Contents

ABS

Continued bid

Canadian ABS to survive BDC programme end

Canadian securitisation is expected to survive after the Business Development Bank of Canada (BDC)'s credit facility for equipment and auto financing expires on 31 March. Similar to the US TALF programme, the Canadian Secured Credit Facility helped jumpstart an ABS new issue queue in the country in the wake of the credit crisis.

Some market participants had expected the Canadian programme to be extended beyond the 31 March deadline, but Paula Cruickshank, vp of securitisation at BDC, says the programme will not be extended. A 30-day grace period will be allowed if an issuer is already working on a deal, however.

The Canadian programme, like its US counterpart, is deemed a success by Canadian securitisation analysts and investors alike. Issuers used about C$4bn out of a C$12bn allocation set out by the BDC.

Unlike TALF, however, the Canadian securitisation programme funded the issuers instead of providing a lending facility for investors. Since the Canadian market is smaller than the US', officials believed a direct purchase rather than assisting investors would be more effective in stabilising the market, according to Cruickshank.

"It was a different orientation, but it seems to have had the same positive effect," she says. "In the Canadian market, there was no bid during the crisis. It was important to establish a bid and we were the bid."

The focus of the Canadian programme, however, was on equipment and auto financing and excluded credit cards - unlike the US lending facility that included all sectors of the consumer ABS market. "We think the programme provided a benchmark for investors and also for issuers in terms of pricing that didn't exist in the market prior to our participation," Cruickshank continues.

GMAC Canada, which closed its C$1.7bn Canadian SWIFT Master Auto Receivables Trust Series 2010-1 last week, was a notable taker of the programme. The floorplan receivables offering followed a Canadian Capital Auto Receivables Asset Trust II (CCARAT) deal earlier this month and several issuances that surfaced in 2009.

"For a period there, the market was pretty closed, but investors have shown more interest," says a credit analyst. "The government programme did help."

"Even in the pre-crisis days, Canadian securitisation volume was never very heavy, but the BDC did assist in getting deals done," adds an investor. The BDC has also encouraged small and large companies to tap into the financing it offers for entire purchases of new or used equipment.

Though enhancement levels are considerably higher compared to where the same offerings could have come a year ago, according to the credit analyst, all of the deals that came in 2010 and 2009 carried a triple-A rated tranche. GMAC's SWIFT deal, for one, consisted of 50.7% overcollateralisation along with a cash reserve initially equal to C$17m.

But both Ford Canada and GMAC Canada were able to bring non-government assisted offerings, as well as government-assisted deals - a sign that there are enough investors interested in the securities. Ford, for one, did not want to use the programme again, having come last June and this year, notes the credit analyst.

"Ford had a good story and it wanted to take advantage of that. For some of the other issuers, depending on whether their book gets big enough, they could do private deals," he says.

The Canadian ABS market does not have much of a secondary market for the securities, which is also a challenge for new issuance. It historically did not have much of a subprime auto market either.

Even smaller issuers, however, have seen investor interest brewing for their deals outside of the BDC-supported bid. In January, US leasing company PHH brought a C$363m fleet leasing receivables trust offering via its wholly owned Canadian fleet management business, PHH Vehicle Management Services.

In the offering, BDC purchased C$91m in class A-2a notes. The rest was purchased by outside participants.

KFH

CLOs

Increasing activity

European CLO market activity in the week to 30 March

The past week has seen much positive activity in the European CLO sector in terms of pricing levels and underlying collateral performance. However, while increased end account participation is driving both improved trading volumes and prospective new issuance in the core market, the SME CLO sector continues to lag behind.

Current CLO trading levels have improved on the softness seen earlier in the year. One investor confirms: "When March came, and especially since mid-March, we have seen a lot of new interest." In particular, levels within the mezzanine segment have improved, lessening the barbell-effect seen in the market over previous months.

"Last week was probably the first week in over two months that we've seen significant demand in the mezz space. Prior to that, we had seen quite a bit of demand in both the senior part of the capital structure and also in lower tranches and the equity piece, but the middle was lagging behind in investor demand and consequently in any spread tightening or price appreciation," the investor says.

The renewed interest is said to be driven by real money accounts, ending the prolonged run of predominantly dealer-based activity. The investor explains: "While previous investor interest was from opportunistic hedge fund investors, we are beginning to see more interest from real money accounts. That's quite an interesting development because since late-2009/early-2010 everyone has been anticipating a significant amount of real money investment, which would be the next trigger or catalyst for spreads tightening and taking prices to the next level."

For the time-being price levels are still fairly healthy. "Over the past week we had single-As trading at high-50s, which is not exactly where January highs were, but they are getting very close to that. We've seen double-As at the mid-70s to high-70s. Even the lower part of the structure, at equity level, has traded very well," the investor says.

In particular, US-originated transactions have performed well. The investor says: "Over the past week the Blackstone deals were well-bid. Alcentra was very close and in its segment did quite well. We looked at the Oakhill triple-Bs, which - like Blackstone paper - were in the very high-50s and almost close to touching 60s."

In addition to increased end account activity, the investor believes that "performance is looking even better now as underlying collateral has improved". He adds: "Overall, what we've seen is a good positive trend in terms of improving fundamentals in CLOs and a continuing trend of improving OC ratios. Deals which had their cashflow cut off and had breached their OC tests are now beginning to come back in terms of performance. Some of them are already cash-flowing, which we think is a very good trend."

The investor continues: "All these factors have added to the positive undertone in the market and support the emergence of new issuance. Although it had previously been suggested that new issuance would come in Q1, the market has lagged somewhat, but I think we are now quite close to seeing new issuance. From our conversations with various managers, I know of at least two deals that are in the works. We've been shown one of them already and we're currently looking at it." Meanwhile, US CLO, COA Tempus CLO, priced this week (see SCI CDO database).

Although the CLO sector generally has shown positive growth, trading volumes for the SME CLO market have remained low since the beginning of the year. UniCredit director Thomas Bremer explains that pricing is still very deal specific in this segment.

He says: "There are high quality, granular transactions which are trading in the area of 150bp and there are transactions trading around even +1000bp. Many Spanish transactions that have a high proportion of real estate and high coastal exposure are trading still on wide levels."

As a result, Bremer believes that current market conditions are not conducive to new issuance in the near future. He says: "Banks have the possibility of getting much cheaper funding from other sources. It makes no sense for banks at the moment, at current levels, to bring new issues. At the moment, the spread differential between senior bank paper or covered bonds and the gap between RMBS and balance sheet CLOs is too huge."

He adds: "For this reason, it makes no sense for a bank to bring in new transactions to the market at a level of plus 200bp for the triple-A side if it's possible to get the funding from the covered bond side far below that."

JA

RMBS

Forbearance to the fore

US RMBS market activity in the week to 24 March

US RMBS market sentiment last week was dominated by the announcement of Bank of America's principal forbearance programme. While the introduction of principal forgiveness has been anticipated by many and described by some as "evolutionary rather than revolutionary", it will undoubtedly impact current and future market activity - not least the continued drive towards new issuance.

One ABS analyst explains that early last week remittance reports for some deals indicated losses as a result of the principal forgiveness. Although initially these losses caused concern, it has since been followed by an official announcement from BofA - the largest mortgage lender in the US - that it will introduce a programme of principal forbearance for subprime, pay-option and prime two-year hybrid mortgages beginning in May.

The analyst notes: "Basically, the programme involves forbearing principal as a modification - if the borrower continues to pay, they'll slowly earn forgiveness, in the sense that the forbearance amount will be written down over a five-year period."

An RMBS portfolio manager comments on BofA's announcement: "One wonders: why so late? It's often a better choice to deal with the existing borrower, if they have a level of income, than going through a long process of repossessing and selling. In addition, the borrowers are going to cooperate more if they know that there's something in it for them and that they know there may be hope."

The analyst points out that although sentiment has improved across the higher quality spectrum, the news regarding principal forbearance may mean short-term disruption in the market. "Generally, pricing has improved across some of the better quality products. It's not too noticeable though because the moves are within a point in price. But definitely the tone is better. This news will probably slow things down and put the break on price improvements, which means that - until there's more clarity around this - the cash market in general will probably lag other credit markets," he says.

In terms of the immediate market impact, the analyst adds: "The loss hits the trust right away, so I think that has shaken up the market a little bit, most likely in the HELOC second-lien market. Second-lien products become a concern once principal forgiveness comes into play because it then becomes a question of whether or not they actually forgive or write-off the second lien entirely. I think in that market we're already starting to see bids come out that have a softer tone."

The portfolio manager adds that despite the initial market disruption, the move towards principal forgiveness will ultimately benefit the market. He says: "The good part about this is that forbearance would create write-downs in the lower tranches and that in some ways cuts off cashflows if there's still any going on down there. It also extends the front-cashflow because they're now going to get the cash slower."

He continues: "This creates an urgency to unclog the system to some degree. I think that would reduce the number of foreclosures, which would ultimately help the market. Everybody who is rational would have come to this conclusion a year and a half ago."

In terms of new RMBS issuance, the analyst believes that within a few months new securitisations are likely to be announced. He says: "It seems that there are a lot of dealers that are close, perhaps within half a point, to being able to potentially have a first attempt at a securitisation. I think at this point there's a lot of back-and-forth with the rating agencies."

The analyst explains that any new securitisation is likely to be very safe. "It might be small. It will definitely be very clean; for example, jumbo collateral and loans with a 55% LTV. But it's a first step to see how the market will take it," he notes.

"We are slowly moving towards where we could see some sort of deal come out. I wouldn't be surprised to see something over the next few months. All the desks are trying to do the same thing," the analyst concludes.

JA

ABS

Active Euro ABS investor base analysed

The European ABS investor base is dominated by UK and Dutch tactical investors, according to a recent survey carried out by ABS analysts at Barclays Capital. They note that this investor base is stable but unlikely to see much, if any, growth this year.

"As things stand, we do not expect much of an expansion of demand for European ABS bonds this year: the tactical investor base in the UK and the Netherlands is barely growing, and demand from other investors is likely to remain minimal," they say. "New mandates will remain equally rare in light of the tarnished reputation of securitisation generally."

BarCap's survey shows that investors based in the UK and the Netherlands are vastly more active than investors in any other European jurisdiction. In part, this is attributed to the fact that these two jurisdictions were among the last to introduce covered bonds legislation and have traditionally relied on securitisation rather than covered bonds as mortgage-specific funding instruments.

The active investor base in Southern Europe is so small that bond demand in these jurisdictions, particularly in Spain and Italy, appears to have recently come mostly from originators rather than investors - usually in the form of public tender offers or private buy-backs. To the extent that demand from investors exists in countries such as Spain and Portugal, it appears to be frequently subject to a strong home country bias. Furthermore, there are very few active investors in France, Germany and Scandinavia, and demand from other jurisdictions - including Ireland - is effectively non-existent, BarCap says.

With the primary investor base being made up of roughly one-third banks, one-third insurance companies and one-third funds, BarCap divides the types of investors into three distinct groups - strategic investors, tactical investors and opportunistic investors.

The strategic investors, the bank says, prefer to have long-term investment strategies and, consequently, tend to invest only in asset classes they believe will remain important for the foreseeable future. "Most strategic investors are unsure of the future of ABS in Europe and, consequently, are disengaging from the asset class, suggesting that demand for bonds from this part of our investor base is and will be non-existent," the analysts explain. "However, at the same time, they are not forced sellers (in part because some of them benefit from government bailout funds) and only let go of bonds whenever doing so is profitable."

By volume, BarCap classifies the majority of holders of ABS bonds in Europe as strategic investors. Opportunistic investors, which entered the ABS market during H109, now appear to be mostly limiting their activities to bonds lower down in the capital structure of CMBS and possibly UK non-conforming RMBS deals. Hence, demand from opportunistic investors for European ABS at current prices is very limited.

