAM) has transferred to Societe Generale Gestion (S2G) all of its rights, title, interest and obligations as collateral manager of Lafayette Sovereign CDO I. Replacement of SGAM by S2G follows the corporate restructuring of SGAM and CAAM and the constitution of a combined asset management group called Amundi. However, the S2G team involved in the management of Lafayette Sovereign CDO I will remain the same and will continue to benefit from the same resources in terms of research, back and middle office and information systems.

Lafayette Sovereign CDO I is exposed to a portfolio of sovereign emerging market debt. The transaction was originally managed by BAREP Asset Management, but these duties were transferred to SGAM when the two institutions merged last June (see SCI issue 140).

Moody's has determined that the amendment and performance of the activities contemplated therein will not cause the current ratings of the notes to be reduced or withdrawn.

CMBS

CMBS capital markets head appointed

Jeffries has appointed Mark Green as md and head of CMBS capital markets in New York. He joins from UBS, where he carried out the same roles for four years.

"The addition of Mark Green as head of CMBS capital markets gives Jefferies an established industry veteran experienced in delivering advisory, restructuring and financing solutions for clients," comment William Jennings and Johan Eveland, co-heads of Jeffries' MBS/ABS group.

"We see the CMBS market as a major investment banking opportunity that will begin to unfold in 2010," adds Benjamin Lorello, global head of investment banking and capital markets at the firm. "Mark's experience in structuring and securitising CMBS securities, coupled with his deep relationships, will allow us to address this opportunity for our corporate and real estate clients."

At Jefferies, Green will work with Joe Accurso and Lisa Pendergast, who co-head CMBS trading and strategy, as well as Dana Arrighi, who heads CRE origination. He will report to Eveland, Jennings and Lorello.

Distressed assets

Citi snatches hedge fund manager

Citigroup has confirmed the appointment of John Liptak as head of Asia-Pacific distressed and special situations, only nine months after he joined Tribridge Investment Partners. Liptak will remain in Hong Kong and begin duties at the end of the month, being responsible for both Japan and non-Japan Asia. He will report to Naresh Narayan for the Japan role and David Rosa for the rest of Asia.

Before Tribridge, Liptak spent eight years with Bank of America, and has 17 years of industry experience.

Distressed assets

Distressed asset advisory head replaced

Deloitte has placed Guy Langford in charge of its distressed asset and debt practice in the US, succeeding Dorothy Alpert, who has become northeast deputy regional managing partner. Langford retains his roles as mergers and acquisitions leader for Deloitte's real estate practice and northeast real estate leader.

Langford's new role will see him oversee the practice's overall strategy and execution of tax, audit, consulting and financial advisory services across the lifecycle of distressed assets and debt. "In the next three to five years, we will likely witness a continuation of an important cycle of deleveraging that will involve restructurings, recapitalisation and ownership transfers that reaches beyond commercial real estate into consumer and industrial segments with significant impact on regional and community banks, private equity firms, hedge funds, insurance carriers and corporations," he says.

He adds: "Lenders, borrowers and investors are all positioning themselves today to weather the current market and the storm that may lie ahead, as well as execute on opportunities that may arise as the cycle of distress works itself through the system. Accordingly, clients are seeking advisors who bring broad industry experience and perspectives to inform customised, time-sensitive solutions."

Investors

Lehman vet joins asset manager

GoldenTree Asset Management has appointed Tom Humphrey as a partner and member of its executive committee. He will work with partners and executive committee members Frank Jordan and Leon Wagner on issues related to firm strategy, client franchise development and the continued expansion of the company. In his new role Humphrey will report to Robert Matza, GoldenTree's president.

Humphrey joins GoldenTree following a 24-year career at Lehman Brothers/Barclays Capital, where he played a leading role in the integration of the two firms in 2008. At Barclays he most recently served as md, head of fixed income distribution Americas, as well as head of global commodities sales. He was also a member of the Americas management committee.

Humphrey joined Lehman Brothers in 1986 and became global head of credit sales in 1998. In 2003, he became head of global fixed income sales.

Investors

PPIP investment announced

NYSE-listed Western Asset Mortgage Defined Opportunity Fund is to invest in a feeder fund that, in turn, invests in a master PPIP sponsored as a joint venture by Western Asset Management Company and The RLJ Companies. Based on the recommendation of its allocation sub-adviser, Wilshire Associates, the fund has subscribed for an investment of US$68m in the PPIP fund. The capital commitment represents between 32.7% and 37.6% of the net proceeds of the fund's IPO, with the percentage dependent on the number of additional shares that may be issued pursuant to the underwriters' over-allotment option.

The fund's capital commitment will be drawn down through a series of capital calls. The initial capital call occurred on 12 March, with the entire capital commitment expected to be called within six to twelve months.

The fund seeks to achieve its investment objectives by investing primarily in a diverse portfolio of MBS, consisting primarily of non-agency RMBS and CMBS directly, and indirectly through a separate investment in a PPIP.

Investors

Permacap's ABS strategy delivers returns

Permacap Queen's Walk Investment Limited (QWIL) says it has started realising gains on ABS it began acquiring in 2008. The company reports that on 22 January 2010 it sold €3.4m (face value) of triple-A RMBS bonds, recording an annualised return on these investments of 28.2%. The average sale price was 92.4 cents versus an average purchase price of 74.2 cents.

Tom Chandos, chairman of QWIL, says: "We are very pleased that our strategy of investing in undervalued investment grade bonds is proving successful and believe that market conditions will allow us to take further advantage of these opportunities for the foreseeable future. The portfolio as a whole continues to generate cash, enabling us to reduce our debt and make regular dividend payments."

QWIL reported a net profit of €0.6m, or €0.02 per ordinary share, for Q409, compared to a net profit of €3.6m, or €0.14 per ordinary share, for the quarter ended 30 September 2009. Fair value write-downs for the quarter were €2.4m, compared to €0.6m of write-ups for the quarter ended 30 September 2009. The company's NAV at quarter end was €3.69 per share compared to €3.75 per share at the previous quarter end.

Legislation and litigation

Connecticut sues over 'tainted ratings'

Connecticut Attorney General Richard Blumenthal is suing both Moody's and S&P for allegedly assigning 'tainted' credit ratings to investments backed by subprime loans. Unlike previous lawsuits filed on behalf of specific investors or pension funds (SCI passim), Blumenthal's latest lawsuits are sovereign enforcement actions brought under the Connecticut Unfair Trade Practices Act.

In a statement regarding the legal action Blumenthal alleges that: "Moody's and S&P knowingly failed to live up to their representations. In particular, their ratings on structured finance securities were tainted by their desire to earn lucrative fees."

Blumenthal goes on to say: "Moody's and S&P violated public trust - resulting in many investors purchasing securities that contained far more risk than anticipated and that have ultimately proven to be nearly worthless. The results have been catastrophic - crippling the entire economy."

Blumenthal's earlier lawsuits filed in July 2008 against Moody's, S&P and Fitch allege that the agencies knowingly gave state, municipal and other public entities lower credit ratings as compared to other forms of debt with similar or worse rates of default. Those cases remain pending.

Legislation and litigation

ILS/securitisation lawyer hired

Law firm Cadwalader, Wickersham & Taft has hired Jennifer Donohue as a partner in the corporate department of the London office. Donohue, who leaves Simmons & Simmons after three years, concentrates her practice in corporate insurance and reinsurance matters and insurance regulation. She also covers insurance-linked securities (ILS), cross-border derivatives, capital markets and securitisation transactions. She has previous experience working for the government as a senior legal adviser in the UK and Brussels.

"Jennifer's diverse experience advising clients that invest in and structure insurance-related products will enhance the services we provide to banks, insurance and reinsurance companies, and pension, private equity and other fund groups," says Christopher White, Cadwalader chairman. "We look forward to working with Jennifer and to expanding our presence in the London market."

"The insurance industry, in developments such as Solvency II and emerging new risks such as longevity, is facing the biggest challenge and profound transformation in the market for decades," adds Donohue. "These legal and transactional challenges dynamically test the development of the individual insurance businesses."

Real Estate

Distressed/opportunistic CRE fund closed

Denver-based commercial real estate finance company JCR Capital has announced the first closing of its JCR Capital Distressed & Opportunistic Real Estate Fund I. The fund's strategy is to be a provider of capital to the commercial real estate industry, as opposed to simply being a buyer of assets. The fund will provide debt, participating debt, preferred equity and equity to distressed and opportunistic real estate transactions.

Jay Rollins, JCR president, notes that the supply/demand imbalance that exists in the commercial real estate finance market has created the most attractive investment environment since the previous dislocation during the RTC era. "The waves of maturing debt on commercial real estate are just beginning and the capital markets have not yet recognised their losses," he says. "The opportunities to provide capital at a reset basis are now starting to appear and will last for some time. We believe that seasoned providers of capital, and those who do not have any legacy assets, will be well positioned to take advantage of the current environment."

Rollins continues: "We believe our strategy is unique, as we are focusing on working with sponsors and entities which control the assets, thus avoiding the bid/ask gap that currently exists."

The fund will target existing borrowers, contract purchasers and legacy lenders, specifically community banks, and JCR has developed specific strategies focused on providing community banks a 'bad bank joint venture' option. The fund has three anchor investors - PartnerRe Capital Markets, JAM Equity Partners and Branzan Investment Advisors.

The initial closing included a US$5m entity level commitment to JCR Capital and US$17m in investment capital to the fund. The fund will remain open for 90 days to accommodate a number of investors who have indicated a strong interest, as well as new investors, to allow JCR to reach its targeted fund size of US$25m-US$30m. The fund will focus on smaller transactions ranging from US$1m-US$10m.

Rollins comments: "We believe there is more opportunity in smaller transactions at this time. There is less competition and exit strategies are easier to achieve because there is more liquidity in the small balance market."