Tactical investors, on the other hand, are more than happy to invest in ABS so long as the asset class offers attractive value relative to neighbouring asset classes, such as covered bonds, bank FRNs (and possibly corporate FRNs) and senior unsecured bank paper. "While the tactical investors were very successful with this investment approach last year and likely will be fairly successful again this year, they almost never have permission to grow their ABS investment portfolio and are limited to re-investing the amortisation cashflows generated by their existing portfolio," comment the analysts. "In addition, they are often limited to investing in senior bonds only and are frequently barred from investing in sectors seen as excessively risky, such as CMBS and UK non-conforming RMBS."

The tactical investor base is finding it uniformly difficult to attract new mandates for European ABS investments, according to BarCap. Hence, as far as new money entering the asset class is concerned, the picture remains bleak.

The analysts suggest that to grow demand for European ABS, investors currently in the strategic category would have to be convinced to at least move into the tactical category. "That would appear to be a difficult task: banks that have benefitted from public funding for their ABS investments effectively cannot buy more ABS while this arrangement persists," they explain. "More generally, strategic investors are highly unlikely to change their stance unless they conclude that the future of ABS in Europe is assured. In light of the fact that upcoming regulation for banks, insurance companies and possibly now also for the fund industry continue to keep regulatory risk in our asset class at an all-time high, such a change in view would appear highly unlikely (as well as ill-advised) for now."

AC

CDS

Falling correlation monitored

A significant portion of the fall in default correlation has now taken place, according to structured credit strategists at Morgan Stanley. At the same time, equity market correlation remains high, but there is good reason to expect lower equity market correlation in the medium term.

The implied default correlation on the first-loss tranche on CDX has dropped from a 60% range in August 2009 to a mid-30% range today. A fall to the sub-20% range observed in the last cycle is unlikely in the medium term however, says MS, given expectations of flows in the structured credit markets.

"We believe that the reduction in credit default correlation from the 60% range to the mid-30% range represents a significant shift, driven by flows in mezzanine tranches, as well as tighter spreads and less IG tail risk," they note.

In equity markets, realised correlation levels are in the +/- 40% range (for the S&P 500 index), as they were in the summer of 2009, and off the slightly higher levels during the Greece sovereign debt fears in early February. These realised correlation levels have fallen from 70% when equity market volatility peaked in the autumn of 2008. However, implied correlation (as measured through options/volatility on the S&P 500 constituent names) remains high (in the low 50% range), about where it was last summer.

Morgan Stanley continues to believe that there is room for this relationship to heal in the medium term. "There are two market data points that indicate that [equity market] correlation could fall going forward. First, realised correlation remains low (37%) relative to implied correlation in the low 50% range, a gap that is among the widest we have seen," the analysts explain. "We do caution that we had a similar gap in the summer of 2009 and implied correlation has still remained high."

Second, the correlation skew curve is steeply sloped today, more so than it was last summer or during the financial crisis. This suggests that there could be significant moves in correlation as the market moves; for example, a 10% move higher in stocks would imply around an 8% fall in correlation.

In discussing why credit correlation fell while equity correlation remains reasonably high, the strategists suggest that it is a function of several factors as well as market flows. "In credit, investors have been indirectly selling correlation by getting long mezzanine forms of structured credit, which is protected from first-loss exposure. Such a trade is effectively a strategy that implies a certain amount of default risk coupled with a healthy broader market, i.e., a low correlation event," they note.

In equities, implied correlation has remained high partly because investors have been hedging macro-type risks at the broad market level where it is cheaper, while asking for less protection at the single name and sector levels.

With the repricing of credit correlation, Morgan Stanley favours principal-only forms of first-loss tranches, given that they are a more conservative way of getting long the bottom part of the structured credit capital structure. The strategists highlight some PO trades in both CDX IG and iTraxx, where pricing ranges from the single-digit range for 10-year IG9 to 60% for shorter-dated iTraxx 9.

"Given low dollar prices and reasonably attractive IRRs in low default scenarios, we think these are a good way to get long equity tranches and we would favour some of the five-year type opportunities here, particularly on healthier portfolios," they conclude.

AC

Insurance-linked securities

Hurdles remain for life settlement securitisations

Far from its growth spurt in 2005 and 2006, life settlement as an asset class still holds some challenges as well as opportunities as markets pull out of the recent credit crisis. But ahead of the development of a securitisation market, issues regarding the underlying collateral still need to be resolved, according to panellists at an IQPC life settlements conference in New York.

There are both qualitative and quantitative reasons holding back the life settlement asset class from securitisation compared to other asset classes, says Manish Kapoor, managing principal at West Wheelock Capital. It's a negative cashflow asset, which presents challenges, he says.

Market participants could possibly securitise pools after they own the policies for years and have positive cashflows but that is still questionable, says Emmanuel Modu, md and head of ILS at AM Best.

But without a fully functioning underlying market, hopes for securitisation may be cut short. As one life settlements investor says: "In a functioning market, securitisations are terrific. But this is not a functioning market yet."

Transparency remains an issue. Investors, for example, are interested in how each insurance policy was originated, while insurance companies are not always forthcoming with their data.

If there were better data from insurers, it might help with improving some liquidity in the market for life settlements, which sometimes sees bid/ask spreads as wide as 10bp, notes the investor.

VBT tables, for example, are based on the general population, but those involved in life settlements are different from the general population, which can result in basis risk, notes Kapoor. "The life expectancy number is important, but you need to understand the shape of the [bell] curve and the part of the curve you are at. We need better data," he adds.

Enhanced servicing on the asset pools of the portfolios would also go a long way towards helping with securitisation. According to Modu, the focus is on servicing lately, especially since portfolios are ageing.

"There are some pools out there that are not being serviced with outside providers; hopefully, that will change," says Kapoor. The collateral goes to zero if one payment is missed, he adds.

Another stumbling block for the asset class is that since life settlements in the US are regulated at the State level and not the federal level, laws differ among the States. Uniformity among States would be helpful, says Kapoor.

The asset class, however, also has no natural long-term buyer in significant notionals, such as a Fannie Mae or Freddie Mac in the mortgage sector. Still, some private securitised deals could get eventually developed.

Kapoor says private tranching life settlement deals could get done in 2011, but he does not expect a publicly rated offering anytime soon. Ratings for such a securitisation are likely to be at the triple-B level for the senior piece, which would not be too competitive against other rated ABS asset classes.

The volatility of the cashflows in such a product is partly the reason why participants expect so few rated offerings. The securities would have to see much more than 300 lives, for example, to keep the cashflows stable, adds Modu. The collateral also has a lot of correlation between policies.

Other panellists also expect one or two private deals to come, but most likely they will be completed in 2011.

"Transaction costs are high, but that can be overcome," notes Modu, who believes 144A deals possibly could occur but not publicly rated offerings just yet.

Despite the current hurdles to securitise the asset class, participants at the conference expect overall interest in the life settlements market to grow. Insurance companies themselves, high net-worth retail investors, private equity and multi-strategy hedge funds have all been interested in the market lately, the panellists say. However, most expect European investor interest to dominate over US interest currently.

KFH

Investors

New source of investors seeking SF exposure

Several consecutive months of positive returns reported by permanent capital vehicles with exposure to structured credit and ABS (SCI passim) assets have resulted in growing investor interest in these companies' shares. Increasingly, it is new, more mainstream investors, such as UK income funds, that are looking to tap the sector.

According to industry insiders, a number of brokers - representing clients who want to get involved - have contacted permanent capital vehicles that invest in structured credit and ABS, such as Volta, Tetragon and Carador. "This is an interesting development as it is bringing a new type of investor base to this area of the market," says one portfolio manager. "Permacaps are generally not very liquid, so as soon as you start getting income fund/equity guys looking to get involved, it makes a difference."

Another manager confirms that he has received frequent requests from investors or brokers that are looking for information on his vehicle in recent weeks. "Permanent capital vehicles tend to trade at a significant discount to their GAV, so it should be considered by investors as a good way of having exposure to these assets through a diversified vehicle that pays regular cashflows," he explains. "It's not surprising that income funds are looking at getting involved."

The portfolio manager suggests that the new influx of investors in the vehicles' shares could shift the dynamics of the structured credit market to some extent. "Say a listed vehicle raises money to seed a CDO or CLO: that money may be coming from a UK income fund and would therefore be indirectly seeded by these new investors. It may almost change the way the market works," he says.

"However, this is not going to happen over night," he adds.

Indeed, the much anticipated revival of the primary CLO is still yet to materialise. Despite rumours that up to three European CLOs are waiting in the wings (see also separate Market Report), one CLO manager confirms that, at present, he's not aware of anything being actively marketed in the European CLO space.

"What we are seeing is a couple of banks trying to sell some of their own portfolios to managers," he says. "Initially they came to us with a portfolio almost like an asset trade - this didn't work. The next step was for them to offer managers the chance to manage the portfolio. This has more chance of happening as managers will be tempted to be the first in the market with a new CLO."

Another CLO market participant adds that any new CLO issuance in 2010 will be anecdotal, with deals that do make it to market backed by legacy portfolios, given that the LBO market has yet to produce enough supply for new deals. "Banks with these legacy portfolios will only go to the big-name managers," he concludes.

AC

RMBS

American General deals no panacea for what ails MBS

Two MBS offerings lining up for American General Financial Services are not exactly causing a rethink of the stalled MBS new issue market. Investors and analysts waiting for the Alt-A legacy deal and the subprime mortgage offering say it is a telling sign that the MBS market has a long way to go before a "come-back" can even be whispered.

The deals are expected to be sizable, given that the issuer's last offering via Credit Suisse in July consisted of US$1.5bn whole loans. RBS Securities will lead-manage American General's Alt-A legacy deal, while Deutsche Bank will lead-manage its subprime deal, according to a source familiar with the offerings.

Similar to its last offering that had about 25% subordination, these deals are also expected to feature high subordination - which is causing some market participants to view the offering as an interesting development, but no real start to the new issue MBS market. Other recent 144A MBS deals with seasoned loans also had high subordination, with some in the 40%-50% level, notes one MBS analyst.

American General's July offering consisted of prime-like collateral with four years worth of seasoning. "These deals used to get done with 5%-7% subordination, so now we're talking four or five times that. It's not the return of the non-agency market with such high subordination. They are paying an exorbitant amount of credit enhancement just to get the deals done," the analyst says.

American General's last offering also consisted of FICO scores that averaged 698, though 35% were below 700, making it a barbelled credit.

According to one MBS strategist, the pending offerings are "a financing trade securitising legacy assets". He expects that the issuer will keep quite a sizable part of the offering itself, like it did last July.

Part of the subordination will also need to be added to compensate for roll rates for delinquencies. The roll rate is still 1% or 2% a month, notes the strategist.

However, the hefty size of the deal is expected to bring out buyers. "Because there is such good demand for re-REMICs, if they structure it to a triple-A rating and people are comfortable with the collateral, banks and insurance companies will definitely look at it," he adds.

Spreads on these offerings are also likely to be better for the issuer compared to American General's last deal. A lot of these transactions are coming inside a 5% yield, says a structured finance investor.

However, the market for new issue securitisations still doesn't have legs yet. But if there were new securitisations from what is actually being originated currently - jumbo prime loans - the deals would be viewed very positively in the market, adds the investor.

"The challenge has been, given how conservative the leverage ratios are in the transactions and given where the interest rates are on the actual underlying assets, that it doesn't quite make economic sense," the investor says.

Other banks are expected to be bringing some kind of MBS offering similar to American General's. "Many investment banks are focused on finding an origination piece that makes sense, so they can put it into securitisations, since there is a lot of demand for them," the investor continues.

Bank of America Merrill Lynch, for one, could be among these banks, since it filed a recent shelf registration with the SEC. The filing cited a senior-subordinate deal with mezzanine bonds, according to the analyst.

"People are definitely trying to find a product that has a little bit of a higher coupon, but still very good credit. They are working with the rating agencies to get a little less credit enhancement," notes the investor.

But not all MBS market participants have securitisations in their sights. "From a cost-effectiveness standpoint, the economics still favour holding loans on balance sheet to securitising off balance sheet," the strategist concludes.

KFH

Trading

High-touch coverage

Mike Foggia, evp, and PK Jain, md, at Advisors Asset Management, answer SCI's questions

Q: How and when did Advisors Asset Management (AAM) become involved in the structured credit market?
MF: Advisors Asset Management is a diversified broker-dealer with a growing separately managed asset accounts group that has been in business since 1979. About 10 years ago the partners at AAM established a fixed income platform, with the aim of serving a niche in the retail sector that was underserved in terms of outsourced financial solutions - independent advisors. The idea was to bring an electronic pipe that aggregated Street bond offerings into retail shops and apply a high-touch coverage model on behalf of the broker-dealers they worked for.

We established a dedicated marketing team to service the sales reps and administer the
Mike Foggia                  compliance and education functions on their behalf. These days plenty of broker-dealers offer the pipe, but not the high-touch service - which has given us an edge.

Now we have service agreements with 90 independent broker-dealers that employ around 45,000 financial advisors. This coverage includes the broad fixed income spectrum, from retail CDs to securitisation product, with these flows being at the heart and soul of the company.

AAM was historically a client of Merrill Lynch, where Rick Perretti - now also an AAM evp - and I previously worked. About four years ago, AAM ceo and cio Scott Colyer met us both to talk about potential new product going into the AAM pipe and this evolved into a small equity infusion into the firm from Merrill Lynch. We developed a close relationship, which ultimately led to Rick and I moving to AAM.

Q: What are you focusing on at the moment?
MF: Five years ago the firm expanded into the advisory business by acquiring a unit investment trust sponsor, Matrix Trust, which enabled us to launch our own-branded UITs and sell them into bulge-brackets, independent brokerage firms and retail RIAs. From this foundation, we began offering separately managed accounts as well. We currently have a US$2.5bn 
Robert Sainato, John Sullivan and PK Jain                                                                   structured product sub-advisory mandate and are aggressively building this out via institutional and retail referrals.

Our focus at the firm is establishing an institutional sales platform, which we began in Q408 - helped by the problems being experienced at that time by bulge-bracket firms. Our New York-based institutional business is split across three buckets: municipal bonds (accounting for around 50% of our retail flow); corporate debt; and structured products/mortgages, which is run by PK, together with Robert Sainato and John Sullivan. We have been able to leverage institutional flows from our strong retail flows.

Q: How do you differentiate yourself from your competitors?
MF: We can be creative and flexible around product mandates, including incorporating securitisation and credit-linked exposures into our offerings. Another of our strengths is having extremely robust buy-side analytics and modelling tools, which translates to unbiased opinions when it comes to advising clients.

PKJ: Our analytics are as strong as those of bulge-bracket firms, yet we're willing to work with smaller clients and provide them with the same level of service - the bigger shops can't do this. This is important because smaller clients can be as sophisticated as institutional customers, but the size they trade isn't as big, so they don't get the attention from large firms. In addition, our product engine is more sophisticated than those offered by most regional broker-dealers.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
MF: The synergies from retail clients has taken longer to cultivate for securitised products because they're more complex, but flow in lightly structured deals should create a foundation for us to build upon. Our team has a wide mandate in terms of product set with which to build out our ABS/MBS capabilities.

The next step for us is to build out an emerging markets platform - first in Latin America and then Eastern Europe. We're in the process of doing due diligence on those opportunities.

PKJ: In terms of the macro-environment, markets appear to have snapped back faster than fundamentals would suggest. Liquidity and capital have returned quickly, which means that firms that beefed up last year are now facing tighter margins.

Smaller shops don't necessarily have the wherewithal to make it and so we'll see a consolidation among regional broker-dealers, with some falling by the wayside and a displacement of personnel occurring. Some will end up at bulge-bracket firms again.

However, our model - based on diversity of client coverage - should enable us to continue expanding in this environment. We'll be buyers of talent in this market.

Q: What major developments do you need/expect from the market in the future?
PKJ: With banks continuing to rebuild their balance sheets and the asset overhang remaining, there are still opportunities to be had in the market dislocation. Our portfolio advisory work should help us in this environment: our model can handle many different line items, which is important given the scale of assets/liquidations coming to the market.

In general the market can absorb these liquidations - non-bank lender appetite has returned for these assets, with credit funds, private equity shops and hedge funds all getting involved from a total return basis. Activity includes robust demand for mezzanine and equity assets.

Importantly, certain segments of ABS new issue supply have also been revitalised, thanks to re-REMIC technology and government support.

But all of these developments could be derailed by overzealous CDS regulation; for example, if every trade is driven onto an exchange. This would hurt prop trading and market-making for bulge-bracket firms, and would force costs to be passed on to customers.

We're more concerned about potential market set-backs than regulation itself - an overreach could be harmful to the market and won't achieve regulators' objectives.

CS

ABS

ABS flow trader recruited

BNP Paribas has hired Llywelyn ap Gwilym as an ABS securities flow trader. He will join on Tuesday 6 April from Commerzbank, where he was a structured credit trader. He previously held a post at Dresdner Kleinwort as an ABS trader.

ABS

Boutique adds in Euro ABS sales

Jefferies has hired Cyril Paillard as md in MBS/ABS sales in Paris, covering institutional clients in France and Northern Europe. He has eighteen years of industry experience and joins from RBS, where he was EMEA head of credit structured products and solutions sales. He has previously worked for ABN AMRO as head of fixed income sales and EMEA head of credit and alternatives sales.

Johan Eveland and William Jennings, co-heads of global MBS/ABS at Jefferies, comment: "Cyril's industry knowledge, extensive experience and broad base of relationships will significantly enhance our MBS/ABS capabilities in Europe. France and Scandinavia are key markets for our business, and Cyril will make a strong and immediate contribution."

The firm says Paillard will work closely with Marion Guilbert, who joined the London office in mid-2009 as part of the group's international expansion (see SCI issue 149), and will report to Steve Hulett and Craig Tipping, co-heads of European MBS/ABS at Jefferies.

Advisory

Law firm hires SF counsel

Sidley Austin has appointed Antony Bryceson to its London office as counsel, working in the investment funds, advisers and derivatives practice. He joins from Simmons & Simmons, where he led the group that advised end-user clients on prime brokerage, derivatives and trading documentation, and asset protection issues.

Sidley says Bryceson will focus his practice on advising clients on prime brokerage, custody, securities lending, repurchase and OTC derivatives trading agreements and structured transactions involving derivatives, such as swaps on baskets of hedge funds or hedge fund indices and pre-paid forward transactions. He will work with the firm's funds, structured finance and derivatives practices in London, and with Sidley's prime brokerage practice in the US, to provide integrated New York and English law capability in relation to prime brokerage and trading documentation issues to Sidley's clients.

Sidley London partner Bruce Gardner comments: "Antony will work closely with our existing funds team and with our established structured finance and derivatives practices in London. As part of our global platform, Antony will also work with our existing prime brokerage practice in the US to provide dual New York and English law capabilities to our hedge funds clients in Europe, the US and Asia."

CDO

Structured credit pro hired

Heritage Capital has appointed Rolf Friedrich as md in the capital markets group covering Germany and Austria. He is based in London and reports to joint ceos Joseph Dryer and Peter Horbye.

Friedrich joins the firm from LBBW in London, where he was head of international sales, responsible for expanding LBBW's capital market activities outside Germany. He joined LBBW in September 2008 from Wachovia in London, where he helped to build out the bank's European sales effort in structured credit products.

"Rolf's appointment forms a crucial piece in our strategy of increasing our origination capabilities in core European markets, as well as in key emerging market economies throughout the world," comments Dryer.

CDO

RPI in profit

Royal Park Investments (RPI) is expected to book a pre-tax gain of €800m, implying an after-tax potential gain for Fortis of €0.25bn, according to RBS credit strategists. In addition, the vehicle guides for a net profit of close to €200m in 2010, implying a net profit on the Fortis share of €87m.

The equity of RPI - Fortis Bank's spun-off structured credit portfolio - is split between Fortis (45%), the Belgian government (44%) and BNP Paribas (12%).

CDS

FGIC spins off CDS exposure

The second monoline to act last week to mitigate its CDS exposure following Ambac's move (see separate News Analysis), FGIC has announced a series of new measures. It plans to form a new, licensed New York financial guaranty insurance corporation subsidiary dubbed Drop Down Company, which will assume all of FGIC's rights, obligations and liabilities under the FGIC policies covering specified CDS.

The monoline has already entered into a commitment with seven counterparties to mitigate mark-to-market termination payment exposure to CDS totalling approximately US$11.7bn. However, it anticipates that other CDS counterparties may join the agreement and, as a result, FGIC policies held by such counterparties with up to an additional US$1bn net par in force may be assumed by the new company.

FGIC will not have any existing or future liabilities under the policies assumed by Drop Down Company. The monoline will capitalise Drop Down Company with US$75m and, in consideration for the assumption of the FGIC policies by Drop Down Company, will pay it an amount equal to 1.5% of the gross par amount in force with respect to such policies as of closing, less US$75m.

The New York State Insurance Department (NYID), which originally gave FGIC until 25 March to remove the impairment of its capital and to return to compliance, has extended its deadline to 15 June 2010.

The seven CDS counterparties with which FGIC has already come to an agreement have agreed to forbear from exercising certain acceleration, termination and assessment rights under their CDS contracts until 31 July 2010 or the occurrence of certain specified events. The agreement further provides that the CDS counterparties would waive all early termination rights existing as of the closing date under all CDS held by them (but not any early termination rights that may arise following the closing with respect to such CDS that are not covered by the FGIC policies assumed by Drop Down Company) and would modify all future early termination rights under the CDS covered by the FGIC policies assumed by Drop Down Company. This is provided that each CDS counterparty retains the right to terminate the CDS due to the appointment of the Superintendent of the NYID as rehabilitator or liquidator of Drop Down Company or the issuance of an order by the Superintendent to Drop Down Company establishing a moratorium on the payment of claims.

The closing of the proposed transactions is subject to various conditions, including approval by the NYID and the acceptance of the offer to exchange certain RMBS and ABS insured by FGIC for cash and uninsured securities.

On 25 March Sharps SP I launched an offer to exchange 119 different CUSIPs of RMBS and ABS insured by FGIC with an aggregate unpaid principal balance of approximately US$9.6bn. Sharps is offering to exchange the insured securities for a combination of cash and certificates. The offer will expire on 29 April.

CDS

EM credit trading desk prepped

Macquarie Group is believed to have hired two senior traders from Citi ahead of its launch of an emerging markets credit trading desk in London. Steve Gooden and Thomas Blondin are expected to be appointed to newly-created roles in the coming weeks, trading cash instruments and CDS referencing emerging market sovereigns.

CLO Managers

US manager sells CDO management rights

Crystal River Capital has entered into an agreement with Ranieri Partners Management under which Ranieri will become replacement manager on Crystal River CDO 2005-1 and Crystal River Resecuritization 2006-1. Ranieri has also agreed to purchase five CMBS from Crystal River Capital.