For larger transactions, JCR will use LP co-investment capital and will team up with a long time managed account relationship.

RMBS

Broker hires MBS sales manager

New York-based broker-dealer Cohen & Company Securities has appointed David Clifford as md and national sales manager for fixed income. In his new role Clifford will manage sales coverage in the US for all fixed income products, including MBS.

His most recent post was running the New York office of Stone and Youngberg, and he has previously been MBS producing sales manager for Prudential Securities and Bank of America.

RMBS

GMAC cfo resigns

Robert Hull, cfo at GMAC Financial Services, is leaving the company to take up a new post at private equity firm Providence. Hull joined GMAC in December 2007 and was responsible for financial analysis, controls and reporting, as well as accounting, business planning, corporate strategy and tax.

Hull's resignation comes amid concerns over the mortgage securities servicing of GMAC's mortgage operations subsidiary, ResCap. Last week Moody's placed more than 500 tranches of GMAC-serviced RMBS rated Baa3 and higher on review for downgrade due to concerns over ResCap's practice of netting cashflows of multiple RMBS deals in a shared custodial bank account. ResCap says it is in the process of separating the trusts into individual custodial bank accounts, which it believes will resolve any issues.

A GMAC spokesperson says Hull's departure is voluntary and not due to any concern over the company's cash management strategies.

ABCP

French ABCP conduit rated

S&P has assigned an A-1 rating to Managed and Enhanced Tap Funding SAT's (Magenta Funding) fully supported multi-seller ABCP programme. The programme limit is €5bn, with €3m issuance currently outstanding.

Natixis set the programme up for the purpose of refinancing various asset types linked to securitisations, including term consumer assets and trade receivables through several compartments. Magenta Funding is a Société de Titrisation based in France and is bankruptcy-remote under French law. The conduit will issue both French commercial paper (Billets de Trésorerie) and European commercial paper.

Natixis provides a liquidity facility (that will fund regardless of asset quality) and thus will fully support transactions funded via Magenta Funding.

ABCP

South African ABCP conduit restructured

Fitch has affirmed Thekwini Warehousing Conduit's commercial paper (CP) at national short-term rating of F1+(zaf), F1(zaf) and F2(zaf) respectively. Thekwini Conduit is a single-seller ABCP conduit backed by mortgage loans originated by South African Home Loans (SAHL). The conduit issues various tranches of CP to fund the purchase of mortgage loans, with the programme benefiting from a subordinated loan provided by SAHL.

The affirmation follows a restructuring of the Thekwini Conduit by the arranger and administrator, The Standard Bank of South Africa (SBSA). The affirmation also follows the review of the Thekwini Conduit. Fitch has remodelled and re-evaluated the revised structure in terms of its current RMBS and ABCP criteria.

The restructuring of the conduit includes restricting the tenor of CP issued to a maximum of six months, the removal of the ability to issue short-term extendible and/or callable notes and the implementation of a non-performing loan facility to cover 60% of the value of NPLs. The latter has been factored into Fitch's analysis of the credit enhancement.

Under the previous structure, CP investors were exposed to the risk that mortgage loans could default during the term of the CP and that such defaults could exhaust the level of credit enhancement then available in the conduit. With the NPL facility, the exposure of CP investors to this risk under the programme will be reduced. Mortgage delinquencies have risen over the past two years in South Africa in response to high interest rates and the economic recession.

Nevertheless, the arrears in Thekwini Conduit have remained at fairly low levels, due to the fact that SAHL has tended to buy defaulted mortgage loans out of the pool. The conduit defines a defaulted mortgage loan as one that is more than three-months in arrears.

Previously, SAHL had no obligation to purchase defaulted loans under the terms of the transaction documents. Under the restructure it is now an obligation of SBSA to buy defaulted loans at 60% of their value under the NPL facility upon a NPL trigger being hit.

The NPL facility will be available on a same-day basis and will be drawn once credit enhancement has been depleted. SBSA in conjunction with SAHL will determine the credit enhancement levels prior to issuance of CP and on a monthly basis.

As of end-February 2010, Thekwini Conduit had a total of ZAR².679bn CP notes outstanding, split between ZAR².59bn CP notes rated F1+(zaf), ZAR43.7m notes rated F1(zaf) and ZAR45.4m notes rated F2(zaf). The conduit also benefits from a subordinated loan sized at just over ZAR69.6m.

ABS

FDIC safe harbour extended

FDIC has approved an extension of its safe harbour until 30 September 2010. Under this safe harbour, all securitisations or participations in process through to that date will be permanently grandfathered under the existing terms of 12 CFR Part 360.6.

The extension will provide continued protection for securitisations under the existing safe harbour until final standards for future safe harbour protections are adopted, as well as allow the industry time for a transition to these new standards, according to the FDIC. It says it will continue to seek broad agreement on securitisation reforms that can be implemented by all the regulatory agencies.

"As we consider the feedback received during the comment period, our focus must remain on protecting the Deposit Insurance Fund from suffering the losses created during the current crisis by misaligned incentives in mortgage finance," FDIC chairman Sheila Bair says. "We hope to foster a sustainable securitisation market that emphasises transparency, improved clarity in transaction structures and responsibilities, and incentives to support sustainable securitisations. These reforms will help restore investor confidence, provide a vibrant source of liquidity for banks, support underwriting standards and prevent a recurrence of the crisis we are now working through."

Given the wide scope of the proposed new regulations for securitisation put forth in the ANPR, ABS analysts at JPMorgan expect that it will take six months - at the very least - to arrive at standards that foster a sustainable securitisation market. "Additionally, we would hope that the FDIC provides a transition period once the final standards are established such that knowing what the new rules are, the industry can work out the best plan of implementation," they add. "We expect this will be a long process, during which regulatory uncertainty remains. We agree with the ASF's response to the ANPR that the FDIC should consider de-linking safe harbour from the new preconditions on securitisation."

ABS

Regulator looks for ABS revival

The UK's Financial Services Authority (FSA) suggests that financial institutions develop plans for new sources of more sustainable and longer-term finance in order to replace the £440bn of maturing debt plus SLS liquidity support which come due between now and the end of 2012.

"Banks and building societies face major challenges in developing alternative sustainable sources of funding needed to close to some degree the 'customer funding gap' which opened up in the years before the crisis," says the regulator in its latest Financial Risk Outlook. "If public issue securitisation can be restarted, this could contribute to closing the gap."

The FSA notes that securitisation issues of almost £10bn were successfully launched in Q3 and Q409, but significant further growth will be needed if such issues are to make more than a marginal contribution to the restoration of a balanced and sustainable funding profile.

"It is therefore vital that firms develop funding strategies which respond to the phase out of SLS and CGS support," says the regulator, which will be reviewing these plans in detail with firms. "The FSA and international authorities will meanwhile design the transition paths to new liquidity requirements which take account of the need to maintain lending volumes in the face of the withdrawal of official support, while making progress towards a sounder future system."

ABS

Argentine ABS issued

Deutsche Bank has closed Fideicomiso Financiero Supervielle Creditos Banex XXXII, an Argentine personal loan-backed ABS. The transaction comprises three classes of debt securities - Class A fixed rate securities and floating rate securities, and class C fixed rate securities - and one class of subordinated certificates, all denominated in Argentine pesos.

Moody's has assigned a triple-A.ar rating (Argentine national scale) and a Ba1 (global scale, local currency) to the Class A fixed rate and floating rate debt securities worth ARS30.4m. It also assigned ratings of Ba1.ar (Argentine national scale) and Caa1 (global scale, local currency) to the ARS8m Class C fixed rate securities; and ratings of Caa2.ar (argentine national scale) and Caa3 (global scale, local currency) to the ARS4m subordinated certificates.

The rated securities are backed by an amortising pool of approximately 20,305 eligible personal loans denominated in Argentine pesos, with a fixed interest rate, originated by Banco Supervielle in an aggregate amount of ARS80m. These personal loans are granted to pensioners that receive their monthly pensions from Argentina's National Governmental Agency of Social Security (Administración Nacional de la Seguridad Social).

The pool is also constituted by loans granted to government employees of the Province of San Luis. Banco Supervielle is the payment agent entity and automatically deducts the monthly loan installment directly from the employee's paycheck and pensioner's payment.

The Class A fixed rate notes will bear a fixed interest rate of 11%, while the floating rate debt securities will bear a BADLAR interest rate plus 266bp. The floating rate notes' interest rate will never be higher than 19% or lower than 12%. The Class C fixed rate securities will bear a fixed interest rate of 19%.

Overall credit enhancement is comprised of subordination: 62% for the Class A notes, 15% for the floating rate securities and 5% for the Class C fixed rate securities. In addition, the transaction benefits from various reserve funds and excess spread.

In terms of its ratings rationale, Moody's considered the credit enhancement provided in this transaction through the initial subordination levels for each rated class, as well as the historical performance of Supervielle's portfolio. In addition, it considered factors common to consumer loans securitisations (such as delinquencies, prepayments and losses), as well as specific factors related to the Argentine market, such as the probability of an increase in losses if there are changes in the macroeconomic scenario in the country.

In assigning the rating to this transaction, the rating agency assumed a triangular distribution for losses centred around the most likely scenario of 10%. Also, it assumed a triangular distribution for the prepayments centred around a most likely scenario of 20%.

ABS

Innovative film equipment financing deal launched

Moody's has assigned a definitive rating to a senior credit facility (SCF), composed of two loans, being extended to Kasima, an indirect subsidiary of Digital Cinema Implementation Partners (DCIP). Both the US$335m senior delayed-draw term loan and the US$110m senior revolver loan received a rating of Baa2.

This transaction is a securitisation of cashflows consisting primarily of virtual print fees (VPFs) payable by motion picture distributors. Drawings under the SCF, in conjunction with proceeds from subordinate financing and equity, will be used to finance the costs associated with acquiring and installing digital cinema projectors and related equipment in theatres owned by DCIP's three joint venture owners.