Ranieri will pay US$8m for the sale of the assets, of which US$2.5m was paid upon the sale of the five CMBS bonds. US$2m is to be paid upon the transfer of the 2006 CDO's rights and US$3.5m will be paid upon the transfer of the 2005 CDO's rights. Crystal River also agreed to grant to Ranieri a right of first refusal to purchase all or any portion of its interest in two CMBS if the company sells those securities in the future.

The completion of the transactions is subject to various customary closing conditions, as well as the execution of definitive documentation.

CLOs

New addition to boost US sales strategy

Naseem Haffar has been hired as US head of loan sales and trading for SG CIB. Haffar has a wealth of experience selling credit instruments and joins the firm after more than 10 years with JP Morgan Securities, where he was credit sales md. He will be based in New York and report regionally to Arnaud Achour, head of capital markets and syndicate for the Americas, and to Alvaro Huete and Ghislain de Brondeau, global co-heads of syndicate and loan sales and trading at SG.

SG says Haffar will use his expertise working with hedge funds, institutional investors, CLO managers and commercial banks to spearhead sales and trading efforts in the US as the firm expands its debt platform in the region.

CMBS

REITs tap final TALF CMBS subscription

Two REITs have announced TALF-funded CMBS investments ahead of today's (31 March) conclusion of the programme for legacy assets. Dynex Capital says it purchased US$45.8m in triple-A rated CMBS issued in 2004 and 2005 during the March subscription period, while Apollo Commercial Real Estate Finance (ARI) acquired triple-A rated CMBS totalling US$104.7m.

Dynex borrowed US$38m for three years under TALF this month, at a rate of 2.72%. In total the company financed US$60.8m in triple-A rated CMBS issued in 2004 and 2005 under the programme, with US$50.8m in three-year funding at a weighted average rate of 2.73% and an estimated leveraged return on invested capital of 14%.

Dynex chairman and ceo Thomas Akin comments: "We are quite pleased with the credit profile of the CMBS and the TALF funding allows us to finance these assets on a non-recourse and non mark-to-market basis for three years. We believe that there will continue to be attractive investment opportunities across the RMBS and CMBS markets, both agency and non-agency, for 2010 at excellent leveraged risk-adjusted returns on our capital."

The securities acquired by ARI are A2 tranches from four securitisations with a weighted average coupon of 5.6%, financed by loan proceeds of US$85.3m and a net equity investment of US$19.4m. The TALF financing is three-year non-cross defaulted, non-recourse and non-mark-to-market with an interest rate of 2.72%, resulting in a levered current cash yield of approximately 17.9%.

Additionally, ARI has recently originated a US$26m first mortgage secured by a well-located nationally-flagged full-service hotel in greater Washington DC. The fixed-rate loan has a five-year tenor and an interest rate of 9% amortising on a 25-year schedule, representing an approximate loan-to-value of 58%.

The REIT has now completed investments totalling US$507.7m and deployed approximately US$201.1m, or 96%, of the equity capital it raised in its IPO. To date, the company's portfolio is comprised of newly originated first mortgage loans totalling US$86m, newly originated mezzanine loans totalling US$50m and CMBS totalling US$371.7m.

Apollo ceo Stuart Rothstein comments: "We are proud to announce that with the completion of these investments, ARI has fully-deployed the equity capital raised in its initial public offering. ARI has a portfolio of investments that includes assets in each of its target asset classes and expected returns are at, or better than, original projections."

He adds: "It is important to note that as we continue to see attractive investment opportunities, the company's US$100m financing facility will enable the company to moderately lever the balance sheet and add accretive investments to the portfolio."

ABCP

Stable growth expected for Euro ABCP market

Fitch says the €40bn European ABCP market may see a return to stable growth during the remainder of 2010, after three years of declining issuance. The rating agency covers in its latest sector newsletter the likely impact of the revised Basel 2 guidelines on European ABCP conduits, the latest outstanding ABCP transactions and the underlying asset pool composition for all Fitch-rated European conduits.

"Although ABCP transactions have shown a decline to date, Fitch believes the market is likely to revert to stable growth during the remainder of the year," says Emma-Jane Fulcher, director, Fitch's European structured finance ABCP group. "A return to growth would be driven by increased investor enquiry and the restructuring of ABCP programmes. Fitch's credit outlook for such conduits is stable and largely driven by the structure and tested mechanics of the programmes, the performance of the underlying transactions and in many cases the full liquidity support provided to the conduits."

ABS

ABS market recommendations released

The Association of Mortgage Investors, representing institutional investors and asset managers, has released a white paper outlining its 'guiding principles' to US Congress and regulators on how it believes the ABS market should be overhauled to protect private sector demand for mortgages.

"The time for action is now," says Micah Green, partner at Patton Boggs representing the association. "Investors provide the capital that make securitisation markets work, yet the lessons learned over the last three years demand greater transparency and empowerment of investors for them to be comfortable buying mortgage products in the future."

Green says investors have little access to critical information about their mortgage securities investments and cannot influence their management, which he says is inappropriate, given their fiduciary responsibilities managing the investments of pension funds, insurance companies and others. "It is important for the government to consider the policy recommendations of investors, whose participation and capital are needed for there to be a viable mortgage-backed securities market, particularly if the role of government in the mortgage market could change in the future," he adds.

The association recommends:

• The provision of loan-level information that investors, rating agencies and regulators can use to evaluate collateral and its expected performance, both at pool underwriting and continuously over the life of a securitisation.
• A compulsory 'cooling off' period when ABS are offered, so investors can review and analyse loan-level information before investing.
• Making deal documents for all ABS and structured finance securities publicly available to market participants and regulators.
• Addressing the conflicts of interest of servicers which have economic interest adverse to those of investors.

ABS

Avis could revisit market following multi-tranche deal

Avis Budget Group could possibly return to the ABS markets with another offering by the end of this year, according to an official at the company. Through its Avis Budget Rental Car Funding (AESOP) subsidiary, Avis brought a US$580m auto lease offering last week that featured three- and five-year tranches.

The oversubscribed deal, AESOP 2010-2 and 2010-3, included triple-A rated tranches and subordinate tranches. The 2010-2 US$115.8m offering priced at a spread of 185bp over swaps for the triple-A rated tranche and 400bp over swaps for the Baa2/BBB tranche. Similarly, the 2010-3 US$462.7m triple-A rated tranche priced at 210bp over swaps and the subordinate tranche priced at 425bp over.

The deal was initiated to prefund 2011 maturities, says the official. Its last two offerings in 2009 - a US$450m single-tranche deal last September and a US$450m single tranche deal last July - were done to prefund maturities due in 2010.

The attractive spread tightening is a key reason behind the timing and the size of the offering, he adds. The issuer managed to get an all-in yield on its triple-A rated five-year tranche below 5%, which compares with about 9.5% yield on its three-year offering last July.

Advance rates have also risen on this transaction compared to where they were on Avis' last offerings. The issuer had an advance rate of about 72% on this deal versus advance rates in the 60% range on prior offerings, the official confirms.

The TALF programme has been widely credited with tightening consumer ABS spreads over the past year, but the issuer has not utilised the programme with its previous deals.

Avis Budget Group earlier this month extended the maturity of about US$1bn of its revolving credit commitments by two years to 2013. It has no borrowings currently outstanding on its revolver.

ABS

Assured wraps primary ABS

Assured Guaranty (AGC) has provided a financial guaranty insurance policy for a US$200m auto ABS priced by AmeriCredit Automobile Receivables Trust 2010-A. The AAA/Aa3 one-year tranche was talked at 90bp-100bp and priced at the tight end of guidance, while the three-year tranche priced at 175bp over swaps. This is the first wrapped ABS to hit the market since AmeriCredit's FSA-wrapped transaction in May 2008.

"This is the first public asset-backed transaction we have guaranteed outside of the secondary market for some time and we look forward to increasing our participation in the resurgent ABS market," says Paul Livingstone, senior md for structured finance at AGC.

The issue will be collateralised by approximately US$238m of loans financing automobiles, light duty trucks and vans. In addition to the overcollateralisation, investors and AGC are protected in the transaction by excess cashflow, an interest spread account and limited cross-collateralisation with certain other AmeriCredit transactions. The AGC financial guaranty insurance policy will unconditionally and irrevocably guarantee payments of interest and principal due on each insured distribution date.

ABS

Agency seeks film rating reviews

DBRS is requesting comments on its proposed rating methodology for global film rights transactions, to be received by the end of April. The rating agency will publish a final methodology following the review and evaluation of all submissions.

Unlike financial assets that have long dominated securitisation, film rights are operating assets, so the impact of the operating company generating the assets on asset performance can be significant. DBRS rates film securitisation transactions based on the expected and stressed cashflows to be produced from film rights by assessing: the studio's strengths and weaknesses; the portfolio of film rights being securitised; the strengths and weaknesses of the distributor; and the transaction structure and how it aligns the studio's and distributor's interests with the securitisation transaction.

ABS

Fitch to comply with amended SEC rules

Fitch has confirmed its compliance with a number of amendments to rules governing the regulation of credit rating agencies that are registered as Nationally Recognised Statistical Rating Organisations (NRSRO), which were adopted by the US SEC on 4 December 2009. Amendments to Rule 240 17g-5 involve the sharing of information used in assigning structured finance ratings that passes between mandated NRSROs, arrangers (defined as issuers, sponsors or underwriters) and other non-mandated NRSROs.

The intent of the amendment is to address perceived conflicts of interest that arise from an arranger paying for a rating, via greater disclosure and the possible encouragement of unsolicited ratings by non-mandated NRSROs. These rules, which come into effect on 2 June 2010, will apply to global structured finance ratings published by Fitch.

Specifically, the Amended Rule 240 17g-5 requires the following:

• Each NRSRO to maintain a password protected website detailing all transactions where the agency has been mandated to provide an initial credit rating. Such information must include the name of the issuer, the type of security, the date the rating process was initiated and the website address where the arranger is hosting the information required in the point below. All NRSROs must have access to this information;
• Arrangers to disclose, again on a password protected website, all the information provided to the hired NRSRO both for determining the initial credit rating and for ongoing surveillance; and
• When arrangers hire an NRSRO to rate a structured finance security, they must provide written representation to the NRSRO that they will make this information available on a password protected website, that any NRSRO can access this website and that all information will be posted that covers both initial credit ratings as well as surveillance. An NRSRO cannot rate a structured finance security unless it receives this written representation.

ABS

New pan-European ABS indices introduced

Barclays Capital has launched new pan-European benchmark bond indices measuring both fixed and floating ABS debt. The new benchmark family expands on the bank's existing euro and sterling ABS indices to offer investors a total return benchmark for multi-currency European ABS portfolios. It is a broad-based measure of both the fixed rate and floating rate euro and sterling-denominated ABS markets, covering multiple ABS collateral types including RMBS, CMBS, auto loan-backed securities and credit card-backed securities.

"The Barclays Capital euro and sterling ABS indices are already an important part of the European ABS landscape," says Waqas Samad, head of index, portfolio and risk solutions for Barclays Capital. "These broader pan-European benchmarks are a clear evolution of our market-leading geographic and sector coverage of the fixed income asset class and are just one component of the valuable index, portfolio and risk solutions we are able to offer ABS investors."

ABS

Student loan ABS set for cancellation

Access to Loans for Learning Student Loan Corporation is seeking to amend the Eleventh Supplemental Indenture of the Student Loan Program Revenue Bonds (Series IV) transaction to allow it to purchase outstanding securities at par or at a discount with funds available in lieu of redemption under the indenture. If directed by the Corporation, securities could be purchased at a price not to exceed the principal amount plus accrued interest on the securities and would then be tendered to the trustee for cancellation.