DCIP was formed in February 2007 by AMC Entertainment, Cinemark and Regal Entertainment Group to upgrade their 35mm projectors in the US and Canada to digital projection systems. The Exhibitor Group's theatres collectively represent over 50% of the box office receipts for US and Canada.

Advances under the US$445m SCF will be secured by the rights to VPFs payable by film distributors for all digital prints exhibited at the theatres where the digital cinema projectors are installed. By converting exhibition to digital, film distributors can cut costs considerably since the cost of distribution is much lower for digital prints than for 35mm prints. Additional minor sources of income securing the SCF and available to repay advances include rental payment from the Exhibitor Group for each installed digital projection system, which will be owned by and leased from Kasima, as well as fees from the exhibition of non-film content, such as special concerts or live sporting events.

The ratings of the loans are mainly derived from an assessment of the strength of the film distributors, which are affiliates of the major Hollywood studios, and the Exhibitor Group. The main driver of revenue to the transaction is the VPFs, which are incurred as studios release films. The ratings are based on a review of past release frequency and the commitment of the studios to release digital films (such as Avatar).

The main risk to this transaction is the risk that the major motion picture studios slow their production and release of large budget films which are widely released. Large budget films are typically released over thousands of screens while running for a number of weeks until moving to DVD or pay-per-view. Over time, the habits of film studios may change; for instance, releasing over fewer screens or running films in the box office for extended periods of time (both subsequently reducing the number of digital prints).

Another major risk is the financial health of the Exhibitor Group. As seen in the 1990s, theatre circuits may close theatres during bankruptcies. As the Exhibitor Group is comprised of below investment grade companies, theatre closure continues to be a possibility and poses a risk to this transaction.

However, the alignment of all parties' interests in digital conversion is a significant strength that counters these risks. The cost savings to film distributors is considerable; the flexibility to change programming and offer alternative content is appealing to the exhibitors; and movie-goers enjoy the digital experience. Moody's believes this profile of risks and benefits is consistent with the ratings of the loans.

ABS

Improving labour market to support card ABS

US credit card charge-offs remain near record highs, increasing by 6bp to 10.43% over the last month, reflecting the still elevated unemployment rate. However, most credit card ABS issuers appear to be optimistic that losses should start to decline in Q210 as labour market conditions improve.

According to ABS analysts at JPMorgan, early signs of this improvement are evident in the delinquency trends, where both 30+ and 60+ arrears have started to inch down over the past three months to 5.66% and 4.29% respectively. Credit support for ABS bondholders remains strong, with three-month excess spread at 8.31% in February, as rising yields have compensated for the higher losses.

Yields reached a high of 22.23% in February, compared to 17.19% one year ago. In comparison, charge-offs increased by 212bp over the same period.

The analysts explain: "The contribution of discount option receivables to higher yields across the bankcard ABS programmes has been significant, accounting for roughly 200bp to as much as 750bp of incremental yield enhancement. The payment rate fell to 17.4% in February from 18% the last month."

On the retail card side, charge-offs on average increased by 47bp to 11.04%. However, excess spread increased by 174bp to 11.87%, reflecting the 278bp increase in yield to 29.24%.

Delinquencies increased and payment rates fell for most credit card master trusts in February, according to JPMorgan.

ABS

Weak economic conditions hit timber transaction

Moody's has downgraded the ratings of certificates issued by TimberStar Trust I Series 2006-1, a securitisation of approximately 900,000 acres of timberlands located in Louisiana, Texas and Arkansas. The rating actions are prompted by the uncertainties regarding the future cashflow from timber and pulp sales generated by the timberlands, the future value of the underlying timberlands and the ability to liquidate them, if necessary, to repay the certificates.

The weakened economy, along with the slump in the construction and packaging industries has reduced the demand for saw timber and pulpwood, Moody's says.

In February 2008, iStar Financial sold the timberlands to investor-clients of the Hancock Timber Resource Group (HTRG) for US$1.7bn, including the assumption of debt. HTRG manages the land on behalf of its investor-clients.

"While some rebound is expected as the economy recovers, the extent and timing is highly uncertain. The decline in demand and lower prices has affected the valuation of the timberland collateral in this transaction," the agency adds.

Lower valuations mean a higher LTV ratio, resulting in a reduction in the amount of credit enhancement supporting the certificates. In addition, the market for timberland, especially large tracts, is relatively thin and could be quite volatile, given the economic weakness and the likely difficulty for the potential buyers to obtain financing.

Furthermore, as a result of weakened timber prices, Hancock has been harvesting a minimal amount of wood in anticipation of a price rebound. Consequently, it has not been generating sufficient timber revenue to make the required interest and fee payments, making up the difference with proceeds from land sales and cash reserves retained by the business.

But reliance on land sales was not contemplated as a major source of support of cashflow for the transaction in the initial rating analysis. "While this can be seen as savvy management in light of economic events, it is unlikely that it can be sustained in the case of a prolonged economic slump, adding to the uncertainty surrounding the deal's performance," Moody's concludes.

ABS

DSB's ABS/RMBS downgraded again

Moody's has downgraded 15 notes issued by Chapel 2003-I, Chapel 2007-I, Monastery 2004-I and Monastery 2006-I. The deals were originated by the now-bankrupt DSB Bank (SCI passim). Around €579m of debt securities are affected and most ratings remain on review for further possible downgrade.

All the affected tranches have been on review for possible downgrade since 13 October 2009 following the announcement of the implementation of emergency regulations in relation to DSB Bank on 12 October 2009 and the subsequent bankruptcy of DSB on 19 October 2009. DSB was the seller and is the servicer on the deals.

Moody's initially lowered the ratings of senior notes in these transactions to Aa2 on 11 November 2009 and kept all the notes on review due to uncertainties relating to the servicing transition for back-up servicing arrangements, operational risk, set-off and asset performance. In the latest ratings sweep ratings on the senior notes remain unchanged.

All payments have been made in full and timely on all interest payment dates on all four transactions since the bankruptcy of DSB.

The rating action results from revisions of the defaults and loss assumptions of the underlying pool backing the notes in the four transactions taking into consideration the current credit enhancement level of each class of notes. The ratings remain under review for downgrade due to servicing uncertainties as no long-term solution has yet been concluded. There are also uncertainties over possible due care complaints on the loans in the pools, according to the rating agency.

CDO

Secondary CDO activity 'demystified'

Using list data as a proxy for cumulative trading volumes, structured credit analysts at JPMorgan have published a report that seeks to provide insight into CDO trading activity after Lehman's demise and through the recovery. They note that secondary activity ebbs and flows as it would in other sectors, but with factors idiosyncratic to the CDO market.

For instance, volatility in flows is visible around month-ends or year-ends. But there were significant spikes in activity around May 2009 (due to the Whistlejacket and other liquidations) and in late-2009 for CLOs (when the rally in triple-A spreads intensified).

The majority of trading volume has been in CLOs, although almost 30% is made up of ABS CDOs, Trups CDOs and emerging markets CDOs (see also separate News Analysis). While trading in senior CLOs dominates, the proportion of more subordinated risk reached relatively high levels at certain points, according to the analysts.

"For example, subordinated trended up late summer and early autumn 2009 when we observed increased buying of mezz/subs following the first stage of the CLO rally, and more recently in February 2010 when triple-As firmed but mezz/subs softened. Historically, it appears triple-As and double-As comprised 70%-80%; this makes sense, given the sizes," they explain.

Indicative spreads for generic triple-A US CLO bonds suggest that the bid/ask is now in line with the early stages of the crisis, or about 1-2 points versus 1-1.5 points in 2007 to mid-2008. "We cannot predict if or when bid/ask reverts to historical norms (as tight as 0.125-0.25 points, 2006 to early 2007), but this probably needs a functioning primary market," the analysts add.

There also appears to be more willingness now across the street to trade triple-A blocks in significant size (US$50m-US$100m), as opposed to the US$10-US$20m clips that were observed when the only real sellers were structured holders of risk (CDOs/SIVs).

CDO

Trups CDO defaults reach 11%

Fitch says two more bank failures last month increased default rates within US Trups CDOs to 11%. Over the same month the bank deferral rate stayed at 16.7%, and six new banks began deferring on their trust preferred securities.

Fitch md Kevin Kendra says banks in the West Coast, Midwest, Plains and Mountains, and Southeast states particularly suffered from poor performance, with US$1.5bn of defaults from 19 closures in West Coast states as of February. The Southeast had the most defaults, with 28.

Eight Trups CDOs were adversely affected by the newly defaulted bank issuers, and deferrals impacted interest proceeds on US$56m of collateral. The cumulative combined default and deferral rate held at 27% in February.

CDO

CRE CDO delinquencies to continue climbing

Asset managers extending loans and disposing of troubled assets resulted in a slight decrease in US CRE CDO delinquencies in February, according to the latest CREL CDO delinquency index results from Fitch. While the CREL CDO delinquency rate is lower this month (to 12.5% from 13%), the number of new delinquencies (15) is approximately equal to the number of loans removed from the index due to extensions, restructurings or resolutions at a loss.

Fitch senior director Karen Trebach says: "Resolved loans have lowered the delinquency rate even as losses continue to climb. Extended and restructured loans also have lowered the delinquency rate, yet the credit characteristics of many restructured loans remain questionable."

Fitch continues to forecast that the delinquency rate will climb throughout 2010. Accounting for loans resolved at a loss, Fitch anticipates that the cumulative delinquency rate will reach 25% by year-end.

Approximately US$41.8m in realised losses were reported in February, which is in line with last month's total. To date, total realised losses to CREL CDOs are approximately 4.6% of the total collateral balance. This realised loss would be higher except that managers often use the proceeds from the resolutions to buy in other assets at a discount, thereby resulting in par building of the collateral pools.