Moody's notes that the execution of the Eleventh Supplemental Indenture will not have an adverse effect on the credit quality of the rated securities, since the supplemental indenture allows available funds to be used to redeem outstanding securities at par value or at a discount and to extinguish them. Furthermore, such purchases could have a positive credit effect on the indenture, especially if they are made at a discount to par value and if the cumulative amounts of such purchases are meaningful.

Repurchases at a discount would reduce the leverage under the indenture and improve parity levels. However, Moody's did not express an opinion as to whether the Eleventh Supplemental Indenture had, or could have, other non credit-related effects that investors may or may not view positively.

ABS

Triple-A ratings possible for Greek SF deals

Greek structured finance and covered bond transactions could achieve triple-A ratings, subject to sufficient protection being put in place, according to Moody's. However, the rating agency says a triple-A rating would be subject to three main conditions.

First, the credit enhancement available to the transaction needs to be sufficient for the pool of collateral to withstand extreme scenarios, including those of potential government debt problems. Second, all operational risks in the transaction should be satisfactorily mitigated. Finally, sufficient liquidity support should be available to protect against the risk of payment default under the senior notes.

To determine the amount of necessary credit enhancement, Moody's considered a few extreme scenarios, such as the crisis in Argentina in 2000, which combined a systemic banking crisis together with a sovereign debt crisis and resulted in inflation exceeding 40% and a real GDP drop of more than 10%. In order to be rated triple-A, a transaction would need to survive a stress that is consistent with such an economic worst-case scenario but specific to the type of the assets in the pool. For example, this would potentially result in required credit enhancement ranges of 25%-45% for residential mortgage, 40%-60% for consumer loan and 45%-65% for SME securitisations.

In the recent review of its criteria for Greek structured finance transactions, Moody's focused on macroeconomic factors that can impact structured finance transactions, particularly those related to the sovereign. In addition to factors typically associated with economic and financial volatility such as business failure rate, unemployment rate, interest rate and market price movements, the rating agency also considered factors related or highly correlated to the strength of public finances and to the local banking system.

Long-term fiscal austerity, availability of credit in the event of a liquidity crisis and even civil unrest would impact the performance of securitised assets. Moody's also considered Greece's membership of the European monetary union, which removes the risk - generally one of the most perilous for investors - of a devastating disruption to the national payment system. The agency believes the risk of a disorderly exit of Greece from the Eurozone is negligible.

Moody's has concluded that a significant stress on these macroeconomic factors, including the government-related ones, would result in severe performance deterioration of securitised assets, but that the deterioration would vary depending on the type of assets in the pool. For instance, a loan to a small enterprise that relies on uncommitted revolving lines from local banks would be more directly exposed to a liquidity crisis than a fully amortising mortgage loan.

On 19 February, the agency placed the triple-A ratings of all but one Greek ABS, RMBS, CLO and covered bond transactions under review for possible downgrade (see SCI issue 173). Both existing and future ratings will need to pass the same stress levels deriving from the analysis of macroeconomic factors, it says.

ABS

Valuation platform adds liquidity metrics

Liquidity metrics for all CDS, evaluated bonds, loans and ABS are to be included in Markit's pricing services. The metrics will be introduced in April 2010 for CDS and evaluated bonds, with loans and European ABS to follow at a later date.

The metrics will include a range of liquidity indicators, such as bid/ask spreads and market depth information, as well as liquidity scores calculated by Markit. The liquidity scores will range from 1 to 5, where 1 indicates the highest level of liquidity.

The liquidity metrics for CDS will consist of bid/ask spread data, market depth information and liquidity scores for CDS entities covered by the firm's end-of-day pricing service. The liquidity scores will be calculated from market depth information, bid/ask spreads and freshness of data contributions.

A liquidity score is being developed for Markit's European ABS pricing service.

Markit will also provide additional liquidity metrics for all 6,500 syndicated loan facilities included in its loan pricing service. The service currently provides bid/ask pricing and depth of contributions and the firm is in the process of developing liquidity scores based on a number of inputs including type of pricing source, bid/ask spreads, size of quotes, depth of observable quotes and freshness of data contributions.

CDO

Euro CDO RACs explored

Increasing demand for rating agency confirmations (RACs) on European rated CDO transactions occurred throughout 2009 due to continuing changes in the market, according to S&P. The rating agency believes that the nature and level of these requests from transaction participants are indicative of the developments in the market since 2007.

The most common RAC requests that S&P received for synthetic structures are in the following broad categories:

• Modification of the counterparty rating requirement;
• Application of the counterparty downgrade language;
• Replacement/change (novation) of a participant;
• Change of portfolio manager;
• Amendment to the transaction documents;
• Collateral substitution;
• Partial redemption or repurchase of notes; and
• Amendment to the swap agreements.

The agency explains that the majority of the RAC requests for synthetic transactions, just below 90%, related to changes of one or more participants in a transaction. In many cases, requests were in response to the short-term and/or long-term rating on that party falling below predefined levels outlined in the so-called 'downgrade provisions' of various transaction documents. In most other cases, such as a change to the portfolio manager, the replacement or novation of a participant's duties was due to reasons involving a merger or voluntary replacement, rather than a rating change.

Approximately 5.4% of changes to synthetic transactions related to adjustments to definitions in the documents and changes to swap agreements, including adherence to ISDA's 'small bang' and 'big bang' protocols.

Changes to the original underlying collateral comprised 4.05% of all synthetic transaction requests. Most of these requests were due to concerns about the quality of the underlying collateral and S&P notes that many involved collateral for money market funds.

In a small percentage of cases, less than 1.5%, the transaction participants sought RACs regarding a partial redemption or repurchase of the rated securities in accordance with the terms of the notes. S&P believes that these were mostly investor-driven requests.

In addition, the rating agency saw a significant demand for RACs on cash and hybrid structures. Given the generally more complex nature of these transactions relative to synthetic transactions, the requests tended to be more varied.

It received RAC requests for cash and hybrid transactions from the following categories:

• Modification of the counterparty rating requirement;
• Application of the counterparty downgrade language;
• Amendment to the collateral management agreement;
• Amendment to the swap agreement;
• Amendment of the liquidity facility agreement;
• Amendment to other documents;
• Effective date confirmation;
• Replacement of a participant;
• Partial redemption or repurchase;
• Novation of a participant;
• To establish tax-blocker subsidiaries to hold workout securities; or
• Issuance of an additional equity tranche.

S&P says that approximately 52% of RACs for cash and hybrid transactions related to modification of the counterparty rating and the application of counterparty downgrade language. These requests were in response to triggers in the downgrade provisions that were in place in the structure. The rating agency assigned RACs when the transaction participants making the request had undertaken the appropriate action as documented, where necessary, within the given timeframe.

Additionally, 7.55% of the requests related to replacement or novation of participant duties, some of which were due to mergers. Approximately 9.5% of these requests related to changes in the transaction documentation, which were mostly clarifying amendments and definitions in the documents.

In addition, roughly 18% of the requests related to changes in a liquidity facility agreement, collateral management agreement or swap agreement. These changes varied from changes to collateral eligibility criteria in the collateral management agreement to replacement of a counterparty under a swap agreement.

S&P points out that unique to cash and hybrid transactions is the provision of an effective date rating confirmation, which the agency assigns in respect of the final ratings on the effective date. It provided such RACs on nine occasions, comprising 4.25% of the cash and hybrid requests.

Some requests did not fall into broad categories and were quite bespoke, such as the 1.9% involving the establishment of tax-blocker subsidiaries to hold workout securities. In two cases, which made up less than 1% of all requests, S&P received requests for a RAC on the issuance of additional equity.

The rating agency also received eight requests, 3.7% of the total, regarding a partial redemption or repurchase (and cancellation) of notes. Investors in these cases requested a partial redemption of their notes from the transaction and this caused the transaction participants to seek a RAC.

CDO

CDO risk model launched

Moody's Analytics has released RiskFrontier 2.4, an update to its portfolio management and economic capital solution, featuring a new CDO risk model. The offering accounts for heterogeneity within collateral pools of structured instruments, covering CDOs, ABS, RMBS, CMBS, basket default swaps and other structured instruments.

"The market convention of treating CDOs and other structured instruments as loan equivalents or homogeneous pools of assets when analysing portfolio and portfolio-referent risk has often been problematic, leaving many portfolio managers with an incomplete view of risk," says Amnon Levy, Moody's Analytics portfolio research md.

Moody's Analytics says that RiskFrontier 2.4 improves the deal analysis module DealAnalyzer and provides greater customisation. "Traders and loan originators can now analyse the impact of different deal structures on a given portfolio," adds Vanessa Wu, portfolio and valuation products md at the firm.

CDS

California treasurer issues CDS dealer RFC

California state treasurer Bill Lockyer has written to Bank of America Merrill Lynch, Barclays Capital, Citi, Goldman Sachs, JPMorgan and Morgan Stanley to request information about the firms' activities in connection with CDS on muni bonds in general and Californian general obligation (GO) bonds in particular. In the letters he expresses his concern about the potential for these firms to both sell Californian GO bonds and trade CDS on them, and indicates that taxpayers have a right to know more about the banks' activities in these markets.

Lockyer points out that California has never defaulted on a debt service payment and that its GO bonds are backed by the full faith and credit, and taxing power, of "the eighth largest economy on the planet". Under the state constitution, debt service has second call on general fund revenues, behind schools.

The revised 2009/2010 state budget projects general fund revenues at US$88.1bn and schools spending at US$41.8bn. Furthermore, GO debt service for the period is projected to be US$5.2bn, suggesting a debt service coverage of more than 8x.

With this in mind, Lockyer questions why spreads on California CDS indicate that GO bonds are 'riskier' than those issued by Kazakhstan or Thailand, for example. "The perception of risk could adversely affect the price of our bonds when we go to market," he writes. "That makes the CDS market important to our taxpayers. That is why I want to fully understand the municipal CDS market in general, the market for California CDS and your firm's role in these markets."

The Treasurer has asked for detailed information to be provided by the banks by the close of business on 12 April on, among other things, their market-making and arranging activity, CDS volume/outstanding notionals, distribution of marketing materials and views as to how California CDS trading has impacted taxpayer borrowing costs.

CDS

Ambac credit event declared, Aiful settled

ISDA's Americas Determinations Committee has voted that a bankruptcy credit event has occurred with respect to Ambac Assurance Corporation (AAC). The move follows the filing by the Wisconsin Office of the Commissioner of Insurance of a petition to take control of the segregated account of AAC. A credit event auction will be held in due course (see News Analysis).

Separately, the final price for Aiful CDS was settled at 33.875 on 25 March under the first Japanese credit event auction. 13 dealers submitted inside markets, physical settlement requests and limit orders. Aiful deliverable obligations are denominated in Yen and US dollars.

CDS

Euro CDS clearer set to open this week

LCH.Clearnet is expected to officially launch its clearing services for European CDS this week. The move follows a period of testing the platform by member banks, including BNP Paribas, Societe Generale, Credit Agricole and Natixis, since its official launch in December 2009.

The service will be managed by Paris-based LCH.Clearnet SA, which is a Eurozone bank and regulated by the Banque de France.

CDS

Approval and caution for EU derivatives regs

The UK House of Lords EU Committee has confirmed its support of the European Commission's plans to regulate OTC derivatives, but believes that regulation of CCPs should be consistent with a global approach. In a new report, the committee states that a balance must be struck between improving stability without increasing the costs of using derivatives to a level that becomes prohibitive.

The committee supports the EC's proposals to increase transparency in the OTC derivatives market by encouraging the use of trade repositories to record OTC derivatives contracts and ensure that all trades are reported. It says that this should help reduce systemic risk by allowing regulators to get a comprehensive picture of exposure in the derivatives market and allow them to identify accurately the misuse of derivatives.