The largest single loss in February was US$26.6m, which resulted from the severely discounted payoff (DPO) of a long defaulted B-note secured by a development site. While this B-note DPO resulted in a limited recovery to the CDO, DPOs and asset sales for the month had a weighted average recovery of 68%.

Furthermore, three CDOs sold interests in the defaulted GGP bank loan for close to or in excess of par, reflecting the market's expectation of a favourable resolution to its bankruptcy proceedings. In 2009, several other CDOs had sold similar interests in the loan at significant discounts to par.

33 of 35 Fitch-rated CREL CDOS reported delinquencies in February, ranging from 1.3% to 40.6%. Two CDOs resolved their delinquencies since last month. Additionally, 15 Fitch-rated CREL CDOs were failing at least one overcollateralisation (OC) test, which is two more CDOs than last month when 13 were failing OC tests.

CDO

Euro CLOs hit by criteria change

S&P has lowered its credit ratings on 122 tranches in 21 European CLO transactions. All of the ratings lowered were previously on credit watch negative, from which they have now been removed.

At the same time, the rating agency affirmed the ratings on eight tranches (in four of the 21 transactions). Of the ratings affirmed, eight were previously on credit watch negative, from which they have now been removed.

Excluding combination notes, S&P reviewed tranches representing a current combined notional amount of US$10.10bn (€7.42bn). Including combination notes, it reviewed tranches representing a current combined notional amount of US$10.17bn (€7.47bn), of which the downgraded tranches represent US$9.33bn (€6.86bn) and the affirmations US$838m (€610m).

The downgrades follow:

• The application of S&P's new corporate CDO criteria; and
• For some of the transactions, its assessment of the deterioration in the credit quality of the collateral supporting the CLO tranches due to increased exposure to obligors that have either defaulted or been downgraded into the triple-C category.

Of the tranches S&P downgraded, eight are constrained under its criteria by the largest obligor default test, which is one of the supplemental stress tests the agency introduced as part of the criteria update. The largest obligor default test assesses whether a CDO tranche has sufficient credit enhancement (not counting excess spread) to withstand specified combinations of underlying asset defaults, with a flat recovery rate of 5%. The other supplemental stress test introduced under the recent criteria update, the largest industry default test, didn't affect S&P's analysis of any tranche ratings.

S&P says it will continue to review the remaining European CLO tranches that it placed on credit watch negative under the corporate CDO criteria and resolve the credit watch status on these in due course.

CDS

Australian succession event pending

An ISDA Determinations Committee decision on whether a succession event has occurred with respect to St George Bank is pending.

CDS

Accounting treatment of embedded CDS clarified

An amendment to the embedded credit derivatives scope exception has been made in the FASB Accounting Standards Codification. The move follows queries over the intended breadth of the scope exception, given the ambiguity in practice about embedded credit derivative features, including those in some CDOs.

The amendment essentially confirms that the transfer of credit risk that is only in the form of subordination of one financial instrument to another (thereby redistributing credit risk) is an embedded derivative feature that should not be subject to potential bifurcation and separate accounting.

In initially adopting the amendments in this update, an entity may elect the fair value option for any investment in a beneficial interest in a securitised financial asset; that is, the entity may irrevocably elect to measure that investment in its entirety at fair value (with changes in fair value recognised in earnings). The election of the fair value option should be determined on an instrument-by-instrument basis at the beginning of the fiscal quarter of initial adoption, with an entity ensuring that an impairment analysis of the investment has been performed before the initial adoption of the amendments.

The amendments are effective for each reporting entity at the start of its first fiscal quarter beginning after 15 June 2010.

CDS

ISDA: Don't blame CDS for Greece's problems

Responding to growing calls for a ban or suspension of naked sovereign CDS, ISDA has defended the product while criticising the "flawed and inconsistent" reasoning of those that believe the CDS market is complex and opaque, yet liquid enough to influence markets of enormous size.

ISDA believes that the most commonly traded CDS, including sovereign CDS, are simple and relatively liquid. At the same time, the market for sovereign CDS is much smaller than the underlying market for government bonds. The association suggests contrasting the activity and outstanding volumes in Greek CDS with the outstanding volumes in the Greek government bond market, which exceeds US$400bn.

"None of the data can possibly lead to a conclusion that a market of US$9bn can dictate prices in the US$400bn government market," it says. "Indeed, if prices in the CDS market widened significantly relative to the Greek government market, arbitrageurs and holders of Greek government bonds would simply sell the bonds and write protection in the form of the sovereign CDS. The fact that government bond and CDS spreads have remained essentially in line while outstanding positions have remained constant underlies our assertion that the CDS market has had little or no impact on the government market."

An examination of DTCC's reports since the beginning of 2010 shows the net outstanding CDS position on the Hellenic Republic has changed little over the course of this year (see last issue). The net position for Greece was US$8.7bn in the week of 1 January 2010 and has ranged between US$8.5bn and US$9.2bn since then.

Furthermore, the DTCC data indicates the net position for Greece was US$7.4bn a year ago. None of the data suggests there has been a surge of open interest in either 2009 or 2010.

ISDA notes that Greek CDS provide effective hedges not only for holders of Greek government bonds, but also for international banks that extend credit to Greek corporations and banks, for investors in Greek stocks and for entities that have significant real estate or corporate holdings in Greece. For many of these participants, the sovereign CDS market is the most effective means of hedging credit risk in Greece.

Anecdotal evidence indicates that banks with significant credit exposure to entities in Greece have been active purchasers of Greek sovereign CDS protection. Much of this activity could be misinterpreted as 'naked CDS'. ISDA further believes that this activity cannot have any significant impact on Greek government prices because of its insignificant size in relation to the underlying government bond market.

Recently, a simplistic analogy has surfaced and been repeated that compares CDS to fire insurance. People who use this analogy point to insurance law prohibiting individuals from buying insurance on a neighbour's house so that they will not burn it down to collect the insurance proceeds. Under this analogy, writing naked CDS is equivalent to buying such insurance and committing arson and should therefore be banned.

"The analogy leaves some important points unsaid: how, for example, can buyers of naked CDS actually burn down the house?" questions ISDA. "It is important to remember that for every buyer of CDS there is a corresponding seller, who benefits when the reference entity's credit quality improves. It is unclear how such activity alone can lead to a default by a sovereign government on bonds it has issued."

The association concludes: "Such claims ignore the commonsense facts available and fail to show either cause or effect. These claims also ignore short selling activity in Greek government bonds, which certainly has a greater effect on Greek bond prices as it involves selling the actual instruments in the market."

CDS

Record year for DTCC CDS processing

The DTCC Trade Information Warehouse reports that it supported the processing and recordkeeping of more than 2.2 million CDS contracts, worth more than US$25.1trn (€17.5trn) by the end of 2009. In addition, the Warehouse managed 50 credit events with a gross value of US$386bn, 129 successor events caused by restructurings and processed 11 million gross payments amounts in nine currencies through its central settlement service.

The total number of contracts in the Warehouse remained relatively flat year-over-year, despite fluctuations in the weekly activity trading volumes reported during the year. At the end of 2008, the Warehouse held 2.2 million contracts with a gross notional value of about US$29.2trn (€21trn).

In 2009, DTCC also began tracking trades that were not recorded as official legal records in the Warehouse. When figures on these contracts were first publicly released in August 2009, there were 216,765 contracts worth an estimated US$5.7trn (€4trn). As of the end of 2009, the number of contracts recorded fell to 145,000, worth an estimated US$4.7trn (€3.3trn).

In part, this reduction was due to the loading of additional trades that could be held in the Warehouse as full legal records. Reductions were also made due to further processes to eliminate duplicate submissions, which increased the number of trades that were identified in August. These occurred when each counterparty to the trade submitted the same details and both submissions were counted as separate trades.

DTCC processed a record-breaking 50 credit events during the year globally, including the General Motors bankruptcy in April. This figure rose dramatically from the 10 credit events processed in 2008.

The total gross value of those credit events in 2009 totalled US$386bn (€270bn), up from the US$285bn (€205bn) in gross value from 2008. Net settlement amount for credit events in 2009 was US$17.7bn (€12.4bn), compared to about US$12bn (€8.6bn) in 2008. In addition, the DTCC handled 129 successor events during the year.

In 2009, the Warehouse processed 10.9 million gross payments amounts, netted down to 557,000 bilateral nets, yielding a 95% netting ratio. In partnership with CLS Bank International, 7.3 million of these gross payments were netted and settled through the Warehouse's central settlement service.

The number of participants who signed up to the central settlement service increased to 34, compared with 14 participants in 2008. This was predominately due to the expansion of central settlement services to buy-side clients, the DTCC says.

As a result of this increase, as of December 2009, the industry achieved nearly 80% of all payments being settled through the central settlement service. Total gross payment obligations, whether processed by the Warehouse through CLS Bank or not, were US$2.1trn - which netted down to US$780bn from US$2.4trn gross and US$1trn net respectively in 2008.

CDS

Changes made to iTraxx, SovX indices

Markit has announced a number of changes to the iTraxx Asia indices ahead of their roll into Series 13. Seven constituents have been replaced in the Japan index, one constituent has been replaced in the Asia ex-Japan HY index and one constituent has been replaced in the Asia ex-Japan IG index. The composition of the iTraxx Australia index remains unchanged, however.

Meanwhile, the following changes have been made to the iTraxx Europe family of indices ahead of their rolls on 22 March:

• Two constituents have been replaced in the iTraxx Europe Main index.
• Three constituents have been replaced in the iTraxx Europe Crossover index.
• Seven constituents have been replaced in the iTraxx Europe HiVol index.

In addition, the SovX family of indices will begin its third series on 22 March, while the SovX CEEMEA index will begin the next series in September.

Seven constituents have been added to the SovX Global Liquid IG index and four have been removed. The composition on both the SovX Western Europe index and the SovX G7 index remain unchanged.