The report also sets out the committee's support for increased standardisation in derivatives products. The committee argues that standardised contracts can improve transparency and stability in the OTC market. However, it stresses that not all products can be standardised and that room must be left for bespoke products to ensure an efficient market.

In addition, the committee also agrees that regulation for minimum standards for CCP clearing of derivatives should take place at the EU level, provided this mirrors globally developed standards. However, the EU is not currently an appropriate or realistic level to undertake supervision of CCPs, as it does not have the financial resources to bail out a large CCP if it were to fail.

The committee points out that the use of derivatives by non-financial businesses is inherently less risky, as the businesses that use them have a close interest in the value of the underlying assets. Further, it argues that the commission's proposals could adversely penalise the use of this type of derivative, but is pleased that the commission has confirmed it will consider this issue in its impact assessment.

Baroness Cohen, chairman of the Lords EU sub-committee on economic and financial affairs, says: "The European Commission's proposals for increasing transparency in the OTC market are to be welcomed as they will increase transparency and ensure all trades are reported to supervisory bodies. We also support proposals for standardisation of contracts, as long as this will still allow flexibility where appropriate."

Cohen continues: "We believe that it is appropriate for the EU to regulate for minimum standards of CCPs, but this must be coordinated with the global approach. However, as the EU does not have the financial resources to bail out a large CCP if it were to fail, supervision of CCPs is likely to remain at a national level."

CDS

Greece sovereign CDS divergence explained

Greece's sovereign CDS liquidity significantly diverged from the broader developed market sovereign liquidity trend between June and August 2009, and was accompanied by the beginning of a sustained market switch to US dollar- rather than euro-denominated Greek sovereign CDS contracts, according to a new report by Fitch Solutions. Increased CDS market uncertainty on the prospects for the country's economy pushed up Greek sovereign CDS liquidity, while activity in the cash bond market drove Greek government bond yields down and consensus CDS spreads narrower.

"The surge in Greek sovereign CDS liquidity last summer was likely caused by active CDS market investors, who believed that lower Greek government bond yields were unsustainable and, furthermore, that the euro would be impacted by any potential widening of yields," says Thomas Aubrey, Fitch Solutions md.

Since the end of January, the USD/Euro FX rate devaluation following any potential Greek default has increased to approximately 10%, having been 5% at its height last year and averaging well below 4% in 2008. This is said to reflect heightened CDS market concerns about Greece's impact on the euro in relation to the dollar.

The report notes that outside the June to August 2009 period Greek sovereign CDS liquidity has been broadly consistent with the overall increasing liquidity trend for developed market sovereigns since the start of 2009, even during the early months of this year when Greek bond government bond yields and CDS spreads widened dramatically. "This evidence suggests economic fundamentals, rather than CDS market speculation, have been driving Greek government bond yields wider," adds Damiano Brigo, Fitch Solutions md.

CLOs

CLO amends WAR calculations

A supplemental indenture has been entered into between Madison Park Funding I and the Bank of New York Mellon Trust Company, which deletes the words 'collateral portfolio' in the 'rating distribution' definition and inserts in their place the words 'aggregate principal balance'. The change represents a technical correction in the method of calculating the Moody's weighted average rating test.

Moody's confirms that the performance of the activities contemplated within the supplemental indenture will not cause its ratings on the CLO to be reduced or withdrawn.

CLOs

93% of Euro CLOs downgraded

S&P has published an update of its rating transitions for European cashflow corporate CLOs to explain the effect on CLO ratings of revised criteria for CDOs and deterioration in the creditworthiness of the underlying collateral portfolio.

As of 16 March 2010, S&P has completed its review of 128 of the 208 European CLOs it rates, accounting for 774 ratings, including 57 combination notes. Of the 774 ratings reviewed, 722 were lowered, 48 were affirmed and four were raised. The rating agency also withdrew 10 ratings due to retirement of the obligation.

CMBS

Euro CMBS 'threatened' by excessive caution

Fitch says the credit profile of European CMBS is being threatened by property valuers and loan servicers showing increasing conservatism in valuations and workout strategies. With continued inactivity and major uncertainty in European commercial property markets, the rating agency warns that special servicers could be encouraged to dispose of properties at depressed prices when resolving distressed loans.

When determining a workout strategy for a defaulted loan, special servicers will typically call on valuers, but Fitch says valuers will not always come to the same conclusions and a special servicer might be encouraged to dispose of a mortgaged property for a readily-attainable undervaluation. This would be especially compelling for properties experiencing income volatility.

"Provided it at least recovers an independently-determined market value, a servicer should be able to defend itself from any accusations that it 'sold noteholders short'", says Euan Gatfield, Fitch CMBS senior director. "In contrast, a workout strategy that delays liquidation may have merit but could nonetheless leave the servicer open to criticism."

The agency believes that servicers reacting to valuations selectively, with disposal activity biased towards cautious appraisals, could make conservative views self-fulfilling, which would adversely impact the credit profile of related CMBS. Not only might properties with lower income visibility be marketed more frequently, but potential buyers would be reluctant to bid above the revised value.

Fitch say its own value estimates, as implied by its published loan-to-value ratios for loans underlying most European CMBS, may have to be changed as recent months have seen a spate of revaluations with several examples of valuers' opinions undershooting Fitch's estimates. Gatfield notes: "When such a margin of difference is significant, the possibility that a servicer could react to the appraisal with a speedy property disposal may oblige Fitch to replace its own assumptions, even if the revaluation can be viewed as particularly cautious."

CMBS

Euro CMBS loan repayments to remain low

Repayment of matured European CMBS loans is expected to remain at low levels until at least the end of the year due to the loans' high loan-to-value ratios (LTVs), according to Fitch. The rating agency has also launched its Maturity Repayment Index - which measures the proportion of the total matured loan balance that has been successfully repaid - and says that although only 34 loans have reached their scheduled maturity dates, repayment trends are becoming evident.

"All of the ten successful loan repayments to date were of loans originated in 2005 or earlier," says Gioia Dominedo, senior director in Fitch's European CMBS team. "While this bodes well for 2010, as 51 of the 73 loans maturing in the remainder of the year are from early vintages, an early origination date does not in itself guarantee an orderly repayment. Factors affecting the availability of replacement debt financing - in particular leverage and loan size - are crucial when determining likely maturity outcomes."

Loan size is a key determinant of the likelihood of loans repaying in an orderly manner, but is less of a concern for 2010 maturities, as the average loan size is €50m and only one loan is greater than €200m. While bank funding for investment properties is once again available, Fitch says difficulties remain in obtaining debt financing in very large volumes.

"Leverage remains the main concern: 49 of the remaining 73 loans maturing in 2010 display either reported or Fitch whole loan LTVs in excess of 80%, implying that significant equity contributions would be required in order for the loans to refinance," says Charlotte Eady, CMBS director at the rating agency.

The European CMBS Maturity Repayment Index currently stands at 16%, having ranged between 6% and 17% over the past 12 months. The index is expressed as a percentage, with 100% indicating a full repayment of all loans that have reached their maturity dates.

CMBS

CMBS certificates default on interest shortfalls

S&P has lowered its ratings of five classes of certificates from five separate US CMBS transactions to single-D due to recurring interest shortfalls, which it expects will continue in the foreseeable future. Five of the downgraded classes have experienced interest shortfalls for nine or more months.

S&P notes that the recurring interest shortfalls for the respective certificates are primarily due to one or more of the following factors:

• Appraisal subordinate entitlement reductions (ASERs) in effect for specially serviced assets;
• Trust expenses that may include, but are not limited to, property operating expenses, property taxes, insurance payments and legal expenses; and
• Special servicing fees.

S&P's analysis primarily considered the ASERs based on appraisal reduction amounts (ARAs) and was calculated using recent Member of the Appraisal Institute (MAI) appraisals. The agency also considered servicer non-recoverable advance declarations, trust expenses and special servicing fees, which it believes are likely to cause recurring interest shortfalls.

The five impacted CMBS transactions are:

• Morgan Stanley Capital I Trust 2007-IQ15
• COMM 2004-LNB3
• DLJ Commercial Mortgage Trust 2000-CF1
• Bear Stearns Commercial Mortgage Securities Inc Series 2000-WF1
• Morgan Stanley Capital I Inc Series 1999-LIFE1.

Indices

Default trend reversal in latest ABX remits

ABX remittance reports for the March distribution date (February collection period) show a turnaround in default trends, which gained approximately 1% CDR after steadily declining over the past few months. The increase in CDR was accompanied by lower delinquencies overall, however.

ABS analysts at Barclays Capital point to an uptick in default rates in three out of the four ABX indices, even as 60 day plus delinquencies declined. They put this down to servicers continuing to convert HAMP trials into permanent modifications and moving loans from deep delinquency into current status.

"On loans that are declined a permanent modification, the servicer is obliged to consider a short sale before moving on the foreclosure process. This could increase liquidation rates," they note.

The share of outstanding loans in foreclosure declined by 70bp-80bp, while REO percentages also dropped marginally in February. The analysts suggest that as servicers begin slowly flushing out their bloated REO and foreclosure pipeline, distressed supply should begin to increase, putting pressure on home prices.

There was also a mild decrease in early stage delinquencies, as the 30 day plus delinquent number fell by 50bp-60bp across indices. "This could point to declining current-to-30 day delinquent rolls for the second month running after a 20bp-30bp drop in rolls in February," notes BarCap.

In terms of severities, numbers continued to be choppy on a deal level, but were up 2-3 points overall from last month (January data). Severities have been rising for the past few months as liquidation timelines increase and servicers extract P&I advances from any recoveries on liquidated loans.

BarCap also points to lower prepayments on the 2006-1 and 2006-2 indices, while finishing slightly higher on the 2007-1 and 2007-2 indices. "In the absence of refinancing opportunities, we expect prepays to remain depressed in the near future," the analysts say. "While a full picture of the extent of modifications will emerge only with the release of loan level data, the remittance reports provide some pointers."

Insurance-linked securities

Latest cat bond placed

Swiss Re has privately placed US$120m of protection in the latest offering under its Successor X catastrophe bond programme for North Atlantic hurricane, European windstorm, California earthquake and Japan earthquake (SCI issue 175). The transaction covers a three-year risk period ending in March 2013.

The Successor offering consists of three series of notes of US$35m, US$40m and US$45m. One class of the notes is rated single-B minus by S&P while the other classes are not rated. The collateral for this issuance of Successor X notes consists of Treasury money market funds.

Swiss Re Capital Markets acted as sole manager and bookrunner on the note issuance. Risk modelling and analysis were performed by EQECAT.

Swiss Re's Chief Underwriting Officer Brian Gray explains that this is the first cat bond transaction issued using a European windstorm index based on PERILS industry loss estimates. "Swiss Re welcomes this independent industry initiative, and sees it as an important step towards more efficient and transparent risk transfer in Europe. We have supported PERILS from the very beginning, and this demonstrates our continued commitment to driving innovation in the ILS sector," he says.

The triggers for the other perils covered by this bond are based on parametric indices or modelled losses.

Monolines

Rating agencies act on Ambac

Moody's has lowered the rating of the senior unsecured debt of Ambac Financial Group to single-C from Ca, and placed the Caa2 insurance financial strength ratings (IFSR) of Ambac Assurance Corporation (AAC) on review for possible upgrade. Moody's also placed the Caa2 IFSR for Ambac Assurance UK Limited (AUK) on review with direction uncertain.

The move comes as S&P revised its counterparty credit, financial strength and financial enhancement ratings on Ambac Assurance Corp to R from double-C.