Markit is understood to be prepping a SovX Asia index, tracking Australia, China, Indonesia, Japan, Malaysia, New Zealand, the Philippines, South Korea, Thailand, and Vietnam.

CDS

Aiful CDS compressed ahead of auction

TriOptima says it has successfully compressed the portfolios of banks holding both CDS covering Aiful debt and Aiful-related iTraxx Japan CDS, eliminating US$43bn (¥3.99trn) of the notional amount of CDS outstanding prior to the Aiful auction settlement, which is scheduled for 25 March. The trade processing group offered two Aiful-related compression cycles after a restructuring credit event had been determined by the ISDA Japan Determinations Committee.

In the Aiful single name CDS cycle 13 banks eliminated US$1.2bn (¥111bn) of the notional amounts outstanding, while in an iTraxx Japan CDS cycle 26 banks eliminated US$41.8bn ( ¥3.88trn) of the notional amounts outstanding.

"We are pleased that we are able to continue to support the industry as part of this special credit event in Japan," says Yutaka Imanishi, evp of TriOptima Japan. "Compressing these trades reduces operational and administrative risk, and contributes to the smooth operation of the settlement process."

CLOs

US arbitrage CLO rated

Preliminary ratings have been assigned to COA Tempus CLO, a US$480m arbitrage CLO managed by Fraser Sullivan COA. The transaction - arranged by Citi - is backed by a revolving pool of broadly syndicated senior secured loans.

S&P has assigned a triple-A rating to the US$327m class A1 notes, double-A to the US$15m class A2 notes and single-A to the US$36.5m class B notes. The notes are expected to price in the region of 190bp, 225bp and 250bp over three-month Libor respectively. A sub note of US$102.1m has not been rated.

Fraser Sullivan COA currently has four CLOs under management amounting to US$1.425bn.

CLOs

Initiative may stem German SME CLO defaults

Following the Association of German Banks' recently-unveiled premium for new SME securitisations (see SCI issue 174), an initiative to provide existing SMEs with additional equity financing has launched. Initially sized at €550m, these capital resources will strengthen the equity base of SMEs and encourage additional financing for these entities.

Moody's notes in its Weekly Credit Outlook that this will help to prevent a rise in default rates among SME loans contained in securitised German SME portfolios. However, it also says the magnitude of the support for German SME CLOs depends on how many of the obligors in the securitised portfolios apply for the available equity funding.

The rating agency explains that the new equity initiative offers twofold help to SMEs. First, as their operating results have deteriorated and capital resources have become depleted recently, the funds will help rebuild their equity base. Second, by increasing their capital, the SMEs' credit quality improves, making it easier for them to secure debt financing (such as bank loans) once again.

The initiative is targeted at smaller SMEs to help them survive the current period of economic stress and improve their capital relative to total assets. Moody's expects this initiative to play an even more significant role in enhancing German SMEs' financing options than the €300m mezzanine capital fund that was announced by Deutsche Bank in February (see SCI issue 171).

There are several reasons for this, according to Moody's: the higher committed volume of €550m for 2010 (which may be increased if necessary) allows the potential support of approximately 2000 small entities (assuming an average capital injection of roughly €250,000) via the broad network of regional public-sector banks participating in this programme; it is offering pure equity funding to companies, which is typically less complex and more transparent than agreements with profit-sharing rights as entered by Deutsche Bank's mezzanine capital fund; and the close link between the public-sector banks and SMEs suggests a higher number of SMEs will apply for support.

Moody's believes that these moves to strengthen the financial conditions of the smaller companies within Germany's SME segment is a positive development as they should help stabilise its overall default performance.

CLOs

Euro high yield CLO liquidated

Fitch has withdrawn the ratings for GS European Performance Fund's class D, E and F notes following an investor-initiated liquidation of the portfolio assets that began this month. The agency says it has not taken any rating action on the class A, B and C notes.

Goldman Sachs International (GSI), the transaction manager, expects the total proceeds from the sale of the portfolio assets, cash from the accounts balances and its unfunded guarantee to be sufficient to fully repay classes A, B and C. However, the full repayment of class D will be dependent on the ultimate realisations from the sale of the portfolio assets. Classes E and F are expected to be impaired.

GSI intends to settle all the trades and distribute all proceeds to the noteholders by June 2010.

CLOs

Retranched CLO sub note acquired

A newly formed special purpose Delaware statutory trust, dubbed Heritage Resources, has been established to acquire the US$65.3m of Class B notes issued by Liston Funding 2009-3. Liston is a recently closed retranching of the most senior class of notes of Fall Creek CLO.

The two classes of notes issued by Liston, consisting of class A-S notes and class B notes, are sequential. Fall Creek CLO closed on 8 September 2005 and was amended and last restructured on 24 November 2008, converting the transaction into a static cashflow CLO structure from the original market-value CLO structure.

Fall Creek CLO is primarily collateralised by senior secured first-lien bank loans and is managed by 40|86 Advisors.

While the current structure of Fall Creek CLO does not allow reinvestment in additional collateral, it can sell assets without any restrictions. The proceeds of the sale of assets have to be used to amortise the notes.

Heritage Resources is acquiring the Liston notes using a US$64.5m term loan rated Baa2 by Moody's. The rating agency says the methodology used to rate the loan is consistent with the rating approach it uses to rate and monitor CLOs.

The loan is a limited recourse obligation of the borrower secured by the underlying security and represents a repackaging of the underlying security into a loan format. The characteristics of the loan are identical to the characteristics of the underlying security, except for frequency of interest payments and maturity. Liston's payment frequency is quarterly, while Heritage Resources' payment frequency is monthly.

However, the Libor portion of the loan interest payments resets quarterly to match the reset on the underlying security interest payments and an interest payment smoothing mechanism is utilised. The maturity of the underlying security is in September 2017, while the maturity of the loan is in June 2017. But if the underlying security is still outstanding at the time of maturity of the loan, it is not required to be liquidated prior to the payment date in September2017 and the parties have agreed not to exercise any rights or remedies under the applicable law in connection with acceleration of the loan.

The loan's governing documents also contain events of default that are broader than events of default under governing documents of the underlying security, including pay-in-kind events of default. Upon the occurrence of any such pay-in-kind events of default, the lenders have agreed to receive the underlying security in satisfaction of the borrower's obligations to them.

CMBS

Aussie CMBS rated

Colonial First State Capital Management (CFSCM) is to launch the first Australian CMBS issue of the year. The 2010 notes of the CMBS Issuer Series 1 (2007) will be used to refinance the existing issue.

S&P has assigned preliminary ratings of triple-A and A-1 plus to the two classes of notes worth A$370m and A$313m respectively. The transaction is expected to close on 21 March.

CMBS

Center Parcs CMBS amendments proposed

Proposals to amend the terms of the loan in UK CMBS Center Parks 2007-1 were unveiled late last week. The key proposals include: an extension of the loan maturity date by two years to October 2013; a prohibition on dividends being paid; new cash sweep provisions for a portion of excess cashflow that will de-lever the deal (with principal allocated to notes pro rata); and a 176bp increase in the margin on all notes.

An extraordinary resolution of the Class A1 noteholders is required for the proposal to be accepted and a resolution will be binding on the other classes. The meeting will take place on 7 April.

"Despite Center Parcs having traded well through a difficult period, it is clear that neither the bank market nor the capital markets are ready to digest a £1bn refinancing of this type of asset - and a loan maturity of October 2011 does not give very long for that to change," note structured finance strategists at Chalkhill Partners. "The restructuring will give Center Parcs (and sponsor Blackstone) the time to consider other options without the pressure the original loan maturity would have implied. We would expect an IPO to be one of the options under consideration, and think that the extension significantly increases the likelihood of a successful refinancing by the revised loan maturity date."

Chalkhill expects the rating agencies to consider the proposal neutral to positive for ratings. "The revised loan maturity will still leave a large enough tail period for any workout given the 2018 legal final maturity. From a credit/pricing perspective, the two-year extension has to be balanced against some of the other aspects of the proposal," they say.
They add that the margin increase is meaningful - comparing well against the 52bp increase in Fleet Street Two (SCI passim), for example. "Furthermore, the cash being trapped rather than being paid in dividends will be used partially to de-lever the transaction and partially to invest in the assets, both of which should improve the LTV versus the alternative of cash leaking to equity and enhance the prospect of principal recoveries," the strategists say.

CMBS

White Tower 06-3 property sale a 'positive'

CB Richard Ellis Loan Servicing's decision to sell several properties backing the White Tower 2006-3 CMBS (SCI passim) will have no immediate impact on the ratings of the transaction's notes, according to Fitch. The rating agency views the commencement of the marketing process as positive for the transaction.

The strategy of the special servicer involves the marketing of the Alban Gate, Leadenhall, and Carey Street properties (33% of the total reported market value, MV) as individual assets. The Victoria Embankment, Sampson, Ludgate House, Millennium Bridge and Chiswick properties (43% of MV) are being marketed together as a high yielding 'Thames Portfolio'. The Aviva property (23% of the MV) is not being marketed at this stage.

The successful sale of one or more properties in the short term will result in a sequential paydown of the notes. While sales prices are not quoted for the properties being marketed as individual assets, the sum of their reported values (£311m as of June 2009) and the price quoted on the 'Thames Portfolio' assets (£466m) now being marketed implies a full paydown of the class A notes and a 71% paydown of the class B notes.

The commencement of the marketing process two and a half years prior to the bonds' legal final maturity date is considered positive in Fitch's view as it allows sufficient time to achieve an orderly sale of the assets. However, any future impact on the rating of the bonds will depend on the sales prices achieved on the properties, either as individual assets or as a packaged portfolio, according to Fitch.

CMBS

Growing backlog for US special servicers

Though US CMBS special servicers are making some progress in working out distressed loans, they still have a sizeable backlog awaiting them, according to Fitch. Servicers resolved approximately US$8.7bn in 2009. However, this number reflects only 11% of the amount in special servicing at the end of last year.

While CMBS servicers resolved over 50% more loans in 2009 compared to 2008, the percentage of the loans resolved in special servicing has declined from 31% to 11% due to the substantial increase into special servicing. The overall average recoveries of 87%, a decrease from 2008, can directly be attributed to the increase of distressed assets, continued lack of liquidity and declining property values.

Fitch md Stephanie Petosa says: "Recoveries on loans with losses are down markedly compared to prior years."

75% of the specially serviced loans were modified and sent back to the master servicer either modified and are now performing or paid-in-full with almost no losses. However, it remains to be seen whether these modifications will prevent a return to special servicing.

Petosa adds: "The health of the property, the borrower and the credit markets will dictate how successful the remedies are at keeping loans out of special servicing."

The balance of US CMBS loans in specially serviced status increased to US$74bn by the end of last year from a trough of US$4.4bn at year-end 2007. Servicers continue to face an uphill battle, with over half (52%) of the unpaid principal balance of specially serviced CMBS transferred due to imminent default.

CMBS

Mild increase in US CMBS delinquency rates

The delinquency rate on US CMBS loans increased by 31bp in February to 5.73% - a relatively mild increase compared to the 44bp average increase observed over the previous five months. The data was compiled by Moody's Delinquency Tracker (DQT), which tracks all loans in US conduit and fusion deals issued in 1998 or later with a current balance greater than zero.

One of the key developments is a drop of 2bp to 5.22% in the delinquency rate of retail loans, the first decline in the delinquency rate in that sector since November 2007. Moody's attributes this to the fact that 45 loans totalling US$780bn, which were delinquent as of the end of January became current, worked out or disposed of in February.

In other property types, hotel loans saw the largest increase in delinquency, 82bp, to stand at 10.64%, while multifamily saw the second largest climb, rising 59bp to 9.36%. Office property delinquencies increased 45bp to 3.98%, and the industrial property DQT passed the 4% threshold for the first time and now stands at 4.28%, following a 40bp jump.

Moody's notes that regional disparities continued to widen, for while the delinquency rate in the East grew just 6bp in February to 3.60%, rates in the West, Midwest and South grew by 33bp, 38bp and 66bp respectively, continuing a trend over the past year which has seen the monthly increase in the delinquency rate in the East average 23bp, as compared to average monthly increases of 47bp, 38bp and 48bp for the West, Midwest and South.

Correlation

Dealers agree on fixed coupon iTraxx tranches

In a move to increase standardisation among CDS indices, iTraxx tranche dealers have agreed on a call this week to use fixed coupons and fixed coupon effective dates following a similar initiative in CDX IG tranches last June. Until now, iTraxx senior tranches have been trading with a flexible coupon. The new format will be effective for series 9 iTraxx tranches at the next European index roll date on 22 March.

Though the roll to the next series for both CDX IG and iTraxx indices is more of a formality than an actual move since most trading still occurs in the older series 9 of CDX IG and iTraxx rather than the on-the-run IG13 and iTraxx 12 indices, dealers made the decision to coincide with the iTraxx roll date for symbolic reasons. The decision to use fixed coupons for the new iTraxx series 13 tranches has not yet been made, however.

Dealers opted for the change on series 9 to be in sync with European single name CDS, which became standardised last year with fixed coupons. The series 9 iTraxx tranches subsequently will now follow the coupon ladder of European single names, such as 500bp for 0%-3% and for 3%-6% tranches, 300bp for the 6%-9% tranche, 100bp for the 9%-12% tranche, 100bp for the 12%-22% tranche and 25bp for the super-senior tranche, according to a tranche trader. In the US, single name CDS trade with coupons of 100bp and 500bp.

The increased standardisation stems from the need to appease regulators. "With all the regulatory pushes right now, any market that is not standardised is being eyed by the regulators," says the trader.

Having more standardisation will make it easier to see daily clearing levels, open shorts and open long interest in the tranches, as well as make this market much more credible after the credit crisis, he adds.

iTraxx tranche dealers have also decided this week to keep super-senior tranches quoted on a running spread basis just like single name CDS, unlike the US where super-senior IG tranches trade on an upfront basis. However, the 0%-3%, 3%-6% and 6%-9% iTraxx tranches will continue to trade on an upfront basis.

The decision to keep iTraxx super-senior tranches quoted on a running basis was also initiated to assist real money investors in this segment of the market.

Investors

Credit managers face repricing risks

Credit managers are currently being presented with a number of cautionary signs following a strong year in 2009. According to Fitch's new Credit Asset Management quarterly newsletter, while fundamentals are improving, heightened sovereign risk, reducing inflows and changing sentiment are increasing the volatility of the entire asset class, exposing it to a risk of repricing.

For credit managers the new landscape requires a renewed focus on credit selection, allocation and relative value strategies in the context of increased credit dispersion, which contrasts with the almost universal spread tightening seen across the credit markets in 2009, suggests the rating agency.

2009 was one of the best ever years for managers of IG corporate credit from an issuance, inflows and return perspective. However, in Fitch's opinion these managers will have to find new sources of return through asset allocation and relative value strategies in the lower spread environment and less directional markets expected in 2010.

"Credit managers who historically focused on individual asset selection are recognising the need to strengthen their 'top down' allocation capabilities. Those managers that are able to dynamically position their portfolios to anticipate the effect of macroeconomic drivers such as sovereign, interest rates or foreign exchange risks on credit spreads and fundamentals are expected to stand out of the crowd in 2010," says Manuel Arrive, senior director in Fitch's fund and asset manager rating team.

"Managers will be further differentiated by the flexibility they show in relative value analysis and trading to exploit mispricing opportunities afforded by market volatility, not only between credits and sectors, but also between countries and regions," adds Alastair Sewell, associate director in Fitch's fund and asset manager rating team.

Operations

US mortgage loss severities to rise

Loss severities on distressed US residential mortgage loans are likely to rise this year as several key government support programmes expire, according to Fitch. Low mortgage rates, homebuyer tax credits and government directed loan-modification programmes have led to an improvement in home prices and loss severities since Q209. But the expiration in the coming months of both the homebuyer tax credit and the Federal Reserve's US$1.25trn MBS purchase programme will increase negative pressure on home prices and loss severities, according to Fitch senior director, Grant Bailey.

Additionally, an increase in the liquidation of loans with unsuccessful loan modifications is expected to add to the supply of distressed inventory in the housing market.

"Servicers are further along in identifying borrowers ineligible for modifications and will likely be more aggressive in liquidating those loans this year compared to last. Less costly alternatives to foreclosure, such as short-sales, should help stem rising loss severities due to the lower costs and speed of the resolution," says Bailey.

Loss severities on loans resolved through short-sales are approximately 10% lower than loss severities on loans in which the servicer takes possession of the property. Additionally, the seasonal increase in housing activity through the summer may delay the full impact of the withdrawal of the government support programmes until later this year.

Loss severity trends continue to be strongly dependent on home price trends. In the two years prior to the recent improvement, national home prices dropped approximately 30% while loss severities on loans which incurred losses doubled to record highs of 43% for private-label prime loans, 58% for Alt-A loans and 72% for subprime loans.

RMBS

Agency IOS index launched

The Markit IOS index - a synthetic total return swap (TRS) index referencing the interest component of 30-year fixed-rate Fannie Mae residential mortgage pools - launches today, 12 March. The index provides a synthetic solution for investing in or hedging exposure to interest-only (IO) securities by replicating these transactions with a TRS contract.

The index is comprised of all Fannie Mae residential mortgage pools issued in 2009 (with at least 90% of the underlying loans originated in 2009) and is divided into three sub-indices: Markit IOS.FN30.400.09 - 4.0% coupon; Markit IOS.FN30.450.09 - 4.5% coupon; and Markit IOS.FN30.500.09 - 5.0% coupon.

Each index references between 1,500 and 4,000 mortgage pools, but only takes into account the interest rate component of the underlying.

RMBS

US subprime prices rise

Fitch Solutions says its latest RMBS CDS indices results indicate that US subprime RMBS prices started to rise again last month. The Fitch Solutions US Subprime RMBS Total Market Price Index increased month-on-month by over 6%, rising from 7.17 as of 1 February to 7.63 at the start of this month.

The 2006 vintage performed most strongly, with a 17% increase as all vintages increased in value. Fitch Solutions says the lone outlier was the 2007 vintage, which declined by 2% to reach its lowest-ever value of 2.06, but the 2005 and 2004 vintages increased by 9% and 6% respectively.

Loan level analysis carried out by the firm found the rise in value for the 2006 vintage was driven by declines in both the constant prepayment rate (CPR) and constant default rate (CDR). Three-month CPR fell from 2.4% to 1.8%, while CDR declined over the same period from 26.3% to 25.7%. Historical 60-day delinquencies also decreased from 1.77% to 1.65%.

Fitch Solutions md Thomas Aubrey says the different performance of the CPR and CDR across diverse vintages reinforces the need to drill down and extensively assess each vintage from a broader perspective, helping explain the different pricing movements of the 2007 and 2006 vintages. Declines in three-month CPR were also cited as primary drivers for the value increase in both the 2004 and 2005 vintages.

RMBS

Servicer flexibility for Cordusio RMBS

Transaction documents of Cordusio RMBS Securitisation Series 2008 and Series 2009 have been amended to allow the servicer to renegotiate some terms of the underlying mortgage loans. In particular, the servicer can allow: a reduction of the fixed interest rate applicable on the loans and a conversion from fixed interest rate to floating interest rate. Moreover, the originator (UniCredit) will be entitled to repurchase individual mortgage loans up to an amount of 7% of the original portfolio.