These rating actions were prompted by Ambac's recent restructuring (see separate News Analysis). Moody's expects the move to improve the credit standing of AAC's senior unsecured policyholders by settling the insurer's most risky exposures, and effectively subordinating (via the segregated account) policyholders with outstanding claims. Its IFSR addresses senior policy obligations residing within AAC's general account, but not the now-subordinated segregated account claims.

According to Moody's, the review for upgrade of AAC's financial strength rating reflects the enhanced credit profile of general account policyholders following the group's restructuring. The potential for upward rating movement is tempered, however, by charges related to potential lawsuits and AAC's inability to write new business before the full repayment of the surplus notes.

Moody's adds that the review direction uncertain of AUK's Caa2 insurance financial strength rating reflects the potential for AUK's financial profile to either improve, if successful in its efforts to terminate the reinsurance agreement and obtain cash in lieu of previously ceded reserves.

The downgrade of Ambac Financial's senior debt rating to single-C, in Moody's opinion, reflects the heightened risk of default and very low ultimate recovery on the debt, whether through distressed exchange or potential bankruptcy proceedings, due to the holding company's modest cash position and limited financial flexibility.

Meanwhile, it is S&P's view that the regulatory directive with respect to the segregated account indicates a level of regulatory intervention at Ambac that is consistent with an R rating. The rating agency believes that such a move will lead to concern that it favours one class of policyholders over another.

Ratings

Moody's assesses SF rating rule implications

Moody's says it is developing mechanisms in order to comply with the SEC's amended rule 17g-5 for credit rating agencies registered as NRSROs that are hired by issuers, sponsors or arrangers to assign credit ratings to structured finance products. Specifically, the rating agency will assess how the rule - announced in December 2009 - will apply to transactions and ratings outside the US and will notify the market once it develops a solution to address the new rule's requirements.

Compliance with the amended rule will be required from 2 June this year. It will prohibit an NRSRO from issuing or maintaining a credit rating on certain structured finance products unless: on a password-protected website, the arranger makes the information that it provides to one NRSRO available to any other NRSRO that wishes to rate the structured finance product; and on a password-protected website, the NRSRO discloses to other NRSROs certain information about the structured finance products it was hired to rate.

Ratings

Fitch publishes SF downgrade tally

Global structured finance rating activity remained negative in 2009 as the economic downturn deepened and more broadly affected consumer and commercial credit quality, says Fitch.

As in 2008, the RMBS and CDO sectors produced the majority of the year's downgrades (accounting for 83%), while the CMBS sector rose from 3% to 16% of the year's downgrade tally. ABS accounted for less than 2% of 2009's downgrades.

"Credit quality deteriorated across all regions in 2009, but to varying degrees of severity," says Stephanie Mah, senior director of Fitch Credit Market Research.

Downgrade rates across North America, Europe and Asia Pacific were 59%, 36% and 22% respectively.

Downgrades affected 54% of Fitch's global structured finance ratings in 2009, while less than 1% of ratings were upgrades. The share of triple-A bonds downgraded was 25%; however, the rating agency says the majority of these downgrades consisted of movements to other investment-grade categories.

The triple-A impairment rate - the default or near default rate, which includes bonds rated double-C or below - was 3.4% in 2009 and 25% across all structured finance ratings. The investment grade impairment rate was 12% in 2009 and ranged from a high of 18.4% across RMBS to a low of 0.1% across ABS.

"Importantly, 66% and 70% of the year's respective downgrades and impaired bonds consisted of issues brought to market from 2005 to 2007, showing further evidence that the vintage effect continued to dominate," says Glenn Costello, md, Fitch US structured finance credit officer.

RMBS

Obvion offering Dutch RMBS

Ratings have been assigned to Dutch RMBS STORM 2010-1. The deal has been arranged by Rabobank, which is also understood to be marketing the deal alongside Société Générale.

The deal, sized at €1bn, is originated by Obvion and its structure remains largely unchanged from previous STORM transactions. The collateral consists of performing loans secured by first-ranking (or first- and consecutive-ranking) mortgages over properties in the Netherlands. Obvion owns and services these mortgages.

S&P has assigned ratings to notes ranging from triple-A down to triple-B. The structure comprises two triple-A rated tranches sized at €240m and €703.5m with WALs of two and five years respectively.

Obvion's deal follows in the wake of NIBC, which last week successfully placed Dutch MBS XV notes in the European primary market (see last issue). However, given the quality of the collateral usually associated with Obvion, the transaction is expected to price through Dutch XV.

RMBS

Dolphin RMBS refinanced

Fortis called the class A1, A2, B1, B2, C1, C2, D1, D2, E1 and E2 notes from Dolphin Master Issuer Series 2009-I on 29 March 2010. At the same time, it refinanced these notes with a new €7.8bn issuance - Dolphin Master Issuer Series 2010-1.

The new series of notes comprises seven tranches - class A1, A2, A3, A4, B, C and D - rated from triple-A to Baa2 by Moody's. The class A1 notes, sized at €3bn, were privately placed with a single investor at 112bp over three-month Euribor. All notes are backed by pools of prime Dutch residential mortgages originated by Fortis Bank or one of its subsidiaries - Fortis Hypotheek Bank, Direktbank, Oosteroever Hypotheken and Quion 9. At closing, the total portfolio of the Dolphin Master Issuer trust will consist of approximately €28bn of mortgage loans.

The master issuer structure comprises an asset purchasing company for each originator, which receives inter-company loans from the Dolphin Master Issuer in order to finance the acquisition of the residential mortgage loan portfolio. The master issuer in turn will issue notes to investors. This two-tier SPV structure involves the tranching and reserve account being held at issuer level and the excess spread remain at asset purchaser level.

The reserve fund is funded at 0.9% of the total class A, B, C and D notes outstanding at closing and the total credit enhancement for the triple-A rated notes is 7.9%. As well as the reserve fund at issuer level, the transaction benefits from a guaranteed excess spread of 50bp on asset purchaser level through the swaps.

A number of changes have been made to the programme structure and documentation since the previous issuance from the Dolphin Master Issuer in November 2009. According to Moody's, the two most noteworthy changes are: the introduction of a subordinate loan structure between asset purchasers, which enables the use of excess spread across asset purchasers; and the introduction of stricter criteria for adding loans during the revolving period.

The rating agency notes that its V-Score for the transaction is medium, which is higher than the low/medium V-Score typically assigned to the Dutch prime RMBS sector. This is due to the missing elements of information on the collateral provided by the originators on a loan-by-loan basis and the complexity of the transaction resulting from the master issuer nature, which is more complex than the average Dutch standalone transactions.

RMBS

Servicer dilemma for EM RMBS

Kazakh MBS 2007-1, a US dollar-denominated RMBS backed by Kazakh mortgages, is facing a servicer quandary. The originator, BTA Ipoteka (BTAI), breached certain provisions of the transaction documents in September 2009 and triggered a servicer termination event. However, the back-up servicer, JSC Halyk Bank, is refusing to take over.

Halyk Bank has provided ATC Capital - the transaction's manager - with a number of reasons why it is currently unable to assume the role of the servicer in place of BTAI. First, its IT and payment processing systems are unable to process convertible currency index loans, which it says might cause operational disruptions and might have a material negative impact on the value of the securities.

Second, it says there are potential risks in relation to collateral enforcement in Kazakhstan. If Halyk Bank enforced security against a defaulting debtor, it would be required to pass the proceeds of sale of the collateral to the purchaser in accordance with the terms of the back-up servicing agreement. If the relevant debtor subsequently challenged the sale in a Kazakh court, Halyk Bank might be required to refund the proceeds of sale to the debtor using its own funds.

Third, as BTAI has not paid any withholding tax in relation to cross-border interest payments, Halyk Bank cannot accept the risk of liability to meet any outstanding tax obligations. Halyk Bank also points out that credit files currently held by BTAI may be incomplete and, therefore, not in compliance with the relevant banking regulations. Halyk Bank says it is not prepared to accept such regulatory risk.

Further, Halyk Bank says it is uncertain whether an obligation to maintain insurance is enforceable in Kazakhstan. Therefore, it might not be able to comply with the terms of the back-up servicing agreement, which requires the servicer to make certain that all debtors maintain insurance policies.

Finally, Halyk Bank says an unexpected notice of change of servicer might create confusion and concern among debtors and may cause disturbance in payments.

An attempt was apparently made by BTAI to retain its servicing role following the trigger breaches, according to ABS analysts at UniCredit, as well as it asking for the servicing fee to be upped to 200bp per annum from the current 30bp as the high level of arrears would require some extra work. However, a single investor, who holds over three-quarters of the controlling class A notes, contacted the issuer and trustee in December to reject the proposals even before a meeting could be held.

ATC Capital is requesting that noteholders get in touch with any comments they may have.

RMBS

Daily valuations offered for growing HMBS market

Interactive Data is now providing daily independent evaluations for fixed-rate reverse MBS (HMBS) issued under the Government National Mortgage Association (GNMA) Home Equity Conversion Mortgage (HECM) programme, designed to provide liquidity to reverse mortgage lenders.

Origination volume in 2009 for GNMA HMBS was approximately US$8.5bn, up more than 600% from the year before, and the agency has indicated that it expects 25%-30% growth in HECM originations. The advent of retirement age for the baby-boomer generation is expected to see many people taking reverse mortgages.

"GNMA HMBS have undergone dramatic growth over the past few years and we find that many of our clients - especially insurance companies, mutual funds and custodian banks - are increasingly requesting evaluations for these structures," says Liz Duggan, Interactive Data evaluations md. "Our clients can now subscribe to our independent evaluations for fixed rate GNMA HMBS as an input to their valuations process."

Whole business securitisations

Gas WBS debuts

Barclays Capital and RBS on 25 March launched what is believed to be the first-ever securitisation of a gas distribution network, Wales & West Utilities Finance (WWF). The £515m transaction comprises two fixed-rate tranches (rated single-A minus and triple-B) and an inflation-linked tranche (single-A minus), the latter pricing at 170bp over Gilts. According to a source close to the deal, the transaction performed well from the break.

Despite being structured as a whole business securititsation (WBS), a trader notes that the deal is classed by market participants as a corporate deal, with real money accounts showing interest. He further comments that while the ABS market is still facing headwinds, utilities companies seeking finance through the capital markets are able to do so without too many problems.

It is understood that £450m of WWF's existing debt has been migrated into the corporate securitisation structure, with the existing notes signing up to the transaction documents, including the security trust and intercreditor deed and the common terms agreement. The transaction is rated by S&P and Fitch..

Whole business securitisations

Pub's new strategy branded credit-negative

Fitch says the new strategic programme announced on 24 March by Mitchells & Butlers Group (M&B), the managed pub operator behind the Mitchells & Butlers Finance whole business securitisation, is potentially credit negative. The rating agency affirmed the transaction's bond ratings on 19 February, five days before M&B unveiled its new strategy, and its assessment does not comment on the impact of the new strategy on shareholders.

Fitch says that although M&B's move to become more food-led is an acceleration of the company's previous strategy, the transaction's sales mix will now inevitably reflect a higher proportion of food sales and a lower proportion of drink sales. This is expected to further dilute the current EBITDA margin, given that the margin for drinks is higher than for food, and will result in lower free cashflow margins. The agency also notes that the disposal of drink-led outlets would represent a loss of long-term revenue diversification for the transaction's ratings and believes M&B's competitive positioning in its various markets could suffer from a food price increase.

Security available to noteholders is expected to be diluted over the long-term by M&B's change of strategy regarding real estate ownership as it moves from freeholds to leaseholds, which Fitch says is a clear credit negative. The agency does, however, note that the number of leaseholds that can be introduced is limited by the transaction documentation up to 20% of all secured properties.