Moody's notes that a number of measures have been implemented to mitigate the risks associated with the renegotiation and repurchase of the mortgage loans in the two pools. First, the originator will indemnify the SPV for any decrease in the cash generated by the portfolio due to renegotiations.

The originator will fund through a subordinated loan a cash reserve, of €40m for Cordusio 5 and €7m for Cordusio 6. At any subsequent payment date the servicer will calculate the amount of cash reserve that needs to be released through the waterfall in order to cover the shortfall due to the renegotiations, so that the yield of the portfolio is not altered by the renegotiations.

In addition, the servicer is allowed to grant renegotiations only if the following conditions are met: the renegotiation cash reserve amount minus the cumulative renegotiation loss is at least equal to the minimum required amount that has been set to €10m for Cordusio 5 and €1.75m for Cordusio 6. The renegotiation cash reserves have been sized in consideration of the amount of fixed rate loans in each pool and assuming that: 10% of the fixed rate loans will switch to floating; for another 10% of fixed rate loans there will be a reduction of interest rate; and in case of renegotation the average yield reduction is 1%. This means that renegotiations can be done only if the cash to cover the renegotiation losses is already available for the SPV.

Moody's considers that this has a positive future because this mechanism helps to leave the SPV neutral to any interest rate renegotiation in the portfolio. The originator has the option to top up the cash reserve again through an increase in the subordinated loan amount or through a new subordinated loan.

The purchase price of the loans will be equal to the outstanding amount of the loan plus accrued interest, even if the loans are not performing. In Moody's opinion the claw-back risk is sufficiently remote, given that the originator will provide solvency certificates each time it decides to exercise this option. However, the rating agency notes that this feature may increase the degree of linkage to the originator in the transactions.

Moody's says it has taken no rating action on the notes issued by these two Italian SPVs.

RMBS

Italian RMBS defaults, delinquencies analysed

The Italian RMBS market had both negative and positive aspects in January 2010, according to Moody's. The rating agency reports that the cumulative default trend increased to 1.4% in January from 1.3% the month before. At the same time, Moody's 90-days plus delinquency trend decreased to 1.7% following growth to 1.8% in December.

Moody's constant prepayment rate (CPR) trend remained stable at 9% in January, having decreased consistently from 12% since February 2009. However, the rating agency urges caution and notes that the good performance in terms of delinquencies is partially due to the inclusion of more recent transactions in the index.

The 'Piano Famiglie' scheme giving certain borrowers a payment holiday period of up to 12 months, which came into effect in January 2010, has been implemented by several banks during the first few months of 2010 (SCI passim). The scheme is approved by the Italian Banking Association and Moody's has been evaluating each transaction and the applied implementation of the scheme. In February it announced that there is no rating impact on UniCredit Group's RMBS deals, Cassa di Risparmio di Parma e Piacenza's (Cariparma's) RMBS deal, ModoMutui Cariparma and on the securities issued by BPM Securitisation 2.

The last Italian RMBS transaction rated by Moody's was issued by Cassa Centrale Finance 3 in December 2009. The transaction consisted of €425m of notes and was the third securitisation of Italian residential mortgage loans originated by Cassa Centrale Banca.

Meanwhile, the reserve funds in 26 Italian RMBS transactions were not at their target amount as of January 2010 for performance-related reasons. Six of these have been fully depleted.

Last month Moody's downgraded all six classes of rated notes issued by Eurohome Mortgages 2007-1 for worse-than-expected collateral performance. The transaction is backed by mortgage loans originated by Deutsche Bank in Germany and Italy and was closed and initially rated in July 2007.

So far this month the agency has placed ten classes of notes issued in six Italian RMBS transactions under review for upgrade and placed one class of notes in Sestante Finance under review for downgrade. The transactions affected by the potential upgrade are Bipitalia Residential, Cordusio RMBS, Heliconus, Mantegna Finance, IntesaBci Sec. 2 and Voba Finance. Within the Italian RMBS sector, these transactions have shown a material deviation from Moody's performance expectations, either positively or negatively.

Moody's outlook for Italian RMBS is negative. Following a 5% decrease in 2009, it expects Italian GDP to increase by 0.4% this year. In Q409 the Italian economy contracted by 0.2%.

Moody's also notes that consumer confidence has been falling throughout 2010, with unemployment continuing to rise. The unemployment rate stood at 8.5% in December, the highest rate since monthly records began.

As of January 2010, the total outstanding pool balance in the Italian RMBS market was €91.2bn, having been €82.1bn one year previously.

RMBS

Portuguese RMBS performance stabilises

Portuguese RMBS performance stabilised during January 2010, according to Moody's. The rating agency reports the outstanding defaults trend (360 plus days overdue up to write-off) remained unchanged at 1.4% from the previous month, while the 60 plus days delinquency trend fell to 1.6%, which is a decrease of 0.5% during the past year. Moody's average constant prepayment rate (CPR) trend continued to decrease slightly and stood at 3.6%.

"The cumulative losses trend increased marginally to 0.74% in January 2010 from 0.71% the previous month. The highest losses were realised in the 2004 vintage, amounting to 2.4%," says Yuezhen Wang, a Moody's senior associate. "In addition, all Portuguese RMBS transactions - except for Magellan Mortgages No. 1 - benefit from a provisioning mechanism, whereby excess spread is captured to provide for future losses on highly delinquent loans, before the losses are actually realised." The large difference in cumulative provisioning levels among transactions is not only due to performance but also the variety of provisioning mechanism.

Due to the deteriorating Portuguese macro-economy, some Portuguese RMBS transactions have been adversely affected by reserve fund draws. So far four transactions have drawn on the reserve funds in this market and one transaction recorded a principal deficiency.

Portugal officially came out of recession in Q209, but economic conditions remain weak. No growth in GDP was recorded in Q409 versus Q309 according to the EU statistical office, Eurostat. Moody's expects unemployment to rise to 9.8% in Q210 from 9.5% in Q409. Moreover, poor levels of productivity in Portugal may limit the scope of the economic recovery, causing elevated unemployment levels for some time.

Moody's notes that the prospect of higher taxes as the Government tries to reduce its fiscal deficits will reduce household disposable income, at least in the short term, which could constrain some mortgage borrowers. However, Portuguese house prices are showing signs of stabilisation after several years of decline. Muted house price growth after a boom-bust cycle in the Portuguese housing market early in the decade may mean that Portuguese house prices are closer to 'fundamental' levels, in contrast to other small EU countries where prices had grown much faster in the years leading to the recession.

Moody's outlook for Portuguese RMBS remains negative reflecting the depressed economy, the high unemployment rate as well as expectations of delayed asset recoveries.

As of January 2010, the total outstanding pool balance in the Portuguese RMBS market was €23.3bn, which compares to a total outstanding pool balance of €23.4bn as at January 2009. One new transaction was closed in December 2009.

RMBS

Spanish RMBS market stabilises

Moody's says its latest indices show that performance of the Spanish RMBS market stabilised during January 2010. The cumulative defaults trend remained stable and ended the month at 1.29%, while the 90 days plus delinquency trend decreased from 1.66% the previous month to 1.63%. The annualised constant prepayment rate (CPR) rose over the same period from 6.61% to 6.65%.

Moody's says rising unemployment, decreasing residential real estate prices and highly levered loan features have all been contributory factors to the macro-economic malaise that has caused significant negative rating migration of RMBS transaction over the past months, with transactions that closed between 2006 and 2008 being particularly affected. Cumulative defaults have more than doubled since the start of 2009 for some of the most recent RMBS vintages.

In February, the rating agency downgraded notes from the Bancaja 9, Bancaja 10 and Bancaja 11 transactions because of weak performance and confirmed the ratings of the notes of Bancaja 3, which were placed on review following the downgrade to A3/P-2 of Caja de Ahorros de Valencia, Castellón y Alicante.

RMBS

Severe stress expected for Irish RMBS

Irish RMBS transactions will come under severe stress as their performance deterioration to date is not yet reflecting the house price decline and recent economic stress in Ireland, according to Fitch in a special report for the sector. House prices have fallen by 31.5% from their peak in late 2006, while the country is undergoing one of the deepest recessions of all the advanced economies.

Prepayment rates have reduced significantly over the last year in Irish RMBS transactions due to limited benefits available to borrowers from refinancing in the current environment of restricted new lending and low existing mortgage costs. Though three-months plus arrears and the repossession rate have increased over the last year, the deterioration is far below levels Fitch would expect, given the stress in the Irish economy. The low repossession rate in the country reflects the attempts made by both servicers and courts to give borrowers all possible opportunities to resolve their financial difficulties.

Trading

CRE auction platform to offer analytics service

DebtX has launched DXMarket Data(SM), a new subscription information service that provides analysis and insight about transactions executed on the DebtX platform. The service offers secondary CRE loan market commentary and origination spreads, CMBS loan collateral prices and asset valuation approaches.

"DXMarket Data(SM) gives loan buyers an edge by providing additional analysis from a team of experts with unmatched insight into the world's largest and most liquid marketplace for whole loans," comments DebtX ceo Kingsley Greenland. "DXMarket Data(SM) provides loan buyers with trade-based market intelligence that isn't available from any other source."

Whole business securitisations

Punch pub deal downgraded

Moody's has downgraded six classes of notes issued by Punch Taverns with a total initial outstanding amount of £1.28bn. They had been placed under review for possible downgrade in October.

Punch Taverns Finance is a whole-business securitisation (WBS) of a portfolio of 3,659 leased pubs across the UK. The transaction closed in March 1998 and has been subject to tap issuances in October 2000, November 2003 and July 2007.

The rating review was prompted by increased concerns regarding the medium-term cashflow generation ability of Punch Taverns Finance's pub portfolio because of the declining annual EBITDA trend on the securitised portfolio and the decreasing operating and profit margins on the estate. On a per pub basis, the normalised turnover for 2009 declined by 4% and the normalised EBITDA declined by 9%, to £59,600 compared to the same period last year. Moody's expects the EBITDA per pub in the transaction to decline by a further 5% to 10% this year, with beer sales declining and profit margins decreasing.

During its review process, Moody's focused its analysis on the securitised pub portfolio's ability to generate sufficient cash flow over the medium-term relative to the outstanding total debt in the transaction. In this respect, it also took into account possible further debt prepayments and note cancellations by the Sponsor (Punch Taverns) of the transaction.

The rating agency expects Punch Taverns to continue to dispose of assets from the underlying portfolio using the disposal proceeds mainly to further de-leverage the transaction through loan prepayments as well as repurchase and cancellation of debt. The borrower has flexibility in choosing which classes of notes to purchase, irrespective of seniority; therefore, Moody's notes that there might be some rating variability with respect to changes in the capital structure of the transaction as a result of further debt cancellations.

However, should the DSCR fall below 1.35x, the borrower would have to apply parts of any disposal proceeds towards prepayment of the loans. Such prepayments would be allocated to the notes in their respective order of seniority - the floating rate notes first and the fixed rate notes thereafter.

As of end-2009, the DSCR for the rolling one quarter was 1.52x and for the rolling four quarter was 1.55x. Both ratios were above the default covenant of 1.25x, but declining and getting close to the restricted payment trigger of 1.5x.

ABS

TALF post mortem

John McElravey, senior analyst at Wells Fargo Securities, expects a more stable ABS market – albeit with structural changes adding uncertainty – to emerge post-TALF

The Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF) completed its final consumer ABS subscription period on 4 March and the programme officially ends on 31 March 2010. The Fed leaves the consumer ABS market in better shape than it found it when TALF was first proposed in late November 2008. However, TALF's direct effect on the ABS market was probably less important than its indirect support.

In our opinion, TALF's real contribution was providing a foundation for the market to restart following the onset of the credit crisis. Issuers could bring new deals to market with greater confidence that they would be completed at economic credit spread levels. For investors, the Fed's programme seemed to provide an endorsement that securitisation was an important financing tool for the economy and that it should continue.

TALF took several months to find its footing and many observers at the time became concerned that it would not provide enough support. Nevertheless, ABS spreads already had peaked in late November 2008, at least for triple-A rated bonds. Much of the spread widening that followed the bankruptcy of Lehman Brothers and the subsequent withdrawal of liquidity from the credit markets had already been recovered when TALF began in March 2009.

For example, spreads on three-year prime auto ABS were around +230bp on 12 September 2008. Spreads in that sector peaked in November 2008 at +665bp (Exhibit 1). When TALF began in March 2009, spreads already had fallen to about +300bp, and they were back to +200bp in time for the May subscription period when TALF lending began to gain traction.

The Fed had never intervened in the credit markets in this way before. The discount window at the Fed was designed to lend primarily against very high-quality, liquid securities. Taking credit risk was never really part of the Fed's playbook.

As a result, it should not have been a surprise that it would take some time for the pieces to come together. Nevertheless, TALF helped to provide a foundation for recovery.

The recovery in the subordinated ABS market took longer, though that segment of the ABS market was influenced by TALF as well. Spreads did not peak until the second quarter of 2009, but once spreads began to tighten they came back in rapidly (Exhibit 2). TALF was part of this process because, in our opinion, it was shifting the risk/reward trade-off in ABS in favour of the senior bonds.

The Fed was offering financing for triple-A securities and offering a put option back to the Fed if the collateral pools performed below expectations. Investors that might have otherwise been interested in subordinated bonds shifted their demand to the senior tranches, in our view, because of the leveraged returns that could be earned. Once triple-A spreads had returned to pre-crisis levels by July 2009, subordinated bonds began to find support and spreads began to tighten in earnest.

The amount of TALF lending hit its stride by the May and June subscription periods, when more than US$10bn of loans were made each month (Exhibit 3). More investors had started their TALF investment funds by then and the dealer community and the Fed had worked out many of the initial kinks of the process.

As spreads tightened in many ABS sectors, the demand for TALF loans dropped commensurately. The TALF programme tended to provide more support for deals that were issued as floating rate bonds (credit cards, floor plans, etc) because spreads on those deals generally remained wider.

This condition was driven in part by the low absolute level of Libor rates so that the all-in yield was low compared to fixed rate bonds unless the spread was larger. By October 2009, the ABS market was operating relatively normally, even for some of the off-the-run asset classes. Issuers could place subordinated bonds on a more regular basis and consumer credit trends had begun to stabilise.

A total of US$59bn of TALF loans backed by consumer ABS were made over the past year. Based on total ABS issuance of US$167.4bn since March 2009, the Federal Reserve provided direct support to 35% of new issue ABS.

Total TALF loans outstanding from the Federal Reserve's H.4.1 release now stand at US$45.7bn as of 10 March 2010. This includes about US$11.1bnof loans backed by CMBS.

Consumer ABS TALF loans outstanding would be US$34.6bn. This amount outstanding should decline over time as bonds mature or bondholders trade out of their ABS positions supported by TALF and repay the loans.

The new ABS market environment
Many observers have been concerned about the effect on the ABS market of the withdrawal of the TALF programme. At this point, it does seem a little anticlimactic.

We believe the ABS market should perform well without the Fed's direct support, though it is unlikely to be as active as it once was. Traditional cash ABS investor demand has returned and we believe it is relatively deep.

Spread volatility has fallen, which should keep valuations more stable. Consumer credit trends are beginning to improve, which could attract additional demand.

However, structural changes in the economy and the credit markets should not be underestimated, in our opinion. They could have an important influence on issuance volume and deal pricing. Some of the factors at work include new regulations for credit card lending, tighter underwriting given the increased costs of origination, changing consumer borrowing behaviour, potential regulation of securitisation and the rating agencies, legislative risk in a number of sectors and the need for issuers to have a specified amount of equity in their ABS deals.

The regulated banking system has been a beneficiary of the credit market dislocation in that it has attracted a substantial amount of new, relatively cheap deposits in a short period of time. A sharp increase in deposits after September 2008 (Exhibit 4) presented commercial bank securitisers with an attractive alternative to issuing ABS, particularly in the credit card sector. We are not yet ready to adjust our forecast for 2010 ABS issuance, but we are watching these structural changes closely for signs of what the future holds for the market.

© 2010 Wells Fargo Securities. All rights reserved. This Research Note is an extract from Wells Fargo Securities' latest Absolute Value publication, published on 12 March 2010.

To view this report in its entirety as originally published, please go to www.wellsfargo.com/research
Wells Fargo Securities, LLC is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. Wells Fargo Securities International Limited is a U.K. incorporated investment firm authorized and regulated by the Financial Services Authority.
This report is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments named or described in this report. Interested parties are advised to contact the entity with which they deal, or the entity that provided this report to them, if they desire further information. The information in this report has been obtained or derived from sources believed by Wells Fargo Securities, LLC, to be reliable, but Wells Fargo Securities, LLC does not represent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgment of Wells Fargo Securities, LLC, at this time, and are subject to change without notice. For the purposes of the U.K. Financial Services Authority's rules, this report constitutes impartial investment research. Each of Wells Fargo Securities, LLC, and Wells Fargo Securities International Limited is a separate legal entity and distinct from affiliated banks. Copyright © 2010 Wells Fargo Securities, LLC.

Trading

Trading ideas: two smoking guns

Byron Douglass, senior research analyst at Credit Derivatives Research, looks at a capital structure arbitrage trade on Altria Group Inc

Our recently launched equity volatility product now allows us to efficiently look across the capital structure of all non-financial companies for potential relative value opportunities. Over the past year, credit and implied volatility completely diverged for Altria Group.

Its CDS is almost double last year's level, while its volatility surface bumps along absolute lows. Even with the overhanging lawsuit potential and the 2008 acquisition of UST, we recommend selling credit protection and buying two-year delta hedged puts on Altria.

A significant divergence between Altria's credit spread and implied volatility is the motivating driver of the trade. Exhibit 1 clearly shows the sharp change that took place back in the summer of 2009.

Our directional volatility model forms the starting point for the valuation of Altria'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 and provides a medium-term forecast for implied volatility.

Considering Altria's factors, we expect the implied volatility of its one-year 25 delta puts to increase from 21% to 29% (Exhibit 2). Altria's credit-implied volatility (CiV) is a driving force in the valuation.

This is largely due to the doubling of its credit spread over the past nine months. However, even if we adjust the company's CiV significantly lower (due to our forecasted credit improvement), its fair implied vol remains four points higher than current market levels.

Our directional credit model forecasts Altria Group's spread to tighten near 40bp; putting the differential between market and expected at an all-time high. The expectation is due to its equity-implied spread, leverage, margins, liquidity and free cashflow factors.

Altria's balance sheet is notably strong. It holds US$1.8bn in cash against total debt of US$11bn and total assets of US$36.7bn. The company's market cap hit a recent high near US$43bn this week.

As indicated by our model, we believe that 114bp for its five-year CDS is more than enough compensation for the credit risk. Up until last spring, the model's expected spread tracked the market spread reasonably well (Exhibit 3).

Because we use equity-implied factors to help forecast changes in credit, we do not necessarily think the model's output of 40bp is its 'true' fair value. We do expect, as stated above, a rise in its equity-implied volatility; therefore, our expectation of its CDS is somewhere between its current and modelled expected spread. We set our target at 75bp.

Hedging risk: Given that the volatility portion of the trade is motivated by a medium-term forecast of volatility, we recommend buying options with at least 12 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. Altria's options are extremely liquid, even out to two years.

Position
Sell US$1m notional MO 5 Year CDS at 116bp.

Buy 500 lots Jan 2012 US$15 strike puts delta-hedged at US$79/lot, 20.62% implied vol, 21.8% delta and equity price of US$20.365.

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).