An increase in leaseholds would mean a reduction of the realisable value for bondholders, an increase in operational gearing and therefore an increase in free cashflow volatility. Increased leaseholds would further result in a potential loss of cashflow if an administrative receiver was appointed, due to forfeiture clauses.

Fitch also notes that M&B will probably invest less in a leasehold property than in a freehold property, so the overall quality of the portfolio could dilute in the long term. With respect to capex, the new stated policy is viewed as less supportive of the quality of estate, although it is mitigated by the capex covenant in place.

The disposal of large freehold properties would also be viewed by the agency as a substantial loss of value for bondholders. Although the transaction is primarily rated on the basis of operating cashflows and not property valuation, Fitch had assigned substantial credit for the realisable value arising from the security on large freehold premises, especially for M&B's higher rated bonds.

Most of the other measures announced by M&B are considered credit positive or credit neutral for the transaction's ratings by Fitch. However, the agency believes that the new strategy could represent a broadly negative outcome for the securitisation, particularly if it is executed without an associated substantial deleveraging for the securitisation.

CDS

Basis basics in a normalised world - part 1

In the first of this two-part series, Morgan Stanley credit derivatives strategists Sivan Mahadevan, Ashley Musfeldt and Phanikiran Naraparaju look at the evolution of the bond-CDS basis over time

From the beginnings of the corporate CDS markets, one of the most basic valuation measures has involved comparing a corporate bond with a CDS contract. While it is simple in concept, this basis relationship is quite complicated, as one instrument is not necessarily an easy substitute for the other.

That complexity led many to treat basis trades as an investment strategy with an opportunity to arbitrage pricing and earn carry for taking on specific 'basis' risks. Consequently, large basis books were built up across the financial markets. However, the basis opportunity was perhaps oversimplified and many basis trades suffered from the actual differences between the instruments during the financial crisis.

Differences range from 'bond math'-type things like coupons, duration, price, yield and convexity to much broader market themes like liquidity, deliverability/fungibility and of course funding costs. In fact, the last point is one that is lost on most pricing models as the dearness of capital at the peak of the crisis pushed the basis to levels that were more negative (cash trading wider than CDS) than the market had ever seen in the history of the CDS market.

The negative basis trade post-Lehman was a significant market opportunity (along with many others) and one that we argued required a long holding period to realise value. Today, the corporate basis relationship has nearly completely healed from the systemic woes that began with the Lehman bankruptcy, as liquidity has returned to the market. While the basis remains negative in the US, it is and has actually been positive in Europe for some time.

So in a more normalised world of funding, liquidity and risk premiums, we see a return to more normalised basis relationships and market themes can push the basis to one extreme or the other. Trading the basis is a notion that feels like it is back in markets today; however, as we highlighted above, basis trades do have a funding/liquidity component to them that we are not willing to ignore, even if it remains difficult to model.

In a sense, the market should demand a premium for taking on this risk and can look to funding markets as a guide. In this report, we use our pre-crisis, crisis and post-crisis experience with the corporate basis relationship to provide our thoughts on basis relationships generally. Summaries of the themes are below.

Over a decade of history. From the early days of CDS, the corporate basis relationship has moved through several cycles. It started out as positive owing to the 'youth' of the then CDS contract and high default risk in the 2001/2002 credit cycle.

The basis then moved to being consistently negative in the midst of the demand for synthetic credit due to the presence of the structured credit bid in the period from 2004-2007. Extreme negative basis levels appeared during the peak of the financial crisis as funding became dear, but today we have moved to a more normalised environment.

Current basis environment. The investment grade basis in Europe is positive on average, while it remains negative in the US. In Europe, risk premium in sovereign debt has pushed corporate bonds richer relative to funding costs, which in turn has made selling protection attractive in CLN form as a corporate bond alternative.

In the US, we continue to see negative basis trades in select parts of the market as bond valuations remain attractive. In both markets, financials still trade on a lower (more negative) basis than non-financials.

Basis metrics. Over the years, we have developed three approaches to measuring the relative value of CDS versus corporate bonds. We review our simple raw basis measure, more elaborate adjusted basis measure and our fair value CAPS basis model to gain some insight into valuation.

Interest rate impact. Rates too can have an impact on basis pricing, as rates impact both bond pricing and discounts on CDS upfronts, as well as play a role in determining the steepness of CDS curves. We examine the impact of potentially rising rates on the basis.

High yield as a special case. The high yield basis has always been a different animal than the investment grade one, owing to a variety of factors including higher default probabilities, dollar price differences, the structure of cashflows and of course the callable nature of much of the market (a meaningful portion of the HY universe is callable). The high yield basis still trades at more negative levels than investment grade in both the US and Europe.

A bit of history of corporate CDS flows
Corporate CDS markets were established in the mid-1990s, mainly as a way for banks to hedge their loan exposures, and much of the initial shape of the contract (restructuring risk, shorter maturities) was influenced by this community. But a one-way trade never makes markets, so it was critically important for the market to embrace CDS from an investment perspective as well. As such, in the late 1990s and early 2000s, CDS took a form that was more 'bond-like' and subsequently the contract became more investor-friendly.

As the CDS market development progressed, we began to see large investment flows through the sale of protection in corporate CDS contracts, mainly in portfolio form through structured credit and market indices. This natural seller of protection was an important factor in market growth by providing a balance in the market.

Eventually this flow became a dominant force for CDS market performance, at least until the systemic risk period of the recent crisis, although even during the crisis cash products suffered more from their inherent funding disadvantage. The most recent changes to the corporate CDS market - the big and small bang protocols - have made the contract more fungible by standardising coupons, requiring adherence with ISDA protocols and addressing the concerns surrounding restructuring risk.

Throughout the history of the development of the CDS market, the basis between CDS and cash bonds has been an important relationship to monitor. Cash bonds once helped price CDS contracts, as cash bond spreads over Libor were the starting point to evaluate credit risk in CDS, after which they were adjusted for restructuring credit events and cheapest-to-deliver optionality.

In the early days, CDS generally traded wide to cash instruments as the newness and nuances of the contract motivated protection sellers to demand a premium. Indeed, the positive basis was a marketing point for market-makers wishing to promote liquidity in the derivatives contracts.

As CDS markets matured, differences became more granular and market participants built more sophisticated models. In these early days funding costs of cash instruments were largely ignored and liquidity on both sides of the basis remained robust.

The corporate negative basis trade - positive carry long bond versus buying protection through CDS - that emerged circa 2004 was essentially a balance sheet usage allowance for those investors who were able to fund at attractive levels and use this balance sheet to earn a small carry for taking on some amount of counterparty risk, but no actual credit default risk.

Regulatory capital charges (for banks) for perfectly matched bond and CDS positions were and continue to be minimal for basis trades. There was also the added benefit of optionality through covenanted basis packages.

Investors bought bonds with covenants (poison puts, rating step-ups), which outperform in LBO/M&A scenarios and ratings deterioration, and bought CDS protection. The basis trade played a part in absorbing protection sold by investors in structured credit and, at the same time, provided the investment community with a way to retain illiquid secondary market cash positions.

Around 2005 the cash-CDS basis turned negative and has remained largely negative ever since, save for a short period when super-senior concerns drove it into positive territory (see Exhibit 1). From 2005 to 2007, the basis traded primarily in the negative 15bp to 20bp range.

In an environment where AAA/AA assets traded under 10bp, 15bp-20bp seemed reasonable compensation for basis trades at that time. In 2008 the basis started dipping to new lows in the negative 50bp range and hovered there until the Lehman bankruptcy triggered a larger credit squeeze (see Exhibit 2).

Conventional wisdom would suggest that CDS should underperform cash bonds in a high default environment, given the fact that CDS is a pure play on credit risk, whereas cash bonds are a combination of interest rate and credit risk and are short cheapest-to-deliver optionality. However, during the credit crisis, liquidity issues trumped default spreads, with balance sheet usage becoming a bigger concern for investors and the market than default risk.

The basis re-priced to unseen levels, reflecting the additional premium charged by the market on fully funded assets. Unsurprisingly, financials were the worst performers during this time period.

With the basis approaching negative 300bp at the height of the crisis, we opined that the basis had become an asset unto itself, which could offer fully funded investors high unlevered returns for no credit risk and little counterparty risk. Abundant liquidity, accommodative policy and deleveraging meant that the basis began on the long road to recovery in the second half of 2009.

Courtesy Morgan Stanley: Copyright 2010 Morgan Stanley. This Research Note is an extract from Morgan Stanley's recent Credit Derivatives Insights publication, published on 19 March 2010.

For important information and disclosures regarding specific companies, derivatives, or other instruments discussed in this report, please refer to the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures.

Trading

Trading ideas: short again

Dave Klein, senior research analyst at Credit Derivatives Research, looks at an equity basket trade

Continued equity outperformance results in shorts outnumbering longs again in our weekly equity basket trade (see Exhibit 1 for basket composition and Exhibit 2 for sector breakdown). Four companies from last week's basket make the cut again, but only one of the four recommendations remained open the entire week.

Last week's basket
Last week's basket performance can be summed up by the letters P, M and I. PMI Group, a short last week, rallied hard this week first on news that the company gained Freddie Mac's approval to insure mortgages and then again after BofA's announcement of billions in mortgage principal forgiveness.

Apart from PMI, our basket traded flat. Overall, seven of ten recommendations outperformed. We exited five recommendations (CAR, NYT, ODP, LIZ and PMI) and four of the five earned a profit.

Three exits (LIZ, NYT and ODP) make a return. Of the remaining open positions, Boeing rolls into this week's basket, while three (TRW, AA, SUN) rank as 'holds' but do not warrant entry at this time. There remains little upside to the MBI long opportunity after its strong performance and taking profits is advised.

Longs
Boston Scientific took a hit last week after news broke of regulatory trouble with its implantable defibrillator. Both CDS and equity deteriorated in the aftermath. With the pain hitting equity harder, short-term outperformance is expected. A long equity/short credit relative value trade also is a good way to play the current disconnect.

Chesapeake Energy ranks as one of the best high yield long credit opportunities, according to our directional credit model. In November, we recommended selling CDS protection on the name in a Trading Idea. Credit improvement will lead to a rise in share price and the current equity-CDS disconnect provides an excellent entry point.

The New York Times Company pops back into the equity basket after an early (profitable) exit last week. With the company's equity underperforming its CDS over the past few days, buying on the dip is warranted.

Shorts
Cytec Industries presents a bit of a puzzle. Its equity is up 2.5% and yet its CDS, which is quite liquid, trades flat. With no news (yet) to warrant the equity move, recent equity outperformance points to going short. Some caution is warranted, as a strong move in equities without a corresponding move in credit could indicate anticipation of a change to the company's capital structure.

Brunswick Corp makes a good equity short. From a credit perspective, little improvement is expected. Recent equity outperformance pushed the company's stock well into expensive territory and a near-term pullback is forecasted.

Packaging Corp enjoyed a strong equity rally since early February and yet its CDS deteriorated over the past week. With PKG's CDS fairly valued according to our directional credit model, its equity should deteriorate to come back to fair.

The Boeing Company is the sole member of last week's basket that makes it into this week's basket without an interim exit. Boeing's equity rallied every day since the short recommendation. With its CDS wider and the disconnect even bigger, sticking with the equity short is advised.

Liz Claiborne's equity climbed back after an early week dive. Credit deterioration and associated equity weakness is anticipated due to weak margins, liquidity and interest coverage.

Office Depot, like NYT, moves back into the basket after a profitable exit last week. With the company's equity again expensive, re-entry is warranted.

Sprint Nextel jumped higher this morning after making news about its WiMax phone. Shares have since given back much of the gain but still trade expensive to CDS.

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).